Jacob K. Thomas

POST-EARNINGS-ANNOUNCEMENT DRIFT - DELAYED PRICE RESPONSE OR RISK PREMIUM

This study seeks to discriminate between competing explanations of post-earnings-announcement drift. Ball and Brown [1968] were the first to note that even after earnings are announced, estimated cumulative abnormal returns continue to drift up for good news firms and down for bad news firms. Foster, Olsen, and Shevlin [1984] (henceforth FOS) are among the many who have replicated the phenomenon. FOS estimate that over the 60 trading days subsequent to an earnings announcement, a long position in stocks with unexpected earnings in the highest decile, combined with a short position in stocks in the lowest decile, yields an annualized abnormal return of about 25%, before transactions costs. Competing explanations for post-earnings-announcement drift fall into two categories. One class of explanations suggests that at least a portion of the price response to new information is delayed. The delay

EVIDENCE THAT STOCK PRICES DO NOT FULLY REFLECT THE IMPLICATIONS OF CURRENT EARNINGS FOR FUTURE EARNINGS

Evidence presented here is consistent with a failure of stock prices to reflect fully the implications of current earnings for future earnings. Specifically, the three-day price reactions to announcements of earnings for quarters t + 1 through I + 4 are predictable, based on earnings of quarter r. Even more surprisingly, the signs and magnitudes of the three-day reactions are related to the autocorrelation structure of earnings, as if stock prices fail to reflect the extent to which each firm’s earnings series differs from a seasonal random walk.

Equity Premia as Low as Three Percent? Evidence from Analysts' Earnings Forecasts for Domestic and International Stock Markets

The returns earned by U.S. equities since 1926 exceed estimates derived from theory, from other periods and markets, and from surveys of institutional investors. Rather than examine historic experience, we estimate the equity premium from the discount rate that equates market valuations with prevailing expectations of future flows. The accounting flows we project are isomorphic to projected dividends but use more available information and narrow the range of reasonable growth rates. For each year between 1985 and 1998, we find that the equity premium is around three percent (or less) in the United States and five other markets. Copyright The American Finance Association 2001.

Inventory Changes and Future Returns

We find that the negative relation between accruals and future abnormal returns documented by Sloan (1996) is due mainly to inventory changes. We propose three explanations for this result, derived from the prior literature, but find evidence inconsistent with all three explanations. To assist future investigations in formulating additional explanations, we document several empirical regularities for extreme inventory change deciles. We speculate that demand shifts explain our results, and examine the feasibility of alternative reasons for the stock markets apparent inability to recognize the impending profitability reversals. Our evidence is consistent with earnings management masking the implications of demand shifts.

Economic consequences of accounting standards : The lease disclosure rule change

this accounting standard essentially rearranged capital lease disclosures (from footnotes to the balance sheet), mandated capitalization substantially altered key accounting ratios. Our results document a systematic substitution from capital leases to operating leases and nonlease sources of financing. In addition, lessees appear to reduce book leverage by increasing equity and reducing conventional debt. The magnitudes of these responses are cross-sectionally related to preadoption levels of footnoted capital leases.

Identifying unexpected accruals: a comparison of current approaches

Abstract While prior research, as noted in our paper, often uses various accrual prediction models to detect earnings management, not much is known about the accuracy, both relative and absolute, associated with these models. Our paper investigates the accuracy of six different accrual prediction models, and offers the following findings. Only the Kang – Sivaramakrishnan (1995) model performs moderately well. The remaining five models provide little ability to predict total accruals: they are less accurate than a naive model which predicts that total accruals equal −5% of the total assets (TA) for all firms and years. Conventional R 2 values from a regression of actual accruals on predicted accruals are less than zero for a substantial majority of firms for these five models. These low R 2 values in the prediction period contrast sharply with the much higher R 2 values that are obtained within the estimation period. Similar performance is observed when predicting current accruals alone. However, the relative rankings of the different models are altered somewhat: the Jones (1991) model is then the only model that exhibits some predictive ability.

Valuation of Permanent, Transitory, and Price-Irrelevant Components of Reported Earnings

Both the economic nature of events and extant accounting rules cause reported earnings to have different components, each with different valuation implications. The price-earnings link is described better by separating components of unexpected earnings and multiplying each by a different response coefficient, rather than applying a single earnings response coefficient (ERC) to aggregate unexpected earnings. Using a simple model that assumes three types of innovations to reported earnings (permanent, transitory, and price-irrelevant), we develop systematic links among current earnings components, future earnings, and stock prices. Empirical tests of the models predictions confirm the validity of our characterization of the price-earnings link. Attempts to understand better the effects of growth and (beta) risk result in little improvement.

