Long-term Earnings Research Articles

Is Debt Maturity Determined by Asymmetric Information about Short-Term or Long-Term Earnings?

This paper empirically examines the effect of asymmetric information between managers and lenders on debt maturity structure of firms. The measures of short and long-term asymmetric information are derived from the dispersion of analysts' earnings forecasts. Short-term information asymmetry positively affects debt maturity. We find no relation between long-term asymmetric information and debt maturity. Goswami, Noe and Rebello (1995) suggest that optimal debt maturity structure depends on the term structure of asymmetric information. Our results provide no support for this model. Next, we focus on short-term asymmetric information. The findings imply that firms with both good news and high short-term asymmetric information rely significantly more on short-term debt. Further, a higher proportion of collateral in informational problematic firms leads to higher debt maturity. The maturity matching is strongly supported.

An analysis of the accuracy of long-term earnings predictions

This paper provides information on the long-term predictive ability of annual earnings numbers. We obtained a sample of 486 calendar, year-end firms that had complete quarterly earnings-per-share (eps) before extraordinary items available from 1978 to 1998. Firm-specific, quarterly, autoregressive-integrated-moving-average (ARIMA) time-series models were used to generate one through five year-ahead annual eps predictions across the 1994–1998 holdout period. Analysis of mean absolute percentage errors indicates: (1) firm-specific ARIMA models outperform so-called, common-structure, “primier” ARIMA models, (2) forecast errors from the firm-specific ARIMA time-series models ranged from 0.358 to 0.547 for one through five year-ahead annual eps predictions, (3) long-term earnings forecast accuracy is linked to firm size and earnings persistence, and (4) further research is needed to develop more powerful, long-term earnings prediction models suitable for use in conjunction with the abnormal earnings valuation model.

The Level and Persistence of Growth Rates

Expectations about long-term earnings growth are crucial to valuation models and cost of capital estimates. We analyze historical long-term growth rates across a broad cross-section of stocks using several indicators of operating performance. We test for persistence and predictability in growth. While some firms have grown at high rates historically, they are relatively rare instances. There is no persistence in long-term earnings growth beyond chance, and there is low predictability even with a wide variety of predictor variables. Specifically, IBES growth forecasts are overly optimistic and add little predictive power. Valuation ratios also have limited ability to predict future growth.

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...

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 (i) lower expected real earnings growth and (ii) 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. A one percentage point increase in expected inflation is estimated to raise required real stock returns about one percentage point, which on average would imply a 20 percent decline in stock prices. But the inflation factor in expected real stock returns is also in long-term Treasury yields; consequently, expected inflation has little effect on the long-run equity premium.

Do Institutional Investors Prefer Near‐Term Earnings over Long‐Run Value?*

AbstractThis paper examines whether institutional investors exhibit preferences for near‐term earnings over long‐run value and whether such preferences have implications for firms' stock prices. First, I find that the level of ownership by institutions with short investment horizons (e.g., “transient” institutions) and by institutions held to stringent fiduciary standards (e.g., banks) is positively (negatively) associated with the amount of firm value in expected nearterm (long‐term) earnings. This evidence raises the question of whether such institutions myopically price firms, overweighting short‐term earnings potential and underweighting long‐term earnings potential. Evidence of such myopic pricing would establish a link through which institutional investors could pressure managers into a short‐term focus. The results provide no evidence that high levels of ownership by banks translate into myopic mispricing. However, high levels of transient ownership are associated with an over‐ (under‐) weighting of near‐term (long‐term) expected earnings, and a trading strategy based on this finding generates significant abnormal returns. This finding supports the concerns that many corporate managers have about the adverse effects of an ownership base dominated by short‐term‐focused institutional investors.

Predicting the next step of a random walk: experimental evidence of regime-shifting beliefs

Barberis et al. (J. Financial Econ. 49 (1998) 307), construct a model in which investors use the prevalence of past trend reversals as an indicator of the likelihood of future reversals. While such ‘‘regime-shifting’’ beliefs are consistent with a variety of psychological theories, other contrary predictions are consistent with the same theories. We report two experiments with MBA-student participants that strongly support the existence of regime-shifting beliefs. We conclude that regime-shifting models can provide a useful framework for understanding market anomalies, including underreactions to earnings changes and overreactions to longterm earnings trends. r 2002 Published by Elsevier Science B.V.

How Do Analysts Use Their Earnings Forecasts in Generating Stock Recommendations?

This paper examines whether valuation estimates based on analysts' earnings forecasts are consistent with their stock recommendations. Because earnings forecasts are linked to value and recommendations reflect analysts' opinions of value relative to current price, earnings forecasts and stock recommendations should be linked in a predictable manner. I consider four possible valuation models of how earnings forecasts and stock recommendations are linked. These models include two specifications of the residual income model, a price-earnings-to-growth (PEG) model, and analysts' projections of long-term earnings growth. The results provide little evidence that analysts' recommendations are explained by either residual income model specification. However, both the PEG model and analysts' projections of long-term earnings growth explain analysts' stock recommendations. The relation between the valuation models and future returns is also examined. Analysts' projections of long-term earnings growth have the greatest explanatory power for stock recommendations, but investment strategies based on these projections have the least association with future excess returns. Overall, the evidence suggests that analysts' recommendations are more correlated with heuristic valuation models than with present value models, and buy-and-hold investors would earn higher returns relying on present value models that incorporate analysts' earnings forecasts than on analysts' recommendations.

