Firm Earnings Research Articles

The Distributional Effects of Disinflationary Monetary Policy

Macroeconomists traditionally focus on the aggregate consequences of disinflationary monetary policy, not its distributional effects. This paper considers these distributional effects. The evidence indicates that contractionary monetary policy harms interest rate-sensitive industries by depressing output and employment and increasing the cost of capital. These industries are further hurt as declines in output and increases in the cost of capital reduce capital formation. The evidence also indicates that tight monetary policy in 1981-82 decimated the earnings of small firms. These earnings have remained at low levels since then. Finally, the evidence indicates that wealth holders are helped by contractionary monetary policy as interest rates increase and inflation declines. Before tightening monetary policy to pursue these benefits, however, policy makers should weigh carefully the damage that they will inflict on interest-sensitive sectors and small firms.

Income smoothing and underperformance in initial public offerings

This paper investigates how firms that made initial public offerings of equity between 1975 and 1984 report earnings. For a sample of 489 firms, we find a positive association between a proxy for income smoothing and firm performance. That is, firms that perform well tend to report earnings with less variability relative to cash from operations compared to other firms. In addition, the five-year earnings response coefficient is greater for firms that are able to smooth earnings relative to cash flows. This result is consistent with a hypothesis that the market makes better assessments of the information content of earnings for firms with smoother earnings. Finally, we show that IPO firms tend to use discretionary accruals to smooth income relative to the prior year's earnings.

New Models of Foreclosure: Should Antitrust Authorities Be Concerned?

Recent models which claim to provide examples of profitable foreclosure--when a firm weakens competition by reducing its access to customers or inputs--have led to calls for more aggressive antitrust activity by courts and regulators. However, we show that the alleged anticompetitive behavior of these models is either typical of competition or simply implausible. In addition, even if foreclosure occurs, it is almost always confined to the short run, and its efficiency consequences are commonly ambiguous. As a result, the new literature on foreclosure provides little impetus for intervention by poorly informed regulators. In most of the models examined, the foreclosing firm earns profits equal to its cost advantage as is typical of Bertrand competition, or makes profits because it was an early investor/innovator. Such profits can hardly be considered anticompetitive, and in any case can rarely be maintained beyond the short run. In addition, in many of these models vertical coordination increases efficiency, so even if foreclosure occurs, overall efficiency could improve. In the remaining models foreclosure obtains because the incumbent, but not entrants, can coordinate buyers. Only allowing incumbents this privilege is implausible, except perhaps in the short term.

The Information Content of Annual Earnings Announcements A Trading Volume Approach

The overall purpose of the study is to investigate the information content of annual earnings announcements in terms of trading volume activities in Jakarta Stock Exchange market of the year 1995. To achieve this objective, 30 firms meeting the following criteria have taken: (1) companies having stocks active for the periode under consideration, (2) having a continuous listing in the exchange for the study period, (3) companies issuing audited financial statement for the year 1994, (4) companies having no news announcement except release of annual earnings announcements. This study uses secondary data the measurement of which is made on an ordinal scale. The statistical techniques used in making the data analysis are the Wilcoxon signed ranks test and the Spearman’s rank correlation coefficients. Based on the data analysis for this study, researcher noticed that security trading volume significantly increases when companies announce annual earnings to the time before the announcement. Morever, findings show that there is a correlation between the unexpected trading volume and the absolute value of the magnitude unexpected earnings. Finally, it also show that there is weither a correlation between unexpected trading value with the size of the firm, mor is there a correlation between the size of the firm and unexpected earnings. Keyword: Unexpected Trading Volume; Unexpected Earnings; Firm size.

