Economic Persistence, Earnings Informativeness, and Stock Return Regularities

Review of Accounting Studies, Forthcoming

47 Pages Posted: 27 Apr 2017 Last revised: 24 Nov 2019

See all articles by Kai Du

Kai Du

Pennsylvania State University - Department of Accounting; U.S. Securities and Exchange Commission

Steven J. Huddart

Pennsylvania State University, University Park - Department of Accounting

Date Written: April 17, 2019

Abstract

We propose a simple framework for understanding accounting-based stock return regularities. A firm's accounting reports provide noisy information about hidden economic states that evolve according to a Markov process. In response to the accounting reports, a representative Bayesian investor forms beliefs about the underlying state and hence the value of the firm. For a population of such firms, the model provides predictions consistent with two sets of well-documented regularities: (i) the market reaction to an earnings announcement that ends a string of consecutive earnings increases and (ii) the return predictabilities based on accruals and book-tax differences. The model also yields novel cross-sectional predictions about the distinct roles of economic persistence and earnings informativeness. We confirm these predictions through empirical tests.

Keywords: Economic persistence; Earnings informativeness; Earnings strings; Accruals anomaly; Book-tax differences anomaly

JEL Classification: D83; G12; G14; M41

Suggested Citation

Du, Kai and Huddart, Steven J., Economic Persistence, Earnings Informativeness, and Stock Return Regularities (April 17, 2019). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2959052 or http://dx.doi.org/10.2139/ssrn.2959052

Kai Du (Contact Author)

Pennsylvania State University - Department of Accounting ( email )

University Park, PA 16802-3306
United States

U.S. Securities and Exchange Commission ( email )

450 Fifth Street, NW
Washington, DC 20549-1105
United States

Steven J. Huddart

Pennsylvania State University, University Park - Department of Accounting ( email )

University Park, PA 16802-3603
United States
814-863-0448 (Phone)

HOME PAGE: http://directory.smeal.psu.edu/sjh11

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