Short-run Earnings Research Articles

Comparing earnings outcome differences between all graduates and title IV graduates

Recently, two public data products have been released that publish earnings outcomes for college graduates by program of study and institution: Post-Secondary Employment Outcomes and College Scorecard, from the Census Bureau and U.S. Department of Education, respectively. While the earnings data underlying the data products is similar, the purposes and scope of the products are different. College Scorecard focuses only on graduates that receive Title IV aid, while PSEO includes all graduates. This paper describes how the differences in these two samples affect the published earnings outcomes. For institutions in my sample, an average of sixty percent of baccalaureate graduates receive Title IV aid. I show that short-run earnings outcomes are very similar for these two samples, while longer-run outcomes (10 years after graduation) are significantly lower for the Title IV population, and that this difference grows consistently over time. I also show that program ranking can change significantly when considering the Title IV population rather than the entire graduate population.

Global economic fluctuations and human development: how is the impact transmitted in Egypt?

Purpose This paper aims to investigate the relationship between global economic fluctuations and human development through four transmission channels (foreign direct investment (FDI), official development aid (ODA), remittances and export earnings) in Egypt as an open developing economy, in the period 1990–2015. Design/methodology/approach The paper uses a vector autoregressive model, which implies examining the impulse response functions and variance decompositions. Findings The results indicate that human development is negatively affected by global economic fluctuations through the four channels, namely, ODA, FDI, export earnings and remittances. In addition, the most effective transmission channels are FDI in the short run and export earnings in the long run. Originality/value While a large body of literature addresses the direct impact of business cycles and economic shocks on human development, only some studies focus on the indirect impact. The contribution is to identify the indirect impact of global economic fluctuations on human development in a developing economy, considering four transmission channels and to determine the most important of these channels. Moreover, using the human development index is an addition in this paper as most previous literature depends on other human development indicators such as children’s health, employment and schooling.

Peer firms’ earnings predictability and pricing efficiency – evidence from IPOs*

We examine the effect of peer firms’ earnings predictability on initial public offering (IPO) underpricing by investigating whether peer firms’ financial characteristics affect IPO pricing and whether the information disseminated by the IPO firm changes product market competition. Analyzing 5,264 IPOs in the 1976–2012 period using data from multiple sources, we find that IPO firms whose peer firms have long-run earnings predictability tend to have lower underpricing compared to those with short-run earnings predictability. Our study makes three central contributions. First, it shows that investors do not consider IPO firms in isolation from their peer firms and that IPO underpricing is highly dependent on peer firms’ earnings characteristics. Second, it demonstrates that the market does not always consider earnings predictability to be a desirable attribute, which has practical implications for regulators and firms. Third, we find that product market competition from peer firms and managerial ability both affect IPO underpricing. These results suggest that investors might interpret short-run peer firms’ earnings predictability as evidence that a majority of the firms in the industry engage in myopic behaviors, while they might interpret long-run peer firms’ earnings predictability as a signal that the majority of firms in the industry have stable cash flows.

Estimating the Equity Risk Premium Using Implied Cost of Capital

Research on the implied cost of capital (ICC) has found that the equity risk premium is approximately 3%, on average, much lower than estimates based on the mean of historical stock market returns. The validity of such ICC estimates, however, faces both theoretical and empirical challenges. The theoretical equivalence between ICC and expected return requires the stringent condition that the latter is a constant, which is inconsistent with theory and empirical evidence. The empirical estimation of ICC depends on short-run and long-run earnings forecasts, whose biases can severely limit the validity of the estimates. By employing a forecasting procedure that induces little bias in both short-run and long-run forecasts and taking into account the stochastic nature of expected returns, we show that the average market risk premium ranges between 3% and 6%. We also demonstrate that the results of prior research are affected by input errors that are partially self-canceling.

