A Model of Stock Prices Leading Earnings

Download or read book A Model of Stock Prices Leading Earnings written by Jay Junghun Lee and published by . This book was released on 2019 with total page 32 pages. Available in PDF, EPUB and Kindle. Book excerpt: Prior literature suggests that stock prices lead earnings in reflecting value-relevant information because accounting income incorporates information discretely to satisfy recognition principles while stock prices incorporate it continuously. Using the future earnings response coefficient (FERC) methodology, this study derives a model that relates the recognition lag of earnings to the incremental informativeness of future anticipated earnings in equity prices after controlling for current realized earnings. The analytical FERC model shows that the pricing coefficient on future earnings is positive in the presence of stock prices leading earnings. More importantly, the pricing coefficient on future earnings increases with the recognition lag but the pricing coefficient on current earnings decreases with the lag. The results suggest that recognition principles that intend to enhance the reliability of earnings inadvertently lower the timeliness of earnings and thus shift the investors' demand for value-relevant information from current realized earnings to future anticipated earnings. In addition, this study confirms the FERC model as an empirical model that investigates the extent to which stock prices lead earnings.