Accrual quality, investor reaction to earnings, and the confirmatory role of sales news

Author/s Carlo D’Augusta
Publishing Year 2023 Issue 2023/2 Language English
Pages 25 P. 97-121 File size 254 KB
DOI 10.3280/FR2023-002004
DOI is like a bar code for intellectual property: to have more infomation click here

Below, you can see the article first page

If you want to buy this article in PDF format, you can do it, following the instructions to buy download credits

Article preview

FrancoAngeli is member of Publishers International Linking Association, Inc (PILA), a not-for-profit association which run the CrossRef service enabling links to and from online scholarly content.

Purpose: Agency theory predicts that information asymmetry provides agents with an incentive to manipulate performance signals to maximize their utility, which gives principals reasons to distrust such signals. The accounting and finance literature finds empirical support for this prediction by studying how earnings reliability attributes affect investors’ reactions to earnings an-nouncements. However, research pays less empirical attention to whether in-vestors skeptical of earnings reliability look for confirmatory signals in other parts of the income statement. This study aims at filling such this research gap. Design/methodology/approach: This study examines investors’ combined use of earnings and sales news. It adopts an event-study methodology to ana-lyze whether sales news moderates the stock market response to annual earn-ings announcements. Findings: The results show that investors do not fully trust earnings news if earnings beat analyst expectations and the firm has a reputation for low accru-al quality. In this case, positive sales data alleviate investors’ skepticism of earnings news and, thus, make them react more favorably. In contrast, sales data do not affect the market response if the earnings news is negative, or the firm accrual quality is high. These results are robust to different model speci-fications and explanations. Originality/value: The findings shed new light on how investors use sales data to complement earnings news and our understanding of the consequences of accruals quality on investor information processing.

