Review of Earnings Response Coefficient Studies

Abstract

The importance of earnings response coefficient (ERC) research arises mainly from the need to enhance confidence of a firm’s stakeholders in accounting information announcements, especially the equity investors, enabling them to make informed stock decisions. Due to the significance of this subject, this paper provides a review of the extant ERC literature and expounds on its evolution and development of the relevant theories, offers perspectives, and highlights the models used since 1968 when the earnings-to-returns relationship first became prominent. The study also evaluates the application of the ERC perspective and highlights the main empirical findings and also elucidates on related research methodologies applied to date and incorporates the relevant explicit and implied critiques. The main research results found while conducting this review supports the relevance of accounting information announcements to stock price formations, and therefore enhancing the confidence of investors and firm’s stakeholders in such announcements (Ball & Brown, 1968; Collins & Kothari, 1989; Cheng, 1994; Kothari et al., 2010; Ariff et al., 2011; Hwang & Zhang, 2012; Patatoukas, 2013; Mostafa & Dixon, 2013; Al-Baidhani et al., 2017). Researchers also calculated and evaluated relevant ERCs using different methods such as event study method and regression methods, and applying different approaches such as individual stocks approach and portfolios approach, as detailed in this review. In addition to the enhancement of the stakeholders’ confidence in the accounting information, this review paper will be useful to financial accounting standards setters and contributes to a holistic understanding of the literature on earnings-to-returns relationship.

Keywords: ERC, Earnings, Stock Returns, Stock Price

JEL Classification: G12, G14, G21