Earnings Quality and Book-to-Market in the Cross Section of Expected Returns
44 Pages Posted: 21 Oct 2019
Date Written: October 10, 2019
The purpose of this paper is to examine whether earnings quality contributes to the book-to- market’s predictive power in the cross section of stock returns. Earnings quality is embedded in the value-growth effect given that retained earnings is a key part of the book value of equity. Earnings quality reflects the effects of managerial discretion on reported earnings, which has been shown to be associated with both risk and behavioral biases in asset pricing. Our results affirm the existence of a value premium and show that the value premium is more pronounced within poor earnings quality stocks. Moreover, we find that poor earnings quality contributes to the value premium mainly through the pricing of growth stocks. Our results suggest that the quality of reported earnings has an incremental role in shaping expected returns of value versus growth stocks.
Keywords: value premium, earnings quality, earnings management, asset pricing
JEL Classification: G12, M41
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