The Aggregate Earnings-Return Relationship: A Global Perspective

Abstract:     
This article examines the relationship between aggregate earnings and returns (ERC) in a global context. We examine a broad international sample of countries which encompass markets with different levels of stock market development, shareholder protection and legal origin. Recent literature finds a puzzlingly negative relationship between aggregate earnings and aggregate returns in the US (Kothari, Lewellen and Warner, 2006; Sadka and Sadka, 2009). Our first main finding is that this puzzlingly negative relationship is not universal.

The relationship between aggregate earnings and each return component (Campbell, 1991) is examined. Empirical results suggest each of these three components play a role in explaining the overall ERC. In particular, we find that cash flow news and discount rate news are both individually important determinants of the earnings-return relationship but they generally offset each other. The expected earnings-return relation also contributes to the aggregate earnings-return coefficient; this effect varies substantially across countries. The dispersion of aggregate ERC across countries is weakly associated with stock market development, shareholder protection and legal origin.

Keywords: global aggregate earnings-return relation, ERC, return decomposition

JEL Classification: G10, G15, G30

working papers series