This paper investigates whether so-called anomalous returns predicted by accounting numbers reflect normal returns for risk or abnormal returns. It does so via a model showing how accounting numbers inform about normal returns if pricing were rational. The model equates expected returns to expectations of earnings and earnings growth, so that any variable that forecasts earnings and earnings growth also indicates the required return if the market prices those outcomes as risky. The empirical results confirm that many accounting anomaly variables (such as accruals, asset growth, and investment) forecast forward earnings and growth, and in the same direction in which they forecast returns. While the lack of an agreed-upon asset pricing model for required returns rules out definitive conclusions, the paper provides both a framework and supporting empirical results indicating that the observed “anomalous” returns associated with accounting numbers are consistent with rational pricing.

The purpose of this article is to discover a theoretically sound model of asset valuation by reference to the basic underlying concept of financial position. It will be shown that several models of asset valuation can be developed from alternative assumptions or definitions of financial position, but that the application of certain metaphysical constraints brings about the rejection of some of these models. The article falls into two parts. Firstly, the financial position assumption and thus the asset valuation model considered theoretically sound and relevant to the environment of accounting will be developed. Secondly, the often-avoided realm of practice will be ventured into in order to subject the model to the constraint of objectivity. These two areas, while complementary to each other, would be seen as quite distinct parts of the development of theory and the application of that theory. It is seen that the need for objectivity in published reports is not a determinant of the theoretical model but rather a constraint on the application of theory. It is anticipated, then, that responses to this article will also be critical of the theoretical laying the model chosen and modification of that model under the constraint of objectivity.

Numerous studies have documented that stock returns are negatively related to changes in interest rates, but there has been little corroborating research on the information in interest‐rate changes about the fundamentals that the stock market prices. The negative correlation is often attributed to changes in the discount rate, a denominator effect in a valuation model. However, there may also be a numerator effect on the expected payoffs that are discounted. This paper shows that changes in interest rates are positively related to subsequent earnings, but the change in earnings is typically not large enough to cover the change in the required return. Hence, the net (numerator and denominator) effect on equity value is negative, consistent with the results of the research on interest rates and stock returns.

Standard formulas for valuing the equity of going concerns require forecasting payoffs to infinity but practical analysis requires that payoffs be forecasted over finite horizons. This truncation inevitably involves often‐troublesome terminal value calculations. This paper contrasts dividend discount techniques, discounted cash flow analysis, and techniques based on accrual earnings when each is applied with finite‐horizon forecasts. Valuations based on average ex post payoffs over various horizons, with and without terminal value calculations, are compared with ex ante market prices to discover the error introduced by each technique in truncating the horizon. Valuation errors are lower using accrual earnings techniques rather than cash flow and dividend discounting techniques. The accounting features that make a given technique less than ideal for finite horizon analysis are also detailed. Conditions where a given technique requires particularly long forecasting horizons are identified and the performance of the alternative techniques under those conditions is examined.

Voluntary Disclosure, Management forecasts, Screening, Signaling

Earnings announcements, Disclosures, Timeliness, Stock price reaction

Accounting changes, Decision makers, Investor behavior

This paper analyzes the empirical behavior of stock-return volatilities prior to and subsequent to the ex-dates of stock splits. The evidence demonstrates rather unambiguously that there is, on the average, an approximately 30% ‘arbitrary’ increase in the return standard deviations following the ex-date. The increase holds for both daily and weekly data, and it is not temporary. No explanatory confounding variables, such as institutional frictions affecting price observations, have been identified. We view the findings as being essentially inconsistent with the notion of ‘rational pricing’.

The paper demonstrates empirically that earnings prepared according to Generally Accepted Accounting Principles (GAAP earnings) have properties necessary to serve as a substitute for dividends in equity valuation analysis. Dividends reduce subsequent GAAP earnings, and "intrinsic" equity prices calculated by forecasting earnings are thus reduced by current dividends. This behavior is in accordance with the Miller and Modigliani principle-the displacement property-which states that the payment of dividends reduces prices, dollar for dollar. Further, the paper demonstrates that it this displacement is accommodated in calculating equity prices from forecasted GAAP earnings, those prices exhibit the dividend irrelevance property, that is, calculated prices are insensitive to future dividends. Forecasted GAAP earnings cannot be substituted for dividends, dollar for dollar, but the two are substitutes in the sense that the replacement value of expected dividends reduces forecasted earnings, dollar for dollar.