Detecting news in aggregate accounting earnings: Implications for stock market valuation

PN Patatoukas - Review of Accounting Studies, 2014 - Springer
Review of Accounting Studies, 2014Springer
How much news is there in aggregate accounting earnings? I provide evidence that
earnings changes at the stock market level are correlated with new information about not
only expected future cash flows but also discount rates. A comprehensive investigation of
the link to discount rates reveals that aggregate earnings changes are tied to news about all
components of the expected future stock market return, ie, the real riskless rate, expected
inflation, and the expected equity risk premium. Over the sample period studied, cash flow …
Abstract
How much news is there in aggregate accounting earnings? I provide evidence that earnings changes at the stock market level are correlated with new information about not only expected future cash flows but also discount rates. A comprehensive investigation of the link to discount rates reveals that aggregate earnings changes are tied to news about all components of the expected future stock market return, i.e., the real riskless rate, expected inflation, and the expected equity risk premium. Over the sample period studied, cash flow news and discount rate news in aggregate earnings changes covary positively and have offsetting impacts on stock market prices. As a result, stock market prices appear to be insensitive to aggregate earnings changes. The findings highlight the importance of separating cash flow news from discount rate news when evaluating the information content of accounting earnings at the stock market level. Overall, my study sheds new light on the informativeness and relevance of accounting earnings for valuation at the stock market level.
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