How To Calculate A Sudy

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1 LTA 4/04 P JUHA-PEKKA KALLUNKI, MINNA MARTIKAINEN and HENRIK NILSSON Analys Poession, Accouning Eanings and Sock Reuns: Swedish Evidence ABSTRACT Recen eseach by Liu and Thomas (2000) and Dechow e al. (1999) sugges ha analyss oecass ae impoan in explaining conempoaneous pices/euns and hey senghen he esimaed euneanings elaion. This sudy invesigaes he ole o he analyss eanings oecass in explaining euns in Sweden whee he analys poession has consideably developed duing he las wo decades. This developmen aises he quesion o how well he Swedish analyss oecass peom i compaed o epoed accouning eanings in explaining euns. Analyss oecass and changes in hem ae ound o be impoan in explaining euns. This owad looking inomaion oupeoms This eseach was suppoed by Jan Wallandes och Tom Hedelius sielse, Sweden and OKO Bank o Finland. The auhos gaeully acknowledge he conibuion o I/B/E/S Inenaional Inc. o poviding eanings pe shae oecas daa, available hough he Insiuional Bokes esimae sysem. We ae gaeul o he valuable commens and suggesions o Las Hassel, Juha Junila and Rickad Olsson. 404 JUHA-PEKKA KALLUNKI Univesiy o Oulu, Depamen o Accouning and Finance juha-pekka.kallunki@oulu.i MINNA MARTIKAINEN Lauea Polyechnic HENRIK NILSSON Umeå School o Business and Economics, Depamen o Business Adminisaion

2 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK cuen eanings and eanings changes in explaining euns. Even so, a combinaion o accouning daa and oecass peoms bes in ems o explanaoy powe. As a obusness check o he esuls, andom coeicien models and indusy eecs ae invesigaed. Key wods: Sock make, Valuaion, Eanings esponse coeiciens, Analyss eanings oecass JEL Classiicaion: M41, G15 1. INTRODUCTION Inenional eanings managemen implemened by he managemen o he im, back-wad looking accouning convenions, ax legislaion and ohe simila easons ae commonly said o ceae biasness in epoed accouning eanings o he im. The biasness in epoed eanings is in uns suggesed o be one eason o he low inomaional conen o accouning eanings wih espec o sock pices and euns (see e.g. Lev 1989). Mainly because o hese poblems in he epoed eanings, eseaches have begun o use analyss eanings oecass when invesigaing he eun/pice-eanings elaion. This appoach is moivaed by he ac ha he independen analyss should disclose eanings oecass ha ae ee o he inluence o he managemen o he im. Analyss monio all he acions o he managemen o he im including he abiliy o he managemen o successully implemen he saegy o he im. Theeoe, analyss eanings oecass ae even said o elec non-numeical inomaion ha canno be involved in any inancial saemen numbes. The use o analyss eanings oecass is especially moivaed in Sweden, whee he analys poession has songly developed duing he pas wo decades as a esul o he developmen o he sock make. The analys poession has developed and he numbe o analyss has inceased, because he equiy invesos need he inomaion poduced by he analyss. In 1985, hee wee only 128 ceiied inancial analyss in Sweden, bu in 2000 he coesponding igue was as high as This developmen aises he quesion o how successul he Swedish analyss have been in poducing he elevan inomaion o invesos compaed o e.g. he U.S. analyss. On he ohe hand, he Swedish accouning legislaion has developed duing he pas wo decades o bee mee he inomaion equiemens se by he sock make. This aises anohe quesion o wha is he elaive impoance o he analyss eanings and epoed accouning eanings in valuaion. Liu and Thomas (2000) use Ohlson s (1995) esidual income model o expess unexpeced euns as a uncion o unexpeced cuen eanings and evisions in eanings oecass. The evised oecass ae assumed o capue he make s evised expecaions o uue eanings, i.e. assumed o capue ohe value elevan inomaion besides cuen eanings change. 405

3 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON Dechow e al. (1999) egess sock pices on book values, cuen eanings, and analyss consensus oecass o nex peiod eanings. Unlike Liu and Thomas (2000) hey use an exension o he esidual income model by Ohlson (1995) as a heoeical backgound o hei sudy. They ind ha he explanaoy powe o his enhanced model is highe han ha o he model conaining only book values and eanings as explanaoy vaiables. This indicaes ha he analyss eanings oecass do have value elevance in he pice-eanings elaion. Moeove, hey ind ha cuen eanings ae no saisically signiicanly elaed o sock pices in he enhanced model indicaing ha analyss oecass o nex peiod eanings subsume he value elevan inomaion involved in cuen eanings. The pimay pupose o his sudy is o compae he ole o he Swedish analyss eanings oecass o ha o he epoed accouning eanings in he esimaed euns-eanings elaion, ha is, he eanings esponse coeiciens (ERC, heeae). The euns-eanings models invesigaed include he adiional eanings levels and changes and models including analyss eanings oecass based on he exended esidual income model by Ohlson (1995). The eunseanings elaion is esimaed by conolling o he limied inomaion conen o accouning losses as epoed by Hayn (1995) and Maikainen (1997). The pape exends he cuen lieaue in wo main especs. Fis, he pevious esuls on he euns-eanings elaion including hose based on he use o he analyss oecas ae mainly based on US daa, and he evidence based on non-us daa is limied. 1 The pape uses daa om he Swedish sock make in which he ole and impoance o he analys poession has consideably inceased duing he sample peiod. This being he case, i can be assumed ha he ole o he analyss oecass has inceased duing he sample peiod. The Swedish sock make is also he leading Nodic sock make and he sevenh lages sock make in Euope in 2000, which calls moe published evidence on he uncioning o he make. Second, he pape diecly compaes he sengh o he euns-eanings elaion by using alenaive euns-eanings model speciicaions based on accouning eanings and analyss eanings oecass. Seveal sudies compae he ERCs esimaed by using he adiional eanings levels and/o changes appoach (see, among ohes, Collins and Kohai 1989, Kohai and Zimmeman 1995 and Bown e al. 2001). Thee is also a gowing body o lieaue ha applies Ohlson s (1995) esidual income appoach and analyss eanings oecass o do he same (see, o insance, Liu and Thomas 2000 and Dechow e al. 1999). The cuen pape exends hese wo eseach aeas by esimaing he ERCs based on boh appoaches. Fuhe Excepions include, o insance, Hais e al. (1994) who, use Geman daa, and Dumonie and Labelle (1998), who use Fench daa o invesigae he value elevance o eanings. Pio Swedish evidence on eun-eanings elaion can be ound in Runsen (1998) and Maon (1998). Howeve, none o heses sudies incopoaes analys consensus oecass in he analysis.

