Uncertainty Of Future Earnings Research Articles

A Study of Financial Acquisition Risk Identification and Prevention

In this paper, the financial risk of Ping An Insurance (Group) Company of China, Ltd. acquisition of Shanghai Jahwa United Co., Ltd is divided into the target enterprise risk assessment risk, financing risk and uncertainty of future earnings according to M & A links. The study finds that the target enterprise value assessment under market approach is close to the transaction price; the financing risk can be divided into long-term risk and short-term risk; Uncertainty of future earnings arises from the volatility of the stock price caused by the uncertainty of the target enterprise. To reduce these three risks, this study suggests that M & A companies adopt a variety of methods to comprehensively assess the value of the target enterprise, rationally design the financing plan and pay close attention to the target business operation.

Forecasting Risk in Earnings

AbstractConventional measures of risk in earnings based on historical standard deviation require long time‐series data and are inadequate when the distribution of earnings deviates from normality. We introduce a methodology based on current fundamentals and quantile regression to forecast risk reflected in the shape of the distribution of future earnings. We derive measures of dispersion, asymmetry, and tail risk in future earnings using quantile forecasts as inputs. Our analysis shows that a parsimonious model based on accruals, cash flows, special items, and a loss indicator can predict the shape of the distribution of earnings with reasonable power. We provide evidence that out‐of‐sample quantile‐based risk forecasts explain incrementally analysts' equity and credit risk ratings, future return volatility, corporate bond spreads, and analyst‐based measures of future earnings uncertainty. Our study provides insights into the relations between earnings components and risk in future earnings. It also introduces risk measures that will be useful for participants in both the equity and credit markets.

The predictive qualities of earnings volatility and earnings uncertainty

This study examines the differential predictive power of past earnings volatility for analyst forecast errors and future returns. Past earnings volatility jointly captures two correlated, but distinct, earnings properties: time-series earnings variation and uncertainty in future earnings. To distinguish between these two earnings properties, we develop a forward-looking measure of earnings uncertainty that has a minimal mechanical link to variation in prior-period earnings realizations and does not rely on analyst forecasts. Our results suggest that future earnings uncertainty, and not time variation in earnings, is associated with overly optimistic future earnings expectations of equity analysts and investors. We provide the first empirical evidence on the relevance of future earnings uncertainty to analysts and investors over 1-year horizons. In addition, we provide empirical evidence showing that forecast dispersion is a poor measure of earnings uncertainty.

Environmental R&D and the uncertainty of future earnings

This paper examines whether the variability in the future earnings stream generated by the investment in environmentally-related R&D projects is different than that created by the investment in other R&D projects. To carry out this investigation, I decompose total R&D expenditures into two components: those related to R&D projects aimed at reducing the firm’s costs to comply with environmental legislation (i.e., the environmental component), and those related to all other R&D projects, which are focused on increasing the firm’s revenues and/or decreasing its other operating costs (i.e., the residual component). As predicted, I find that the environmental component of R&D expenditures contributes significantly less to the variability of future earnings than the residual component.

Earnings Variability and Disclosure of R&D: Evidence from Press Releases

AbstractThis study explores press releases in the pharmaceutical industry to expand our understanding of how investments in R&D outlays influence uncertainty of future earnings. The findings make two contributions to the literature. First, they provide evidence that equal investments in different R&D ventures are associated with differential variability of future earnings. This result suggests that non‐financial information contained in press releases captures attributes of firm‐specific R&D investments that are not revealed through R&D expenditures reported in financial statements. Second, prior studies have indicated that investments in pharmaceutical R&D are associated with the highest variability of future earnings among all industries. The results, however, suggest that for a large class of low‐risk pharmaceutical R&D investments, the relative variability of future earnings is low and similar to that generated by capital expenditures. The findings hold when we control for endogeneity in voluntary disclosure of press releases.

The Effect of R&D Investment on Future Earnings Uncertainty: New Evidence

The effect of R&D on firms’ future earnings uncertainty is an important factor in the decision of accounting treatment of the investment (expensing vs. capitalization). This study provides new evidence on the effect of R&D investment on future earnings uncertainty. We posit that R&D investment and future earnings uncertainty are simultaneously associated. On the one hand, high earnings uncertainty increases firms’ incentive to invest in R&D because R&D strengthens firms’ innovative capability and competitiveness in an uncertain environment. On the other hand, the outcome of R&D project is subject to uncertainty, but the advantage of R&D can also lead to durable and persistent future benefits, rendering the effect of R&D on future earnings variability an empirical question. Our examination of the simultaneous relation between R&D investment and future earnings uncertainty indicates that like capital expenditure, R&D does not increase the variability of future earnings. We also find that for firms with relatively high R&D investment intensity, R&D has a stronger effect on decreasing firms’ future earnings variability than capital expenditure. This result is in contrast to earlier evidence that R&D and capital investment increase future earnings uncertainty and that R&D has greater association with future earnings uncertainty than capital investment.

