• Selected
• Entire List

Abstract:
Basu (1997) views earnings conservatism as being exhibited in a shift in the relationship between returns and earnings when returns are negative. The shift means that a given level of return is associated with a lower level of earnings (or alternatively, a given change in earnings is associated with a smaller change in returns). This arises because earnings is more closely aligned with returns when returns are negative. We argue that the Basu model will indicate that earnings conservatism exists even when it is absent. This result is driven by observations on returns which are negative but very close to zero. Empirically, we find that the Basu model does not indicate earnings conservatism when these observations are excluded.

Within the Basu framework, we suggest a more appropriate test. However, we find the opposite of earnings conservatism; a given change in earnings gives rise to a larger change in returns. We argue that the explanation for this finding is that when returns are negative, a downward adjustment of expectations will have taken place. In these circumstances, it seems prudent that the market should place more weight on current performance.

Capital markets, earnings-return relation, negative returns

Abstract:
The generally accepted factors that determine the bid-ask spread are volatility, trading volume and market value (Atkins and Dyl, 1997; Glosten and Harris, 1988; and Menyah and Paudyal, 2000). Following Kim and Verrecchia (1994) we include a measure of the disagreement in analysts' earnings forecasts in our model of the bid ask spread. This measure serves as a proxy for the informational disadvantage of market makers with respect to informed traders. Market makers respond to the additional risk by increasing the bid-ask spread. We find that the disagreement amongst analysts is significant for horizons up to and including six months (and with the hypothesised sign) in explaining FTSE 100 company spreads, rendering strong empirical support for our model.

spread, analysts' forecasts, trading volume, volatility of returns

Abstract:
We revisit the debate on the interpretation given to prior-year earnings changes in predicting analysts' future forecast errors. We advance a new specification of this relation that distinguishes between earnings reversion and momentum. For a large UK dataset for the years 1990-1996, we find substantial underreaction, particularly in situations of earnings momentum. We find that underreaction is further increased for cases of downward earnings momentum when the analyst's merchant bank acts as a broker to the company. We interpret this as a reporting bias caused by an analyst's response to bad news being compromised.