4 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK moe, he ERCs based on models conaining boh accouning eanings and analyss eanings oecass ae diecly compaed. In his espec, he pape conibues o he lieaue by invesigaing he adequacy o dieen ypes o eanings inomaion as a summay o value elevan evens. The emainde o he pape is oganized as ollows. The nex secion discusses alenaive appoaches o modeling he eun-eanings elaion. The daa and saisical mehods used in he sudy ae eviewed in he hid secion. The ouh secion povides he empiical esuls o he pape, and he conclusions ae dawn in he ih secion. 2. MODELLING RETURNS-EARNINGS RELATION 2.1 Godon s dividend discoun model as a heoeical backgound Godon s dividend discoun model is a equenly used heoeical undepinning in sudies empiically modeling he euns-eanings elaion. Accoding o Godon s model, sock euns ae a uncion o unexpeced eanings (see, o insance, Collins and Kohai 1989), because dividends can be expessed as a popoion o eanings. Following his easoning, he euns-eanings elaion is commonly invesigaed by egessing (abnomal) sock euns on he measue o he unexpeced eanings as ollows: (1) CAR i = α + βux i + ei, whee CAR i equals cumulaed abnomal euns o peiod, UX i denoes he unexpeced eanings o he ih im o peiod, α is an inecep em, β is he esimaed slope coeicien, i.e. he ERC, and e i is an eo em wih zeo mean and consan vaiance. Sudies esimaing he pice-eanings egessions ae mainly ineesed in he signiicance o he esimaed ERC and he explanaoy powe o he model. The esimaed ERC should be saisically signiicanly dieen om zeo i accouning eanings ae elaed o sock euns. In accodance wih he pioneeing sudy by Ball and Bown (1968), unexpeced eanings, i.e eanings changes, ae oen inepeed as a signal o new inomaion upon which he make may eac. Hence, hese ypes o sudies invesigaing he ERCs ae conduced om an inomaion pespecive. Lo and Lys (2000) called his appoach owad esimaing he ERCs he valuaion elevance appoach. Thee ae hee assumpions in he valuaion elevance appoach owad esimaing he ERCs (Collins and Kohai 1989). Fis, hee is a link beween secuiy pices and uue dividends as decibed in Godon s dividend discoun model. Second, hee is a elaion beween uue dividends and uue eanings. Thid, uue eanings ae elaed o cuen eanings. 407

5 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON These assumpions ae oen ciizised o being abiay and wihou heoeical igo (see o insance, Benad 1995 and Lo and Lys 1999). Paly due o his ciicisim, alenaive models ae suggesed as a backgound o model he euns-eanings elaion as descibed in he nex subsecion. 2.2 Accouning-based model as a heoeical backgound Ohlson s (1995) accouning-based valuaion model consiues he heoeical backgound o sudies invesigaing he euns-eanings elaion om he value elevance pespecive. As compaed o he valuaion elevance appoach based on Godon s dividend discoun model, his appoach expesses sock pices diecly in ems o accouning igues and povides a amewok o link analys oecass o valuaion. The lae chaaceisic o he model is especially impoan o his sudy. In conas o he valuaion elevance appoach, he value elevance appoach does no equie explici speciicaions o unexpeced eanings and abnomal euns. Howeve, boh appoaches equie a valuaion model o link accouning eanings o value changes. Ohlson (1995) shows ha he value o he im can be expessed as a linea uncion o book value (b ), eanings (x ) and ohe inomaion (v ) 2 : (2) 1+ P = ( 1 k) b + k x d + αv 408 whee: ω k =, d 1+ ω is ne dividend paymens a ime, is he isk ee ae o eun and ω is a is ode auo egessive paamee aking values beween zeo and one. Compaed o pevious valuaion models his model incopoaes boh eanings and book value as elevan valuaion aibues. Thee is a gowing body o lieaue ha uses Equaion (2) as a basis o he invesigaion o he value elevance o accouning inomaion (see, o insance, Bah, Beave and Landsman, 2001 and Hohausen and Was, 2000 o a eview). As poined ou by Eason and Somme (2000) and Lo and Lys (2000), mos o hese sudies ae levels (pice) sudies, i.e. sock pices ae egessed on accouning numbes. This sudy uses dieen euns speciicaions o Equaion (2) o invesigae he adequacy o accouning eanings and analyss oecass as a summay o he value elevan inomaion ha have aeced he sock pice ove he eun 2 The model is based on he ollowing assumpions: (a) value equals discouned pesen value o uue dividends, (b) clean suplus accouning (c) esidual income (x a and ohe inomaion (ν ) ollows an AR(1) pocess. Residual income is deined as: x a = x *b 1.

