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Why financial reports are used?
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Economics of accounting information
SUPPLY
DEMAND
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Demand for financial statements
Shareholders • Investment
and investors decisions
• Performance assessment
Managers and • Compensation contracts
employees • Company-sponsored pension plans
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Supply of financial statements
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Example: Outotec, Interim report Q2/2015
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Dechow et al. (2014), Figure 2
Investors’
reactions:
Firms with
positive
Net Income
surprise
Firms with
negative
Net Income
surprise
Notes: Sample consists of US firms. Time period from 1971-2012. A positive (negative) annual
change in earnings defines a positive (negative) earnings surprise. Abnormal returns are market
adjusted returns using the CRSP equal-weighted return.
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Earnings and stock prices:
Evidence on value relevance
The test:
Stock Earnings
• If investors use accrual earnings to price per
price stocks, then earnings share
Random
differences across firms should error
explain differences in stock prices Stock Earnings multiple
price at (should be
$0 EPS statistically positive)
Regression
Result:
Dechow et al. (2014): The adjusted R2 of
annual cross-sectional price regressions
Notes: Prices are measured 3 months after the fiscal year-end. Earnings per share is measured as income
before extraordinary items (IB) divided by common shares outstanding (CSHO) from Compustat. Earnings
before special items is measured as income before extraordinary items (IB) less special items (SPI) divided
by common shares outstanding (CSHO) from Compustat. “Street” earnings per share is the actual annual
EPS reported by I/B/E/S. CFO per share is measured as cash flow from operations (OANCF) divided by
CSHO from Compustat. Free cash flow is measured as cash flow from operations (OANCF) plus cash flow
from investing (IANCF) divided by CSHO. Net cash flow is measured as the annual change in cash balance
(ΔCH) divided by CSHO from Compustat. 10
Other sources of information
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Summary
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