Francesco Reggiani

An Accounting-Based Characteristic Model for Asset Pricing

We develop a framework to identify firm characteristics that forecast stock returns. We show that forecasting returns is equivalent to forecasting earnings and earnings growth. Thus a characteristic indicates expected returns if it indicates expected earnings and earnings growth that the market prices as being at risk. The model identifies two important characteristics that explain cross-sectional variation in equity returns: (1) earnings-to-price (E/P) and (2) book-toprice (B/P). Because E/P is a yield, it is a valid characteristic to indicate expected returns, though it has not been emphasized in most prior research. B/P is a valid characteristic because it is positively associated with future (risky) earnings growth. This positive correlation is surprising since most prior research labels low B/P stocks as growth stocks. As a validation of our model, we revisit the puzzling negative relation that has been observed between leverage and realized returns. We find evidence of a positive relation between leverage and returns only when returns are conditioned on the set of characteristics identified by our model.The paper presents an accounting framework for identifying characteristics that indicate expected returns. A model links expected returns to expected earnings and earnings growth, so a characteristic indicates expected returns if it indicates expected earnings and earnings growth that the market prices as being at risk. In applying the framework, the paper confirms book-to-price (B/P) as a valid characteristic in asset pricing: B/P is associated with higher expected earnings growth and also captures the risk of that growth not being realized. However, the framework also points to the forward earning-to-price (E/P) as a risk characteristic. Indeed, E/P, rather than B/P, is the relevant characteristic when there is no expected earnings growth, but the weight shifts to B/P with growth. The framework also enables the separation of the expected return for operating risk from that due to financing risk. With this separation, the paper revisits the puzzling negative relation that has been observed between leverage and realized returns, a finding that has been attributed to failure to control for operating risk. We find a positive relation between leverage and returns when operating risk characteristics identified by our model are recognized.

The market acceptance of corporate social responsibility: a comparison across six countries/regions

Information on the link between market performance and corporate social responsibility (CSR) activities provides an indication of the extent of acceptance by investors of these types of activities. The nature of this relationship is of critical importance for management trying to reconcile the demands of the company’s shareholders with those of a much wider group of stakeholders and for investors pursuing a socially responsible investing strategy. Using an international database we investigate the extent to which expenditures on CSR activities are valued across market in six countries/regions. We find that CSR activities are highly valued by the investors in the European markets, where our findings clearly indicate that such activities lead to higher market valuations. In the US, Japan and Australia expenditures on CSR activities have a neutral impact on company valuation, which is still a good outcome for management who wish to incorporate into their decision process the objectives of a wide spectrum of stakeholders and for investors wishing to tilt their investments towards the more socially responsible companies.

Accruals and Future Performance: Can It be Attributed to Risk?

We decompose broad based measures of accruals into firm specific and related firm components. We find that the negative relation between accruals and future firm performance is almost entirely attributable to the firm specific component. Standard risk based explanations are hard to reconcile with this fact. To the extent expected returns have a common component spanning related firms, a risk based explanation would suggest a stronger negative relation between accruals and future firm performance when related firms are also growing. Instead, the attenuation we document is more likely attributable to sub-optimal investment decisions, which the stock market and analysts do not incorporate in a timely manner.

Accounting for Employee Stock Options: What Can We Learn from the Market's Perceptions?

The scope of this is paper is to provide new empirical evidence on the value relevance of employee stock options (ESOs) in Europe. We show, empirically, that the market participants when pricing a firms equity place approximately the same valuation weights on the ESO-deferred compensation expense (the so called “ESO asset”) and the compensation option liability (the so called “ESO liability”). Our empirical findings support the theoretical work of Ohlson and Penman who suggest that the deferred compensation expense be treated as a contra-liability. The second contribution of our work rests on the nature of the ESO expense. We show that the distinction between persistent and non-persistent ESO expenses is of critical importance for the market participants. Accordingly, an improved accounting disclosure should assist the investors in assessing the long-term goals of the ESO plans at the firm level.

A Framework for Identifying Accounting Characteristics for Asset Pricing Models, with an Evaluation of Book-to-Price

The paper presents a framework for identifying accounting numbers that indicate risk and expected return. The framework establishes conditions under which book-to-price (B/P), so prominent in asset pricing, indicates expected returns: B/P indicates expected returns if it forecasts future earnings growth and the risk that the growth will not be realized. However, that condition is satisfied only under specific accounting conditions — it depends on the accounting for book value and associated earnings. The empirical analysis confirms that the conditions are satisfied under GAAP accounting, and so identifies book-to-price (B/P) as a valid risk characteristic for asset pricing. However, the framework also points to earnings-to-price (E/P) as a risk characteristic. Indeed, E/P, rather than B/P, is the relevant characteristic when there is no expected earnings growth, but the weight shifts to B/P with growth. The framework also enables the separation of the expected return for operating risk from that due to financing risk. With this separation, the paper revisits the puzzling negative relation that has been observed between leverage and realized returns, a finding that has been attributed to failure to control for operating risk. We find a positive relation between leverage and returns when operating risk characteristics identified by our framework are recognized.