Artikelen HC Seminar Financial Accounting Research
Week 1
Ball and Brown (1968) - An Empirical Evaluation of Accounting Income Numbers
General questions
What is the research question? What is the intuition/theory behind the research question?
Does net income have an impact on investment decision, i.e., is it useful and hence reflected
in security prices?
Why is this question relevant?
It tests how income reporting is relevant for the stock market.
How do the authors answer the research question?
They compare the abnormal performance index to the months before and after the annual
report announcement date with an event study. This examines the reaction to abnormal
earnings.
What is the setting/sample?
Sample between 1957-1965, no young or failing firms, consisting of 261 firms, 2,340
observations
What do they find?
1. Firms with unexpected increases in earnings have positive abnormal returns and vice
versa.
2. Capital markets already reacted based on the abnormal performance index prior to the
annual report announcement date
3. This reaction is thus far accurate that there are no big jumps on or after the annual report
announcement date.
4. This reaction begins at least 12 months before the news, and successfully continues to
do this throughout the year.
Questions specific for paper
What is the goal of this paper?
To assess the usefulness of the information provided by accounting income by examining
their information content and timeliness.
Describe their tests in understandable language – what are the authors trying to document?
The reaction of investors to abnormal earnings announced by the annual reporting.
Nichols and Wahlen (2004) – How Do Earnings Number Relate to Stock Returns?
General questions
What is the research question? What is the intuition/theory behind the research question?
Research question: Do firms with earnings increases (decreases) experience positive
(negative) abnormal returns? How is this association affected by earnings persistence? Do
earnings numbers convey new information to the capital markets? How efficient are capital
markets in this association?
Theoretical framework: current earnings is a predictor of future earnings provides
information to develop expectation about future dividends provides information to
determine share value, which represents the present value of expected future dividends.
How do the authors answer the research question?
First question: Averaging the cumulative abnormal returns relative to the earnings
announcements
Second question: Same procedure as first question, but dividing firms based on high
persistence versus low persistence.
, Third question: Examining stock price reactions during days immediately surrounding
quarterly earnings announcements.
Fourth question: Examining stock price reactions during 60 days around earnings
announcement.
What is the setting/sample?
Firms listed on the NYSE, AMEX, and NASDAQ
Between 1988 to 2002
31,923 firm-year observations and 90,470 firm-quarter observations
What do they find?
1. Firms with positive annual earnings changes experience positive average abnormal
returns and vice versa.
2. Earnings numbers contain information that relates to changes in the market’s
expectation of future dividends and thus changes in contemporaneous market values.
3. On average during years with earnings increases, high persistence firms experience
higher abnormal returns than low persistence firms. There is little difference during years
with earnings decreases.
4. The market reacts swiftly and significantly to quarterly earnings surprises, thus meaning
that these convey new information.
5. Capital markets anticipate the information in quarterly earnings announcements,
because prior to the earnings announcement abnormal returns move significantly with
the sign and magnitude of quarterly unexpected earnings.
6. A small but significant portion of the market’s reaction to the new information in earnings
occurs after the announcement, which implies that the market is not completely efficient.
Week 2
Dechow (1994):
General questions
What is the research question? What is the intuition/theory behind the research question?
What is the relative information value of earnings and cash from operations/net cash flows to
reflect firm performance?
The primary role of accruals is to overcome problems with measuring firm performance
when firms are in continuous operation. It mitigates timing and matching problems inherent
in cash flows so that earnings more closely reflect firm performance. However, cash flows
are less subject to distortion from differing accounting practices.
Why is this question relevant?
This question should answer if the two different methods are more valuable in predicting firm
performance.
How do the authors answer the research question?
H1: Stronger association between stock returns and earnings than with cash flows over short
measurement intervals.
H2: Over a longer measurement interval cash flows will suffer from fewer timing and
matching problems and so the importance of accruals diminishes. So the association of
stock returns with cash flows improves relative to earnings as the measurement interval is
increased.
H3: The larger the absolute magnitude of aggregate accruals, the lower the association
between stock returns and cash flows compared to earnings.
H4: The longer a firm’s operating cycle, the lower the association between stock returns and
realized cash flows (through volatility of working capital).
Also examines the differences in type of accruals.