Forecasting Risk in Future Earnings

Conventional measures of risk in earnings based on historical standard deviation require long time series data and are inadequate when the distribution of earnings deviates from normality. We introduce a methodology based on current fundamentals and quantile regression to forecast risk reflected in the shape of the distribution of future earnings. We derive measures of dispersion, asymmetry and tail risk in future earnings using quantile forecasts as inputs. Our analysis shows that a parsimonious model based on accruals, cash flow, special items and a loss indicator can predict the shape of the distribution of earnings with reasonable power. We provide evidence that out-of-sample quantile-based risk forecasts explain incrementally analysts’ equity and credit risk ratings, future return volatility, corporate bond spreads and analyst-based measures of future earnings uncertainty. Our study provides insights into the relations between earnings components and risk in future earnings. It also introduces risk measures that will be useful for participants in both the equity and credit markets.

The appeal of vague financial forecasts

Prior findings suggest managers often choose ranges to communicate uncertainty in future earnings. We analyzed earnings forecasts over 11 years and find higher earnings uncertainty firms are more likely to choose range estimates. We study investors’ attitudes to forecast precision and argue investors’ evaluations of forecasts can be explained by a sequential non-compensatory two-stage process – First, investors determine whether a point or a range estimate is more appropriate for a particular domain based on the congruence principle. Then, they seek the most precise reasonable range to maximize informativeness. Results from three experiments indicate the preference for (im)precision is non-monotonic – it peaks for low levels of imprecision and diminishes when the range gets wider, and is consistent with participants’ desire for congruent and informative estimates, and supports the claim that investors favor forecasts that are as precise as warranted by the information available, but not more precise.

Environmental R&D and the Uncertainty of Future Earnings

This paper examines whether the variability in the future earnings stream generated by the investment in environmentally-related R&D projects is different than that created by the investment in other R&D projects. To carry out this investigation, I decompose total R&D expenditures into two components: those related to R&D projects aimed at reducing the firm’s costs to comply with environmental legislation (i.e., the environmental component), and those related to all other R&D projects, which are focused on increasing the firm’s revenues and/or decreasing its other operating costs (i.e., the residual component). As predicted, I find that the environmental component of R&D expenditures contributes significantly less to the variability of future earnings than the residual component.

Uncertainty and Expectation Revisions after Earnings Announcements*

Bayesian theory predicts an increase in market participants' reliance on reported current earnings to revise their expectations of future earnings when the uncertainty in future earnings is higher. Prior studies focus on price reactions and find negative associations between measures of earnings uncertainty and investors' reliance on reported current earnings. This study examines analysts' forecast revisions (of future earnings) around the announcements of current period earnings and finds positive associations between measures of earnings uncertainty and analysts' reliance on reported current earnings. The findings suggest that uncertainty measures and discount rates are correlated, and cross-sectional differences in the discount rate taint the interpretation of price reactions as evidence of expectation revisions under uncertainty. This study sheds additional light on the complex relationships among earnings uncertainty measures, price reactions to earnings surprise, and cost of capital.

Information Technology Capability: Firm Valuation, Earnings Uncertainty, and Forecast Accuracy

Prior literature argues that information technology (IT) capability, an organization's ability to effectively use IT-based resources in combination with other organizational resources, can create unique and sustainable competitive advantages and thus intangible assets for a company. However, current accounting rules do not allow the capitalization of IT-enabled intangible assets. We hypothesize that IT-enabled intangible assets are value-relevant and provide incremental explanatory power for firm valuation beyond traditional accounting information. IT capability is inherently risky as it is subject to implementation challenges, technological complexity, and innovative integration of IT investments with other organizational resources. Thus, we argue that IT capability is positively associated with future earnings uncertainty and decreased analyst forecast accuracy. Using InformationWeek 500 ranking index as a proxy for IT capability, we find evidence supporting these hypotheses. This study contributes to the growing literature on IT capability.

Uncertainty of Future Performance: The Impact of Labor Investment and Labor Flexibility

Abstract: Theory suggests that human capital investment decreases in response to an increase in the riskiness of the return on the investment which suggests a link between the uncertainty of future performance and investments in labor. While labor investment has been the subject of numerous academic studies, the notion of labor flexibility is a relatively new research issue and is of fundamental interest due to the rise of contingent labor in our competitive global economy. In this study, we investigate the relations between fixed labor investments, labor flexibility and their impact on future earnings uncertainty while controlling for capital and R& D investment. The empirical analysis compares the relative contributions of current investments in labor, labor flexibility, R&D and PP&E to future earnings variability using a sample of roughly 20,000 firm-year observations from 1970-1999. We perform extensive robustness checks and provide strong results consistent with our predictions that fixed labor investments increase the uncertainty of future earnings. In contrast, labor flexibility reduces uncertainty in future benefits. Our results have implications for management's human capital operating decisions and are consistent with the extraordinary growth in contingent employment arrangements in the United States and abroad.

