Persistence and Predictive Ability of Earnings: Evidence from France and the UK
DOI:
https://doi.org/10.2478/eb-2021-0013Keywords:
Cash flows from operations, Current earnings, Earnings persistence, French companies, Future cash flows, Future earnings, Predictive ability of earnings, UK companiesAbstract
The persistence and predictive ability are extensively requested as desirable attributes of earnings quality in the literature. The paper aims at investigating the persistence and predictive ability of earnings in French and UK companies. The study included a panel data of 1035 firm-year observations for 115 French listed companies from the CAC All-Tradable and 900 firm-year observations for 100 UK listed companies from the FTSE All-Share, during the period of 2011–2019. The research design was based on two equations starting from Sloan (1996) that were estimated using Fixed Effects Method. The study showed that earnings were persistent but they had no predictive ability regarding the future cash flows whether in French or UK companies and that earnings of UK companies were more persistent than those of the French companies. We argue that the persistence of earnings and the inability to predict future cash flows can be evidence of earnings management. The study contributes to the literature about earnings quality by studying earnings persistence and earnings predictive ability together in two different environments. The results require that users must take into consideration the illusory persistence of earnings, auditors must be cautious regarding the manipulation of earnings by managers, and accounting standard setters must review the reporting guidelines of cash flows to enhance their predictability by earnings.References
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Atwood, T. J., Drake, M. S., & Myers, L. A. (2010). Book-Tax Conformity, Earnings Persistence and the Association between Earnings and Future Cash Flows. Journal of Accounting and Economics, 50(1), 111–125. https://doi.org/10.1016/j.jacceco.2009.11.001
Ball, R., & Brown, P. (1968). An Empirical Evaluation of Accounting Income Numbers. Journal of Accounting Research, 6(2), 159–178. https://doi.org/10.2307/2490232
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Ben Mhamed, Y., & Jilani, F. (2015). Earnings Volatility and Earnings Predictability. Journal of Business Studies Quarterly, 6(3), 36–53.
Bissessur, S. W. (2008). Earnings Quality and Earnings Management: The Role of Accounting Accruals (PhD thesis). Amsterdam, Rotterdam: Thela Thesis.
Canina, L., & Potter, G. (2019). Determinants of Earnings Persistence and Predictability for Lodging Properties. Cornell Hospitality Quarterly, 60(1), 40–51. https://doi.org/10.1177%2F1938965518791729
Carvalho, F. L., Camargo, M. B., & Kalatzis, A. (2017). Earnings Quality Attributes and Investment Opportunities for Latin American Firms. Advances in Scientific and Applied Accounting, 10(1), 110–131. http://doi.org/10.14392/asaa.2017100107
Clubb, C., & Wu, G. (2014). Earnings Volatility and Earnings Prediction: Analysis and UK Evidence. Journal of Business Finance and Accounting, 4(1–2), 53–72. https://doi.org/10.1111/jbfa.12055
Cupertino, C. M., & Galimberti, G. K. (2009). Explaining Earnings Persistence: A Threshold Autoregressive Panel Unit Root Approach. MPRA Working Paper 14237. Germany: Munich Personal RePEc Archive.
Dechow, P. M., & Ge, W. (2006). The Persistence of Earnings and Cash Flows and the Role of Special Items: Implications for the Accrual Anomaly. Review of Accounting Studies, 11(2–3), 253–296. http://doi.org/10.1007/s11142-006-9004-1
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Doukakis, L. C. (2010). The Persistence of Earnings and Earnings Components after the Adoption of IFRS. Managerial Finance, 36(11), 969–980. https://doi.org/10.1108/03074351011081286
Ebaid, I. E. (2011). Persistence of earnings and earnings components: Evidence from the emerging capital market of Egypt. International Journal of Disclosure and Governance, 8(2), 174–193. https://doi.org/10.1057/jdg.2010.29
Francis, J., LaFond, R., Olsson, P. M. & Schipper, K. (2004). Costs of Equity and Earnings Attributes. The Accounting Review, 79(4), 967–1010. http://www.jstor.org/stable/4093083
Givoly, D., & Hayn, C. (2000). The Changing Time-Series Properties of Earnings, Cash Flows and Accruals: Has Financial Reporting become more Conservative? Journal of Accounting and Economics, 29(3), 287–320. https://doi.org/10.1016/S0165-4101(00)00024-0
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IASB (2018). The Conceptual Framework for Financial Reporting. London: IFRS Foundation.
Jelodari, A., & Kordshouli, F. A. (2016). A survey of the role of earnings quality in accurately forecasting of operational and cash circulation of companies listed on Tehran stock exchange. International Journal of Academic Research in Accounting, Finance and Management Sciences, 6(4), 82–89.