Within- and Cross-Firm Mobility and Earnings Growth

A widely accepted premise is that promotions within firms and mobility across firms lead to significant earnings progression. Existing research generally has examined cross-firm mobility separately from hierarchical advancement. Yet, as the authors’ descriptive evidence from Danish panel data shows, how the two types of mobility interact is important for understanding earnings growth. Cross-firm moves at the nonexecutive level provide sizable short-run earnings growth (similar to the effect of being promoted to an executive position). These gains, however, appear modest compared with the persistent impact on earnings growth of promotions (either within or across firms) and subsequent mobility at a higher hierarchy level.

Implied returns, costly reversibility and the value premium

The countercyclical price of risk is revealed through declining earnings, dividends, equity book and equity market values, short-run earnings expectations and increasing market returns (k), risk premiums (MRP) and book-to-market (BM) with contractions. Consistent with costly reversibility, high BM firms with more fixed assets are less profitable and dispose of more fixed assets during contractions than low BM firms. Support for costly reversibility looking at k and MRP is found when firms are ranked according to fixed-asset-to-total-assets (FATA) but not BM. Low BM firms with generally lower k and MRP experience greater increases in k and MRP than high BM firms during contractions whereas high FATA firms with generally lower k and MRP experience greater increases in k and MRP than low FATA firms during contractions. With expected earnings growth increasing for high BM firms, BM as a measure to distinguish between growth and value is challenged. Thus, while support is provided for costly reversibility, it is limited in explaining the value premium.

The Pricing of Growth Opportunity and Stock Market Liquidity

This study presents a simple asset pricing model with liquidity, short-run earnings growth, and long-run growth opportunity as risk factors and with the presence of transaction costs. The model provides a framework for understanding the channel through stock market liquidity affects asset prices by aligning growth opportunity. Empirical results suggest that the return sensitivity to growth and liquidity sensitivity to growth appear to be the most important sources of risks in determining the asset prices. Furthermore, the Granger causality test suggests the systematic liquidity variation through the business cycle is related to the growth opportunity. Liquid stock recover faster than illiquid stocks in response to the upcoming growth opportunity by the end of market downturns and therefore illiquid stocks that are unable to respond to growth opportunity are riskier in face of market shocks. Overall, the findings of this paper shed light on a new channel which liquidity risk affect asset prices and complement the mechanism of “flight to quality”.

Net Impact Estimates of the Workforce Development System in Washington State

This study estimates the net impacts and private and social benefits and costs of nine workforce development programs administered in Washington State. Five of the programs serve job-ready adults: Community and Technical College Job Training, Private Career Schools, Apprenticeships, Job Training and Partnership Act (JTPA) Title III programs, and Community and Technical College Worker Retraining. Two of the programs serve adults with employment barriers: Community and Technical College Adult Basic Skills Education and JTPA Title II-A programs. The other two programs serve youth: JTPA Title II-C programs and Secondary Career Technical Education. The net impact analyses were conducted using a nonexperimental methodology. Individuals who encountered the workforce development programs were statistically matched to individuals who did not. Administrative data with information from the universe of program participants and Employment Service registrants (who served as the comparison group pool) supported the analyses. These data included over 10 years of pre-program and outcome information including demographics, employment and earnings information from the Unemployment Insurance wage record system, and transfer income information such as Food Stamp and Temporary Assistance for Needy Families (TANF) recipiency and benefits. A variety of estimation techniques were used to calculate net impacts including comparison of means, regression-adjusted comparison of means, and difference-in-difference comparison of means. We estimated short-run net impacts that examined outcomes for individuals who exited from the education or training programs (or from the employment service) in the fiscal year 1999/2000 and longer-run impacts for individuals who exited in the fiscal year 1997/98. Short- run employment impacts are positive for seven of the nine programs and negative for the other two. Short-run earnings impacts are insignificant for four of the programs, negative for two, and positive for the remaining three. The longer-run impacts are more sanguine. Employment impacts are positive for all nine programs, and earnings are positive for seven and insignificantly different from zero for the other two. The benefit-cost analyses show that all of the programs have discounted future benefits that far exceed the costs for participants, and that society also receives a positive return on investment.

