Daniella Acker

Accounting standards and analysts’ forecasts:the impact of FRS3 on analysts’ ability to forecast EPS

Abstract This paper assesses the impact of the UK Financial Reporting Standard 3 (FRS3) “Reporting Financial Performance” on the ability of analysts to predict companies’ future earnings per share. FRS3 requires companies to publish a wider information set than before, to help users to appraise current performance and to form an opinion of future levels of performance. Our findings suggest that although in the first year of FRS3 there was some confusion over definitions, so that analysts’ forecast errors increased, in following years the additional information provided by FRS3 increased the accuracy of analysts’ forecasts.

Reference-Day Risk and the Use of Monthly Returns Data

Investment practitioners and the empirical finance literature make extensive use of monthly stock returns, where a monthly return is based on the change in stock price between one particular day of the calendar month—the reference day—and the corresponding day of the following month. We show that the choice of reference day seriously affects estimates of the properties of monthly returns, including their means, medians, variances, correlations, and betas. We find these effects both in individual stocks and in market indexes. Our evidence indicates the effects are generally unsystematic and are caused by sampling variation but are sufficiently pervasive and serious to suggest that studies that use estimates of the properties of monthly returns as inputs, and portfolio decisions based on such estimates, should be tested for robustness against different reference days.

Implied Standard Deviations and Post-earnings Announcement Volatility

This paper investigates volatility increases following annual earnings announcements. Standard deviations implied by options prices are used to show that announcements of bad news result in a lower volatility increase than those of good news, and delay the increase by a day. Reports that are difficult to interpret also delay the volatility increase. This delay is incremental to that caused by reporting bad news, although the effect of bad news on slowing down the reaction time is dominant. It is argued that the delays reflect market uncertainty about the implications of the news.

Stock Return Volatility and Dividend Announcements

This paper is based on models presented in Kim and Verrecchia (1991a, 1991b) relating to share price volatility and the quality of announcements. It investigates the differences in informational quality between dividend cuts and dividend rises, and between interim and final dividend announcements. The results indicate that when dividends are cut, the interim announcement is perceived as being more significant than the final, whereas the reverse is true when dividends are increased. Implied standard deviations suggest that volatility is expected to peak on the day of final announcements. A peak is also expected after interim announcements of a cut in dividend, but not after announcements of an increase.

Tax, corporate behaviour and the foreign income dividend scheme

A model is derived which considers the interactions of corporation tax, advance corporation tax (ACT) and capital gains tax and their impact on UK corporate behaviour. It is shown that the recent changes to the ACT system, in the form of the Foreign Income Dividend (FID) scheme, will increase the gearing ratios of those firms affected by the changes. Debt will become more attractive, since it no longer increases irrecoverable ACT by reducing taxable profits. Furthermore, retention rates will fall, since retentions no longer serve as an ACT shield. Copyright Blackwell Publishers Ltd 1997.

Inflation illusion and the dividend yield: evidence from the UK

We report evidence that the UK dividend yield and expected inflation are positively correlated from 1962 to 1997, but negatively correlated subsequently. Using a commonly used VAR (vector auto-regression)-based procedure we find strong evidence that the positive correlation is caused both by inflation illusion and the effect of inflation on required rates of return. We also find some evidence that it is caused by inflation rationally reducing expected real dividend growth. We find that Chen and Zhaos (2009. “Return Decomposition.” Review of Financial Studies 22 (12): 5213–5249) criticism of the VAR-based procedure has little empirical relevance but that the procedure can be highly sensitive to the choice of data period.

Which Stocks are Inflation-Proof?

Returns from a zero-investment portfolio that is long in US firms whose dividends alter during a year, and short in firms whose dividends remain the same, produces positive returns in 52 of the 53 years between 1955 and 2007. These positive returns are related to expected inflation, which appears to contribute between 3 and 7 percentage points to the annual nominal return.We suggest that this is partly due to the signaling role of quarterly dividends. We argue that the greater the tendency of a company to smooth its dividends, the less likely are its shareholders to adjust their estimates of future nominal dividend growth in line with inflation. The more the company smooths its dividends, the greater the lag in incorporating current inflation into the dividend; and the less informative they are about future earnings. If dividend smoothing does affect the extent to which shareholders adjust their expectations in response to expected inflation, we would expect to see this effect show up in stock returns.We relate smoothing of annual dividends to smoothing of quarterly dividends, identifying extreme smoothers as those who pay four identical quarterly dividends in a 12-month period. We find no evidence that paying four such identical dividends is a signal of a firm in trouble; rather that such a policy reduces the informativeness of dividends about future earnings and growth. We also find no evidence that the extreme smoothers have unusual characteristics that would cause investors in these stocks to require from these stocks, ex ante, lower returns, or returns that are less responsive to inflation.

Volatility Implied by Option Prices: The Case of Takeover Bids

We model the effect of an impending share price jump on the implied standard deviation (ISD) of a companys options, testing the model by investigating its predictive ability for ISDs of companies subject to a takeover bid. Our model fits the observed ISDs well for all but certain deep in-the-money options. However, the model demonstrates that a discontinuity in the relationship between moneyness and the ISD both explains the combination of high and zero ISDs exhibited by these options, and impairs the predictive power of the model at these levels of moneyness. Copyright Blackwell Publishers Ltd 2000.