Kabir, M. H., & Laswad, F., (2011). Properties of Net Income and Total Comprehensive Income: New Zealand Evidence. Accounting Research Journal, 24(3), 268–289. https://doi.org/10.1108/10309611111187000
Kazemi, H., Hemmati, H., & Faridvand, R. (2011). Investigating the Relationship Between Conservatism Accounting and Earnings Attributes. World Applied Sciences Journal, 12(9), 1385–1396.
Kim, J. (2021). Earnings Attributes that Contribute to Analyst Forecasting Errors: Empirical Evidence from Korea. Journal of Asian Finance, Economics and Business, 8(8), 647–658. https://doi.org/10.13106/jafeb.2021.vol8.no8.0647
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Kimouche, B. (2020). The Persistence of Accounting Accruals Components: An Empirical Study of Some Algerian Companies. Journal of Economic Sciences Institute, 23(2), 4142–4123. https://www.asjp.cerist.dz/en/article/140928
Kimouche, B. (2021). The Persistence of Earnings and Earnings Components: Evidence from Algerian Companies (2006-2017). Les Cahiers du Cread, 37(4).
Kordestani, G., Taqiporian, M., Biglari, V., & Minaei, V. (2016). Persistence of Earnings and Prediction of Future Cash Flows: The Role of Timely Recognition of Bad News. Business: Theory and Practice, 17(4), 353–360. https://doi.org/10.3846/btp.17.11124
Kundu, K., & Banerjee, A. (2021). Predictability of Earnings and its Impact on Stock Returns: Evidence from India. Cogent Economics & Finance, 9(1), 1898112. https://doi.org/10.1080/23322039.2021.1898112
Legenzova, R. (2016). A Concept of Accounting Quality from Accounting Harmonisation Perspective. Economics and Business, 28(1) 33–37. https://doi.org/10.1515/eb-2016-0005
Lev, B. (1983). Some Economic Determinants of Time-Series Properties of Earnings. Journal of Accounting and Economics, 5, 31–48. https://doi.org/10.1016/0165-4101(83)90004-6
Licerán-Gutiérrez, A., & Cano-Rodríguez, M. (2019). A Review on the Multidimensional Analysis of Earnings Quality. Revista de Contabilidad Spanish Accounting Review, 22(1), 41–60. https://doi.org/10.6018/rc-sar.22.1.354301
Lipe, R. C. (1986). The Information Contained in the Components of Earnings. Journal of Accounting Research, 24, 37–64. https://doi.org/10.2307/2490728
Lyimo, G. D. (2014). Assessing the Measures of Quality of Earnings: Evidence from India. European Journal of Accounting Auditing and Finance Research, 2(6), 17–28.
Martinez, A. L., Tolentino de Souza, T. B., & Monte-Mor, D. S. (2016). Book-Tax Differences, Earnings Persistence and Tax Planning before and after the Adoption of IFRS in Brazil. Advances in Scientific and Applied Accounting, 9(2), 162–180. http://doi.org/10.14392/asaa.2016090203
Penman, S. H., & Zhang, X. J. (2002). Modeling Sustainable Earnings and P/E Ratios with Financial Statement Analysis. Forthcoming. https://doi.org/10.2139/ssrn.318967
Pimentel, R. C., & De Aguiar, A. B. (2012). Economic Variables and Earnings Persistence in Brazil. The 36th Encontro da ANPAD.
Pirveli, E. (2020). Earnings Persistence and Predictability within the Emerging Economy of Georgia. Journal of Financial Reporting and Accounting, 18(3), 563–589. http://doi.org/10.1108/JFRA-03-2019-0043
Pivorienė, A. (2017). Real Options and Discounted Cash Flow Analysis to Assess Strategic Investment Projects. Economics and Business, 30(1), 91–101. https://doi.org/10.1515/eb-2017-0008
Rajizadeh, S., & Rajizadeh, S. (2013). Examining the Factors Affecting Earnings Persistency among the Listed Firms in Tehran Stock Exchange. European Online Journal of Natural and Social Sciences, 2(3s), 2073–2079.
Senan, N. A. M. (2019). Ability of Earnings and Cash Flows in Forecasting Future Cash Flows: a Study in the Context of Saudi Arabia. Academy of Accounting and Financial Studies Journal, 23(1), 1–13.
Sloan, R. G. (1996). Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings? The Accounting Review, 71(3), 289–315. http://www.jstor.org/stable/248290
Sun, Q. (2010). A Review of Literature on Earnings Persistence and its Implications. Journal of Xiamen University (Arts & Social Sciences), Year 2010(1), 30–37.
Watts, R. L., & Leftwich, R. W. (1977). The Time Series of Annual Accounting Earnings. Journal of Accounting Research, 15(2), 253–271. https://doi.org/10.2307/2490352
An, Y. (2017). Measuring Earnings Quality over Time. International Journal of Economics and Financial Issues, 7(3), 82–87.