6 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK peiod. Vaious vesions o Equaion (2) ae deived o invesigae he conempoaneous associaion beween sock euns and levels o eanings, changes o eanings, levels o oecased eanings and changes in analyss eanings oecass. Alenaive vesions o Ohlson s model can be deived by changing he assumpion o he model paamees. Fis, i ω = 0 and ν = 0, Equaion (2) educes o: (3) P = b Equaion (3) is he book value model o equiy valuaion indicaing ha all asses and liabiliies o he im ae valued a make values and hee ae no economic ens ha should incease he value o he im. By aking is dieences, invoking he clean suplus elaion, e-aanging and dividing by he beginning peiod pice, Equaion (3) akes he ollowing om: (4) P + d P x = P The le-hand side o Equaion (4) is he sock eun om 1 o. Hence, assuming no economic ens and a one-o-one elaion beween make and book values, he levels o eanings should be a suiable vaiable in he ERC esimaion. Second, i ω = 1 and ν = 0 hen Equaion (2) educes o: (5) 1+ P + d = x Equaion (5) expesses he cum-dividend value as a muliple o cuen eanings. Taking is dieences o pice and eanings and dividing by he beginning peiod pice yields: (6) P + d P 1 + x d = + P P Accoding o Equaion (6), euns can be modelled as a uncion o changes in eanings. This model speciicaion moivaes he use o eanings changes in he ERC esimaion. Boh Equaions (3) and (5) ule ou he combinaion o eanings and book value in equiy valuaion. As suggesed in Equaion (2), he sock pice is a uncion o boh book value and eanings. Assuming ha 0 < ω < 1 and ν = 0, aking is dieences, invoking he clean suplus assumpion and hen eaanging ems yields he ollowing model: 409 (7) P + d P 1+ x + x d = k ( 1 k ) + k P P P,

7 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON Equaion (7) demonsaes ha he sock eun is a uncion o eanings changes, eanings levels, and pio peiod dividends. Accoding o he heoeical model (Equaion 2), hei elaive impoance is deemined by he auo egessive paamee, ω. Ou inal heoeical elaion is based on he complee Ohlson model. Unlike pio models his model conains boh accouning inomaion and ohe inomaion. Adding changes in ohe inomaion ( ν ) o he above model yields a change speciicaion o Equaion (2): (8) P + d P 1+ x + x d = k ( 1 k ) + k P P P v + α 2. P When applying Equaion (8) o he empiical ERC esimaions, he ohe inomaion vaiable needs o be opeaionalized. In his sudy, analyss eanings oecass ae used as a measue o he ohe inomaion. This allows he invesigaion o he incemenal value elevance o analyss eanings oecass wih espec o published eanings. 3. RESEARCH DESIGN In wha ollows, he empiical models o he ERC esimaions based on he valuaion models deived in Secion 2 ae pesened. Since he valuaion impac o accouning losses is ound o be close o zeo (see, o insance, Hayn 1995 and Maikainen 1997), he models ae adjused o conol o he impac o losses. Theoeical elaions beween sock euns and eanings vaiables deived in Secion 2 do no include an inecep. Howeve, since hee ae likely o be ohe acos ouside hese elaions ha deemine he change in sock pice, an inecep em is included o capue he ixed eecs o hese acos in he empiical models. Anohe deviaion om he heoeical elaions is he absence o dividends in some o he empiical models. Dividends ae no included o aciliae compaisons wih pio sudies. In he is sage o he empiical analyses, he ollowing pooled OLS egessions ae esimaed: (9) a a a a = α + β x /P + δ ( loss x ) / P + ε, 410 (10) (11) + ε b b = α + β /P 1 b, c c b c = α + β x /P + δ ( loss x )/P + ε, (12) d d d = α + β /P + ε,

8 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK (13) (14) e = α + β e c x / P + β x /P + δ d δ ( loss x )/P + ε whee =(P P 1 + d )/P 1, and is he sock eun o yea calculaed om July 1 o June, x is he annual eanings in yea, P 1 is he make value o he im a he beginning o he eun peiod, x is he change in annual eanings in yea, is he analyss consensus eanings oecas o yea +1 issued on he las Wednesday in June yea, equals change in analyss oecas, i.e. he change in nex peiod oecas beween 1 and, loss is a dummy vaiable aking he value o 1 i he eanings o peiod ae negaive and 0 ohewise 3,α is an inecep em, β is he esimaed slope coeicien, and e is an eo em wih zeo mean and consan vaiance. Following he pevious lieaue in he ield, all egession models ae divided by he opening sock pice o educe he pesence o heeoscedasic disubances. In addiion, he heeoscedasiciy consisen vaiance-covaiance maix suggesed by Whie (1980) ae used in all egessions. Ineences egading he validiy o he alenaive model speciicaions ae based on he signiicance o he esimaed slope coeiciens, i.e. ERCs in equaions (9) (16) ha measue he eec o one Swedish kona o levels/changes o eanings/analyss eanings oecass on he sock eun. In addiion, he sengh o he associaion beween dieen eanings measues and euns is assessed by compaing he adjused R 2. The eseach design makes i possible o sudy he acual, elaive and combined value elevance o eanings levels and changes. In addiion, he impoance o analyss oecass in explaining euns can be invesigaed. The egession models ae discussed in deail below. Model (9) is he empiical counepa o Equaion (4). A numbe o pio sudies analyze he elaion beween euns and accouning eanings (see, o insance, Eason and Hais 1991, Kohai and Zimmeman 1995, and Dumonie and Labelle 1998). In ode o aciliae a come + ε g h = α + β / P + β /P ( loss x ) / P + (15) (16) g i / j k e = α + β x P+ β x/p + β + δ ( loss x)/ P+ g δ ( loss x ) /P 1) + ε h l m n o g = α + β x / P+ β x/p + β + β + δ ( loss x)/ P+ δ h ( loss x ) 1) h /P + ε 3 Losses dummies ae used only o he epoed eanings, because he low value elevance o accouning losses is based on he hypohesis ha he sock make believes cuen losses o be empoay by naue and assumes uue eanings o be posiive (see Hayn 1995). This hypohesis does no necessaily hold ue o he analyss eanings oecass. 411