Does the color of the collar matter? Employment and earnings after plant closure

We investigate whether the costs of job displacement differ between blue and white collar workers. In the short-run earnings and employment losses are substantial for both groups but stronger for white collars. In the long run, there are only weak effects for blue collar workers but strong and persistent effects for white collars.

Does the Color of the Collar Matter? Firm Specific Human Capital and Post-Displacement Outcomes

We investigate whether the costs of job displacement differ between blue collar and white collar workers. In the short run earnings and employment losses are substantial for both groups but stronger for white collar workes. In the long run, there are only weak effects for blue collar workers but strong and persistent effects for white collars. This is consistent with the idea that firm-specific human capital and internal labor markets are more important in white-collar than in blue collar jobs.

The Economic Implications of Corporate Financial Reporting

We survey 401 financial executives, and conduct in-depth interviews with an additional 20, to determine the key factors that drive decisions related to reported earnings and voluntary disclosure. The majority of firms view earnings, especially EPS, as the key metric for outsiders, even more so than cash flows. Because of the severe market reaction to missing an earnings target, we find that firms are willing to sacrifice economic value in order to meet a short-run earnings target. The preference for smooth earnings is so strong that 78% of the surveyed executives would give up economic value in exchange for smooth earnings. We find that 55% of managers would avoid initiating a very positive NPV project if it meant falling short of the current quarter's consensus earnings. Missing an earnings target or reporting volatile earnings is thought to reduce the predictability of earnings, which in turn reduces stock price because investors and analysts hate uncertainty. We also find that managers make voluntary disclosures to reduce information risk associated with their stock but try to avoid setting a disclosure precedent that will be difficult to maintain. In general, management's views provide support for stock price motivations for earnings management and voluntary disclosure, but provide only modest evidence in support of other theories of these phenomena (such as debt, political cost and bonus plan based hypotheses).

PE Ratios, PEG Ratios, and Estimating the Implied Expected Rate of Return on Equity Capital

I describe a model of earnings and earnings growth and I demonstrate how this model may be used to obtain estimates of the expected rate of return on equity capital. These estimates are compared with estimates of the expected rate of return implied by commonly used heuristics—viz., the PEG ratio and the PE ratio. Proponents of the PEG ratio (which is the price-earnings [PE] ratio divided by the short-term earnings growth rate) argue that this ratio takes account of differences in short-run earnings growth, providing a ranking that is superior to the ranking based on PE ratios. But even though the PEG ratio may provide an improvement over the PE ratio, it is arguably still too simplistic because it implicitly assumes that the short-run growth forecast also captures the long-run future. I provide a means of simultaneously estimating the expected rate of return and the rate of change in abnormal growth in earnings beyond the (short) forecast horizon—thereby refining the PEG ratio ranking. The method may also be used by researchers interested in determining the effects of various factors (such as disclosure quality, cross-listing, etc.) on the cost of equity capital. Although the correlation between the refined estimates and estimates of the expected rate of return implied by the PEG ratio is high, supporting the use of the PEG ratio as a parsimonious way to rank stocks, the estimates of the expected rate of return based on the PEG ratio are biased downward. This correlation is much lower and the downward bias is much larger for estimates of the expected rate of return based on the PE ratio. I provide evidence that stocks for which the downward bias is higher can be identified a priori.

