Persistence of Components of Industry-wide and Firm-Specific Earnings

Document Type : Research Paper

Authors

Abstract

  Introduction
Economic theory suggests that firm performance determined by industry fundamentals is relatively long lasting. On the other hand, performance that deviates from industry norms tends to dissipate more quickly. Investors tend to fixate on reported earnings, however, not fully recognizing differences in the persistence of its components. As a result, we expect the market to underreact to the higher persistence of the industry-wide component of earnings.
 
Research Hypothesis
The aim of the study is to investigate the persistence of components of industry and firm earnings.
H1. The industry-wide component of earnings is more persistent than the firm-specific component.
H2. Investors fail to fully appreciate difference persistence of industry-wide component of earnings and firm-specific earnings.
H3. Investors underreact to the persistence of industry-wide earning.
H4.  Investors overreact to the persistence of firm-specific earning.
H5. Industry wide cash flows is the most persistent component of earnings.
H6. Firm-specific accruals is the least persistent component of earnings.
H7.  Investors underreact to industry-wide cash flows component.
H8. Investors overreact to firm-specific accruals component.
 
Method
To achieve the purpose of this study, a sample consisting of 113 companies listed in Tehran Stock Exchange during the year 2005 to 2015 were selected. In order to test the hypothesis, model of Mishkin approach was applied. The Mishkin test was conducted using non-linear least square estimation. The cross-equation restrictions were tested using a Wald-based test with robust Wald statistics.
 
Results
The results of research indicate that industry-wide component of earnings is more persistent than the firm-specific component and investors fail to fully appreciate difference persistence of industry-wide component of earnings and firm-specific earnings; also they underreact to the persistence of industry-wide earning and overreact to the persistence of firm-specific earning. The results show that industry wide cash flows is the most persistent component of earnings and firm-specific accruals is the least persistent component of earnings. Research data show investors underreact to industry-wide cash flows component and they overreact firm-specific accruals component.
 
Conclusion
We find that industry-wide earnings are significantly more persistent than firm-specific earnings. However, investors fail to fully distinguish this differential persistence as stock prices place similar weights on these two earnings components in forecasting one-year-ahead earnings. In other words, the market underreacts to the persistence of industry-wide earnings and overreacts to the persistence of firm-specific earnings. Finally,we find that industry-wide cash flow is the most persistent component of earnings while firm-specific accruals is the least persistent. Results indicates that investors underreact to industry-wide cash flows component while they overreact to firm-specific accruals component.
 
Keywords: Accruals, Cash flows, Earning persistence, Stock returns
 
 

Keywords

References

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  • Receive Date: 11 April 2018
  • Accept Date: 11 April 2018

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