Earnings Quality and Stock Returns

Posted: 28 Feb 2005

See all articles by Konan Chan

Konan Chan

National Chengchi Unversity (NCCU) - Finance

Narasimhan Jegadeesh

Emory University - Department of Finance

Louis K.C. Chan

University of Illinois at Urbana-Champaign - Department of Finance

Josef Lakonishok

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Abstract

An exclusive focus on bottom-line income misses important information about the quality of earnings. Accruals (the difference between accounting earnings and cash flow) are reliably, negatively associated with future stock returns. Earnings increases that are accompanied by high accruals, suggesting low-quality earnings, are associates with poor future returns. We explore various hypotheses - earnings manipulation, extrapolative biases about future growth, and under-reaction to changes in business conditions - to explain accruals' predictive power. Distinctions between the hypotheses are based on evidence from operating performance, the behavior of individual accrual items, discretionary versus nondiscretionary components of accruals, and special items. We check for robustness using within-industry comparisons, and data on U.K. stocks.

JEL Classification: G12, G14, M41, M43

Suggested Citation

Chan, Konan and Jegadeesh, Narasimhan and Chan, Louis K.C. and Lakonishok, Josef, Earnings Quality and Stock Returns. Journal of Business, July 2006. Available at SSRN: https://ssrn.com/abstract=577081

Konan Chan

National Chengchi Unversity (NCCU) - Finance ( email )

No. 64, Chih-Nan Road
Section 2
Taipei, 11623
Taiwan
+886-2-29393091 ext 81239 (Phone)

Narasimhan Jegadeesh

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States

Louis K.C. Chan (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-333-6391 (Phone)
217-244-3102 (Fax)

Josef Lakonishok

University of Illinois at Urbana-Champaign ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
217-333-7185 (Phone)
217-244-3102 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Register to save articles to
your library

Register

Paper statistics

Abstract Views
3,348
PlumX Metrics