9 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON paison beween eanings and analyss eanings oecass in ems o value elevance, an empiical counepa o Equaion (4) based on analyss oecass, i.e. Model (10) is also esimaed. Models (11) and (12) conaining changes as independen vaiables ae deived om he heoeical elaion given in Equaion (6). The use o analyss eanings oecass and changes in analyss oecass o model changes in he sock pice is also inuiively appealing, because mos o he valuaion models used by paciiones ae based on oecass o eanings o cash lows. Accoding o Equaion (7) boh eanings levels and eanings changes should be impoan aibues in explaining changes in value. Following Eason and Hais (1991), Fancis and Schippe (1999) and Maon (1998), among ohes, Model (13) is esimaed o invesigae he incemenal value elevance o levels and changes o epoed eanings. In he same way, Model (14) is esimaed o invesigae he incemenal value elevance o levels and changes o analyss eanings oecass. Consisen wih he change speciicaion o he Ohlson model (Equaion 8), Model (15) conains hee explanaoy vaiables. In addiion o levels and changes o epoed eanings, he model conains changes in analyss eanings oecass as a poxy o ohe inomaion. In ode o invesigae he elaive impoance o all alenaive eanings measues, Model (16) is esimaed. The model conains levels and changes o epoed eanings as well as he levels and change o he analyss eanings oecass. By using nesed models o Model (16), he incemenal explanaoy powe o each vaiable can be invesigaed. 4. DATA ENVIRONMENT The Swedish sock make The daa used in he sudy consis o ims lised on he Swedish sock exchange, i.e. Sockholmsbösen duing he whole peiod om 1987 o 1998 o which he equied daa wee available. Sockholmsbösen is he leading Nodic sock make wih an annual unove o 4455,9 billion Swedish kono (SK) o he yea 2000 (one SK was appoximaely equal o 0,11 US dollas). In ems o he annual unove, he Swedish sock make was he sevenh lages sock make in Euope in Like mos o he sock makes in he wold, Sockholmsbösen was seadily gowing in ems o ading volume and make value duing he las decade. Moeove, he numbe o shaes aded has been monoonically inceasing duing he eseach peiod. Excep o he yeas 1987 and 1990, he change in he make eun is posiive. As he sock make has been gowing, he numbe o poessional inancial analyss has inceased as well. 4 Inomaion abou Sockholmsbösen can be ound a

10 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK The Swedish Sociey o Financial Analyss (SFF) was ounded in 1970 and is iniial aciviy ocused on vaious accouning and valuaion issues. The is ecommendaion issued in 1975 deal wih eanings pe shae calculaions. The level o aciviy has been inceasing in lae yeas including educaional seminas and egula meeings wih copoae execuives, scieniss and poliicians. In addiion, SFF has oeed an educaional pogam o ceiied inancial analyss since The AMIR (Associaion o Invesmen Managemen and Reseach) pogam in US seved as a model when his pogam was developed. Hence he level o sophisicaion o Swedish inancial analyss has been inceasing ove he eseach peiod. 4.2 Sample selecion The sample includes im-yea obsevaions o daa o Swedish ims ha wee lised duing he peiod on he Sockholm sock exchange. Financial ims (banks and insuance companies) ae excluded because o hei dieen accouning pacices. The sample is consuced by meging daa om wo souces. All daa excep o he analyss eanings oecass ae colleced om he publicly available Bonnie-Findaa daa base o ims ha have a Decembe iscal yea end. Analyss eanings oecass ae obained om he I/B/E/S daa base. Boom-line ne income is used as a measue o accouning eanings (x ). This eanings igue is mos consisen wih he clean suplus elaion used o deive he heoeical euns-eanings elaions. I/B/E/S has been collecing analyss eanings oecass o Swedish ims since 1987, which is he beginning yea o he sample peiod. The I/B/E/S eanings oecass ( ) o peiod + 1 ae om June each yea. This pocedue ensues ha he eanings inomaion o yea is available when analyss make hei oecass. Fo example, i yea ends 12/31/1990 and eanings o yea is epoed some ime beween 01/01/1991 and 06/30/1991, he consensus oecas is aken o he hid Wednesday in June This pocedue is in line wih Dechow e al. (1999) and Hand and Landsman (1999). A leas wo consecuive oecass and eanings igues ae equied o he im o be included in he sample. Monhly secuiy eun daa adjused o dividends needs o be available o each sock. Finally, sock pices a he las ading day in Decembe and he numbe o socks, boh adjused o sock splis and new issues, need o be available in he daa base. I/B/E/S povides oecass on a pe shae basis. To avoid he possibiliy ha I/B/E/S pe shae daa elec a dieen numbe o socks compaed o he Bonnie-Findaa base, we is adjus he I/B/E/S daa using he I/B/E/S coecion aco o ge he oecass as hey acually wee as o he saisical peiod. Then we adjus he oecas using he adjusmen aco con In Sweden, ims ae obligaed o pesen hei inancial epo no lae han six monhs ae he accouning yea ends. Unounaely he exac epoing dae is no available in he daa base.

