Dissecting Earnings Recognition Timeliness


  • Accepted by Abbie Smith. We thank Ana Albuquerque, Elio Alfonso, Ravi Avram, Brad Badertscher, Ray Ball, Phil Berger, Jeff Burks, Robert Bushman, Jeff Callen, Hans Christensen, Dan Collins, Bill Cready, Christine Cuny, Dain Donelson, Jere Francis, Robert Freeman, Jim Fuehmeyer, Eric Ghysels, Cristi Gleason, Mary Hill, Leslie Hodder, Robert Hogan, Pat Hopkins, Paul Hribar, Wenli Huang, Ross Jennings, Bruce Johnson, Steve Kachelmeier, Inder Kharana, Christian Leuz, Lorie Marsh, Ed Maydew, John McInnis, Brian Miller, Mike Minnis, Partha Mohanram, Steve Monahan, John O'Hanlon, Ken Peasnell, Raynolde Pereira, Jan Pfister, Ram Ramanan, Gord Richardson, Haresh Sapra, Mark Shakleton, Shiva Shivakumar, Kumar Sivakumar, Doug Skinner, Christian Stadler, Tom Stober, Philip Stocken, Xiaoli Tian, Eric Weisbrod, Teri Yohn, Yong Yu, Yong Zhang, two anonymous reviewers, workshop participants at Arizona State University, Boston University, Brock University, Florida International University, Hong Kong Polytechnic University, Indiana University, Lancaster University, London Business School, Louisiana State University Regional Conference, Ohio State University, Pennsylvania State University, Tel Aviv University, Tilburg University, the University of Chicago, the University of Iowa, the University of Miami, the University of Michigan, the University of Missouri, Columbia, the University of North Carolina/Duke University Fall camp, the University of Notre Dame, the University of Texas, and the University of Toronto for helpful comments on earlier drafts of this paper. Ryan Ball gratefully acknowledges financial support from the University of Michigan, the University of Chicago Booth School of Business, and the Neubauer Family Fellowship.


We dissect the portion of stock price change of the fiscal year that is recognized in reported accounting earnings of the year. We call this portion earnings recognition timeliness (ERT). The emphasis in our dissection is on empirical identification of two fundamental precepts of financial accounting: (1) the matching principle, which is manifested in the recognition of expenses in the same period as the related benefits (i.e., sales revenue) accrue; and (2) recognition of expenses in the current period due to changes in expectations regarding earnings of future periods (we refer to these expenses as the expectations element of expenses). Although the expectations element has implicitly been at the core of much of the recent empirical literature on asymmetry in the earnings/return relation, it has not been explicitly identified. This recent literature is based on the premise that bad news about the future leads to more recognition of expenses in the current period (such as write-downs) whereas good news about the future tends to have a much lesser effect on expenses of the current period; asymmetry in the expenses/return relation is captured implicitly via the observation of asymmetry in the earnings/return relation (i.e., asymmetry in ERT). Since the ERT reflects the relation between sales revenue and returns, matched expenses and returns, as well as the relation between the expectations element of expenses and returns, a focus on the expectations element may lead to sharper inferences. Our straightforward empirical procedure permits a focus on this element.