Earnings Components Research Articles

A Structural Break in the Aggregate Earnings–Returns Relation

Abstract This study empirically estimates the date of the structural change in the aggregate earnings–returns relation and reports it as the fourth quarter of 1991. We identify three sources of the structural change: (i) an increase in the relative importance of cash flow news contained in stock returns; (ii) a decrease in the importance of discount rate news contained in aggregate earnings; and (iii) a decrease in the persistence or the predictability of aggregate earnings and returns. Next, we examine the components of aggregate earnings and find that the change in the aggregate earnings–returns relation is largely driven by intertemporal changes in aggregate inventory accruals, suggesting the structural change is attributable to improved inventory management systems.

BETWEEN THE SCYLLA OF EQUALIZATION AND THE CHARYBDIS OF INEQUALITY: LABOR REMUNERATION ON THE ALTAI RAILWAY IN 1917

The authors examine inequality in an important branch of the Russian economy during the World War I using the materials of one of the large West Siberian enterprises. The study relies on the sources for the first time introduced into the scientific circulation: data from the funds of the tax inspectorate, which are related to the determination of the circle of income taxpayers and their earnings. The advantageous feature of these lists is that they include not only taxpayers (recipients of relatively high income), but all employees of the enterprise in general. Information on the wages of almost 400 employees of the Altai Railroad, from watchman to manager, was used to calculate the decile coefficient. This allows us to expand the field for microhistorical study of inequality by statistical methods through including new industries and new regions. In addition, one of the lists contains information that allows us to raise the question of the need to study additional parameters of inequality in Russia at the beginning of the20th century. It is shown that the income differentiation of railroad workers increases significantly when taking into account their dependents (primarily children), i.e. taking into account family composition can change the interpretation of the degree of income inequality. Another list gives the authors a rare opportunity to examine the wages of railroad employees taking into account individual components of earnings (including salary, military increment, bonuses, payment for extracurricular work). The analysis of change in the decile ratio depending on the above-mentioned payment issues allowed us to prove that one of the weighty additions to the salary reduced the gap between the incomes of the highest and lowest employees, and the other, on the contrary, gave an opportunity to earn more to those who wanted it. Thus, it is demonstrated that one of the wage systems created before the revolution allowed to avoid simultaneously both problems that would become urgent for the new authorities in the 1920s - equalization and excessive inequality.

The role of the net purchase of stocks by foreign investors in boosting stock returns: Evidence from the Indonesian stock market

Low reporting quality, as demonstrated by lower earnings informativeness, can exacerbate the information asymmetry gap, particularly in emerging markets. Although recent research shows that aggregate earnings can predict future economic growth, accruals, an important earnings component, are more likely to be manipulated in less sophisticated markets. Using data from Indonesia, we examine the impact of foreign stock investors' activities and accruals on stock returns. Our findings show that foreign stock investors' optimism, as measured by their net purchases of stocks, leads to higher excess returns. Foreign investors improve the quality of financial information. They provide benefits through two channels. First, foreign investors’ trading value significantly impacts stock prices in a thin market. Second, net stock purchases by foreign investors can help reduce information asymmetry. Our results contribute to the investment strategy by examining the relationship between sentiment generated by foreign investors and stock returns.

Distinguishing between recurring and nonrecurring components of earnings using unobserved components modeling

Distinguishing between recurring and nonrecurring components of earnings is a critical task in financial analysis and valuation. Academics and quantitative investors often rely on measures of recurring and nonrecurring components derived from standardized financial databases. We use unobserved components modeling and the Kalman smoother to obtain efficient ex-post estimates of the recurring and nonrecurring components of annual earnings. We then show that popular measures are significantly misspecified and that investors appear to anticipate a significant portion of the misspecification. Finally, we identify certain misclassified items that drive misspecification and provide algorithms to improve their ex-ante classification.

Do farmers always choose agricultural insurance against climate change risks?

In response to climate change, many countries are introducing agricultural insurance. But will farmers buy more agricultural insurance as climate change deepens? The literature has shown that climate change has a significantly positive impact on agricultural insurance. Using data from China over the period 2012–2021, we examine the effects of climate change (CC) on agricultural insurance coverage (AIC). We find that CC does not always have a positive impact on AIC; instead, farmers’ insurance choices depend on the difference between their total costs and earnings. Only when total earnings are greater than total costs will farmers choose agricultural insurance. Compensation and subsidies are components of total earnings and premiums are components of total costs. They are affected by the government's insurance policies and charging standards and insurance companies' compensation schemes. This study examines the factors that affect farmers’ insurance choices and recommends strategies for improving agricultural insurance.

