Earnings Quality and Price Quality

29 Pages Posted: 17 Aug 2002

See all articles by Rani Hoitash

Rani Hoitash

Bentley University - Department of Accountancy

Murugappa (Murgie) Krishnan

Yeshiva University

Srinivasan Sankaraguruswamy

National University of Singapore (NUS) - Department of Accounting

Date Written: July 2002

Abstract

Several papers have considered the relevance or quality of earnings by examining its relationship to prices, implicitly assuming that the quality of prices (or the market in which prices are set) remains constant. However, the quality of prices can vary across firms and over time, and irrational trading can contribute to such variation. In view of the possible importance of irrational trading we relax this assumption and reconsider the relevance of earnings. We construct a firm-specific measure of speculative intensity based on autocorrelation in daily trading volume adjusted for the amount of information available, and find that irrational trading has a significant positive impact on returns. However, after controlling for irrational trading, our results confirm a key result of previous research that earnings numbers still matter but departs from other work that suggests that earnings relevance has declined. We find that the explanatory power of earnings surprises has not declined, the influence of irrational trading has increased, and so the omission of irrational trading explains the previously documented decline in earnings relevance. This result is robust to excluding loss observations, which is another potential explanation for previous results.

Keywords: irrational trading, measuring speculation, earnings quality, earnings response coefficients

JEL Classification: G12, G14, G10, M41

Suggested Citation

Hoitash, Rani and Krishnan, Murugappa (Murgie) and Sankaraguruswamy, Srinivasan, Earnings Quality and Price Quality (July 2002). Available at SSRN: https://ssrn.com/abstract=320831 or http://dx.doi.org/10.2139/ssrn.320831

Rani Hoitash

Bentley University - Department of Accountancy ( email )

175 Forest Street
Waltham, MA 02452-4705
United States

Murugappa (Murgie) Krishnan

Yeshiva University ( email )

500 West 185th Street
New York, NY 10033
United States

Srinivasan Sankaraguruswamy (Contact Author)

National University of Singapore (NUS) - Department of Accounting ( email )

1 Business Link
Singapore, 117592
Singapore
+65 6874 4473 (Phone)
+65 6779 2083 (Fax)

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