Demand for Stocks and Accounting Information

Abstract

We use equity portfolio allocation decisions to study the relevance of accounting information for investors’ demand for stocks. Investors’ revealed preferences indicate that operating profit dominates gross profit and net income in explaining the aggregate demand for stocks. Further, accrual-based profitability measures dominate and largely subsume cash-based measures. However, these conclusions do not hold for investor-specific demands. We document significant heterogeneity across investors in the demand relevance of profitability measures. We predict and find that the relevance of accounting information varies as a function of investors’ objectives. Furthermore, our findings reveal that individual investors’ demands have an important effect on the equilibrium relation between stock prices and accounting profits.

Keywords: Demand relevance, portfolio decisions, accruals, earnings, demand for stocks, investor heterogeneity

JEL Classification: G10, G18, M40, M41, M44, M45