On the Persistence and Pricing of Industry-Wide and Firm-Specific Earnings, Cash Flows, and Accruals

46 Pages Posted: 1 Jul 2015

See all articles by Kai Wai Hui

Kai Wai Hui

The University of Hong Kong (HKU) - Department of Accounting

Karen K. Nelson

Texas Christian University - Department of Accounting

P. Eric Yeung

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: June 17, 2015

Abstract

Economic theory suggests that the industry-wide component of firm performance is more persistent than the firm-specific component. This paper provides evidence on this assertion and tests whether investors misprice these components of earnings. Consistent with predictions, we find greater persistence in the industry-wide component of earnings that is not fully recognized in stock prices. We show that these effects are partially driven by the market’s inability to recognize the differential persistence of industry-wide earnings in homogenous industries or in the presence of a large business shock. Finally, we show that industry-wide cash flows is the most persistent component of earnings while firm-specific accruals is the least persistent, suggesting that economic fundamentals and accounting constructs are jointly informative about firms’ future earnings. The market predictably misprices these components, however, significantly underweighting the persistence of industry-wide cash flows and overweighting the persistence of firm-specific accruals.

Suggested Citation

Hui, Kai Wai and Nelson, Karen K. and Yeung, P. Eric, On the Persistence and Pricing of Industry-Wide and Firm-Specific Earnings, Cash Flows, and Accruals (June 17, 2015). Journal of Accounting & Economics (JAE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=2624669

Kai Wai Hui

The University of Hong Kong (HKU) - Department of Accounting ( email )

Pokfulam Road
Hong Kong, Pokfulam
Hong Kong

Karen K. Nelson (Contact Author)

Texas Christian University - Department of Accounting ( email )

M.J. Neeley School of Business
TCU Box 298530
Fort Worth, TX 76129
United States
817-257-7567 (Phone)

P. Eric Yeung

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

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