11 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON ained in he Bonnie-Findaa daa base. Finally, o ensue ha he egession esuls ae no unduly sensiive o saisical oulies, we delee he one pecen ail o he disibuion o each vaiable. Ae deleion he inal sample consiss o obsevaions. 5. EMPIRICAL RESULTS 5.1 Peliminay daa analysis Table 1 epos he descipive saisics o he vaiables used in he empiical analyses. All vaiables ae scaled by sock pices a he beginning o he eun peiod o each yea. Disibuion saisics o he vaiables ae epoed in Panel A o Table 1. The mean (median) sock eun,, equals (0.18) indicaing he peiod o he bull make in he end o 1980s and ae he mid o 1990s. The level o he epoed eanings (x ) has a mean o 0.067, wheeas he coesponding igue o analyss eanings oecass is The ac ha hee seems o be a sligh upwad bias in he analyss eanings oecass is commonly epoed in he pevious lieaue (see, o insance, Bown, 1997 and Richadson e al., 1999). The aveage pice/ eanings aios based on epoed eanings and nex yea eanings oecass ae 15 and 12, especively. Panel B o Table 1 epos he coelaion maix o he vaiables. Peason coelaion coeiciens ae given in he uppe main diagonal and Speaman coelaion coeiciens in he lowe main diagonal. The coelaion beween he accouning vaiables and he wo vaiables based on analyss oecass anges om o The highes coelaion, 0.628, is epoed beween and D. The coelaions beween hese wo vaiables, hough elaively high, ae unlikely o be high enough o cause a mulicollineaiy poblem. The coelaion beween euns and he independen vaiables is discussed in he nex secion whee he esuls o he egession models ae epoed Reun-eanings elaion based on alenaive model speciicaions Table 2 epos he esuls o esimaing models (9 12) in pooled egessions. The esuls indicae ha boh levels and changes o he epoed eanings ae saisically signiicanly elaed o euns even ae conolling o he impac o losses. Accodingly, boh levels and changes o analyss eanings oecass ae signiicanly elaed o euns. The esimaed ERC and adjused R 2 ae he highes when euns ae egessed on analyss eanings oecass in Model (10). The esimaed ERC and adjused R 2 based on Model (10) ae (p<0.001) and 0.11, especively. The lowes values o he esimaed ERC and he adjused R 2 ae epoed when euns ae egessed on changes in epoed eanings in Model (11). Consisen wih he esuls epoed in many pevious sudies, he magniudes o he esi-

12 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK TABLE 1. Descipive chaaceisics o vaiables. Panel A: Disibuional saisics Vaiable Mean Median Sd. deviaion Minimum Maximum x x Panel B: Pooled Peason and Speaman coss-secional coelaions x Vaiable (<0.001) (<0.001) (<0.001) (<0.001) x (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) x (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) (<0.001) Noes. The able povides descipive chaaceisics o he vaiables included in he sudy. is he sock eun o yea calculaed om July -1 o June, x is he annual eanings pe shae in yea, is he analyss consensus oecas o yea + 1 issued in June o yea. x is he change in annual eanings in yea, is he change in analyss consensus oecas o he nex peiod. In Panel B, Peason coelaions ae epoed in he uppe main diagonal and Speaman coelaions in he lowe main diagonal. P-values o esing whehe he coelaions ae dieen om zeo ae epoed in paenheses. x maed ERCs epoed in Table 2 ae vey low in ems o hei economic inepeaion. To illusae, he value o he esimaed ERC o he eanings changes (Model 11) is Based on he simple eanings capializaion model, he annual expeced ae o sock eun implied by his esimae is 156% (=1/0.639), which is an uneasonably high numbe. Even he esimaed ERC based on changes in analyss eanings oecass (Model 12) implies an expeced ae o eun o 64% (=1/1.563). Neveheless, he esuls in Table 2 indicae ha he euns-eanings models based on he analyss eanings oecass poduce esimaes o he ERCs ha ae much close o hei economically easonable values han he models based on published ean- 415

13 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON TABLE 2. Eanings esponse coeiciens based on dieen eanings measues. Model (9) (10) (11) (12) Consan (4.12)*** (2.49)** (16.21)*** (15.99)*** x (9.39)*** (11.20)*** x (6.19)*** loss * x (-7.39)*** loss * x (-1.73)* (9.14)*** 2 Adj.R Noes. The esimaed models ae as ollows: a a a a = α + β x /P + δ (( loss* x ) / P ) + ε (9) b b b = α + β /P + ε (10) c c b c = α + β x /P + δ ((loss* x )/P ) + ε (11) d d d = α + β /P + ε (12) whee is he sock eun o yea calculaed om July -1 o June, P is he sock pice a he beginning o he eun peiod, x is he annual eanings pe shae in yea, is he analyss consensus oecas o yea + 1 issued in June o yea. x is he change in annual eanings in yea, is he change in analyss consensus oecas o he nex peiod, loss is a dummy vaiable aking he value o 1 i eanings ae zeo o negaive and ohewise he value zeo, β is he esimaed slope coeicien (he eanings esponse coeiciens), and e is an eo em. Whie s (1980) heeoscedasiciy consisen covaiance maix is used o all he egessions o calculae sandad eos. The -saisics ae in paenheses. A wo-sided es is used o ineceps and a one-sided es o he slope coeiciens. *, ** and *** epesen signiican a he 5%, 1% and 0,1% level especively. 416 ings igues. The signiicanly negaive slopes o he ineacion ems loss * x and loss * x indicae ha accouning losses have a negaive valuaion impac on sock euns. The esuls in Table 2 conim he validiy o he alenaive euns-eanings speciicaions deived om he accouning-based valuaion model. Mos impoanly, he esuls suppo he use o analyss eanings oecass in his conex. I seems ha he inomaion in-