The Accruals–Cash Flow Relation and the Evaluation of Accrual Accounting

Considerable research has evaluated the role of accruals in determining informative earnings, with an accrual–cash flow relation at the centre of the investigation. However, much of the research is based on a misunderstanding. First, accruals are identified as the numbers that reconcile earnings to cash flows in the cash flow statement. But these are not the non‐cash accruals applied in determining earnings in the accrual accounting system; rather, they are changes in balance sheet items, most of which are the relevant accruals reduced by cash flow. Thus, they are in part determined by cash flows. Second, accruals are characterized as an adjustment to cash flows, to reduce volatility of cash flows. Consequently, a negative correlation between accruals and cash flow—the accruals–cash flow relation—has been taken as the criterion for quality accruals. However, the correlation with cash flows is spurious, for the so‐called accruals are determined in part by cash flows. This paper presents a corrective analysis under which non‐cash accruals are identified as the components of earnings that do not involve cash flows. With this correction, the paper then conducts empirical tests that re‐examine hypotheses about accruals tested in previous research, reporting contrasting results.

The relative valuation of cash flow and current accruals affected by their extremity

PurposeRecent studies on the securities market’s differential pricing of earnings components have shown that cash flow from operations is more highly valued than total accruals and that moderate cash flow from operations has higher valuation than extreme total accruals. An interesting question that follows is whether these findings hold regarding the differential valuations of cash flow and current accruals. This study aims to extend prior research by addressing this issue in two ways. First, the authors examine the incremental information content of cash flow from operations beyond working capital from operations. Second, the authors assess the effect of extreme working capital from operations on the incremental information content of cash flow from operations. This study aims to extend prior research by addressing this issue in two ways.Design/methodology/approachThis study adopts market-based accounting research to test its hypotheses and to achieve its objectives. Specifically, this study uses statistical associations between accounting data and stock returns to examine the incremental information content (value relevance) of cash flow and working capital from operations and the effect of extreme working capital from operations on the incremental information content of cash flow.FindingsThe results show that cash flow from operations is not more highly valued than current accruals (both being valued equivalently). However, moderate cash flow from operations has higher valuation than extreme current accruals (each is valued differently). Overall, these research findings indicate that cash flow becomes more important for valuation as accruals get “extreme”.Practical implicationsAs accruals are unlikely to persist to be permanent across the years, these results can be interpreted as indicating that cash flow and accruals information are used jointly by investors, with one being more important than the other depending on the relative “extremeness” of each. Therefore, both are of value to the investor and both should be reported.Originality/valueThe paper contributes to the UK research on determining the preferred level of disaggregation of earnings components, i.e. operating cash flow, current accruals and non-current accruals. This would help investors to improve their investment and credit decisions.

Independent Corporate Governance Organ Busyness, Earnings Quality, And Market Mispricing: Evidence From Indonesia

This research aims to give empirical evidence of the impact of independent corporate governance organ's busyness on earnings quality and market mispricing. This research utilized a sample of non-financial firms. It investigated the effect of independent corporate governance organ's busyness on earnings management and earnings persistence using random-effect panel data regression. Furthermore, the Mishkin Test was used to investigate market mispricing. The results showed that the busyness of independent commissioners and independent audit committees had a positive effect on increasing the magnitude of earnings management and a negative impact on the persistence of the accrual component but did not cause market confusion in assessing the company's earnings components. Furthermore, it was discovered that the degree of independent director's business did not influence the magnitude of earnings management. Instead, it resulted in poor persistence of the accrual component and market uncertainty in assessing earnings components.

Impact of earnings components on future profitability of banking and insurance companies in Jordan

This study aimed to examine the impact of a firm’s total accruals and operating cash flows on future profitability (one-year-ahead ROA) using a static model on unbalanced panel data for all the (15) banks and (18) insurance companies listed on the Amman Stock Exchange from 2002 to 2019. The final sample of the study, for analysis, consisted of 280 observations taken from the banking sector and 410 observations from the insurance sector. The pooled sample of banks’ observations showed no significant impact of a firm’s total accruals and operating cash flows on one-year-ahead ROA. This result is consistent with previous studies’ results, which are still under debate, especially in developed countries. The investors of the Jordanian banks are not counting on the accrual earnings components, which are affected by the different estimation procedures of GAAP and managerial discretion. The pooled sample of the insurance companies’ observations showed a significant impact of a firm’s total accruals and operating cash flows on one-year-ahead ROA. The result showed a higher variable value of a firm’s operating cash flow than the firm’s total accruals for the pooled sample of insurance companies. This result indicates a more incrementally negative relation between the growth in operating assets and a one-year-ahead ROA in addition to the probable impact of the lower rate of economic profits and the conservative bias in accounting.