Parent and Subsidiary Earnings Announcements and Parent and Subsidiary Valuation

A firm's earnings announcements are an important source of value relevant information to market participants. They are, however, only one such source of information. The study reported in this paper involves another source of information: the earnings announcements within pairs of parents and their majority-held subsidiaries. We examine both firms ‘security price reactions to both firms’ earnings announcements for evidence of information flows within the pairs of firms. We find significant parent and subsidiary price reactions at their own earnings announcements only when the announcement is the first within a parent-subsidiary pair. The implication is that the first earnings announcement pre-empts some of the information released by the later announcing firm. In addition, parent firms also exhibit significant price reactions to subsidiary earnings announcements when subsidiaries announce earnings first. The magnitude of the parent price reactions suggests that incremental information is conveyed in the subsidiary earnings announcement regarding the earnings of the parents' non-subsidiary assets. The implication of this information transfer is that subsidiary earnings are particularly valuation-relevant to parent firm shareholders.

The valuation of the foreign income of US multinational firms: a growth opportunities perspective

We demonstrate the value-relevance of foreign earnings for US multinational firms by examining the associations between annual abnormal stock performance and changes in firms′ domestic and foreign incomes. For 2570 tirm-year observations between 1985 and 1993, both foreign and domestic earnings changes have significant positive associations with annual excess return measures: however, the association coefficient on foreign income is significantly larger than the association coefficient on domestic income. We demonstrate this larger association coefficient for foreign income is consistent with differences in growth opportunities between domestic and foreign operations.

Market assessment of industry and firm earnings information

This study examines the timing of security returns associated with industry-wide earnings and firm-specific earnings. We predict and find that returns associated with differences in performance across industries begin and end earlier than returns associated with differences in firm-specific performance within industries. To earn abnormal profits, a trading strategy based on forecasts of future earnings would require earlier predictions of industry-wide earnings than of firm-specific earnings.

Discretionary Accounting Choices: A Debt covenants Based Signalling Approach

This paper seeks to explain the discretionary accounting choices made by managers in a world characterised by asymmetric information between managers and investors. It considers a firm whose capital structure consists of both debt and equity, a manager who protects the interests of the firm's existing shareholders, and a financial market. The manager is committed to engage in an investment opportunity and needs to raise some equity to finance it. He is furthermore endowed with some private information about his firm's future earnings. The paper shows how, under certain conditions, the manager may credibly communicate his private information to investors through his accounting choices. In this equilibrium, the selection of balance sheet strengthening and income increasing accounting choices signals unfavourable information while the use of balance-sheet weakening and income- decreasing accounting choices signals favourable private information. The latter firms should thus experience positive abnormal returns around the announcement dates of their accounting choices.

The Small Firm Effect and Earnings Predictability

This paper considers whether the market overreacts to current earnings information and ignores the company's long term earnings potential. The paper examines whether size is helpful in being able to predict the market's reaction to a change in earnings, and indicate the market's ability to accurately value earnings prospects.

Analyst Reaction to Negative Earnings for Large Well-Known Firms

Analyst Reaction to Negative Earnings for Large Well-Known Firms

The Relation Between Security Returns, Firm Earnings, and Industry Earnings*

Abstract. In this paper we examine the relation between a firm's stock return and the earnings of other firms in the same industry, controlling for the firm's own earnings. We present a model in which the sign of this relation depends on the relative uncertainty there is about the size of the total industry value versus the division of that value between firms. We document considerable cross‐industry variation in the relation between a firm's return and other firms' earnings, and demonstrate empirically that the sign of the relation depends on information provided prior to the industry earnings announcement period.Résumé. Les auteurs examinent la relation entre le rendement de l'action d'une société et les bénéfices des entreprises appartenant au même secteur d'activité, en veillant à contrôler les bénéfices de la société en question. Dans le modèle qu'ils proposent, le sens (positif ou négatif) de cette relation dépend de l'incertitude relative qui caractérise l'importance de la valeur globale du secteur d'activité par rapport au partage de cette valeur entre les entreprises qui le constituent. Les auteurs ont recueilli quantité d'information confirmant l'existence d'une forte variation dans la relation entre le rendement des actions d'une entreprise et les bénéfices des autres entreprises d'un même secteur; ils démontrent aussi empiriquement que le sens de la relation dépend de l'information produite avant la période où les bénéfices du secteur sont communiqués.

