Both authors are from the Center for Accounting Research, University of Graz, Universitaetsstrasse 15, A-8010 Graz, Austria. The authors thank Phil Brown, Robert Bushman, Lucie Courteau, Thomas Dangl, Ralf Ewert, John Hand, Jack Hughes, Andrei Kovrijnykh, Wayne Landsman, Catherine Schrand, Jean-Philippe Weisskopf, David Windisch, Josef Zechner, an anonymous referee, participants at the 2011 Accounting Research Workshop in Fribourg, the 2012 EAA Annual Meeting in Ljubljana, the 2012 EFMA Meeting in Barcelona, and workshops at the University of North Carolina, Vienna University of Economics and Business, and the Free University of Bozen for helpful comments. Part of this work was accomplished when Perotti was visiting Bocconi University. The authors gratefully acknowledge financial support from the Austrian Science Fund (FWF), P 24911-G11. (Paper received May 2012, revised version accepted December 2013).
Earnings Quality Measures and Excess Returns
Article first published online: 18 APR 2014
© 2014 The Authors Journal of Business Finance & Accounting published by John Wiley & Sons Ltd
This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited.
Journal of Business Finance & Accounting
Volume 41, Issue 5-6, pages 545–571, June/July 2014
How to Cite
Perotti, P. and Wagenhofer, A. (2014), Earnings Quality Measures and Excess Returns. Journal of Business Finance & Accounting, 41: 545–571. doi: 10.1111/jbfa.12071
- Issue published online: 15 JUL 2014
- Article first published online: 18 APR 2014
- earnings quality;
- excess returns;
- abnormal returns;
- accruals quality;
- value relevance
This paper examines how commonly used earnings quality measures fulfill a key objective of financial reporting, i.e., improving decision usefulness for investors. We propose a stock-price-based measure for assessing the quality of earnings quality measures. We predict that firms with higher earnings quality will be less mispriced than other firms. Mispricing is measured by the difference of the mean absolute excess returns of portfolios formed on high and low values of a measure. We examine persistence, predictability, two measures of smoothness, abnormal accruals, accruals quality, earnings response coefficient and value relevance. For a large sample of US non-financial firms over the period 1988–2007, we show that all measures except for smoothness are negatively associated with absolute excess returns, suggesting that smoothness is generally a favorable attribute of earnings. Accruals measures generate the largest spread in absolute excess returns, followed by smoothness and market-based measures. These results lend support to the widespread use of accruals measures as overall measures of earnings quality in the literature.