The Effect of Growth Opportunity, Profitability, CSR, Firm Size, And Leverage on Earning Response Coefficient

The earnings response coefficient (ERC) measures the magnitude of a stock's abnormal return in response to the abnormal earnings components (unexpected earnings) reported by the company that issued the stock. This study, thus, aims to analyze the effect of growth opportunity, profitability, corporate social responsibility (CSR), company size, and leverage on the earnings response coefficient (ERC) in manufacturing companies listed on the Indonesia Stock Exchange for the 2019-2021 period. The sampling technique used in this study was purposive sampling. The sample of this study consisted of 180 companies that met the criteria as the unit of analysis. The analytical method employed was multiple linear regression analysis. The study results provide empirical evidence that CSR, firm size and leverage affected the earnings response coefficient. Meanwhile, growth opportunity and profitability did not affect the earnings response coefficient.

Do Taxes Still Affect Earning Persistence?

While financial statements are the primary source of information about a firm, they tend to be under earnings management practices, namely to avoid paying tax. Therefore, we aim to examine whether taxes still affect earning persistence in an era of prevalent digital information. For that purpose, we use book–tax differences considering the deductible temporary differences and the taxable temporary differences. In addition, we analyze which of the two earnings components are more affected by taxes, specifically cash flow or accruals. We estimate econometric regressions using panel data to test our hypotheses. Through a sample of 421 small- and medium-sized (SME) Portuguese firms, between 2016 and 2020, we found empirical evidence that earning persistence tends to be lower when deductible temporary differences increase, while taxable temporary differences produce no statically significant effect. Furthermore, our results suggest that cash flow component increases more earning persistence than accruals. Therefore, deductible temporary difference may be an indicator of earnings management activities in these firms. These results are relevant, given the potential negative consequences of earnings management for the efficient decision making of stakeholders and even more because SMEs represent a substantial number of firms in European countries, particularly in Portugal.

How do experienced analysts improve price efficiency?

We document that return anomalies related to management discretions are mitigated for firms followed by more experienced analysts. Nonetheless, only experience directly covering the firm matters while experience covering other firms is not associated with greater price efficiency. Focusing on the accrual anomaly, we then examine research and monitoring as possible channels through which experience mitigates mispricing. For firms followed by more experienced analysts, we find that forecast revisions and stock prices respond more positively to the accrual component of earnings. We further find that accrual quality is higher in firms followed by more experienced analysts, which holds after using both propensity score matching and exogenous events of brokerage closures and mergers to control for endogeneity. Collectively, our results are consistent with monitoring being the primary mechanism by which experienced analysts reduce accrual mispricing.

Hedging Performance and Fair-Value Financial Reporting: Evidence from Bank Holding Companies

This study investigates whether the inclusion of the fair-value-based hedging performance measure improves the value and risk relevance of accounting earnings using data from the regulatory filings of bank holding companies required by the Federal Reserve Bank. Statement of Financial Accounting Standards No. 133 (SFAS 133) requires most types of hedge ineffectiveness to be measured on a fair value basis and reported in earnings. This earnings recognition requirement was the focal point of controversy surrounding the adoption of SFAS 133. This study provides new evidence that the fair-value-based earnings component required under SFAS has predictive power over future performance. I further show that incorporating this fair-value-based hedging performance measure helps improve the value and risk relevance of accounting earnings. The findings of this study help inform the broader debate over the effect of fair-value-based financial reporting on capital markets.

Do Cashflow Components and net profit affect earnings per share in the IDX-listed LQ-45 company?

The purpose of this study is to test the relationship between Cash Flow Component Disclosures and Net Income to Earnings Per Share in LQ-45 companies. The population in this study was LQ-45 companies listed on the Indonesia stock exchange during the period 2017 to 2020 consisting of 28 companies. The sampling technique used in this study was purposive sampling. Multiple regression analysis is used to analyze the data. The results of this study Through multiple linear regression analysis, it is known that the components of cash flow and net profit affect earnings per share. Simultaneously independent variables show can jointly affect earnings per share.

The differential pricing of cash flows and total accruals

PurposeRecent studies on the securities market's differential pricing of earnings components indicate that cash flows from operations are valued more highly than extreme total accruals. However, no previous study has examined whether cash flows from operations have a higher valuation than moderate total accruals. Therefore, this study examines the securities market's differential pricing of cash flows from operations and both moderate and extreme total accruals.Design/methodology/approachThe study's sample is divided into two sub-samples: a moderate total accruals sub-sample; and an extreme total accruals sub-sample. To evaluate whether cash flows have a higher valuation when compared to total accruals, for the entire sample and for each of the two sub-samples, the study examines the statistical significance of the difference between slope coefficients of cash flows and total accruals for regression of returns on both unexpected cash flows from operations and unexpected total accruals.FindingsConsistent with prior research, results from the entire sample show a differential higher valuation of cash flows when compared to total accruals. Another finding, consistent with recent studies, is that cash flows from operations have a higher valuation when compared to extreme total accruals. However, there is no higher differential valuation of cash flows over moderate total accruals. These findings support the decomposition of earnings into the components of cash flows from operations and total accruals only when total accruals are extreme (rather than moderate).Practical implicationsA possible explanation for these results is that since accruals predict cash flows, total accruals – when moderate (i.e. not extreme) – are priced similarly to cash flows. These results reveal that when total accruals are moderate, earnings are a better proxy for the underlying cash flows (over the entire future horizon, not just the current period) than is cash flows. However, since total accruals are unlikely to persist in a permanent way over the years, these results indicate that the decomposition of earnings into the components of cash flows from operations and total accruals is consistent with the information set used to value equity securities. Therefore, separate disclosure of cash flows is value relevant. In addition, users of financial statements certainly need the cash flows information as an ex-post validation of the prior earnings.Originality/valueThis study's contribution stems from its determination of the preferred level of disaggregation of earnings components (i.e. operating cash flows and total accruals). This is expected to help investors in their attempt to enhance the outcome of their informed investment and credit decisions.