Investment Earnings and the Characteristics of Life Insurance Firms: New Zealand Evidence

This study examines the relationship between the investment earnings of life insurance firms in New Zealand and their organisational characteristics. Using data for the period 1988–1993, a pooled Weighted Least Squares regression model is estimated. Consistent with expectations, the empirical results indicate that investment earnings were higher for stock companies than for mutuals. They were also positively associated with the size, leverage and underwriting risk of life insurance firms. Life insurance firms holding proportionately more financial than non-financial assets have low investment yields. The liability structure of life insurance firms was unrelated to their investment earnings.

(Dutch) Auction Share Repurchases

Optimal shareholder bidding strategies in a dutch auction share repurchase are derived when shareholder heterogeneity could be due to either differential expectations regarding the firm's future earnings or differential tax bases. Predictions of the theory are tested by analysing the actual tender premiums paid by firms completing dutch auction share repurchases.

Determinants of the Returns‐Earnings Correlation*

Abstract. The weak correlation between accounting earnings and security returns documented by numerous empirical studies is an issue of concern in current accounting research. Given that price is determined not solely by accounting earnings but also by other sources of information about future earnings, this paper focuses on the relation between earnings and other information to understand the returns‐earnings association. The analysis indicates that current earnings exhibit high explanatory power for returns if they correlate with expected future earnings (or with other information that reflects expected future earnings). A high price‐to‐earnings (P/E) ratio coupled with a high return on equity (ROE) can ex ante indicate earnings growth, and the earnings of firms with these attributes are positively correlated with future earnings. The high‐growth subset obtains an impressive returns‐earnings R2 of 31 percent and an earnings coefficient of 6.17, demonstrating that it is possible to identify firms whose earnings are strongly correlated with returns using a parsimonious set of firm characteristics.Résumé. La faible corrélation entre les bénéfices comptables et le rendement des titres de placement sur laquelle se sont penchés de nombreux auteurs d'études empiriques retient aujourd'hui l'attention des chercheurs en comptabilité. Le cours des titres étant déterminé non seulement par les bénéfices comptables mais aussi par d'autres sources d'information relative aux bénéfices futurs, l'auteur s'intéresse ici à la relation entre les bénéfices et d'autres renseignements, dans le but d'expliquer le lien entre rendement et bénéfices. L'analyse révèle que les bénéfices courants ont un pouvoir explicatif élevé à l'égard du rendement si ce dernier est en corrélation avec les bénéfices futurs prévus (ou avec d'autres renseignements indicateurs des bénéfices futurs prévus). Un ratio cours/bénéfice élevé associé à un rendement des capitaux propres élevé peut indiquer, ex ante, une croissance des bénéfices, et les bénéfices des entreprises qui possèdent ces caractéristiques sont en corrélation positive avec les bénéfices futurs. Le sous‐groupe des entreprises à forte croissance obtient un R2 étonnant de 31 pour cent, résultat d'une analyse de régression du rendement par rapport aux bénéfices, et un coefficient de bénéfices de 6,17, ce qui démontre qu'il est possible de déterminer quelles sont les entreprises dont les bénéfices présentent une forte corrélation avec le rendement, lorsqu'on utilise un ensemble parcimonieux de caractéristiques des entreprises.

The Japanese Firm from a Financial Perspective

The following concept is frequently noted: The prevailing management style of Japanese firms—as portrayed in traditional economics textbooks—is oriented toward the worker-managed business rather than the maximization of the firm's stock price. 1 This can be interpreted to mean that many Japanese firms are not the providers of capital (i.e., stockholders). Instead, the workers, in essence, occupy the position of the residual claimant with the right to receive the firm's residual earnings. The residual earnings refers to that part of the total firm's earnings which remain after satisfying prior contracts with other providers of factors of production. 2

THE RELATION AMONG DIVIDEND POLICY, FIRM SIZE, AND THE INFORMATION CONTENT OF EARNINGS ANNOUNCEMENTS

AbstractIn this paper we investigate the role of dividends in explaining the size effect. The previous literature concludes that before the firm's earnings announcement, small firm stock prices impound less information than large firm stock prices. This size effect is evidenced by the greater market reaction to small firm earnings announcements than to large firm earnings announcements. We find that if the dividend announcement precedes the earnings announcement, no size effect exists. The implication is that the information conveyed by dividend announcements includes the information conveyed to investors in large firms by other information sources. However, if the firm does not pay dividends or if the firm's earnings announcement precedes its dividend announcement, the size effect exists. The implication is that dividends do not completely explain the size effect. That is, there are information sources other than dividends that are exclusively available to investors in large firms, and the information provided by these sources is reflected in the stock price of large firms before the earnings announcement.