PE Ratios, PEG Ratios, and Estimating the Implied Expected Rate of Return on Equity Capital

I describe a model of earnings and earnings growth and I demonstrate how this model may be used to obtain estimates of the expected rate of return on equity capital. These estimates are compared with estimates of the expected rate of return implied by commonly used heuristics - viz., the PEG ratio and the PE ratio. Proponents of the PEG ratio (which is the price-earnings (PE) ratio divided by the short-term earnings growth rate) argue that this ratio takes account of differences in short-run earnings growth providing a ranking that is superior to the ranking based on PE ratios. But even though the PEG ratio may provide an improvement over the PE ratio, it is arguably still too simplistic because it implicitly assumes that the short-run growth forecast also captures the long-run future. I provide a means of simultaneously estimating the expected rate of return and the rate of change in abnormal growth in earnings beyond the (short) forecast horizon - thereby refining the PEG ratio ranking. The method may also be used by researchers interested in determining the effects of various factors (such as disclosure quality, cross-listing, etc.,) on the cost of equity capital. Although the correlation between the refined estimates and estimates of the expected rate of return implied by the PEG ratio is high supporting the use of the PEG ratio as a parsimonious way to rank stocks, the estimates of the expected rate of return based on the PEG ratio are biased downwards. This correlation is much lower and the downward bias is much larger for estimates of the expected rate of return based on the PE ratio. I provide evidence that stocks for which the downward bias is higher can be identified a priori.

The age profile of mobility measures: an application to earnings in West Germany

This paper develops a technique for estimating age-profiles of earnings mobility using conditional kernel density estimation and establishes their statistical properties. Both pointwise and simultaneous confidence intervals are derived. The paper then examines the age-profile of short-run earnings mobility in Germany between 1983 and 1993 using the Socio-Economic Panel data. It turns out that earnings mobility is significantly higher for young people than for elder ones. Mobility declines rather rapidly until the age of thirty-five or so and remains constant thereafter. The shape of the profile does not change significantly during the observation period. © 1998 John Wiley & Sons, Ltd.

Racial Differences in Short-Run Earnings Stability and Implications for Credit Markets

This paper examines the claim that observed racial differences in rejection rates for mortgage applications, which persist after controlling for many relevant factors, are due to racial differences in short-run earnings stability, which has not typically been included in empirical tests. The evidence does not support the proposition that blacks suffer from greater earnings instability than comparable whites, as few consistent significant differences between black and white earnings volatility are found. Only in the case of drastic earnings shocks with persistent effects does the possibility of significant racial differences reasonably remain. In general, racial differences in earnings stability appear to be minor and are unlikely to result in substantial differences in creditworthiness

Racial Differences in Short-Run Earnings Stability and Implications for Credit Markets

This paper examines the claim that observed racial differences in rejection rates for mortgage applications, which persist after controlling for many relevant factors, are due to racial differences in short-run earnings stability, which has not typically been included in empirical tests. The evidence does not support the proposition that blacks suffer from greater earnings instability than comparable whites, as few consistent significant differences between black and white earnings volatility are found. Only in the case of drastic earnings shocks with persistent effects does the possibility of significant racial differences reasonably remain. In general, racial differences in earnings stability appear to be minor and are unlikely to result in substantial differences in creditworthiness.

AN EXPERIMENTAL STUDY OF ANALYSTS' REACTIONS TO CORPORATE R&D EXPENDITURE

Company management have incentives to consider the impact of their decisions on short-term reported earnings if either investors adopt a mechanistic approach to earnings numbers or behave myopically. Previous research, mainly in the US, suggests that, while individuals may respond mechanistically to earnings numbers, investors in aggregate (i.e. the market) do not. Similarly, evidence suggests that company management may believe the market to be short-termist, whereas research has indicated that, at least in relation to R&D expenditure announcements, it is not. The present study investigates whether UK investment analysts exhibit mechanistic or myopic tendencies with respect to research and development expenditure. Two experimental studies using a postal questionnaire were undertaken in which investment analysts were asked to forecast earnings and market values of electronics companies based on simulated financial statements. The first experiment involved two companies which were identical in all respects except for the method used to account for R&D expenditure. The mean market value estimates for the companies were almost identical, a result which is inconsistent with a mechanistic approach. Analysts did not seem to be misled by the higher earnings reported for the company capitalizing R&D expenditure. In the second experiment, the only difference between the two companies was that one invested in tangible fixed assets rather than in R&D. In this case, the mean market value estimate for the R&D spender was significantly higher. This suggests that analysts recognize the importance of long-term R&D investment and are not myopic in this respect. Overall, the results imply that company management's pre-occupation with short-run earnings may be unnecessary.

