Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences

Researchers have used various measures as indications of “earnings quality” including persistence, accruals, smoothness, timeliness, loss avoidance, investor responsiveness, and external indicators such as restatements and SEC enforcement releases. For each measure, we discuss causes of variation in the measure as well as consequences. We reach no single conclusion on what earnings quality is because “quality” is contingent on the decision context. We also point out that the “quality” of earnings is a function of the firm’s fundamental performance. The contribution of a firm’s fundamental performance to its earnings quality is suggested as one area for future work

Why Are Earnings Kinky? An Examination of the Earnings Management Explanation

Prior research has documented a “kink” in the earnings distribution: too few firms report small losses, too many firms report small profits. We investigate whether boosting of discretionary accruals to report a small profit is a reasonable explanation for this “kink.” Overall, we are unable to confirm that boosting of discretionary accruals is the key driver of the kink. We caution the use of the ratio of small profit firms to small loss firms as a measure of earnings management. We investigate and discuss a number of alternative explanations for the kink.Peer Reviewedhttp://deepblue.lib.umich.edu/bitstream/2027.42/47741/1/11142_2004_Article_5127187.pd

Implied Equity Duration: A New Measure of Equity Risk

Duration is an important and well-established risk characteristic for fixed income securities. We use recent developments in financial statement analysis research to construct a measure of duration for equity securities. We find that the standard empirical predictions and results for fixed income securities extend to equity securities. We show that stock price volatility and stock beta are both positively correlated with equity duration. Moreover, estimates of common shocks to expected equity returns extracted using our measure of equity duration capture a strong common factor in stock returns. Additional analysis shows that the book-to-market ratio provides a crude measure of equity duration and that our more refined measure of equity duration subsumes the Fama and French (1993) book-to-market factor in stock returns. Our research shows how structured financial statement analysis can be used to construct superior measures of equity security risk.Peer Reviewedhttp://deepblue.lib.umich.edu/bitstream/2027.42/47748/1/11142_2004_Article_5272372.pd

The Impact of Brand Quality on Shareholder Wealth

This study examines the impact of brand quality on three components of shareholder wealth: stock returns, systematic risk, and idiosyncratic risk. The study finds that brand quality enhances shareholder wealth insofar as unanticipated changes in brand quality are positively associated with stock returns and negatively related to changes in idiosyncratic risk. However, unanticipated changes in brand quality can also erode shareholder wealth because they have a positive association with changes in systematic risk. The study introduces a contingency theory view to the marketing-finance interface by analyzing the moderating role of two factors that are widely followed by investors. The results show an unanticipated increase (decrease) in current-period earnings enhances (depletes) the positive impact of unanticipated changes in brand quality on stock returns and mitigates (enhances) their deleterious effects on changes in systematic risk. Similarly, brand quality is more valuable for firms facing increasing competition (i.e., unanticipated decreases in industry concentration). The results are robust to endogeneity concerns and across alternative models. The authors conclude by discussing the nuanced implications of their findings for shareholder wealth, reporting brand quality to investors, and its use in employee evaluation

Short-sellers, fundamental analysis, and stock returns

http://deepblue.lib.umich.edu/bitstream/2027.42/35551/2/b2036010.0001.001.pdfhttp://deepblue.lib.umich.edu/bitstream/2027.42/35551/1/b2036010.0001.001.tx

The Quality of accruals and earnings : the role of accrual estimation errors

http://deepblue.lib.umich.edu/bitstream/2027.42/35550/2/b2037816.0001.001.pdfhttp://deepblue.lib.umich.edu/bitstream/2027.42/35550/1/b2037816.0001.001.tx