Keywords: accrual quality, sales news, revenue reaction, earnings response

Jel codes: M41, G14

  1. Abdel-Meguid A.M., Fernando G.D., Schneible R.A. and Suh S.H. (2019). Differential interpretations and earnings quality. Accounting Horizons, 33(2), pp. 59-73,
  2. Arena C., Bozzolan S. and Imperatore C. (2021). The Trade-Off Between Mandatory and Voluntary Disclosure: Evidence from Oil Companies’ Risk Reporting. Journal of Accounting, Auditing & Finance, 0148558X211025250, DOI: 10.1177/0148558X211025250
  3. Baginski S.P., Clinton S.B. and Mcguire S.T. (2014), Forward-looking voluntary disclosure in proxy contests. Contemporary Accounting Research, 31(4), pp. 1008-1046, DOI: 10.1111/1911-3846.12057
  4. Ball R. and Shivakumar L. (2006). The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition. Journal of Accounting Research, 44(2), pp. 207-242,
  5. Basu S., Duong T.X., Markov S. and Tan E.-J. (2013), How Important are Earnings Announcements as an Information Source?. European Accounting Review, 22(2), pp. 221-256, DOI: 10.1080/09638180.2013.782820
  6. Beaver W.H. (1968). The Information Content of Annual Earnings Announcements. Journal of Accounting Research, 6, pp. 67-92, DOI: 10.2307/2490070
  7. Beatty A.L., Ke B. and Petroni K. R. (2002). Earnings Management to Avoid Earnings Declines across Publicly and Privately Held Banks. The Accounting Review, 77(3), pp. 547-570,
  8. Bens D.A., Monahan S.J. and Steele L.B. (2018). The Effect of Aggregation of Accounting Information via Segment Reporting on Accounting Conservatism. European Accounting Review, 27(2), pp. 237-262, DOI: 10.1080/09638180.2016.1260488
  9. Bozzolan S., Imperatore C. and Mattei M. (2022), Family Ownership and Impression Management: An Integrated Approach. European Accounting Review, 0(0), pp. 1-26, DOI: 10.1080/09638180.2022.2141287
  10. Burgstahler D.C. and Dichev I.D. (1997), Earnings management to avoid earnings decreases and losses. Journal of accounting and economics, 24(1), pp. 99-126, DOI: 10.1016/S0165-4101(97)00017-7
  11. Callen J.L., Robb S.W.G. and Segal D. (2008), Revenue Manipulation and Restatements by Loss Firms, Auditing: A Journal of Practice & Theory, 27(2), pp. 1-29,
  12. Cao S.S. and Narayanamoorthy G.S. (2012). Earnings Volatility, Post-Earnings Announcement Drift, and Trading Frictions. Journal of Accounting Research, 50(1), pp. 41-74,
  13. Chang E.C., Xu J. and Zheng L. (2013). Short sale constraints, heterogeneous interpretations, and asymmetric price reactions to earnings announcements. Journal of Accounting and Public Policy, 32, pp. 435-455,
  14. Dal Maso L., Liberatore G. and Mazzi F. (2017). Value Relevance of Stakeholder Engagement: The Influence of National Culture. Corporate Social Responsibility and Environmental Management, 24(1), pp. 44-56,
  15. D’Augusta C. (2022). Does Accounting Conservatism Make Good News Forecasts More Credible and Bad News Forecasts Less Alarming?. Journal of Accounting, Auditing & Finance, 37(1), pp. 77-113, DOI: 10.1177/0148558X18780550
  16. D’Augusta C., Bar-Yosef S. and Prencipe A. (2016), The Effects of Conservative Reporting on Investor Disagreement. European Accounting Review, 25(3), pp. 451-485, DOI: 10.1080/09638180.2015.1042890
  17. D’Augusta C. and Prencipe A. (2022). Accruals Quality, Shocks to Macro-uncertainty, and Investor Response to Earnings News. European Accounting Review, in press, DOI: 10.1080/09638180.2022.2141288
  18. Dechow P.M. and Dichev I. D. (2002). The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors. The Accounting Review, 77(s-1), pp. 35-59,
  19. Dechow P.M., Sloan R.G. and Sweeney A. (1995). Detecting earnings management. The Accounting Review, 70(2), pp. 193-225, --
  20. Di Narzo A.F., Freo M. and Mattei M.M. (2018). Estimating accruals models in Europe: Industry-based approaches versus a data-driven approach. Economic Research-Ekonomska Istraživanja, 31(1), pp. 37-54, DOI: 10.1080/1331677X.2017.1421991
  21. Ecker F., Francis J., Kim I., Olsson P.M. and Schipper K. (2006). A returns-based representation of earnings quality, Accounting Review, 81(4), pp. 749-780,
  22. Edmonds C.T., Leece R.D. and Maher J.J. (2013), CEO bonus compensation: The effects of missing analysts’ revenue forecasts, Review of Quantitative Finance and Accounting, 41(1), pp. 149-170,
  23. Ertimur Y., Livnat J. and Martikainen M. (2003), Differential market reactions to revenue and expense surprises, Review of Accounting Studies, 8, pp. 185-221, DOI: 10.1023/A:1024409311267