Atwood, T. J., Drake, M. S., & Myers, L. A. (2010). Book-Tax Conformity, Earnings Persistence and the Association between Earnings and Future Cash Flows. Journal of Accounting and Economics, 50(1), 111–125. https://doi.org/10.1016/j.jacceco.2009.11.001
Ball, R., & Brown, P. (1968). An Empirical Evaluation of Accounting Income Numbers. Journal of Accounting Research, 6(2), 159–178. https://doi.org/10.2307/2490232
Ball, R., & Watts, R. L. (1972). Some Time Series Properties of Accounting Income. Journal of Finance, 27(3), 663–681. https://doi.org/10.1111/j.1540-6261.1972.tb00991.x
Ben Mhamed, Y., & Jilani, F. (2015). Earnings Volatility and Earnings Predictability. Journal of Business Studies Quarterly, 6(3), 36–53.
Bissessur, S. W. (2008). Earnings Quality and Earnings Management: The Role of Accounting Accruals (PhD thesis). Amsterdam, Rotterdam: Thela Thesis.
Canina, L., & Potter, G. (2019). Determinants of Earnings Persistence and Predictability for Lodging Properties. Cornell Hospitality Quarterly, 60(1), 40–51. https://doi.org/10.1177%2F1938965518791729
Carvalho, F. L., Camargo, M. B., & Kalatzis, A. (2017). Earnings Quality Attributes and Investment Opportunities for Latin American Firms. Advances in Scientific and Applied Accounting, 10(1), 110–131. http://doi.org/10.14392/asaa.2017100107
Clubb, C., & Wu, G. (2014). Earnings Volatility and Earnings Prediction: Analysis and UK Evidence. Journal of Business Finance and Accounting, 4(1–2), 53–72. https://doi.org/10.1111/jbfa.12055
Cupertino, C. M., & Galimberti, G. K. (2009). Explaining Earnings Persistence: A Threshold Autoregressive Panel Unit Root Approach. MPRA Working Paper 14237. Germany: Munich Personal RePEc Archive.
Dechow, P. M., & Ge, W. (2006). The Persistence of Earnings and Cash Flows and the Role of Special Items: Implications for the Accrual Anomaly. Review of Accounting Studies, 11(2–3), 253–296. http://doi.org/10.1007/s11142-006-9004-1
Dimitropoulos, P. E., & Koronios, K. (2018). Earnings Persistence of European Football Clubs under UEFA’s FFP. International Journal of Financial Studies, 6(43), 1–15. http://doi.org/10.3390/ijfs6020043
Doukakis, L. C. (2010). The Persistence of Earnings and Earnings Components after the Adoption of IFRS. Managerial Finance, 36(11), 969–980. https://doi.org/10.1108/03074351011081286
Ebaid, I. E. (2011). Persistence of earnings and earnings components: Evidence from the emerging capital market of Egypt. International Journal of Disclosure and Governance, 8(2), 174–193. https://doi.org/10.1057/jdg.2010.29
Francis, J., LaFond, R., Olsson, P. M. & Schipper, K. (2004). Costs of Equity and Earnings Attributes. The Accounting Review, 79(4), 967–1010. http://www.jstor.org/stable/4093083
Givoly, D., & Hayn, C. (2000). The Changing Time-Series Properties of Earnings, Cash Flows and Accruals: Has Financial Reporting become more Conservative? Journal of Accounting and Economics, 29(3), 287–320. https://doi.org/10.1016/S0165-4101(00)00024-0
Graham, B., & Dodd, D. L. (1951). Security Analysis. New York: McGraw-Hill.
Hardiningsih, P., Hadi, T. P., & Ariani, N. (2018). Determinant Earnings Persistence with Corporate Governance as Moderating Factors. Proceedings of the International Conference on Banking, Accounting, Management, and Economics (ICOBAME 2018). https://doi.org/10.2991/icobame-18.2019.17
IASB (2018). The Conceptual Framework for Financial Reporting. London: IFRS Foundation.
Jelodari, A., & Kordshouli, F. A. (2016). A survey of the role of earnings quality in accurately forecasting of operational and cash circulation of companies listed on Tehran stock exchange. International Journal of Academic Research in Accounting, Finance and Management Sciences, 6(4), 82–89.
Kabir, M. H., & Laswad, F., (2011). Properties of Net Income and Total Comprehensive Income: New Zealand Evidence. Accounting Research Journal, 24(3), 268–289. https://doi.org/10.1108/10309611111187000
Kazemi, H., Hemmati, H., & Faridvand, R. (2011). Investigating the Relationship Between Conservatism Accounting and Earnings Attributes. World Applied Sciences Journal, 12(9), 1385–1396.
