Long-term Earnings Research Articles

What do Analysts' Forecasts Reveal about Analysts' Private Information?*

Analysts often provide forecasts of one-year ahead earnings, earnings two years ahead, as well as long-term earnings growth rates. In this paper, we assume that analysts make earnings forecasts consistent with abnormal earnings exhibiting linear information dynamics (LID) in Ohlson (1995). Under this assumption, each analysts' consensus earnings forecast is determined by three components: analysts' private/other information about future abnormal earnings (not in current abnormal earnings), the persistence in this private/other information, and the persistence in abnormal earnings. For firms with three contemporaneous multi-period earnings forecasts available, we develop a procedure to infer these three implied components from analysts' forecast for each individual firm year. We begin by examining whether analysts' earnings forecasts exhibit LID. We find that LID is not an appropriate description of analysts' information processing for 22% of our firm-year observations. For the remaining 78%, the two symmetrical combinations of the (median) persistence in other information and abnormal earnings are (0.79, 0.36) and (0.36, 0.79). Demonstrating that the two symmetrical combinations of the persistence parameters lead to the same price estimate, we then calculate the predicted firm value (incorporating analysts' private information). Our results show that the predicted firm value is statistically associated with the observed market value. In addition, when abnormal earnings are expressed as an ARMA (2,1) process, the median persistence in current abnormal earnings into forecasted future abnormal earnings is 0.94 and the median persistence in lagged abnormal earnings into forecasted future abnormal earnings is 0.15. Lastly, we show that the association between return and the innovations in other information is statistically significant.

Decomposing Credit Spreads

This paper investigates the information contained in the yields of corporate debt securities using a structural credit risk model. As previous studies have found, credit risk is not the only factor that affects corporate yield spreads. The aim is to decompose credit spreads, using a structural model of credit risk, into credit and non-credit risk components. The contribution relative to the existing literature is the use of contemporaneous forward-looking information on equity risk premia and equity value uncertainty in a structural model. In particular, implied equity risk premia from a three-stage dividend discount model that incorporates analysts' long-term earnings forecasts are used, together with implied measures of equity value uncertainty from option prices. The paper examines the evolution of the different components of spreads across time as well as the effect of particular events. It also analyses the relationship between the derived components and other financial variables, such as swap spreads and the equity risk premium.

The Role of 'Other Information' in the Valuation of Foreign Income for U.S. Multinationals

In this paper, we examine investors' valuation of the domestic and foreign components of total earnings after controlling for beyond current earnings. Our sample consists of U.S. multinationals during the 1985-2002 period. In a prior study, Bodnar and Weintrop (1997) find that investors place a higher weight on foreign earnings than on domestic earnings in valuing securities, and that this finding can be explained in part by the higher growth opportunities in foreign markets. While this explanation is intuitively appealing, possible explanations include the varying importance of than current accounting earnings in pricing securities and the possible mis-specification of their model. One potentially important source of is contained in revisions of analysts' forecasts of future (abnormal) earnings and terminal values. Excluding this from the regression specification potentially leads to a correlated omitted variables problem. In this paper, we use the Liu and Thomas (2000) proxy for other information, which is derived from analysts' revisions of near-term and long-term earnings forecasts and discount rate changes. Including the other information variable greatly improves the explanatory power of the returns-earnings regression. Consistent with our predictions, we find that the bias resulting from excluding value-relevant has a greater effect on foreign earnings than on domestic earnings. Foreign earnings are no longer incrementally value relevant when we control for other information.

The Impact of Community College Retraining on Older Displaced Workers: Should We Teach Old Dogs New Tricks?

The authors estimate the returns to retraining for older displaced workers—those 35 or older—by estimating the impact of community college schooling on earnings. The analysis relies on longitudinal administrative records covering workers displaced from jobs in Washington State during the early 1990s. The authors find that older displaced workers participated in community college schooling at lower rates than younger workers. Among those who participated, however, the impact on quarterly earnings was similar across the two age groups. One academic year of community college schooling is estimated to have increased long-term earnings by about 7% for older men and by about 10% for older women. Although these percentages are consistent with those reported in the schooling literature, estimates of the social internal rates of return from this retraining may differ substantially among older and younger workers because of differences in their work lives and their opportunity costs of retraining.

The Effect of Investment Horizon on Institutional Investors' Incentives to Acquire Private Information on Long-Term Earnings*

We use quarterly institutional ownership changes to test the effect of investment horizon on institutional investors' incentives to acquire private information on long term earnings. Short horizon institutions' ownership changes contain private information on long term earnings, but only to the extent that such private information will be reflected in near term stock prices. There is little evidence that long horizon institutions' ownership changes contain private information on long term earnings that will be revealed in near term stock prices, but long horizon institutions' ownership changes contain private information on long term earnings that will be reflected in longer term stock prices.