Portfolio Choice With a Correlated Background Risk: Theory and Evidence

We extend the static portfolio choice problem with a small background risk to the case of small partially correlated background risks. We show that respecting the theories under which risk substitution appears, except for the independence of background risk, it is perfectly rational for the individual to increase his optimal exposure to portfolio risk when risks are partially negatively correlated. Then, we test empirically the hypothesis of risk substitutability using INSEE data on French households. We find that households respond by increasing their stockholdings in response to the increase in future earnings uncertainty. This conclusion is in contradiction with results obtained in other countries. So, in light of these results, our model provides an explanation to account for the lack of empirical consensus on cross-country tests of risk substitution theory that encompasses and criticises all of them. ∗ This paper is strongly motivated by a common work with Andre Masson (Arrondel and Masson, 1996). The authors thank Rob Alessie, Jean-Marc Robin, Maximus Spadaro and two anymous referees for their comments on a previous version of the text. We acknowledge research support from CNRS and SEEUID. The second author acknowledges financial support from the Bank of Spain.

The Association between the Uncertainty of Future Economic Benefits and Current R&D and Capital Expenditures: Industry and Intertemporal Analyses

Since 1974, R&D expenditures have been fully expensed when incurred partly because R&D activities are claimed to be associated with a high degree of uncertainty in future economic benefits. In this study, we estimate the association between R&D expenditures and capital expenditures (CAPEX) and the variance of future earnings per share and operating income. We show that R&D expenditures lead to higher volatility of future earnings than capital expenditures only in R&D-intensive industries, where industry R&D intensity is measured as the R&D-to-CAPEX ratio. We also find that the stronger association of R&D with uncertainty in future earnings is a recent phenomenon. Finally, we show that in industries that are relatively less dependent on R&D activities, the probability of recovering R&D expenditures is similar to that of capital expenditures. Overall, our results suggest that while some industries engage in a more innovative and uncertain R&D activities, R&D in other industries is less uncertain. These results suggest that the impact of R&D on future performance considerably varies across industries and time periods.

Capitalization versus Expensing: Evidence on the Uncertainty of Future Earnings from Capital Expenditures versus R&D Outlays

We propose and implement a new method to estimate the relation between R&D investments and the uncertainty of future benefits from those investments. The empirical analysis compares the relative contributions of current investments in R&D and PP&E to future earnings variability using a sample of roughly 50,000 firm-year observations from 1972–1997. Evidence is strongly consistent with the hypothesis that R&D investments generate future benefits that are far more uncertain than benefits from investments in PP&E. Our results should help the current discussion on accounting for R&D and the methodology might be helpful in standard setting in other contexts as well.

Valuation relevance of allowance for funds used during construction and operating income: The effects of regulatory climates and deregulation

This study considers the valuation relevance allowance for funds used during construction (AFUDC), operating income (OI), and their innovations across regulatory climates and regulatory reforms. Valuation relevance is assessed by examining the coefficients and R 2s from the regressions of returns on AFUDC, OI, and their innovations. Regulatory climate is predicted to affect valuation relevance of earnings components on the premise that different regulatory regimes enact and enforce policies that differently affect (1) the uncertainty of future earnings, (2) the recovery of deferred assets, and (3) the sustainability of earnings innovations. In an extended analysis, indicators of rate-base valuation method and leverage are added as control variables to isolate their mediating effects on returns for electric utilities. Additional analysis considers the effects of the Energy Policy Act (EPAct) of 1992 on the valuation of earnings components. The results reveal that AFUDC and OI are valued differently relative to each other and across regulatory climates. The results also show a significant decline in the explanatory power of earnings components after the passage of the EPAct in 1992. Rate-base valuation method has no discernible effects on returns for the utilities. On the other hand, the effect of leverage on returns for the utilities is reliably negative.

Capitalization versus Expensing: Evidence on the Uncertainty of Future Earnings from Current Investments in PP&E versus R&D

Accounting standards reflect a trade-off between relevance and reliability. This trade-off is intensely debated in the context of the accounting standard for R&D costs. However, almost all of the empirical research focuses only on the relevance of accounting disclosures about R&D costs. Little systematic evidence exists on the reliability of future benefits from R&D outlays. We propose and implement a new method to estimate the relation between investments in R&D and the uncertainty of future benefits from those investments. The empirical analysis compares the relative contributions of current investments in R&D and PP&E to future earnings variability using a sample of more than 50,000 firm-year observations. Evidence is strongly consistent with the hypothesis that R&D investments generate future benefits that are far more uncertain than benefits from investments in PP&E. Our results, together with the evidence on value relevance of R&D from previous research, should be helpful in the current discussion on accounting for R&D.

Risk and Return of Value Stocks

The authors find that value stocks are riskier because they are usually firms under distress, have high financial leverages, and face substantial uncertainty in future earnings. These risk characteristics are as powerful as are size and book-to-market in explaining cross-sectional differences in return in Pacific Rim markets. Value stocks offer reliably higher returns in the United States, Japan, Hong Kong, and Malaysia, corresponding to the higher risk, but not in the high-growth markets of Taiwan and Thailand because the spread of risk between small high-book-to-market stocks and big low-book-to-market stocks is small. Copyright 1998 by University of Chicago Press.