  24. Fama E.F. and French K.R. (1997). Industry costs of equity. Journal of Financial Economics, 43(2), pp. 153-193, DOI: 10.1016/S0304-405X(96)00896-3
  25. Fischer P.E. and Verrecchia R.E. (2000). Reporting Bias, The Accounting Review, 75(2), pp. 229-245, --
  26. Francis J., Lafond R., Olsson P. and Schipper K. (2007). Information uncertainty and post-earnings-announcement-drift. Journal of Business Finance and Accounting, 34(3-4), pp. 403-433,
  27. García Lara J.M., García Osma B. and Penalva F. (2020). Conditional conservatism and the limits to earnings management. Journal of Accounting and Public Policy, 39(4), 106738,
  28. Garfinkel J.A. and Sokobin J. (2006). Volume, Opinion Divergence, and Returns: A Study of Post-Earnings Announcement Drift. Journal of Accounting Research, 44(1), pp. 85-112,
  29. Geiger M.A., O’Connell B.T., Clikeman P.M., Ochoa E., Witkowski K. and Basioudis I. (2006). Perceptions of Earnings Management: The Effects of National Culture. Advances in International Accounting, 19, pp. 175-199, DOI: 10.1016/S0897-3660(06)19007-8
  30. Gervais S., Kaniel R. and Mingelgrin D.H. (2001). The High-Volume Return Premium. The Journal of Finance, 56(3), pp. 877-919, DOI: 10.1111/0022-1082.00349
  31. Ghosh A., Gu Z. and Jain P.C. (2005). Sustained Earnings and Revenue Growth, Earnings Quality, and Earnings Response Coefficients. Review of Accounting Studies, 10(1), pp. 33-57,
  32. Graham J.R., Harvey C.R. and Rajgopal S. (2005). The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1-3), pp. 3-73,
  33. Greco G. and Neri L. (2021). Accounting discretion in family firms: The case of goodwill write-off. Evidence from US firms. Financial Reporting,
  34. Gu Z., Jain P.C. and Ramnath S. (2006). In-Sync or Out-of-Sync? The Joint Information in Revenues and Expenses (SSRN Scholarly Paper Fasc. 579381). Social Science Research Network,
  35. Hodge F., Hopkins P.E. and Pratt J. (2006). Management reporting incentives and classification credibility: The effects of reporting discretion and reputation. Accounting, Organizations and Society, 31(7), pp. 623-634,
  36. Holthausen R.W. and Verrecchia R.E. (1988). The Effect of Sequential Information Releases on the Variance of Price Changes in an Intertemporal Multi-Asset Market. Journal of Accounting Research, 26(1), pp. 82-82, DOI: 10.2307/2491114
  37. Hopwood W.S. and McKeown J.C. (1985). The Incremental Informational Content of Interim Expenses over Interim Sales. Journal of Accounting Research, 23(1), pp. 161-174, DOI: 10.2307/2490912
  38. Hoskin R.E., Hughes J.S. and Ricks W.E. (1986). Evidence on the Incremental Information Content of Additional Firm Disclosures Made Concurrently with Earnings. Journal of Accounting Research, 24, pp. 1-32, DOI: 10.2307/2490726
  39. Hurwitz H. (2017). The understatement of large negative earnings news in managers’ annual guidance. Journal of Contemporary Accounting & Economics, 13(2), pp. 119-133,
  40. Hutton A.P., Miller G. and Skinner D.J. (2003). The role of supplementary statements with management earnings forecasts. Journal of Accounting Research, 41(5), pp. 867-891,
  41. Imhoff E.A. and Lobo G.J. (1992). The effect of ex-ante earnings uncertainty on earnings response coefficients. The Accounting Review, 67(2), pp. 427-439, --
  42. Jain A., Jain C. and Khanapure R.B. (2020), Pre-earnings announcement returns and momentum, Economics Letters, 196, 109521,
  43. Jegadeesh N. and Livnat J. (2006a), Post-Earnings-Announcement Drift: The Role of Revenue Surprises, Financial Analysts Journal, 62(2), pp. 22-34,
  44. Jegadeesh N. and Livnat J. (2006b), Revenue surprises and stock returns, Journal of Accounting and Economics, 41(1-2), pp. 147-171,
  45. Jegadeesh N. and Titman S. (1993), Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, The Journal of Finance, 48(1), pp. 65-91,
  46. Jennings R. (1987). Unsystematic Security Price Movements, Management Earnings Forecasts, and Revisions in Consensus Analyst Earnings Forecasts. Journal of Accounting Research, 25(1), pp. 90-110, DOI: 10.2307/2491260
  47. Jones J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29, pp. 193-228, DOI: 10.2307/2491047
  48. Kama I. (2009). On the Market Reaction to Revenue and Earnings Surprises. Journal of Business Finance & Accounting, 36(1-2), pp. 31-50,
  49. Kim O. and Verrecchia R.E. (1991). Trading volume and price reactions to public announcements. Journal of Accounting Research, 29(2), pp. 302-321, DOI: 10.2307/2491051
