Aggregate accounting earnings can explain most of security returns

Easton, Peter D.; Harris, Trevor S.; Ohlson, James A.

doi:10.1016/0165-4101(92)90015-t

Cited by 386 publications

(293 citation statements)

References 18 publications

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“…Many of the other Stern Stewart adjustments to GAAP earnings relate to accounting treatment and timing differences and we expect, based on the prior literature, that the effect of these to be less evident in our long-window research design. For example, O'Hanlon and Pope (1999) find little evidence that dirty-surplus flows (e.g., goodwill, prioryear adjustments) are value relevant in explaining valuation errors using long-window tests similar to Easton, Harris and Ohlson (1992). Further, in a cross-country comparison, Isidro, O'Hanlon and Young (2006) report similar findings for the UK, but also report some weak 'predictable' evidence between dirty-surplus flows and valuation errors for the US.…”

Section: Introductionmentioning

confidence: 55%

A Comparison of Error Rates for EVA, Residual Income, GAAP-earnings and Other Metrics Using a Long-Window Valuation Approach

Forker

Powell

2008

European Accounting Review

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Predictability and variability are two measures commonly used in the empirical literature to gauge the quality of earnings and hence, decision usefulness to investors. We adopt both measures to investigate empirically the relative quality of Stern Stewart's measure of economic value added (EVA) compared to GAAP (generally accepted accounting principles) earnings, residual income, cash flows and other mandated metrics in the USA and UK. We proxy for accounting quality by applying a long-window methodology to obtain hindsight valuation errors based on the difference between ex ante market value and discounted ex post metrics. Decision usefulness, in terms of ease of forecasting, is proxied by differences in valuation errors between the benchmark and alternative accounting methods. Contrary to the Biddle et al. (Journal of Accounting and Economics, 24, pp. 301-336, 1997) finding that mandated earnings were superior to EVA and residual income, we find that EVA and other residual income metrics consistently give rise to lower average valuation errors and thus have higher predictability across a variety of windows and terminal dates. Further, on the basis of our second measure of accounting quality, the variability of valuation errors, EVA performs best in the USA and third in the UK. The results strongly indicate that differences between residual income constructs, including EVA, are generally small but that earnings quality will be improved by recognition of a cost of equity capital in measuring reported income.

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Section: Introductionmentioning

confidence: 55%

A Comparison of Error Rates for EVA, Residual Income, GAAP-earnings and Other Metrics Using a Long-Window Valuation Approach

Forker

Powell

2008

European Accounting Review

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“…Equation (1) is rationalised by the anecdote that earnings reliability captures the information of management opportunistic accounting adjustments (Klein, 2002) and that the presence of strong governance control is imperative to indicate high accounting reliability. Prior studies suggest that the incident of deteriorating accounting reliability is apparently due to both the informational and opportunistic (political cost, debt and equity contracting hypotheses) (Godfrey et al, 2006;Dechow et al, 1996) manipulations of accounting accruals (e.g., Ho & Sia, 2007, Dechow et al, 1995, Easton et al, 1992, Jones, 1991. Whereas, EARNREL j,t is the proxy of accounting earnings reliability established from Sloan"s (1996) theoretical work on earnings persistency.…”

Section: Testing Of Managerial Opportunism and Corporate Governance Omentioning

confidence: 99%

The Impact of Managerial Opportunism on Earnings Reliability

Chang¹

2015

IJEF

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This study is motivated by the increasing incidences of corporate failures caused by fraudulent accounting and breaches in corporate governance and ethical conducts. For example, it is expected that managers will resort to activities that are not consistent with appropriate governance and ethics just to keep up with the market expectations to safeguard their position. This study investigates the impact of five managers" opportunistic incentives on the reliability of firms" reported earnings (namely free cash flow, abnormal capital expenditure, bonus plan, distress sign and leverage), controlled by six other widely implemented standard structural governance mechanisms. The earnings reliability tests are conducted using the balanced panel data analysis specification covering 323 sample firms with continuous accounting and corporate governance data of 15 years beginning 1993. Consistent with literature, the results reveal that firms" earnings reliability is significantly related to all managerial opportunism attributes, implying the adverse effect of these incentives on the usefulness of accounting information in assessing management"s stewardship. These findings suggest the need for a better management mechanism to integrate governance and effective enforcement of control requirements to mitigate managerial opportunism and hence uphold the quality of published accounting information.

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“…Even though discounted cash flow analysis has much value missing from the balance sheet (such that typically Pt+T -Bt+T > Pt+T), it survives without error if one expects the premium of price over net debt to be constant. 6 Easton et al (1992) first invoked the idea in a valuation setting. Ohlson (2005) elaborates.…”

Section: P Earnings R T T T T +mentioning

confidence: 99%

Financial Forecasting, Risk and Valuation: Accounting for the Future

Penman

2010

Abacus

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Valuation involves forecasting payoffs and discounting expected payoffs for risk. Forecasting is often seen as the province of the statistician, risk determination the province of asset pricing. This paper elaborates on the idea that financial forecasting, risk determination and valuation are a matter of accounting.Accounting not only provides information to forecast payoffs but also specifies the payoffs to be forecasted. Further, accounting determines the transition from the present to the future and thus implicitly the evolutionary parameters that a statistician might estimate for forecasting. Accounting also bears on risk determination in the way it handles uncertainty. Accordingly, accounting is involved in both the numerator and the denominator of a valuation model. Indeed, a valuation model is a model of accounting for the future, and the effectiveness of a valuation model rides on the accounting principles employed.

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Aggregate accounting earnings can explain most of security returns

Cited by 386 publications

References 18 publications

A Comparison of Error Rates for EVA, Residual Income, GAAP-earnings and Other Metrics Using a Long-Window Valuation Approach

A Comparison of Error Rates for EVA, Residual Income, GAAP-earnings and Other Metrics Using a Long-Window Valuation Approach

The Impact of Managerial Opportunism on Earnings Reliability

Financial Forecasting, Risk and Valuation: Accounting for the Future

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