Earnings Quality and Stock Returns
AbstractAn 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 associated with poor future returns. We explore various hypotheses -- earnings manipulation, extrapolative biases about future growth, and under-reaction to business conditions -- to explain accruals' predictive power. Distinctions between the hypotheses are based on evidence from operating performance, the behavior of individual accrual items, and discretionary versus nondiscretionary components of accruals.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8308.
Date of creation: May 2001
Date of revision:
Publication status: published as Chan, Konan, Louis K. C. Chan, Narsimhan Jegadeesh, and Josef Lakonishok. "Earnings Quality and Stock Returns." Journal of Business 79, 3 (May 2006): 1041-82.
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Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
This paper has been announced in the following NEP Reports:
- NEP-ACC-2001-06-08 (Accounting & Auditing)
- NEP-ALL-2001-06-08 (All new papers)
- NEP-FMK-2001-06-08 (Financial Markets)
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