Accounting Quality, Stock Price Delay, and Future Stock Returns

Authors


  • Accepted by Christine Botosan. Helpful comments were received from participants at the BANDS Boston Area Research Conference (Boston College, Boston University, Harvard University, and MIT), the 2010 Global Finance and Business Conference, the 2011 CAAA conference, and the 2011 Maui International Business Conference, as well as from seminar participants at City University of Hong Kong, Columbia, Fudan, ICTSE Portugal, Interdisciplinary Center Hertzliya, Iowa, Louisiana State, Notre Dame, MIT, Penn State, Texas A&M, University of Minnesota, and the University of Southern California. We further thank the anonymous referees of this journal, Christine Botosan (Editor), Brian Akins, Randy Beatty, Rei-Ning Chen, Zhaoyang Gu, Michelle Hanlon, Chandra Kanodia, Stephannie Larocque, Maria Ogneva, Sugata Roychowdhury, Devin Shanthikumar, K. R. Subramanyam, Rodrigo Verdi, Ross Watts, Joe Weber, and Franco Wong for their useful input. We especially thank Feng Li both for helpful comments and for providing us with access to his data set. Yiwei Dou, Yanju Liu, and Yuri Loktionov are to be commended for excellent research assistance.

Abstract

In frictionless capital markets with complete information and rational investors, stock prices adjust to new information instantaneously and completely. However, a substantial body of research studies information imperfections such as asymmetric information and incomplete information. Information imperfections potentially hinder timely price discovery and are likely associated with delayed stock price adjustment to information. Our first research question therefore is whether the quality of accounting information (or “accounting quality”) is one such information imperfection that is associated with cross-sectional variation in stock price delay. We define accounting quality as the precision with which financial reports convey information to equity investors about the firm’s expected cash flows. Poor accounting quality is likely associated with higher expected returns through uncertainty about stock valuation parameters and incomplete information. Our second research question therefore is whether the accounting quality component of price delay is associated with higher future stock returns. Consistent with our hypotheses, the results show that poor accounting quality is associated with delayed price adjustment and higher future stock returns. Thus, accounting quality plays a role in timely stock price discovery.

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