Dissecting Earnings Recognition Timeliness

Abstract:     
We dissect the portion of stock price change of the fiscal year that is recognized in reported accounting earnings of the year. We call this portion earnings recognition timeliness (ERT). The emphasis in our dissection is on empirical identification of two fundamental precepts of financial accounting: (1) the matching principle, which is manifested in the recognition of expenses in the same period as the related benefits (i.e., sales revenue) accrue; and, (2) recognition of expenses in the current period due to changes in expectations regarding earnings in future periods. The distinction is important because the accounting for these elements (and the associated ERT) differs considerably and it follows that the mapping from returns to these elements, which is the empirical manifestation of ERT, may also differ. The elements of expenses that are matched to sales of the current period and those that are related to expectations of future periods are identified via regressions of annual sales and annual expenses on contemporaneous returns within the fiscal year. The change in the expenses/return coefficient over the year captures the element of expenses that is related to sales of the current year and the end-of-year coefficient captures the expenses that are related to changes in expectations of future sales and future related expenses.

Number of Pages in PDF File: 45

working papers series