  50. Kothari S.P., Leone A.J. and Wasley C.E. (2005). Performance-matched discretionary accrual measures. Journal of Accounting and Economics, 39(1), pp. 163-197,
  51. Kothari S.P., Shu S.Z. and Wysocki P.D. (2009). Do Managers Withhold Bad News?. Journal of Accounting Research, 47(1), pp. 241-276,
  52. Lipe R. (1990). The relation between stock returns and accounting earnings given alternative information. The Accounting Review, 65(1), pp. 49-71, --
  53. Mafrolla E. and Nobili V. (2017). Discretionary Accruals in Italian Private Firms and Non-Linear Bank Loan Granting. Financial Reporting, 1, pp. 83-99, DOI: 10.3280/FR2017-001004
  54. Mashruwala C. and Mashruwala S. (2014). Is there a «torpedo effect» in earnings announcement returns? The role of short-sales constraints and investor disagreement. Journal of Accounting, Auditing, and Finance, 29(4), pp. 519-546, DOI: 10.1177/0148558X14537827
  55. Massel N., Park J.E. “JP” and Reichelt K. (2021). Do Revenues Matter More Than Earnings for Initial Public Offerings?. Journal of Accounting, Auditing & Finance, 1,
  56. Mattei M.M. (2007). Earnings management to avoid losses and earnings decreases in the Italian stock exchange. Improving business reporting: New rules, new opportunities, new trends, pp. 781-802.
  57. Mattei M.M. (2012). Family CEO firms and earnings management to avoid losses: Evidence from Italy. In: S. Gigli (a cura di). Corporate Governance (pp. 11-40). Aracne.
  58. Mazzi F., Slack R. and Tsalavoutas I. (2018). The effect of corruption and culture on mandatory disclosure compliance levels: Goodwill reporting in Europe. Journal of International Accounting, Auditing and Taxation, 31, pp. 52-73,
  59. McNichols M.F. (2002), Discussion of the Quality of Accruals and Earnings: The Role of Accrual Estimation Errors, The Accounting Review, 77(s-1), pp. 61-69,
  60. Mikhail M.B., Walther B.R. and Willis R. H. (2003). Security Analyst Experience and Post-Earnings-Announcement Drift. Journal of Accounting, Auditing & Finance, 18(4), pp. 529-550, DOI: 10.1177/0148558X0301800406
  61. Neilson J.J. (2022). Investor information gathering and the resolution of uncertainty. Journal of Accounting and Economics, 74(1), 101513,
  62. Ng J., Tuna I. and Verdi R.S. (2013). Management Forecast Credibility and Underreaction to News. Review of Accounting Studies, 18(4), pp. 956-986,
  63. Quagli A., Avallone F., Ramassa P. and Di Fabio C. (2021). Someone else’s problem? The IFRS enforcement field in Europe. Accounting and Business Research, 51(3), pp. 246-270, DOI: 10.1080/00014788.2020.1802217
  64. Rees L. and Sivaramakrishnan K. (2007). The Effect of Meeting or Beating Revenue Forecasts on the Association between Quarterly Returns and Earnings Forecast Errors. Contemporary Accounting Research, 24(1), pp. 259-290,
  65. Rogers J.L. and Stocken P. C. (2005). Credibility of management forecasts. The Accounting Review, 80(4), pp. 1233-1260,
  66. Shih M. (2019). Investor skepticism and the incremental effects of small positive sales surprises. Journal of Economics and Business, 106, 105847,
  67. Skinner D.J. and Sloan R. G. (2002). Earnings surprises, growth expectations, and stock returns, or don’t let an earnings torpedo sink your portfolio. Review of accounting studies, 7(2-3), pp. 289-312, --
  68. Stein J.C. (1989). Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior. The Quarterly Journal of Economics, 104(4), p. 655, DOI: 10.2307/2937861
  69. Swaminathan S. and Weintrop J. (1991). The Information Content of Earnings, Revenues, and Expenses. Journal of Accounting Research, 29(2), pp. 418-427, DOI: 10.2307/2491058
  70. Taffler R.J., Lu J. and Kausar A. (2004). In denial? Stock market underreaction to going-concern audit report disclosures. Journal of Accounting and Economics, 38, pp. 263-296,
  71. Tucker J.W. (2007). Is openness penalized? Stock returns around earnings warnings. The Accounting Review, 82(4), pp. 1055-1087, --
  72. Wilson G.P. (1986). The Relative Information Content of Accruals and Cash Flows: Combined Evidence at the Earnings Announcement and Annual Report Release Date. Journal of Accounting Research, 24, pp. 165-200, DOI: 10.2307/2490736
  73. Zhang F.X. (2006). Information uncertainty and stock returns. The Journal of Finance, 61(1), pp. 105-136,

Carlo D’Augusta, Accrual quality, investor reaction to earnings, and the confirmatory role of sales news in "FINANCIAL REPORTING" 2/2023, pp 97-121, DOI: 10.3280/FR2023-002004