Does Idiosyncratic Risk Affect Earnings Quality? Evidence from Indonesia

This study examines whether idiosyncratic risk significantly affects earnings quality in non-financial companies listed on the Indonesia Stock Exchange. Research on developing countries, especially Indonesia, which links idiosyncratic risk and earnings quality, has not been widely conducted. This is interesting because the characteristics of the markets in developing countries are different from those in developed countries. This study uses the dependent variable of earnings quality, which is the residual value of the Kasznik and Dechow–Dichev model, and idiosyncratic risk, which is measured based on the Capital Assets Pricing and Fama–French models. The overall results indicate that high idiosyncratic risk is associated with low earnings quality (large residual value). Robustness tests are also conducted based on groups of positive and negative profit companies, as well as industry groups. The same results were obtained for each earnings component, namely, innate and discretionary factors. These findings contribute to the development of firm-specific risk literature as an additional analytical tool to assess earnings quality based on accrual rates. This allows regulators and standard-setters to provide more relevant information regarding investment decisions.

Effect of CSR on the Overall and Components of Firm-Specific Earnings

Effect of CSR on the Overall and Components of Firm-Specific Earnings

Long Term Earnings Inequality, Earnings Instability and Temporary Employment in Spain: 1993–2000

This paper provides a longitudinal perspective on changes in Spanish male earnings inequality for the period 1993-2000, by decomposing the earnings covariance structure into its permanent and transitory parts. According to the Spanish sample of the European Community Household Panel, cross-sectional earnings inequality of male full-time employees falls over the second half of the Nineties. The longitudinal analysis shows that such decline was determined by a decrease in earnings instability and an increase of the permanent earnings component. Given the marked decline in temporary employment over the sample period, we also examine the effect of the type of contract on earnings variance components, and we find that workers with fixed-term contract have on average more instability than workers with permanent contract. This evidence suggests that the decline in temporary employment is responsible for the decreasing earnings instability.

Filling in the GAAPs in Individual Analysts’ Street Earnings Forecasts

Analysts’ street earnings forecasts are sometimes based on GAAP earnings and sometimes based on non-GAAP earnings, which exclude various GAAP earnings components. Therefore, differences in analysts’ street earnings forecasts may capture differences in not only expected performance but also the earnings metric forecasted. We argue that analysts who forecast non-GAAP, rather than GAAP, street earnings are more likely to separately analyze earnings components. Consistent with this argument, we find that analysts who forecast non-GAAP street earnings issue relatively more accurate forecasts. We also argue that excluded earnings components often reflect negative transitory items, and that variation across analysts in the earnings metric forecasted suggests that the negative excluded items are forecasted by only a subset of analysts. Consistent with this assertion, we find that variation across analysts in the earnings metric forecasted is associated with a lower consensus GAAP earnings surprise and lower stock returns around the earnings announcement. Finally, although variation in the earnings metric forecasted is a source of analyst forecast dispersion, we find that it is also incrementally associated with a lower earnings response coefficient, consistent with the existence of transitory items. We therefore find that the variation in the earnings metric forecasted is an important source of analyst forecast dispersion that predicts not only a lower earnings surprise but also a lower earnings response. This paper was accepted by Brian Bushee, accounting. Funding: Financial support from the Gatton College of Business & Economics, the KPMG Fellowship at the Mendoza College of Business, and the Goizueta Business School is gratefully acknowledged. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2022.4553 .

Is it time for popcorn? Daily box office earnings and aggregate stock returns

AbstractWe quantitatively measure the interactions between daily consumption and the stock market. We find that daily consumption, proxied by the cyclical component of theatrical box office earnings, can significantly and positively predict stock returns for up to 5 days. We also demonstrate a trading strategy using our consumption measures that yield nontrivial excess returns with little risk. These findings suggest that the box office effect is an economically important factor for equities. The framework implies that daily consumption carries value‐relevant public information, which leads to price reaction at a daily frequency.