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Review of Recent Research on Improving Earnings Forecasts and Evaluating Accounting-based Estimates of the Expected Rate of Return on Equity Capital

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  • Peter D. Easton
  • Steven J. Monahan

Abstract

type="main"> We extend Easton's (2007) review of the literature on accounting-based estimates of the expected rate of return on equity capital, which we refer to as the ERR. We begin by reiterating the reasons why accounting-based estimates are used. Next, we briefly review the recent literature that focuses on improving forecasts of expected earnings by either (i) removing predictable errors from analysts’ forecasts of earnings or (ii) developing cross-sectional regression-based estimates of earnings using prior-period financial data. In the remainder of our review we discuss a recent debate on methods for evaluating estimates of the ERR. We highlight the key points in the debate so that the reader will find it easier to form an independent view of the relative merits of the proposed methods.

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  • Peter D. Easton & Steven J. Monahan, 2016. "Review of Recent Research on Improving Earnings Forecasts and Evaluating Accounting-based Estimates of the Expected Rate of Return on Equity Capital," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 35-58, March.
    • Handle: RePEc:bla:abacus:v:52:y:2016:i:1:p:35-58
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    3. Zixuan Qin & Abeer Hassan & Mahalaxmi Adhikariparajuli, 2022. "Direct and Indirect Implications of the COVID-19 Pandemic on Amazon’s Financial Situation," JRFM, MDPI, vol. 15(9), pages 1-25, September.
    4. Demetris Christodoulou & Colin Clubb & Stuart Mcleay, 2016. "A Structural Accounting Framework for Estimating the Expected Rate of Return on Equity," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 176-210, March.
    5. Balakrishnan, Karthik & Shivakumar, Lakshmanan & Taori, Peeyush, 2021. "Analysts’ estimates of the cost of equity capital," Journal of Accounting and Economics, Elsevier, vol. 71(2).
    6. Sami Keskek & James N. Myers & Linda A. Myers, 2020. "Investors' Misweighting of Firm‐Level Information and the Market's Expectations of Earnings," Contemporary Accounting Research, John Wiley & Sons, vol. 37(3), pages 1828-1853, September.
    7. Jan A. Kempkes & Francesco Suprano & Andreas Wömpener, 2023. "An empirical evaluation of dynamic approaches for estimating firms’ expected cost of equity capital," The Financial Review, Eastern Finance Association, vol. 58(4), pages 859-886, November.
    8. Schreder, Max, 2018. "Idiosyncratic information and the cost of equity capital: A meta-analytic review of the literature," Journal of Accounting Literature, Elsevier, vol. 41(C), pages 142-172.
    9. David Schröder, 2020. "The role of market efficiency on implied cost of capital estimates: an international perspective," Annals of Finance, Springer, vol. 16(4), pages 463-499, December.
    10. Stephen Penman & Julie Zhu & Haofei Wang, 2023. "The implied cost of capital: accounting for growth," Review of Quantitative Finance and Accounting, Springer, vol. 61(3), pages 1029-1056, October.
    11. Stephen Penman, 2016. "Valuation: Accounting for Risk and the Expected Return," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 106-130, March.
    12. Max Schreder & Pawel Bilinski, 2022. "Information Quality and the Expected Rate of Return: A Structural Equation Modelling Approach," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 29(2), pages 139-170, June.
    13. Guilherme Belloque & Martina K Linnenluecke & Mauricio Marrone & Abhay K Singh & Rui Xue, 2021. "55 years of Abacus: Evolution of Research Streams and Future Research Directions," Abacus, Accounting Foundation, University of Sydney, vol. 57(3), pages 593-618, September.
    14. Francesco Mazzi & Paul André & Dionysia Dionysiou & Ioannis Tsalavoutas, 2017. "Compliance with goodwill-related mandatory disclosure requirements and the cost of equity capital," Accounting and Business Research, Taylor & Francis Journals, vol. 47(3), pages 268-312, April.
    15. Frank Ecker, 2016. "Review of Recent Research on Improving Earnings Forecasts and Evaluating Accounting-based Estimates of the Expected Rate of Return on Equity Capital. Discussion of Easton and Monahan," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 59-69, March.
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    17. Philip L. Baird, 2020. "Do investors recognize biases in securities analysts’ forecasts?," Review of Financial Economics, John Wiley & Sons, vol. 38(4), pages 623-634, October.

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