14 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK volved in analyss eanings oecass oupeoms, a leas o some exen, he inomaion involved in epoed eanings in ems o hei value elevance. The make paicipans seem o pu moe ocus on oecased eanings inomaion han epoed eanings igues when seing pices. The lowe value elevance o epoed eanings elaive o analyss oecass can be inepeed as accouning eanings being less inomaive abou value changes. As discussed by Was and Zimmeman (1996), he lowe inomaiveness o he epoed eanings may exis because accouning eanings ae no being designed o measue value changes alone. Fuhemoe, in he pesence o eanings managemen, he abiliy o epoed eanings o measue value changes could be disoed uhe. Table 3 epos he esuls o esimaing models (13 16) in which he incemenal impoance o dieen eanings measues in euns-eanings models is invesigaed. The esuls o including boh levels and changes o epoed eanings (13) indicae ha changes in epoed eanings do no seem o conibue much in addiion o levels o epoed eanings when explaining euns. Simila esuls ae epoed by Eason and Hais (1991) and Maon (1998), among ohes. Howeve, he esuls o egessing euns on levels and changes o analyss eanings oecass in model (14) indicae ha he changes o he oecased eanings have incemenal inomaion wih espec o levels. The esimaed ERCs based on levels and changes o he oecased eanings ae (p-value <0.001) and (p-value <0.001), especively. The heoeical elaion given in Equaion 8 suggess ha a combinaion o epoed and oecased eanings can be used o model he changes in make values. Repoed in Table 3 ae he esuls o egessing euns on changes in analyss oecass and boh eanings vaiables in he same model (Model 15). The esimaed ERCs ae (p-value <0.001) o he accouning eanings vaiable and (p-value <0.001) o he vaiable measuing changes in analyss consensus oecass. Howeve, changes in accouning eanings do no emain signiican. The inomaion in oecas changes seems o subsume he inomaion in epoed eanings changes. The las column o Table 3 epos he esuls o esimaing Model (16) ha conains levels and changes o boh he epoed and oecased eanings. The esuls indicae ha he levels o he epoed and oecased eanings and he changes in he oecased eanings ae incemenally impoan in explaining sock euns. Adjused R 2 is highe o Models 15 and 16 han o any o he ohe models. Oveall, he esuls epoed in Table 3 sugges ha boh he levels o he epoed eanings and he levels and changes in analyss oecass ae elevan in explaining euns, and he hee vaiables ae no jus subsiues. 5.3 Sensiiviy analyses The esuls epoed in he pevious subsecion ae based on he pooled ime-seies and cosssecional egession. In ode o check he obusness o he esuls, his subsecion povides 417

15 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON TABLE 3. Incemenal inomaion conen o dieen eanings measues in euns-eanings elaion. Model (13) (14) (15) (16) Consan (4.50)*** (3.84)*** (3.67)*** (0.94) x (7.01)*** (6.95)*** (4.89)*** (6.12)*** (4.26)*** x (1.93)** (-1.13) (-0.47) (3.42)*** (7.08)*** (3.35)*** loss * x (-6.60)*** (-5.39)*** (-4.87)*** loss * x (0.98) (1.40) (1.41) 2 Adj.R Noes. The esimaed models ae as ollows: = e α e + β x / p c + β x /p + δ ( loss x d e δ ( loss x )/p + ε g h = α + / p + β /p ε g i j k e = α + β x / p + β x /p + β + δ β + (14) = h α δ h δ ( loss* x l + β x / p ( loss* x )/p ) + g ε h ε ) / p + (loss x ) / p m n o g + β x /p + β + β + δ )/p ) + + (loss x ) / p whee is he sock eun o yea calculaed om July -1 o June, P is he sock pice a he beginning o he eun peiod, x is he annual eanings pe shae in yea, is he analyss consensus oecas o yea + 1 issued in June o yea, x is he change in annual eanings in yea, is he change in analyss consensus oecas o he nex peiod, loss is a dummy vaiable aking he value o 1 i eanings ae zeo o negaive and ohewise he value zeo, β is he esimaed slope coeicien (he eanings esponse coeiciens), and e is an eo em. Whie s (1980) heeoscedasiciy consisen covaiance maix is used o all he egessions o calculae sandad eos and -saisics. The -saisics ae in paenheses. A wo-sided es is used o ineceps and a one-sided es o he slope coeiciens. *, ** and *** epesen signiican a he 5%, 1% and 0,1% level especively. + (13) (15) (16)

16 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK vaious sensiiviy analyses. Fis, all he models ae e-esimaed coss-secionally o each yea in he sample peiod esuling in a ime seies o esimaed annual ERCs. Thei disibuions ae hen used o es he saisical signiicance o he euns-eanings elaions. This appoach conols o he poenial bias in he esimaed ERCs ha esul om any coss-secional coelaion in he eo ems. Second, all he models ae e-esimaed as andom coeicien models by including annual dummy vaiables o conol o he ime vaiaion in euns and by allowing andom im-speciic ineceps and andom ERCs. Thid, indusy-eecs in he esimaed ERCs ae invesigaed. Annual egessions In he pooled coss-secional and ime-seies egessions, he esimaed slope coeiciens may be biased due o coelaion in eo ems boh in ime and space. Benad (1987) suggess ha he disibuions o he ERCs obained om he annual egessions can be used o es whehe he sample means o he esimaed ERCs ae saisically dieen om zeo. I i is assumed ha he annual coss-secional egessions ae independen, he disibuion o he esimaed annual ERCs can be used o es whehe hei sample means ae saisically signiicanly dieen om zeo. Figue 1 depics he ime-seies o he esimaed annual ERCs based on single vaiable euns-eanings models (9 12). The annual vaiaion in he esimaed ERCs can clealy be seen om Figue 1, which suppos he use o he annual coss-secional egessions as a check o he obusness he esuls. In addiion, i can be seen om Figue 1 ha he esimaed annual ERCs based on he levels and changes o he analyss eanings oecass (Models 10 and 12), ae clealy highe han hose based on he levels and changes o he epoed eanings (Models 9 and 11). This inding songly suppos he esuls o he pooled daa epoed in Table 2. Repoed in Table 4 ae he ime-seies means o he esimaed annual coss-secional ERCs and -ess o es whehe he annual ERCs ae signiicanly dieen om zeo. Resuls o he single vaiable euns-eanings models (Models 9 12) epoed in he is Panel o Table 4 ae in line wih hose epoed in Table 2 indicaing ha he dieen eanings measues ae signiicanly elaed o sock euns. The aveage ERCs epoed in Table 4 ae, howeve, lowe han hose epoed in Table 2. This is especially he case o he changes and levels o he epoed eanings. The second panel o Table 4 epos he aveages o he esimaed annual ERCs based on Models These obusness checks conim he esuls epoed in Table 3, i.e. ha he levels o he epoed and oecased eanings and he changes in he oecased eanings ae incemenally impoan in explaining sock euns. 419

