The power of accounting information in explaining stock returns
57 Pages Posted: 21 Dec 2017 Last revised: 13 Jul 2018
Date Written: July 13, 2018
Prior literature shows that earnings have come to explain less stock price movement over time, suggesting that accounting information has become less important. In this paper, we replace earnings with earnings announcement returns as a measure of accounting information and find that earnings news has come to explain more price movement over time. In the years after 2004, earnings announcement returns explain roughly 20% of the annual return—twice as much as they did before, indicating that accounting information has become more important, not less, in explaining stock returns. This pattern occurs for other forms of firm-specific fundamental information. Collectively, the returns around earnings announcements, analyst forecast revisions and recommendations, and 8-K filings went from explaining 15% of annual returns in the 1990s to 35% in the 2010s. In exploring possible explanations for the increase in the explanatory power of accounting information, we find evidence consistent with regulatory changes, such as Sarbanes-Oxley and the Global Settlement, collectively making disclosures more informative. In contrast, neither pre-announcement information leaks, sample composition changes, changes in preemptive disclosures, nor concurrent information events (e.g., management forecasts) explain the increase in explanatory power.
Keywords: earnings, cash flows, firm fundamentals, stock returns
JEL Classification: M40, M41, G12, G14
Suggested Citation: Suggested Citation