A Reexamination of the Factors Important to Selection of Accounting as a Major

This study reexamines and extends the conclusions drawn from the Felton et al. (FBN) 1994 study that investigated a set of explanatory factors in the decision to choose a career as a chartered accountant (CA). The current study extends the findings of FBN in two primary ways. First, we improve upon their study by adding the students' overall experience in the first accounting course into the analysis. Second, we expand the analysis to include sophomores and juniors rather than seniors only. When we add the students' overall experience in the introductory accounting class into the analysis, it becomes the most important factor in distinguishing major choice between accounting and nonaccounting students. Consistent with FBN, we find that accounting majors place less importance on intrinsic factors and report a higher ratio of perceived benefits to costs of choosing accounting than nonaccounting majors. Unlike FBN, we find that initial earnings, long-term earnings, and job market considerations rank at or near the bottom in discriminating between accounting and nonaccounting majors. By shedding further light on the factors that attract students to the accounting profession, the results have recruiting, educational, and public interest implications.

The Nature and Persistence of Buyback Anomalies

Using recent data, we reject the hypothesis that the buyback anomalies first reported by Lakonishok and Vermaelen (, Journal of Finance 45:455-77) and Ikenberry, Lakonishok, and Vermaelen (, Journal of Financial Economics 39:181-208) have disappeared over time. We find evidence consistent with the hypothesis that open market repurchases are a response to a market overreaction to bad news: significant analyst downgrades, combined with overly pessimistic forecasts of long-term earnings. Stock prices after tender offers are set as if all investors tender their shares, but empirically they do not. Thus, the arbitrage opportunity persists because the market sets prices as if the average, not the marginal investor, determines the stock price.

Estimating the returns to community college schooling for displaced workers

Abstract Studies show that high-tenure displaced workers typically incur substantial long-term earnings losses. As these losses have become increasingly apparent, policy makers have significantly expanded resources for retraining, much of which takes place in regular community college classes. To analyze the effectiveness of such training, we link administrative earnings records with the community college transcript records of workers displaced from jobs during the first half of the 1990s in Washington State. We explore several issues of statistical specification for regression models quantifying the impact of community college credits on earnings. These include (i) the need to allow for a transition period immediately after the end of workers’ schooling when their earnings may be temporarily depressed, (ii) whether earnings gains are strictly proportional to credits earned, and (iii) how to model worker-specific unobserved heterogeneity. In our preferred specification, we find that the equivalent of an academic year of community college schooling raises the long-term earnings of displaced workers by an average of about 9 percent for men and about 13 percent for women. However, these average returns mask substantial variation in the returns associated with different types of courses. On the one hand, we estimate that an academic year of more technically oriented vocational and academic math and science courses raise earnings by about 14 percent for men and 29 percent for women. On the other hand, we estimate that less technically oriented courses yield very low and possibly zero returns. About one third of the increase in earnings associated with more technically oriented vocational and academic math and science courses is estimated to be due to increases in wage rates, with the remainder attributable to increased hours of work.

The Role of Expectations in Explaining the Cross-Section of Stock Returns

We find highly significant results when the cross-section of market-adjusted stock returns is regressed against changes in analyst expectations this year about: (1) this year's earnings, (2) next year's earnings, (3) long-term earnings growth, and (4) noise (measured as the standard deviation of analyst forecasts). Surprisingly, changes in expectations about this year's earnings are not significant in a multiple regression with the other independent variables. Changes in expectations about next year's earnings are highly significant but with an impact that is much smaller than that of changes in expectations about the long-term growth in earnings. Changes in noise are also statistically significant and are negatively related to market-adjusted returns, an indication that the signal to noise ratio, rather than merely the signal, is what drives price adjustments to new information.

The Effects of Limiting Accounting Discretion on the Informativeness of Financial Statements: Evidence from Software Revenue Recognition

This paper examines the effects on the informativeness of software companies' financial statements of limiting the amount of discretion with respect to software revenue recognition following the issuance of Statement of Position 91-1 in 1992. The requirement that companies adopt SOP 91-1 by restating earnings for prior periods allows to compare the value-relevance of two sets of data, the originally reported and the restated earnings numbers. I find that the originally reported numbers provide incremental information content over the more conservative restated earnings numbers. This finding is consistent with managers using their discretion in pre-SOP 91-1 periods to convey private information about their firms' underlying economics. Furthermore, relative to a control group of software firms less sensitive to the accounting change, I document a significant decline in the information content of sample firms' reported earnings following the issuance of SOP 91-1, as well as a significant increase in the voluntary disclosure of long-term earnings projections and non-financial information. I interpret these findings as evidence that limiting the amount of discretion has adversely affected managers' ability to communicate effectively with investors through the financial statements.