17 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON 4,00 3,50 3,00 2,50 ERC 2,00 1,50 1,00 0,50 0,00-0, Yea Model (9) Model (10) Model (11) Model (12) FIGURE 1. Annual coss-secional eanings esponse coeiciens. Noes. The esimaed models ae as ollows: 420 a a a a = α + β x /P 1 + (( loss* x ) / P 1 ) + ε (9) b b b = α + β /P 1 + ε (10) c c b c = α + β x /P 1 + δ ((loss* x )/P 1 ) + ε (11) d d d = α + β /P 1 + ε (12) whee is he sock eun o yea calculaed om July -1 o June, P 1 is he sock pice a he x is he annual eanings pe shae in yea, beginning o he eun peiod, consensus oecas o yea + 1 issued in June o yea + 1. is he analyss is he change in annual eanings in yea, is he change in analyss consensus oecas o he nex peiod, loss is a dummy vaiable aking he value o 1 i eanings ae negaive and ohewise he value zeo, and e is an eo em Finally, is he esimaed slope coeicien, i.e. he eanings esponse coeicien (ERC) depiced in he igue. x

18 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK TABLE 4. Time-seies aveages o he annual coss-secional eanings esponse coeiciens. Panel 1: Models 9-12 Model (9) (10) (11) (12) Consan (1.53) (0.90) (2.60)* (2.66)* x (7.36)*** (5.95)*** x (3.61)** (6.40)*** 2 Aveage Adj.R Panel 2: Models Model (13) (14) (15) (16) Consan (1.34) (1.26) (1.36) (0.76) x (6.14)*** (5.33)*** (4.29)*** (3.00)** (1.81) x (-0.62) (-1.90)* (-1.88)* (2.60)* (5.10)*** (3.08)** Aveage 2 Adj.R Noes. See Table 1 and 3 o deails o he models esimaed. Numbes in he able ae he ime-seies aveages o he slope coeiciens (ERCs) o he annual egessions. -saisics ae based on he ime seies sandad eos o he eleven yealy esimaes. The -saisics ae in paenheses. A wo-sided es is used o ineceps and a one-sided es o he slope coeiciens. *, ** and *** epesen signiican a he 5%, 1% and 0,1% level especively. 421

19 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON Random coeicien models wih annual dummies Table 5 epos he esuls o egessing euns-eanings model 9 12 by including annual dummy vaiables o conol o he possible ime-seies vaiaion in euns and by allowing andom im-speciic ineceps and andom slope coeiciens o he eanings vaiables. In ode o save space, he esimaed coeiciens o he annual dummy vaiables ae no epoed. The likelihood aio es indicaes ha allowing andom eecs and conolling o poenial ime vaiaion in euns impoves he explanaoy powe o Models 11 and 12 in which euns ae egessed on changes in eanings o changes in analyss eanings oecass. The esimaed ERCs ae, howeve, signiicanly posiive alhough hei values ae slighly below hose epoed in Table 2. Consisen wih he esuls epoed in Table 2, he value o he log likelihood uncion is smalles o he (10) indicaing ha he bes i o he euns-eanings egessions is achieved when euns ae egessed on analyss eanings oecass. Indusy eecs To uhe invesigae he obusness o he esuls and o miigae poenial poblems o vaiaions in he esimaed ERCs acoss ims, Models 9 12 ae e-esimaed by aking indusy eecs ino accoun. To es o he dieences in esuls acoss indusies, 10 indicao vaiables ae inoduced o he euns-eanings models, one o each indusy, especively. The I/B/E/S indusy classiicaion is used o consuc he indicao vaiables. 7 These indicao vaiables ae ineaced wih each eanings measue in each model. The seco Basic Indusies is used as he indusy o eeence. A signiican coeicien on one o he ineacion ems elecs he dieenial value eec o he eanings measue in his seco compaed o he Basic Indusies seco. Table 6 epos he esuls o he ou univaiae eun-eanings egessions wih indusy ineacions included. Noe ha accoding o he I/B/E/S classiicaion, invesmen companies and eal esae companies ae included in he inance seco. As peviously menioned, no banks o insuance companies ae included in he sudy. The esuls o Model (9) show ha he coeiciens o he ineacion ems ae posiive and saisically signiican in hee cases, i.e. Capial Goods (IND1), Consume Sevice (IND4) and Technology (IND8), especively. This In he inenaional daa base, I/B/E/S classiies companies accoding o he 48 indusies in he Mogan Sanley Capial Inenaional Pespecive. These 48 indusies ae hen classiied by IBES ino 11 make secos and one Miscellaneous caegoy. In he cuen sample six im yea obsevaions wee caegoized as miscellaneous by I/B/E/S. Because o he limied numbes o obsevaions in his caegoy, we manually eclassiied each o hem ino one o he IBES make secos. Fuhe, he seco Enegy only conains 10 obsevaions, so we meged i wih he public uiliies seco. Hence, alogehe 10 dieen indusies ae invesigaed. The seco Basic Indusies is used as he benchmak. Also noe, ha he seco Finance only conains eal esae companies and invesmen companies.

