Going Concern Status, Earnings Persistence, and Informativeness of Earnings
Posted: 3 Jul 1998
Valuation theory recognizes that the relation between earnings innovations and changes in security valuation is increasing in the persistence of the earnings innovations. Analyses in this article reveal that the present value of revisions in expected future benefits is a function of the length of revision horizon, suggesting that earnings persistence is determined in part by an entity's going concern status. These analyses predict an inverse relation between earnings informativeness and an entity's probability of termination. Drawing on a sample of quarterly earnings and returns data from more than 1,500 distinct firms for the period 1981-1990, a statistically significant inverse relation is documented between an entity's probability of termination and the informativeness of earnings -- the latter measured as the coefficient from a regression of returns on earnings. Further empirical analyses reveal that this result is a pervasive economic phenomenon not attributable to extreme conditions or other prevailing explanations of earnings informativeness. This inference is robust to variations in research design, including measurement of earnings informativeness and termination probability and alternative specifications of the relation between returns and earnings. Consequently, the evidence in this article is consistent with a fundamental role for an entity's going concern status in determining the usefulness of earnings.
JEL Classification: M41, G12
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