Abstract

http://ssrn.com/abstract=2193579
 
 

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Earnings Metrics, Motivated Reasoning and Market Efficiency


W. Brooke Elliott


University of Illinois at Urbana-Champaign

Jessen L. Hobson


University of Illinois at Urbana-Champaign

Brian J. White


University of Texas at Austin - Department of Accounting

December 24, 2012


Abstract:     
We examine the effect of displaying salient, yet redundant, summary measures of firm performance, or “earnings metrics,” on market price efficiency in laboratory markets. Specifically, holding constant the availability of underlying information, we consider the salient display of earnings metrics that (1) aggregate persistent and transitory elements, (2) disaggregate persistent and transitory elements, and (3) include only persistent elements. We find that saliently displaying a disaggregated earnings metric improves market efficiency compared to an aggregated metric, but harms market efficiency compared to a metric that includes only persistent elements. Thus, excluding transitory elements from earnings metrics yields the greatest efficiency benefits, even though traders need this information to accurately estimate fundamental value. We also shed light on the biased judgments of individual traders underlying this result. Specifically, we find that long traders “misunderstand” persistence when transitory earnings are saliently presented in a disaggregated earnings metric and consistent with their directional preference for higher earnings, as evidenced by their upwardly biased bids and less time spent processing underlying information. Our study cautions regulators who seek to “increase the prominence of items reported in other comprehensive income” (FASB [2011], 1).

Number of Pages in PDF File: 46

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Date posted: December 25, 2012  

Suggested Citation

Elliott, W. Brooke and Hobson, Jessen L. and White, Brian J., Earnings Metrics, Motivated Reasoning and Market Efficiency (December 24, 2012). Available at SSRN: http://ssrn.com/abstract=2193579 or http://dx.doi.org/10.2139/ssrn.2193579

Contact Information

W. Brooke Elliott
University of Illinois at Urbana-Champaign ( email )
1206 South Sixth Street
Champaign, IL 61820
United States
Jessen L. Hobson
University of Illinois at Urbana-Champaign ( email )
4011 Business Instructional Facility
515 East Gregory Drive
Champaign, IL 61820
United States
Brian J. White (Contact Author)
University of Texas at Austin - Department of Accounting ( email )
Austin, TX 78712
United States
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References:  52
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