Predicting the Next Step of a Random Walk: Experimental Evidence of Regime-Shifting Beliefs

Two experiments with MBA-student participants support Barberis, Shleifer, and Vishny's (1998) prediction that investors expect random-walk sequences to shift between continuation regimes (in which changes tend to be followed by like changes) and reversal regimes (in which changes tend to be followed by reversing changes). As predicted, investors overreacted to changes that were preceded by many continuations, and underreacted to changes that were preceded by many reversals. We conclude that regime-shifting models can provide a useful framework for understanding market anomalies, including underreactions to earnings changes and overreactions to long-term earnings trends.

Research design issues in earnings management studies

This paper discusses trade-offs associated with three research designs commonly used in the earnings management literature: those based on aggregate accruals, those based on specific accruals and those based on the distribution of earnings after management. A key theme of the paper is that empirical procedures for aggregate accruals studies lag both our theories of incentives to manage accruals and our institutional knowledge of how accruals behave. Empirical findings suggest that aggregate accruals models that do not consider long-term earnings growth are potentially misspecified and can result in misleading inferences about earnings management behavior. It is suggested that future progress in the earnings management literature is more likely to come from application of specific accrual and distribution-based tests than from aggregate accruals tests.

Discussion of “The Relation Between Analysts' Forecasts of Long‐Term Earnings Growth and Stock Price Performance Following Equity Officering”

Discussion of “The Relation Between Analysts' Forecasts of Long‐Term Earnings Growth and Stock Price Performance Following Equity Officering”

The Relation between Analysts' Forecasts of Long‐Term Earnings Growth and Stock Price Performance Following Equity Offerings*

AbstractIn this paper we evaluate the role of sell‐side analysts' long‐term earnings growth forecasts in the pricing of common equity offerings. We find that, in general, sell‐side analysts' long‐term growth forecasts are systematically overly optimistic around equity offerings and that analysts employed by the lead managers of the offerings make the most optimistic growth forecasts. In additional, we find a positive relation between the fees paid to the affiliated analysts' employers and the level of the affiliated analysts' growth forecasts. We also document that the post‐offering underperformance is most pronounced for firms with the highest growth forecasts made by affiliated analysts. Finally, we demonstrate that the post‐offering underperformance disappears once we control for the overoptimism in earnings growth expectations. Thus, the evidence presented in this paper is consistent with the “equity issue puzzle” arising from overly optimistic earnings growth expectations held at the time of the offerings.

Is the U.S. Stock Market Myopic?

This paper tests whether the U.S. stock market is myopic in the sense of overvaluing short-term earnings and undervaluing long-term earnings (see, e.g., Porter [1992; 1993]). Our tests rely on an accounting-based valuation model that generates predictions about how prices should relate to expected future earnings under the null hypothesis of market efficiency.' Using this model and Value Line earnings forecasts for a sample of firms during the period 1978-93, we estimate the value an efficient market would have assigned to firms' book values as well as near-term and long-term expected earnings. Regressions of actual stock prices against these estimates (Test 1) are used to infer whether market agents underprice long-term earnings, relative to current book value and near-term earnings. Our regression estimates from Test 1 are consistent with either such mispricing orwith certain forms of measurement error in Value Line data. Analyses of trading strategies that would exploit the mispricing caused by market myopia (Test 2) suggest that measurement error is the

Transitory and persistent earnings components as reflected in analysts' short-term and long-term earnings forecasts: evidence from a nonlinear model

This study uses a nonlinear framework to examine the relative proportion of transitory and persistent earnings components in financial analysts' earnings forecasts for three different time horizons (one quarter ahead, one year ahead, and three-to-five years ahead). We find that the proportion of transitory earnings components in analysts' forecasts decreases as the forecast horizon is extended. Using a nonlinear multivariate model, we find that both short-term and long-term forecast revisions are important for explaining stock price changes. Our study is important to investors because its results are consistent with analysts using short-term earnings forecasts to signal their expectations about a firm's reported GAAP earnings, and longer-term forecasts to convey their expectations about a firm's more persistent earnings. Moreover, both short-term and long-term forecasts are shown to provide value-relevant information to investors. Our study is important to researchers because it suggests that a nonlinear model is more appropriate for describing the relation between returns and analysts' forecast revisions. Prior studies, using linear models, have underestimated the value-relevance of forecast revisions, especially short-term ones.

Do Institutional Investors Prefer Near-Term Earnings over Long-Run Value?