Kim, J. (2021). Earnings Attributes that Contribute to Analyst Forecasting Errors: Empirical Evidence from Korea. Journal of Asian Finance, Economics and Business, 8(8), 647–658. https://doi.org/10.13106/jafeb.2021.vol8.no8.0647
Kimouche, B., & Charchafa, I. (2020). Characteristics of Accounting Earnings in the Algerian Companies. Proceedings of the 2nd International European Conference on Interdisciplinary Scientific Researches, July 4–5, Ankara, Turkey: FARABI Publications, 407–416.
Kimouche, B. (2020). The Persistence of Accounting Accruals Components: An Empirical Study of Some Algerian Companies. Journal of Economic Sciences Institute, 23(2), 4142–4123. https://www.asjp.cerist.dz/en/article/140928
Kimouche, B. (2021). The Persistence of Earnings and Earnings Components: Evidence from Algerian Companies (2006-2017). Les Cahiers du Cread, 37(4).
Kordestani, G., Taqiporian, M., Biglari, V., & Minaei, V. (2016). Persistence of Earnings and Prediction of Future Cash Flows: The Role of Timely Recognition of Bad News. Business: Theory and Practice, 17(4), 353–360. https://doi.org/10.3846/btp.17.11124
Kundu, K., & Banerjee, A. (2021). Predictability of Earnings and its Impact on Stock Returns: Evidence from India. Cogent Economics & Finance, 9(1), 1898112. https://doi.org/10.1080/23322039.2021.1898112
Legenzova, R. (2016). A Concept of Accounting Quality from Accounting Harmonisation Perspective. Economics and Business, 28(1) 33–37. https://doi.org/10.1515/eb-2016-0005
Lev, B. (1983). Some Economic Determinants of Time-Series Properties of Earnings. Journal of Accounting and Economics, 5, 31–48. https://doi.org/10.1016/0165-4101(83)90004-6
Licerán-Gutiérrez, A., & Cano-Rodríguez, M. (2019). A Review on the Multidimensional Analysis of Earnings Quality. Revista de Contabilidad Spanish Accounting Review, 22(1), 41–60. https://doi.org/10.6018/rc-sar.22.1.354301
Lipe, R. C. (1986). The Information Contained in the Components of Earnings. Journal of Accounting Research, 24, 37–64. https://doi.org/10.2307/2490728
Lyimo, G. D. (2014). Assessing the Measures of Quality of Earnings: Evidence from India. European Journal of Accounting Auditing and Finance Research, 2(6), 17–28.
Martinez, A. L., Tolentino de Souza, T. B., & Monte-Mor, D. S. (2016). Book-Tax Differences, Earnings Persistence and Tax Planning before and after the Adoption of IFRS in Brazil. Advances in Scientific and Applied Accounting, 9(2), 162–180. http://doi.org/10.14392/asaa.2016090203
Penman, S. H., & Zhang, X. J. (2002). Modeling Sustainable Earnings and P/E Ratios with Financial Statement Analysis. Forthcoming. https://doi.org/10.2139/ssrn.318967
Pimentel, R. C., & De Aguiar, A. B. (2012). Economic Variables and Earnings Persistence in Brazil. The 36th Encontro da ANPAD.
Pirveli, E. (2020). Earnings Persistence and Predictability within the Emerging Economy of Georgia. Journal of Financial Reporting and Accounting, 18(3), 563–589. http://doi.org/10.1108/JFRA-03-2019-0043
Pivorienė, A. (2017). Real Options and Discounted Cash Flow Analysis to Assess Strategic Investment Projects. Economics and Business, 30(1), 91–101. https://doi.org/10.1515/eb-2017-0008
Rajizadeh, S., & Rajizadeh, S. (2013). Examining the Factors Affecting Earnings Persistency among the Listed Firms in Tehran Stock Exchange. European Online Journal of Natural and Social Sciences, 2(3s), 2073–2079.
Senan, N. A. M. (2019). Ability of Earnings and Cash Flows in Forecasting Future Cash Flows: a Study in the Context of Saudi Arabia. Academy of Accounting and Financial Studies Journal, 23(1), 1–13.
Sloan, R. G. (1996). Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings? The Accounting Review, 71(3), 289–315. http://www.jstor.org/stable/248290
Sun, Q. (2010). A Review of Literature on Earnings Persistence and its Implications. Journal of Xiamen University (Arts & Social Sciences), Year 2010(1), 30–37.
Watts, R. L., & Leftwich, R. W. (1977). The Time Series of Annual Accounting Earnings. Journal of Accounting Research, 15(2), 253–271. https://doi.org/10.2307/2490352
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03.11.2021
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Kimouche, B. (2021). Persistence and Predictive Ability of Earnings: Evidence from France and the UK. Economics and Business, 35, 190-200. https://doi.org/10.2478/eb-2021-0013
