Trends of the Returns-Earnings Associations Over the Last Three Decades
FOCUS ON FINANCE AND ACCOUNTING RESEARCH, Michael H. Neelan, ed., Nova Science Publishers, 2007
29 Pages Posted: 6 Jun 2006 Last revised: 18 Mar 2016
Ball and Brown (1968) had run the first empirical investigation on the association between accounting earnings, as the premier information item in the financial statements, and stock returns in order to assess the usefulness of accounting information. Accounting earnings is considered to be useful if it causes a change in the receiver's probability distribution (beliefs) of the concerned random variable (stock returns) (Lev, 1989). The main objective of this chapter is to synthesize the direction of the returns-earnings association over the last three decades (1968-2003). This can be done through analyzing the two metrics, coefficient of determination and earnings response coefficient, often used to express the returns-earnings associations in the traditional simple linear regression models. In the analytical study made by Lev (1989) he had summarized results of twenty years of this line of research stream starting from (Ball & Brown's study, 1968) till 1989 in order to investigate the usefulness of accounting information. He concluded that the association is very modest on average the coefficient of determination is 10%. Moreover, the nature of the relation exhibits considerable instability over time. Following the first twenty years of empirical research (1968-1989), researchers have attempted to refine/improve the specification of the regression model for the sake of better understanding of the actual usefulness of accounting information. In fact, most of the empirical studies are considered as methodological refinements in both measurements and statistical techniques of the pioneer work of Ball & Brown (1968), and Beaver (1968) as suggested by Cheng, Hopwood, & McKeown (1992). Research streams underlying the association studies, following Lev's study, are further classified into: 1- The Earnings Persistence stream. 2- The Explanatory Power stream. 3- The Competing Variables stream. Results support that the returns-earnings association has decreased over the last three decades as evidenced by a decrease in both coefficient of determinations and earnings response coefficients throughout this period.
Keywords: Returns-Earnings Associations, Earnings Persistence , Competing Variables, Explanatory Variables
JEL Classification: M41, G12, G15, G22, G23
Suggested Citation: Suggested Citation