Critics often argue that institutional investors have an excessive focus on short-term firm performance that leads corporate managers to make decisions to boost short-term earnings at the expense of long-run value. This paper examines whether institutional investors exhibit preferences for near-term earnings over long-run value and whether such preferences have implications for firms' stock prices. Using the Ohlson [1995] model, I separate firm value into three components-book value, expected near-term earnings, and expected long-term (terminal) value-and test whether institutions prefer firms for which more of firm value is expected to be realized as near-term earnings rather than as long-term earnings. The results indicate that the level of ownership by institutions with short investment horizons (transient institutions) and by institutions held to stringent fiduciary standards (banks) is positively (negatively) associated with the amount of value in near-term (long-term) earnings. This evidence indicates that institutions with the strongest incentives to favor firms with a high proportion of value in near-term earnings exhibit such preferences. This evidence that banks and transient institutions prefer near-term earnings over long-run value raises the question of whether such institutions myopically price firms, overweighting short-term earnings potential and underweighting long-term earnings potential. Evidence of such myopic pricing would establish a link through which institutional investors could pressure managers into a short-term focus. The results provide no evidence that high levels of ownership by banks translate into myopic mispricing. However, high levels of transient ownership are associated with an over- (under-) weighting of near-term (long-term) expected earnings and a trading strategy based on this finding generates significant abnormal returns. This finding supports the concerns that many corporate managers have about the adverse effects of an ownership base dominated by short-term-focused institutional investors.

The Relation between Analysts' Forecasts of Long-Term Earnings Growth and Stock Price Performance Following Equity Offerings

We evaluate the role of sell-side analysts' long-term earnings growth forecasts in the pricing of common equity offerings. We find that, in general, sell-side analysts' long-term growth forecasts are systematically overly optimistic around equity offerings and that analysts employed by the lead managers of the offerings make the most optimistic growth forecasts. Additionally, we find a positive relation between the fees paid to the affiliated analysts' employers and the level of the affiliated analysts' growth forecasts. We also document that the post-offering under performance is most pronounced for firms with the highest growth forecasts made by affiliated analysts. Finally, we demonstrate that the post-offering under performance disappears once we control for the over optimism in earnings growth expectations. Thus, the evidence presented in this paper is consistent with the 'equity issue puzzle' arising from overly optimistic earnings growth expectations held at the time of the offerings.

Policy reform dilemmas in promoting employment of persons with severe mental illness.

Recent evaluations by the U.S. General Accounting Office and the National Alliance for the Mentally Ill of reemployment efforts of the federal-state vocational rehabilitation program found that services offered by state vocational rehabilitation agencies do not produce long-term earnings for clients with emotional or physical disabilities. This paper examines reasons for these poor outcomes and the implications of recent policy reform recommendations. Congress must decide whether to take action at the federal level to upgrade programs affecting persons with severe mental illnesses or to continue to rely on state decision making. The federal-state program largely wastes an estimated $490 million annually on time-limited services to consumers with mental illnesses. Rechanneled into a variety of innovative and more appropriate integrated services models, the money could buy stable annual vocational rehabilitation funding for 62,000 to 90,000 consumers with severe mental illnesses. Larger macrosystem problems involve the dynamics of the labor market that limit job opportunities and the powerful work disincentives for consumers with severe disabilities now inherent in Social Security Disability Insurance, Supplemental Security Income, Medicare, and Medicaid.

Job Displacement

The past decade and a half has seen tremendous research growth in the area of job displacement. This paper discusses the state of knowledge on the issues and questions of job loss. The 1984-96 Displaced Worker Surveys are used to describe how the characteristics of displacement are changing to include more college educated, white collar, and nonmanufacturing workers. For many workers, the long-term earnings losses following displacement are large due to the loss of firm-specific human capital. More research is needed on the questions of the causes of job displacement and on the efficacy of employment and training programs.

The Partners of Welfare Mothers: Potential Earnings and Child Support

Public interest in promoting the self-sufficiency of families that depend on welfare concerns the ability of fathers, as well as mothers, to support their children through employment. Many welfare recipients are never-married women, and their children seldom receive child support payments. This article estimates the financial resources that go untapped when child support is not collected from the men who father children who later receive AFDC benefits. While these men may earn little at the time the child is born, their incomes are likely to escalate over time. The child support payments they would make over the child's first 18 years equal almost half of the welfare benefit received by the mother and child. Based on these probable long-term earnings, the authors urge policymakers to invest in efforts to establish paternity and collect child support.

The Education and Labor Market Outcomes of Adolescent Fathers

The author examines the educational and labor market outcomes of young men in the United States, with a particular emphasis on adolescent fathers. She finds that men who were teen fathers complete fewer years of education and are less likely to finish high school compared to men who were not teen fathers. These educational deficits persist even after family and personal characteristics are taken into account. Teen fathers enter the labor market earlier and initially earn more money than do other men; by the time teen fathers reach their mid-20s, however, they earn less. After controlling for personal traits and family background, the long-term earnings deficits of teen fathers disappear, implying that teen fathers are as capable of providing for their children as are other young men from similarly disadvantaged backgrounds. Unfortunately, this will not ease the jobs of child support enforcement officials, who must regularly confront young, low-income, absent fathers and/or improve the plight of welfare-dependent and other impoverished children. Data are from the National Longitudinal Survey of Labor Market Participation—Youth Cohort.