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The declining association between earnings and returns

Author

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  • Steve C. Lim
  • Taewoo Park

Abstract

Purpose - This paper aims to identify what drives the temporal reduction in the value relevance of earnings documented in the literature. Is it the increasing noise in stock returns over time, noise in earnings, or both? Design/methodology/approach - The authors develop hypotheses from the lead/lag structure between stock returns and accounting earnings and perform empirical tests using data from annual COMPUSTAT and monthly CRSP over the sample period of 39 years (1970‐2008). Findings - The test results show that increasing noise in stock returns over time is primarily responsible for the temporal reduction ofR2in regressions of returns on earnings. Additional analysis shows weak evidence that both the noise in returns and the noise in earnings are responsible for the declining association between earnings and returns in a sub‐period (1970‐1982). Research limitations/implications - TheR2‐based methodology has limitations because, as Gu points out, regressionR2s might be incomparable across samples. The findings suggest that future research should control for the effects of the temporal increase in market noise before making value relevance inferences from the declining association between earnings and returns. Originality/value - The paper contributes to the limited body of research on noise in stock returns as the main driver for the temporal reduction in value relevance of earnings.

Suggested Citation

  • Steve C. Lim & Taewoo Park, 2011. "The declining association between earnings and returns," Management Research Review, Emerald Group Publishing Limited, vol. 34(8), pages 947-960, July.
    • Handle: RePEc:eme:mrrpps:v:34:y:2011:i:8:p:947-960
    DOI: 10.1108/01409171111152538
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    Citations

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    Cited by:

    1. Carmen- Alexandra BALTARIU, 2015. "The Current State Of Knowledge In The Value Relevance Research Field," SEA - Practical Application of Science, Romanian Foundation for Business Intelligence, Editorial Department, issue 7, pages 13-20, April.
    2. Clout, Victoria J. & Willett, Roger J., 2016. "Earnings in firm valuation and their value relevance," Journal of Contemporary Accounting and Economics, Elsevier, vol. 12(3), pages 223-240.
    3. Reddy, Kotapati Srinivasa & Nangia, Vinay Kumar & Agrawal, Rajat, 2013. "Share repurchases, signaling effect and implications for corporate governance: Evidence from India," MPRA Paper 60147, University Library of Munich, Germany.
    4. Jihene Chedlia Soussi, 2012. "Impact of Voluntary Disclosure on the Relevance of Accounting Information," Journal of Education and Vocational Research, AMH International, vol. 3(5), pages 138-153.

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