Demand for Stocks and Accounting Information

Abstract

We study the demand-relevance of accounting information by examining the direct link between different accounting profitability amounts and the demand for stocks. Because value relevance does not imply demand relevance, the latter presents a useful perspective on the role of accounting. Investors’ revealed preferences show the aggregate demand for stocks is best explained by operating profit compared to gross or net profit. Accrual-based measures dominate and largely subsume cash-based measures when explaining aggregate demand. However, these conclusions do not hold for investor-specific demands because of significant heterogeneity in investors’ preferences. Our findings reveal that heterogeneity in investors’ demands for profitability has an important effect on the equilibrium stock prices and the relation between stock prices and accounting profits. Our results shed new light on the demand for accounting information in equity markets.

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

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