20 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK TABLE 5. Eanings esponse coeiciens based on andom coeicien models. Ineceps and slopes o he eanings vaiables ae allowed o vay acoss ims. Model (9) (10) (11) (12) Consan (4.65) *** (3.34)*** (6.87)*** (6.46)*** x (7.69)*** (9.48)*** x (4.42)*** loss * x (-4.08)*** loss * x (-1.04) (7.30)*** -2 log likelihood LR-Tes *** 10.50* Noes. The esimaed models ae as ollows: a a a a = α + β x /P + δ (( loss* x ) / P ) + ε (9) b b b = α + β /P + ε (10) c c b c = α + β x /p + δ ((loss * x )/p ) + ε (11) d d d = α + β /p + ε (12) Alhough no epoed, all egession models include annual dummies. A wo-sided es is used o ineceps and a one-sided es o he slope coeiciens. *, ** and *** epesen signiican a he 5%, 1% and 0,1% level especively. indicaes ha he ERCs based on epoed eanings o hese indusies ae, on aveage, highe han hose o he Basic Indusies seco. Regading he Technology seco, posiive and saisically signiican ineacion eecs ae also ound in models (10) and (11). The eec o epoed eanings levels and changes on euns seems o be moe poound in his seco compaed o he basic indusies. This esul is somewha supising since pio US sudies (see, o insance, Ami and Lev, 1996) epo ha he value elevance o accouning igues is lowe in he echnology seco han in ohe indusies. Neveheless, he esuls epoed in Table 6 423

21 LTA 4/04 J-P. KALLUNKI, M. MARTIKAINEN AND H. NILSSON TABLE 6. Eanings esponse coeiciens when conolling o indusy eecs. Model (9) (10) (11) (12) Consan (4.65) *** (3.34)*** (6.87)*** (6.46)*** x (7.69)*** (9.48)*** x (4.42)*** loss * x (-4.08)*** loss * x (-1.04) (7.30)*** -2 log likelihood LR-Tes *** 10.50* Noes. The esimaed models ae as ollows: a a a a = α + β x /P + δ (( loss* x ) / P ) + ε (9) b b b = α + β /P + ε (10) c c b c = α + β x /p + δ ((loss * x )/p ) + ε (11) d d d = α + β /p + ε (12) Alhough no epoed, all egession models include annual dummies. A wo-sided es is used o ineceps and a one-sided es o he slope coeiciens. *, ** and *** epesen signiican a he 5%, 1% and 0,1% level especively. sugges ha no majo indusy-elaed acos ae diving he main esuls. Simila esuls based on Swedish daa ae ound in Maon (1998) Maon (1998) and Runsen (1998) esimae he eanings level and change models (simila o model 13 in his pape) o dieen indusies. Boh sudies use an indusy classiicaion o hei own. Maon (1998) epos no indusy eecs in hei esuls excep o he uiliies indusy. Runsen (1998) epos simila esuls, excep ha he elaion beween euns and accouning igues is weak in he pulp and pape indusy.

22 A NALYST PROFESSION, ACCOUNTING EARNINGS AND STORCK 6. CONCLUSIONS This pape invesigaes he ole o analyss eanings oecass in conempoaneous associaion beween sock euns and accouning eanings. The euns-eanings models invesigaed ae he eanings levels and changes models and models including analyss eanings oecass based on he exended esidual income model by Ohlson (1995). The dieen valuaion impac o accouning losses and pois in he euns-eanings models is also invesigaed. The esuls indicae ha he analyss eanings oecass and changes in hese oecass ae impoan in explaining sock euns. The owad-looking oienaion o analyss oecass oupeoms cuen eanings and eanings changes in explaining euns. Moeove, he indings indicae ha he levels o he published eanings and he levels and changes o he analyss eanings oecass ae signiicanly elaed o sock euns. The esuls also indicae ha dieen eanings measues have incemenal impoance wih espec o each ohe. The exended vesions o he Ohlson (1995) esidual income model seem o geneae easonable euns-eanings models in ems o hei empiical validiy. Consisen wih he esuls o pevious sudies, he esimaed eanings esponse coeiciens (ERCs) un ou o be elaively low. Vaious sensiiviy analyses including andom coeicien models, annual coss-secional egessions and indusy-level models ae conduced o check o he obusness o he esuls. The oucome o he pooled ime seies coss-secional egessions seems o be aily obus wih egad o hese ess. REFERENCES ALFORD, A., J. JONES, R., LEFTWHICH, and M., ZMIJEWSKI, 1993, The elaive inomaiveness o accouning income disclosues in dieen counies. Jounal o Accouning Reseach 31, AMIR, E. and B. LEV, 1996, Value-elevance o non-inancial inomaion: The wieless communicaions indusy, Jounal o Accouning and Economics 22, BALL, R. and BROWN, P., 1968, An empiical evaluaion o accouning income numbes. Jounal o Accouning Reseach, BARTH, M. E., W. H. BEAVER and W.R. LANDSMAN, 2001, The elevance o he value elevance lieaue o inancial accouning sandad seing: Anohe view, Woking Pape: Sanod Univesiy. BERNARD, V. L., 1987, Coss-secional dependence and poblems in ineence in make-based accouning eseach, Jounal o Accouning Reseach, BERNARD, V. L., 1995, The Felham-Ohlson amewok: Implicaions o empiiss, Conempoay Accouning Reseach 11, BROWN, L. T. and K. SIVAKUMAR, 2001, Compaing he qualiy o hee eanings measues. Woking pape: Geogia Sae Univesiy. BROWN, L., 1997, Analys oecasing eos: Addiional evidence, Financial Analyss Jounal 53, BROWN, S., L. KIN and T. LYS, 1999, Use o R2 in accouning eseach: measuing changes in value elevance ove he las ou decades. Jounal o Accouning and Economics 28, COLLINS D. W., KOTHARI S. P, J. SHANKEN and R. G. SLOAN, 1994, Lack o imeliness and noise as explanaions o he low conempoaneous eun-eanings associaion, Jounal o Accouning and Economics 18,

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