Investor protection and price informativeness about future earnings: international evidence

This study draws on the investor protection literature to identify structural factors in a country’s information environment that are likely to explain cross-country differences in the extent to which future earnings information is capitalized in current stock returns. Using a sample of 55,900 firm-years from 32 countries, we find that greater financial disclosure, higher quality earnings, and greater information dissemination through news media are associated with stock prices that are more informative about future earnings, whereas strong enforcement of insider trading laws is associated with stock prices that are less informative about future earnings. We also find that, on average, price informativeness about future earnings is greater in countries with strong investor protection. Our results illuminate the importance of structural factors constituting a country’s information environment in explaining cross-country variation in price informativeness about future earnings.     

Bringing the Future Forward: The Effect of Disclosure on the Returns-Earnings Relation

This paper studies how firm disclosure activity affects the relation between current annual stock returns, contemporaneous annual earnings and future earnings. Our results show that firms with relatively more informative disclosures "bring the future forward" so that current returns reflect more future earnings news. We also find that changes in disclosure activity are positively related to changes in the importance of future earnings news for current returns. These results suggest that a firm's disclosure activity reveals credible, relevant information not in current earnings, and that this information is incorporated into the current stock price.     

Loss firms’ annual report narratives and share price anticipation of earnings

We extend prior research into the association between disclosure quality and share price anticipation of earnings by discriminating between firms that report profits and firms that report losses. As a measure of disclosure quality we count the number of forward-looking earnings statements in annual report narratives. To measure the extent to which current share price movements anticipate future earnings changes we regress current stock returns on current and future earnings changes. The coefficients on the future earnings change variables are our measure of share price anticipation of earnings.Our regression results show that the association between annual report narratives and share price anticipation of earnings is not the same for profit and loss firms. For loss firms we find that the ability of stock returns to anticipate next period's earnings change is significantly greater when the firm provides a large number of earnings predictions in annual report narratives. We make no such observation for profit firms. In addition, once we control for variations in the intrinsic lead–lag relation between returns and earnings across industries, the observed difference between profit and loss firms becomes statistically significant. Overall, our results are consistent with annual report narratives being a particularly important source of information for loss-making firms.     

Does board gender diversity improve the informativeness of stock prices?

We show that stock prices of firms with gender-diverse boards reflect more firm-specific information after controlling for corporate governance, earnings quality, institutional ownership and acquisition activity. Further, we show that the relationship is stronger for firms with weak corporate governance suggesting that gender-diverse boards could act as a substitute mechanism for corporate governance that would be otherwise weak. The results are robust to alternative specifications of informativeness and gender diversity and to sensitivity tests controlling for time-invariant firm characteristics and alternative measures of stock price informativeness. We also find that gender diversity improves stock price informativeness through the mechanism of increased public disclosure in large firms and by encouraging private information collection in small firms.     

Share price anticipation of earnings and management's discussion of operations and financing

This paper combines research on the measurement of disclosure quality and the measurement of share price anticipation of earnings to produce a new test of the usefulness of the information disclosed in management discussions of operations and financing for predicting future earnings. Market-Based Accounting Research has shown that earnings changes are anticipated and impounded in prices well before the financial year for which earnings are reported. This price anticipation leads to downward biased earnings response coefficients (ERCs) in the commonly estimated regression model of returns on contemporaneous earnings changes. We exploit predictable differences in the biasedness of the ERC estimate across firm-years to test the hypothesis that share prices are better informed when the annual report contains a detailed discussion of the firm's operations and financing. Our results suggest that such voluntary disclosure may have been useful in predicting future earnings changes. The effect would appear to be strongest (1) in models that examine one-period-ahead and two-period-ahead share price anticipation and (2) when we employ a disclosure index that captures forward-looking information.     

Understanding analysts' use of stock returns and other analysts' revisions when forecasting earnings

We investigate analysts' use of stock returns and other analysts' forecast revisions in revising their own forecasts after an earnings announcement. We find that analysts respond more strongly to these signals when the signals are more informative about future earnings changes. Although analysts underreact to these signals on average, we find that analysts who are most sensitive to signal informativeness achieve superior forecast accuracy relative to their peers and have a greater influence on the market. The results suggest that the ability to extract information from the actions of others serves as one source of analyst expertise.     

Security Analysts’ Site Visits and Stock Price Synchronicity

This paper investigates how security analysts’ corporate site visits impact listed firms’ stock-price informativeness. Examining a sample of security analysts’ visits to Chinese listed firms from 2010 to 2019, we find that security analysts incorporate firm-specific information into share prices through site visits, significantly reducing the visited firms’ stock price synchronicity. This finding is robust to an alternative measure of stock price informativeness and a two-stage least-squares approach using the introduction of high-speed rail as the instrumental variable. We also find that the impact of analysts’ site visits on firms’ stock price synchronicity is more pronounced for firms with lower information disclosure quality and poor corporate governance than for other firms. Further analysis on firm characteristics documents that this effect is stronger for large-size firms, firms in the manufacturing industry, and state-owned enterprises.     

Economic determinants of price informativeness about future earnings

This study investigates how the value-creation process affects the extent to which stock prices incorporate value-relevant information about future earnings. In contrast to previous studies focusing on the value-reporting process, this paper shows that strong product market power accelerates the incorporation of future earnings into current equity prices due to less uncertainty about future cash flows and that intensive long-term investment deters such incorporation because of greater uncertainty regarding future cash flows. The results suggest that firm fundamentals shaped by product market competition and long-term investment explain the price informativeness about future earnings beyond the impact of management’s reporting discretion.     

Earnings quality and the heterogeneous relation between earnings and stock returns

We adopt a heterogeneous regime switching method to examine the informativeness of accounting earnings for stock returns. We identify two distinct time-series regimes in terms of the relation between earnings and returns. In the low volatility regime (typical of bull markets), earnings are moderately informative for stock returns. But in high volatility market conditions (typical of financial crisis), earnings are strongly related to returns. Our evidence suggests that earnings are more informative to investors when uncertainty and risk is high which is consistent with the idea that during market downturns investors rely more on fundamental information about the firm. Next, we identify groups of firms that follow similar regime dynamics. We find that the importance of accounting earnings for returns in each of the market regimes varies across firms: certain firms spend more time in a regime where their earnings are highly relevant to returns, and other firms spend more time in a regime where earnings are moderately relevant to returns. We also show that firms with poorer accrual quality have a greater probability of belonging to the high volatility regime.     

Board structure and price informativeness

We develop and test the hypothesis that stock price informativeness affects the structure of corporate boards. We find a negative relation between price informativeness and board independence. This finding is robust to the inclusion of many firm-level controls, including firm fixed effects, and to the choice of the measure of price informativeness. Consistent with the hypothesis that price informativeness and board monitoring are substitutes, this relation is particularly strong for firms more exposed to both external and internal governance mechanisms and for firms in which firm-specific knowledge is relatively unimportant. Our results suggest that firms with more informative stock prices have less demanding board structures.