This is tested through the higher R-squared.
Week 1
Ball and Brown (1968) - An Empirical Evaluation of Accounting Income Numbers
General questions
What is the research question? What is the intuition/theory behind the research question?
Does net income have an impact on investment decision, i.e., is it useful and hence reflected
in security prices?
Why is this question relevant?
It tests how income reporting is relevant for the stock market.
How do the authors answer the research question?
They compare the abnormal performance index to the months before and after the annual
report announcement date with an event study. This examines the reaction to abnormal
earnings.
What is the setting/sample?
Sample between 1957-1965, no young or failing firms, consisting of 261 firms, 2,340
observations
What do they find?
1. Firms with unexpected increases in earnings have positive abnormal returns and vice
versa.
2. Capital markets already reacted based on the abnormal performance index prior to the
annual report announcement date
3. This reaction is thus far accurate that there are no big jumps on or after the annual report
announcement date.
4. This reaction begins at least 12 months before the news, and successfully continues to
do this throughout the year.
Questions specific for paper
What is the goal of this paper?
To assess the usefulness of the information provided by accounting income by examining
their information content and timeliness.
Describe their tests in understandable language – what are the authors trying to document?
The reaction of investors to abnormal earnings announced by the annual reporting.
Nichols and Wahlen (2004) – How Do Earnings Number Relate to Stock Returns?
General questions
What is the research question? What is the intuition/theory behind the research question?
Research question: Do firms with earnings increases (decreases) experience positive
(negative) abnormal returns? How is this association affected by earnings persistence? Do
earnings numbers convey new information to the capital markets? How efficient are capital
markets in this association?
Theoretical framework: current earnings is a predictor of future earnings provides
information to develop expectation about future dividends provides information to
determine share value, which represents the present value of expected future dividends.
How do the authors answer the research question?
First question: Averaging the cumulative abnormal returns relative to the earnings
announcements
Second question: Same procedure as first question, but dividing firms based on high
persistence versus low persistence.
, Third question: Examining stock price reactions during days immediately surrounding
quarterly earnings announcements.
Fourth question: Examining stock price reactions during 60 days around earnings
announcement.
What is the setting/sample?
Firms listed on the NYSE, AMEX, and NASDAQ
Between 1988 to 2002
31,923 firm-year observations and 90,470 firm-quarter observations
What do they find?
1. Firms with positive annual earnings changes experience positive average abnormal
returns and vice versa.
2. Earnings numbers contain information that relates to changes in the market’s
expectation of future dividends and thus changes in contemporaneous market values.
3. On average during years with earnings increases, high persistence firms experience
higher abnormal returns than low persistence firms. There is little difference during years
with earnings decreases.
4. The market reacts swiftly and significantly to quarterly earnings surprises, thus meaning
that these convey new information.
5. Capital markets anticipate the information in quarterly earnings announcements,
because prior to the earnings announcement abnormal returns move significantly with
the sign and magnitude of quarterly unexpected earnings.
6. A small but significant portion of the market’s reaction to the new information in earnings
occurs after the announcement, which implies that the market is not completely efficient.
Week 2
Dechow (1994):
General questions
What is the research question? What is the intuition/theory behind the research question?
What is the relative information value of earnings and cash from operations/net cash flows to
reflect firm performance?
The primary role of accruals is to overcome problems with measuring firm performance
when firms are in continuous operation. It mitigates timing and matching problems inherent
in cash flows so that earnings more closely reflect firm performance. However, cash flows
are less subject to distortion from differing accounting practices.
Why is this question relevant?
This question should answer if the two different methods are more valuable in predicting firm
performance.
How do the authors answer the research question?
H1: Stronger association between stock returns and earnings than with cash flows over short
measurement intervals.
H2: Over a longer measurement interval cash flows will suffer from fewer timing and
matching problems and so the importance of accruals diminishes. So the association of
stock returns with cash flows improves relative to earnings as the measurement interval is
increased.
H3: The larger the absolute magnitude of aggregate accruals, the lower the association
between stock returns and cash flows compared to earnings.
H4: The longer a firm’s operating cycle, the lower the association between stock returns and
realized cash flows (through volatility of working capital).
Also examines the differences in type of accruals.
This is tested through the higher R-squared.