Is Cash Flow King in Valuations

Contrary to the common perception that operating cash flows are better than accounting earnings at explaining equity valuations, recent studies suggest that valuations derived from industry multiples based on reported earnings are closer to traded prices than those based on reported operating cash flows. The question addressed in the article is whether the balance tilts in favor of cash flows when the following are considered: (1) forecasts rather than reported numbers, (2) dividends rather than operating cash flows, (3) individual industries rather than all industries combined, and (4) companies in non-U.S. markets. In all cases studied, earnings dominated operating cash flows and dividends. Even though many finance academics and practitioners believe that operating cash flows are better than accounting earnings at explaining equity valuations, the evidence from recent studies suggests the opposite. For example, we previously investigated the performance of industry multiples based on a comprehensive list of value drivers for a sample of U.S. companies. Performance was measured as the ability of valuations derived from industry multiples to approach traded prices, and the value drivers considered included forward earnings; reported earnings; book value of equity; sales; earnings before interest, taxes, depreciation, and amortization; and various cash flow measures. Our results suggested that earnings clearly outperform other value drivers. In this study, we focused on a comparison of cash flows and earnings because of the prominence of these two measures in practice but we expanded our analysis in four directions to see whether cash flows outperform earnings in other contexts. First, we considered forecasts of cash flows in addition to reported numbers. Because analysts exclude in their forecasts the one-time items that tend to blur the relationship between reported numbers and value, moving from reported numbers to forecasts should improve the performance for both cash flows and earnings. The open question was whether the improvement in performance for cash flow forecasts would be large enough to overcome the initial performance gap between reported earnings and cash flows. Second, we broadened the definition of cash flows to consider both dividends and operating cash flows. Even though many companies do not pay dividends, we considered that dividends might outperform earnings for the subset of dividend-paying companies. Third, we compared the performance of earnings with the performance of cash flows within industries to determine whether for a subset of industries, dividends or operating cash flows would outperform earnings. Fourth, we considered nine markets in addition to the United States: Australia, Canada, France, Germany, Hong Kong, Japan, South Africa, Taiwan, and the United Kingdom. To the extent that factors such as accounting rules and the informativeness of dividends vary across markets, that variation could result in across-market variation in the performance of earnings, operating cash flows, and dividends. Our main finding is that valuations based on industry multiples using earnings forecasts are remarkably accurate. About half the companies had valuations that were within 20 percent of traded prices for the three markets where earnings forecasts performed well (Australia, the United Kingdom, and the United States) and were within 30 percent of traded prices for the three markets where earnings forecasts were the least informative (Germany, Japan, and Taiwan). In effect, the lead that reported earnings exhibit over reported operating cash flows and dividends increased when we considered forecasts. Although the earnings multiple was outperformed by operating cash flows or dividends in some industries—and in one market (Japan), where the performance of dividends approached that of earnings—the dominance of earnings multiples was very evident. Overall, our results suggest that proponents of using cash flow multiples consider using earnings multiples instead, especially if earnings forecasts are available.

Why do firms terminate their overfunded pension plans

Abstract Financial and pension variables are analyzed to test predictions of a number of explanation for the recent surge in reversions of excess assets from terminations of overfunded pension plans. Terminations are apparently motivated by cash needs, rather than tax, accounting, or wealth transfer considerations. These cash needs arise from large unexpected declines in funds from operations or financial restructuring subsequent to hostile takeover attempts. However, terminations appear to be a costly source of funds, since firms seek funds from numerous other sources (dividend cuts, ‘slow’ withdrawals of pension assets, and investment cuts) before resorting to terminations.

CORPORATE TAXES AND DEFINED BENEFIT PENSION PLANS

Abstract The Tepper–Black arguments for tax-arbitrage opportunities from overfunding pension plans are critically examined and modifications proposed. Tax status, a function of current marginal tax rates and expected future taxable income, is predicted to determine funding policy. Tests of this modified tax benefits view suggest that 1) tax status declines are associated with pension contribution reductions, 2) reductions in contributions are related to previous excess contributions as well as non-pension tax shield increases causing the decline in tax status, and 3) cross-sectionally, tax status is related to fund levels, choice of actuarial variables, and the use of defined benefit plans.