The Incremental Informativeness of Stock Prices for Future Accounting Earnings

Posted: 26 Aug 1996

See all articles by Richard M. Morton

Richard M. Morton

Florida State University - Department of Accounting

Abstract

This study extends previous research that documents a stock price reaction leading accounting earnings. The primary issue is that prior studies use a naive earnings expectations model (random walk) as the benchmark for the information content of lagged returns and do not adequately address the incremental information content of lagged returns. This study identifies and estimates firm-specific models of earnings to directly control for the autocorrelation in earnings. The explanatory power of lagged prices with respect to this earnings residual is investigated using both a multiple regression model of lagged returns and also a multiple time-series vector autoregressive model. In-sample estimation of the models provides clear evidence that stock prices impound information about future earnings incremental to the information contained in historical earnings data. Holdout-period analysis of the earnings forecasts from these lagged-return models finds that both models outperform the naive seasonal random walk expectation, but neither model outperforms the more sophisticated Box-Jenkins forecasts. On an individual firm basis, earnings forecasts supplemented with the lagged-return data tend to be less precise than the Box-Jenkins forecasts, but the price-based models demonstrate an ability to rank order the earnings forecast error from the time-series model. The analysis helps to characterize the limitations of lagged returns as a means of predicting future earnings innovations.

JEL Classification: M41, G12, G14

Suggested Citation

Morton, Richard M., The Incremental Informativeness of Stock Prices for Future Accounting Earnings. Contemporary Accounting Research, Vol 15, No 1, Spring 1998. Available at SSRN: https://ssrn.com/abstract=2726

Richard M. Morton (Contact Author)

Florida State University - Department of Accounting ( email )

Room No. 421
Tallahassee, FL 32306-8234
United States
850-644-7877 (Phone)

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