This paper examines the extent to which aggregate stock return variation is explained by variables chosen to reflect revisions in expectations of future dividends. In effect, we decompose realized dividend growth into expected and unexpected components using information in aggregate investment, dividend yield, and future returns. A parsimonious specification accounts for over 70% of annual return variation. We also conduct a cross-sectional experiment using portfolios formed on the basis of annual return performance. This analysis shows that nearly 90% of the portfolio return variation is explained by dividend and expected return variables.

Recent evidence reveals significant negative serial correlation in aggregate (market-wide) stock returns. We extend this result to relative (market-adjusted) returns, demonstrating negative serial correlation in five-year returns. We then test two competing explanations: (1) market mispricing and (2) changing expected returns in an efficient market. The tests are conducted using the capital asset pricing model to estimate relative returns. The evidence suggests that negative serial correlation in relative returns is due almost entirely to variation in relative risks, and therefore expected relative returns, through time. We document substantial relative risk shifts, particularly for extreme-performing stocks.

We examine cross-sectional determinants of the informativeness of analyst research, i.e., their effect on security prices, controlling for endogeneity among the factors affecting informativeness. Analyst reports are more informative when the potential brokerage profits are higher (e.g., high trading volume, high volatility, and high institutional ownership) and lower when information processing costs (e.g., more business segments) are high. We also find that the informativeness of analyst research and informativeness of financial statements are complements.

International differences in the demand for accounting income predictably affect the way it incorporates economic income (change in market value) over time. We characterize the `shareholder’ and `stakeholder’ corporate governance models of common and code law countries respectively as resolving information asymmetry by public disclosure and private communication. Also, code law directly links accounting income to current payouts (to employees, managers, shareholders and governments). Consequently, code law accounting income is less timely, particularly in incorporating economic losses. Regulation, taxation and litigation cause variation among common law countries. The results have implications for security analysts, standard-setters, regulators, and corporate governance.

[In competitive product markets, product prices and thus firms' revenues incorporate the cost of equity capital. In a competitive capital market, the cost of equity capital (the expected return on equity) increases with the risk of firms' investments. Because accounting earnings are calculated without deducting the cost of equity capital, they are expected to be an increasing function of firms' investment risks. This simple competitive equilibrium analysis predicts a positive relation between changes in investment risk and expected earnings. The presence of corporate debt complicates the analysis because leverage effects seem likely to affect the relation between changes in investment risk and expected earnings. Using annual earnings and return data from 1950 to 1988, we document a statistically significant positive association between changes in equities' relative risks and in earnings. However, on average, only a small proportion of changes in earnings can be attributed to changes in risk. A much larger proportion is attributable to changes in economic rents (windfall gains and losses). The observed positive association between changes in earnings and changes in equities' risks suggests that leverage effects do not fully offset the effect of changes in investment risks. This association is robust with respect to subperiod analysis, alternative specifications of the earnings change variable, alternative data-availability requirements, and the number of portfolios formed.]

We find evidence that conflicts of interest arising from mergers and acquisitions (M&A) relations influence analysts' recommendations, corroborating regulators' and practitioners' suspicions in a setting, i.e., M&A relations, not previously examined in research on analyst conflicts. In addition, the M&A context allows us to disentangle the conflict of interest effect from selection bias. We find that analysts affiliated with acquirer advisors upgrade acquirer stocks around M&A deals, even around all-cash deals, in which selection bias is unlikely. Also consistent with conflict of interest but not selection bias, target-affiliated analysts publish optimistic reports about acquirers after, but not before, the exchange ratio of an all-stock deal is set.

The authors' examination of the cross-section of expected returns reveals economically and statistically significant compensation (about 6 to 9 percent per annum) for beta risk when betas are estimated from time-series regressions of annual portfolio returns on the annual return on the equally weighted market index. The relation between book-to-market equity and returns is weaker and less consistent than that in Fama and French (1992). The authors conjecture that past book-to-market results using COMPUSTAT data are affected by a selection bias and provide indirect evidence.

Based on extant literature, we review the positive theory of GAAP. The theory predicts that GAAP’s principal focus is on control (performance measurement and stewardship) and that verifiability and conservatism are critical features of a GAAP shaped by market forces. We recognize the advantage of using fair values in circumstances where these are based on observable prices in liquid secondary markets, but caution against expanding fair values to financial reporting more generally. We conclude that rather than converging U.S. GAAP with IFRS, competition between the FASB and the IASB would allow GAAP to better respond to market forces.

Predictability of future returns using ex ante information (e.g., analyst forecasts) violates market efficiency. We show that predictability can be due to non-random data deletion, especially in skewed distributions of long-horizon security returns. Passive deletion arises because some firms do not survive the post-event long horizon. Active deletion arises when extreme observations are truncated by the researcher. Simulations demonstrate that data deletion induces a negative relation between future returns and ex ante information variables. Analysis of actual data suggests a 30–50% bias in the estimated relations. We recommend specific robustness checks when testing return predictability using ex ante information.

Assessing the predictive ability of behavioral finance theories using out-of-sample data is important. Otherwise, the potentially boundless set of psychological biases underlying the behavioral explanations for security price behavior can lead to overfitting of theories to data. We test pricing effects attributed to two psychological biases, representativeness and conservatism, which underlie many behavioral finance theories. Using trends and consistency of accounting performance, we look for the pricing consequences of representativeness and conservatism. We find mixed evidence consistent with behavioral finance. Specifically, the theories based on representativeness are not supported, but we find some evidence of the pricing implications of conservatism.