Transparency, disclosure and the pricing of future earnings in the European market

Abstract

Paper presented at "Accounting at a Tipping Point", the American Accounting Association (AAA) Annual Meeting held in New York City on August 1-5, 2009. Final version published in Journal of Business Finance and Accounting until title Accruals, Disclosure and the Pricing of Future Earnings in the European Market. Available online at http://onlinelibrary.wiley.com/The present study examines the role of disclosure in assisting market participants to form expectations of future earnings by observing the accrual content of reported earnings. Accounting research has been focusing on investigating the ability of accounting numbers and practices to provide relevant information to market participants. In the context of the association between market returns and accounting numbers or practices, conclusions can be only drawn on the effect of these numbers and practices at an average level of disclosure. Here it is shown that these conclusions can be significantly altered at varying levels of disclosure. Employing a sample of European firms and their Transparency and Disclosure ratings conducted by Standard and Poor’s, we show how disclosure and accruals jointly affect earnings expectations that are included in current stock returns. It is shown that both the joint effect of disclosure and accruals depends on the magnitude, sign and the nature of accruals (i.e. current and non-current accruals), and that increased disclosure appears to correct overstated expectations arising mostly from the extensive use of current accruals and negative non-current accruals