The Dynamics of Corporate Dividend Reductions

The claim that divided payments serve as signals to market participants is widely accepted. However, recent evidence has increased the uncertainty regarding the information conveyed when a firm drops its dividend. In particular, DeAngelo, DeAngelo, and Skinner (1992) and Healy and Palepu (1988) find that a dividend reduction tends to be followed by a significant increase in firm earnings. Our analysis extends prior research by examining twenty-one firm characteristics three years before and three years after a dividend drop. Consistent with past results, we find that firm earnings drop prior to a dividend reduction and increase afterwards. However, following a dividend drop, firms tend to reduce asset expenditures, external financing activities, employees, and spending on R&D. In addition, firms tend to sell more assets and their sales level remains depressed in the post-dividend-drop period. These post-dividend-drop occurrences may negatively impact a firm's future competitive position and, furthermore, may explain the negative stock price reaction that accompanies the dividend-drop announcement. Overall, our results suggest that a dividend-drop marks the end of a firm's financial decline and the beginning of firm restructuring.

Earnings forecast accuracy and geographic segment disclosures

Statement of Financial Accounting Standards (SFAS) No. 14 requires U.S. firms with significant foreign operations to disaggregate certain disclosures into geographic segments. To date, however, there have been few studies that investigate the usefulness of this information to financial statement users. This study investigates whether or not financial analysts' earnings forecasts for multinational firms improved after SFAS 14. The results indicate that after adjustment for differences in earnings variability, financial analysts' forecasts of the earnings of multinational firms did become significantly more accurate (relative to that of a group of control firms) after the disclosure of geographic segment information.

Political scrutiny and earnings management in the oil refining industry

The fortunes of the oil refining industry have historically been tied to the political process. In periods of high gasoline prices public outcry increases pressure on the political process to increase regulation, taxation, and other costs on the industry. This study explores the relationship of gasoline prices and oil firm earning with accounting earnings management of oil firms. Findings indicate that firms make accounting changes and discretionary accruals to decrease (increase) earnings in periods when gasoline prices and oil firm earnings are rising (falling).

Discussion of “Noisy Accounting Earnings Signals and Earnings Response Coefficients: The Case of Foreign Currency Accounting”*

This paper extends the growing literature on factors affecting cross-sectional and intertemporal variation in earnings response coefficients. It tests the empirical implications of recent theoretical work by Choi and Salamon (1989) and Holthausen and Verrecchia (1988), who model the degree of price adjustment associated with earnings announcements as a function of the amount of noise or garbling in the accounting earnings signal relative to valuation-relevant cash flows or dividends. The particular earnings measurements considered relate to U.S. multinational companies and to the differences in income determination under Statement of Financial Accounting Standards (SFAS) No. 8 and SFAS No. 52. The study finds a modestly smaller relative price adjustment for a given amount of unexpected earnings for multinational firms than for nonmultinationals during the SFAS No. 8 period. This finding is consistent with multinationals producing "noisier" earnings signals during this time period. However, several indirect measures suggest that there was greater prior probability uncertainty associated with the future cash flows or dividends of the nonmultinational sample. Accordingly, this cannot be ruled out as a competing explanation for the observed differences in the market's response to earnings signals during the SFAS No. 8 period. Following the implementation of SFAS No. 52, the earnings response coefficient increased substantively for firms whose accounting for translation gains or losses was most affected by this standard. These results suggest that the earnings measurements produced under SFAS No. 52 were perceived by market participants to be of higher quality (less noisy) than those produced under SFAS No. 8. The framework and analysis in this paper hold promise for investigating the relative informativeness of earnings signals produced under alternative income determination rules.