Should We Teach Old Dogs New Tricks? The Impact of Community College Retraining on Older Displaced Workers

This paper estimates the returns to retraining for older displaced workers--those 35 or older--by estimating the impact that community college schooling has on their subsequent earnings. Our analysis relies on longitudinal administrative data covering workers who were displaced from jobs in Washington State during the first half of the 1990s and who subsequently remained attached to the state's work force. Our database contains displaced workers' quarterly earnings records covering 14 years matched to the records of 25 of the state's community colleges. We find that older displaced workers participate in community college schooling at significantly lower rates than younger displaced workers. However, among those who participate in retraining, the per-period impact for older and younger displaced workers is similar. We estimate that one academic year of such schooling increases the long-term earnings by about 8 percent for older males and by about 10 percent for older females. These per-period impacts are in line with those reported in the schooling literature. These percentages do not necessarily imply that retraining older workers is a sound social investment. We find that the social internal rates of return from investments in older displaced workers' retraining are less than for younger displaced workers and likely less than those reported for schooling of children. However, our internal rate of return estimates are very sensitive to how we measure the opportunity cost of retraining. If we assume that these opportunity costs are zero, the internal rate of return from retraining older displaced workers is about 11 percent. By contrast, if we rely on our estimates of the opportunity cost of retraining, the internal rate of return may be less than 2 percent for older men and as low as 4 percent for older women.

Estimating the Returns to Community College Schooling for Displaced Workers

Studies show that high-tenure displaced workers typically incur substantial long-term earnings losses. As these losses have become increasingly apparent, policy makers have significantly expanded resources for retraining, much of which takes place in regular community college classes. To analyze the effectiveness of such training, we link administrative earnings records with the community college transcript records of workers displaced from jobs during the first half of the 1990s in Washington State. We explore several issues of statistical specification for regression models quantifying the impact of community college credits on earnings. These include (i) how to allow for a transition period immediately after the end of workers' schooling when their earnings may be temporarily depressed, (ii) whether earnings gains are strictly proportional to credits earned, and (iii) how to model worker-specific unobserved heterogeneity. In our preferred specification, we find that the equivalent of an academic year of community college schooling raises the long-term earnings of displaced workers by an average of about 9 percent for men and about 13 percent for women. However, these average returns mask substantial variation in the returns associated with different types of courses. On the one hand, we estimate that an academic year of more technically oriented vocational and academic math and science courses raise earnings by about 14 percent for men and 29 percent for women. On the other hand, we estimate that less technically oriented courses yield very low and possibly zero returns. About one third of the increase in earnings associated with more technically oriented vocational and academic math and science courses is estimated to be due to increases in wage rates, with the remainder attributable to increased hours of work.

The Dynamics and Inequality of Italian Men’s Earnings

Abstract This paper provides a longitudinal perspective on changes in Italian men’s earnings inequality since the late 1970s by decomposing the earnings autocovariance structure into its long-term and transitory parts. Cross-sectional earnings differentials grew over the period and the longitudinal analysis shows that such growth was determined by the long-term earnings component. Using parameter estimates to analyze low-pay probabilities shows that low-pay persistence and the probability of repeated low-pay episodes grew for all birth cohorts during the early 1990s. Moreover, long-term heterogeneity is found to characterize the earnings distribution of nonmanual workers, accounting for a large part of overall heterogeneity.

Analyst Conflicts and Research Quality

This paper examines whether the quality of stock analysts’ forecasts is related to conflicts of interest from their employers’ investment banking (IB) and brokerage businesses. We consider four aspects of forecast quality: accuracy, bias, and revision frequency of quarterly earnings per share (EPS) forecasts and relative optimism in long-term earnings growth (LTG) forecasts. Using a unique dataset that contains the annual revenue breakdown of analysts’ employers among IB, brokerage, and other businesses, we uncover two main findings. First, accuracy and bias in quarterly EPS forecasts appear to be unrelated to conflict magnitudes, after controlling for forecast age, firm resources and analyst characteristics. Second, relative optimism in LTG forecasts and the revision frequency of quarterly EPS forecasts are positively related to the importance of brokerage business to analysts’ employers. Additional tests suggest that the frequency of quarterly forecast revisions is positively related to analysts’ trade generation incentives. Our findings suggest that reputation concerns keep analysts honest with respect to short-term earnings forecasts but not long-term growth forecasts. In addition, conflicts from brokerage appear to play a more important role in shaping analysts’ forecasting behavior than has been previously recognized.

