Ray J. Pfeiffer, Jr., Pieter T. Elgers, Controlling for Lagged Stock Price Responses in Pricing Regressions: An Application to the Pricing of Cash Flows and Accruals, Journal of Accounting Research, Vol. 37, No. 1 (Spring, 1999), pp. 239-247

This paper reassesses evidence of anticipatory income smoothing reported in DeFond and Park (DP) (J. Accounting Econom. 23 (1997) 115) in light of knowledge about measurement error in discretionary accrual estimates. We argue that the method DP use to measure un-managed earnings mechanically biases the evidence in a manner consistent with anticipatory income smoothing. Using an approximate randomization approach, we find that DP's results cannot be distinguished from those achieved when discretionary accruals are randomly assigned to firm-years in our sample. Overall, these results show that the ‘backing out’ approach to measuring un-managed earnings is ineffective in testing earnings management hypotheses.

[This study evaluates the relation between security returns and funds-based earnings components. We document that proxies for market expectations of the components that are based on measures of historical serial-and cross-dependencies are substantially more accurate than random-walk proxies. Moreover, we detect significantly higher valuations of the operating cash flow component of earnings, relative to current accruals, when market expectations are represented using the dependency-based predictions. Such differential valuation is not detectable for random-walk representations. Contrary to results in Ali (1994), we find incremental information in unexpected cash flows over the whole spectrum (moderate and extreme) of unexpected cash flow realizations.]

This paper documents that the weighting of analysts' annual earnings forecasts implicit in security prices is lower than the historical relation between financial analysts' forecasts and realized earnings. Short positions in securities in the bottom decile and long positions in the top decile of the crosssectional distribution of analysts' early-in-the-year earnings forecasts generate significant hedge-portfolio returns in the year after portfolio formation. This delayed price response is more pronounced for firms with relatively low analyst coverage, consistent with the premise that low financial analyst coverage is associated with a variety of factors that impede the information efficiency of the security market. The hedge-portfolio returns concentrate in the months of subsequent quarterly earnings announcements, suggesting that the delayed security price adjustments reflect the market's failure to incorporate information in analysts' forecasts about future earnings, rather than deficiencies in our conditional expectations of security returns.

Abstract This study evaluates the relation between security returns and funds-based earnings components. We document that proxies for market expectations of the components that are based on measures of historical serial- and cross-dependencies are substantially more accurate than random-walk proxies. Moreover, we detect significantly higher valuations of the operating cash flow component of earnings, relative to current accruals, when market expectations are represented using the dependency-based predictions. Such differential valuation is not detectable for random-walk representations. Contrary to results in Ali (1994), we find incremental information in unexpected cash flows over the whole spectrum (moderate and extreme) of unexpected cash flow realizations.