Economic persistence, earnings informativeness, and stock return regularities

Kai Du () and Steven Huddart
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Kai Du: Pennsylvania State University

Review of Accounting Studies, 2020, vol. 25, issue 4, No 3, 1263-1300

Abstract: Abstract We propose a simple framework for understanding accounting-based stock return regularities. A firm’s accounting reports provide noisy information about hidden economic states that evolve according to a Markov process. In response to the accounting reports, a representative Bayesian investor forms beliefs about the underlying state and hence the value of the firm. For a population of such firms, the model provides predictions consistent with two sets of well-documented regularities: (i) the market reaction to an earnings announcement that ends a string of consecutive earnings increases and (ii) the return predictabilities based on accruals and book-tax differences. The model also yields novel cross-sectional predictions about the distinct roles of economic persistence and earnings informativeness. We confirm these predictions through empirical tests.

Keywords: Economic persistence; Earnings informativeness; Earnings strings; Accruals anomaly; Book-tax differences anomaly (search for similar items in EconPapers)
JEL-codes: G12 M41 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s11142-020-09531-2

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