Playing on Profits Cycle?

In the article it is shown that year-to-year change of the S&P 500 does not depend on profits cycle. On the other hand, year-to-year change of earnings multiple P/E tends to anticorrelate with profits cycle. It shows sluggishness of market response in relation to profits cycle. It is shown that there is one important condition for development of new long-term bull trend. It is presence of phase of earnings accumulation. Such accumulation is possible only during periods of significant outstripping of earnings growth over the market growth. Now there is no phase of earnings accumulation, because market returned to 8% long-term growth rate, which outstrips the 5.5% long-term earnings growth rate. Such conditions can support only sideways market at best.

Do Analysts at Independent Research Firms Make Better Earnings Forecasts?

This study compares the earnings forecasts of analysts employed by independent research firms to those of analysts employed by investment banks along the dimensions of accuracy and optimism. We discuss the conflicts of interest faced by both groups and suggest that, despite incentives stemming from corporate financing operations, investment bank analysts may nevertheless provide superior forecasts. We provide evidence on this empirical question using a sample of analyst forecasts from 1998-2001. Our results reveal that short-term forecasts made by investment bank analysts are on average more accurate and less optimistic than those from analysts employed by independent research firms. Our results are robust to controlling for several relevant factors identified in prior research and are consistent across both annual and quarterly earnings forecasts. We also examine the optimism in long-term earnings growth forecasts and fail to find a significant difference between the two groups.

Properties of Implied Cost of Capital Using Analysts' Forecasts

We evaluate the influence of measurement error in analysts' forecasts on the accuracy of implied cost of capital estimates from various implementations of the 'implied cost of capital' approach, and develop corrections for the measurement error. The implied cost of capital approach relies on analysts' short- and long-term earnings forecasts as proxies for the market's expectation of future earnings, and solves for the implied discount rate that equates the present value of the expected future payoffs to the current stock price. We document predictable error in the implied cost of capital estimates resulting from analysts' forecasts that are sluggish with respect to information in past stock returns. We propose two methods to mitigate the influence of sluggish forecasts on the implied cost of capital estimates. These methods substantially improve the ability of the implied cost of capital estimates to explain cross-sectional variation in future stock returns, which is consistent with the corrections being effective in mitigating the error in the estimates due to analysts' sluggishness.

Analyst Following and Equity Offerings Subsequent to Initial Public Offerings

Analyst forecast information is collected for firms following their IPOs and is used in an examination of subsequent seasoned equity offerings (SEOs). Consistent with information asymmetry arguments, the analysis indicates that a larger percentage of firms conducting SEOs within three years of the IPO are covered by financial analysts than those without SEOs, and that analyst coverage is a significant predictor of subsequent SEOs. In addition, the results indicate that long-term earnings growth forecasts are larger for firms with subsequent SEOs, but growth forecasts decline significantly following the SEOs. Further, SEO abnormal returns exhibit a significant negative relationship with earnings growth forecasts. These results are consistent with “windows of opportunity” arguments since they suggest that SEOs are “timed” to coincide with the peak of earnings growth expectations, but that market participants compensate by reacting more negatively to offerings by firms with high growth forecasts.

Reexamining Stock Valuation and Inflation: The Implications Of Analysts' Earnings Forecasts

This paper examines the effect of inflation on stock valuations and expected long-run returns. Ex ante estimates of expected long-run returns are constructed by incorporating analysts' earnings forecasts into a variant of the Campbell-Shiller dividend-price ratio model. The negative relation between equity valuations and expected inflation is found to be the result of two effects: a rise in expected inflation coincides with both lower expected real earnings growth and higher required real returns. The earnings channel mostly reflects a negative relation between expected long-term earnings growth and expected inflation. The effect of expected inflation on required (long-run) real stock returns is also substantial. An increase of one percentage point in expected inflation is estimated to raise required real stock returns about one percentage point, which on average would imply a 20% decline in stock prices. But the inflation factor in expected real stock returns is also in long-term Treasury yields; consequ...

On the Wages of Temporary Help Service Workers in Germany

This paper produces first econometric estimates for Germany of the contemporanous wage gap associated with Temporary Help Service (THS) employment, as well as the long-term effects of THS work on the future earnings of workers. In addition, we present evidence showing that average male real earnings in the THS industry have declined by about 9% in the period 1975-1995. Our estimates of the overall and group-specific wage gaps attached to THS work are large, albeit significantly smaller than those cited in the existing descriptive literature. Moreover, we find no evidence for any discernable negative average long-term earnings effects of THS work. If anything, THS work seems to have aided workers in putting to a halt declines in their relative earnings observable before joining the THS market.