Intertemporal Variation in the Information Content of Aggregate Earnings and its Effect on the Aggregate Earnings-Return Relation

We develop and test explanations for sources of intertemporal variation in the information content of aggregate earnings and how that variation explains variation in the relation between aggregate earnings growth and market returns over time. We find that the correlation between aggregate earnings growth and leading market-wide real output shocks (measured by the growth in the Federal Reserve Board’s index of industrial production) becomes more pronounced in the 1990s and 2000s, which explains why the aggregate earnings-return relation is significantly positive in this period. Further analysis shows that an increasingly positive relation between aggregate earnings growth and real output shocks is attributable to the changing nature of the economic activity in the United States, namely, a shift in the composition of firms toward financial services and away from manufacturing. Changes in accounting measurement rules over time to include more fair value estimates also play a role in explaining why the aggregate earnings–return relation has become significantly positive in recent decades.

Keywords: aggregate earnings; aggregate earnings-return relation; market returns; real output; industrial production growth; financial sector; fair value accounting

JEL Classification: E30, G10, M41

Suggested Citation: Suggested Citation

Kim, Jaewoo and Schonberger, Bryce and Wasley, Charles E. and Land, Hunter, Intertemporal Variation in the Information Content of Aggregate Earnings and its Effect on the Aggregate Earnings-Return Relation (January 15, 2020). Review of Accounting Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2746508 or http://dx.doi.org/10.2139/ssrn.2746508