Earnings Quality Measures and Excess Returns

27 Pages Posted: 26 Jul 2014

See all articles by Pietro Perotti

Pietro Perotti

University of Bath - School of Management

Alfred Wagenhofer

University of Graz

Multiple version iconThere are 2 versions of this paper

Date Written: June/July 2014

Abstract

This paper examines how commonly used earnings quality measures fulfill a key objective of financial reporting, i.e., improving decision usefulness for investors. We propose a stock‐price‐based measure for assessing the quality of earnings quality measures. We predict that firms with higher earnings quality will be less mispriced than other firms. Mispricing is measured by the difference of the mean absolute excess returns of portfolios formed on high and low values of a measure. We examine persistence, predictability, two measures of smoothness, abnormal accruals, accruals quality, earnings response coefficient and value relevance. For a large sample of US non‐financial firms over the period 1988–2007, we show that all measures except for smoothness are negatively associated with absolute excess returns, suggesting that smoothness is generally a favorable attribute of earnings. Accruals measures generate the largest spread in absolute excess returns, followed by smoothness and market‐based measures. These results lend support to the widespread use of accruals measures as overall measures of earnings quality in the literature.

Keywords: earnings quality, excess returns, abnormal returns, accruals quality, smoothing, value relevance

Suggested Citation

Perotti, Pietro and Wagenhofer, Alfred, Earnings Quality Measures and Excess Returns (June/July 2014). Journal of Business Finance & Accounting, Vol. 41, Issue 5-6, pp. 545-571, 2014. Available at SSRN: https://ssrn.com/abstract=2472218 or http://dx.doi.org/10.1111/jbfa.12071

Pietro Perotti (Contact Author)

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

HOME PAGE: http://www.bath.ac.uk/management/faculty/pietro-perotti.html

Alfred Wagenhofer

University of Graz ( email )

Austria
+43 316 380 3500 (Phone)
+43 316 380 9565 (Fax)

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