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Value Relevance of Earnings Changes and Levels

Takashi Obinata
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Takashi Obinata: Faculty of Economics, The University of Tokyo

No CARF-J-043, CARF J-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: The purpose of this paper is to investigate the value relevance of current year earnings with condition of previous year earnings. First, since negative changes in earnings may contain more transitory elements, the capitalization coefficient on earnings decrease is smaller. However, that asymmetry of coefficients is determined not only by the direction of earnings changes, but also by environmental conditions. The asymmetric effects are not observed in some industry sectors and periods. Second, we cannot detect the sufficient evidence supporting the hypothesis that current earnings would contain more transitory elements as the size of changes in earnings becomes larger, i.e. S shaped response hypothesis. On the contrary the large size increase in earnings is more persistent than the smaller. In some industry sectors and periods, we find the evidence supporting the capitalization coefficient of earnings levels with larger positive changes is larger than the smaller, i.e. J shaped relationship between earnings and firm value.Third, the value relevance of earnings changes and levels differs among the sign of the previous year earnings. This effect of previous year earnings also depends on the environmental conditions of industries and years.

Pages: 54 pages
Date: 2007-10
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