Analysts' use of earnings forecasts in predicting stock returns: Forecast horizon effects

Little attention has been paid to a principal decision context in which analysts' earnings forecasts are prepared, namely, as an input to their recommendations. We use two data sets, Value Line, USA, and Research Evaluation Service, Canada, and examine the importance of analysts' earnings forecasts for their stock price forecasts via three hypotheses: (1) analysts' earnings forecasts are important for their stock price forecasts; (2) analysts' long-term earnings forecasts are more important than their short-term earnings forecasts for their predictions of stock prices over a particular stock price forecast horizon; (3) the importance of analysts' earnings forecasts for their stock price forecasts rises as the joint earnings and stock price forecast horizon increases. We show that: (1) when the earnings forecast horizon is the next fiscal year, forecasted earnings explain only 30% of the variation in forecasted price; (2) the importance of forecasted earnings for forecasted price rises as the earnings forecast horizon increases; (3) in the long run, (i.e. three to five years hence), forecasted earnings explain about 60% of the variation in forecasted price. Decision usefulness is an ex ante concept, but tests regarding the usefulness of earnings for stock price generally have used actual (not expectational) data. Our evidence suggests that earnings expectations are decision useful, where the decision context is sell-side analysts' stock price forecasts. Our results are potentially important to users of sell-side analyst research reports. When a stock recommendation is accompanied only by short-run earnings forecasts, investors need to closely examine estimates of non-earnings variables to assess the quality of stock recommendations. In contrast, when stock recommendations are accompanied by both short-run and long-run earnings forecasts, investors need to examine estimates of non-earnings information variables less closely.

The Adjustment of Dividends to Permanent Earnings

A fundamental issue in corporate finance is whether dividend changes convey information about future earnings of the firm. There is an extensive literature in finance and accounting which discusses this issue.' However, these studies have yielded puzzling results. Studies using the eventstudy methodology and the cross-sectional regression approach have usually found a significant relationship between dividend changes and subsequent earnings. On the other hand, empirical studies based on time-series regression by Watts [32] and Gonedes [8] have found that dividends convey little information about subsequent earnings. Most of the previous studies have examined the relationship between dividends and reported earnings or the relationship between dividends and analyst earnings forecasts. However, as Nakamura and Nakamura [26] suggested, dividend changes may be related to the permanent earnings of the firm. If managers have superior information to investors on future earnings, they should be able to form more precise estimates of permanent earnings. Managers may then use dividends as an instrument to reflect their beliefs about the likely changes in permanent earnings. Thus, consistent with Lintner's [19] observations, an increase in current earnings which reverses in subsequent periods would typically not elicit a dividend change, whereas an increase in earnings that is expected to persist would lead to a dividend change. The use of reported earnings figures, rather than permanent earnings, in the empirical examination may explain the puzzling results documented in previous dividend studies. If managers indeed determine dividends based on their forecasts of permanent earnings, empirical investigation using either reported earnings or short-run earnings forecasts will be subject to a serious measurement error. This measurement problem could distort the empirical relationship in dividend-earnings studies. In this paper, we propose a permanent earnings model to explain the corporate dividend behavior. The model is an extension of the previous partial adjustment models of dividends by

Internal corporate restructuring: An empirical analysis

Firms that alter their divisional configurations on average increase shareholder wealth. Gains appear to come from information about investment opportunities and increases in efficiency. Performance before the restructurings suggests poorly organized firms are motivated by market pressures to change their organizations. Change also occurs in healthy firms as part of the growth process. Restructuring often occurs where there is no evidence of takeover threats. While stock prices increase around the restructurings, there is a contemporaneous decline in earnings due to increased expenses. These findings appear inconsistent with the contention that the market pressures managers into focusing on short-run earnings.