Stock Returns and Accounting Earnings

55 Pages Posted: 12 Nov 1998

See all articles by Jing Liu

Jing Liu

The Cheung Kong Graduate School of Business

Jacob K. Thomas

Yale School of Management

Date Written: October 1998


Although much market-based accounting research is based on regressions of abnormal returns on contemporaneous unexpected earnings, many have despaired about the intrinsic ability of accounting earnings to explain stock returns. These regressions exhibit low R2, lower than expected coefficients on unexpected earnings (ERC's), and various unusual features including non-linearity, lower R2 and response coefficients for loss firms, and lower R2 and response coefficients for high-growth and high-tech firms. Some improvement in explanatory power has been achieved by including various proxies for information that is currently available about future period earnings. This paper contributes to that line of research by deriving a specification, from the abnormal earnings model, that extends the traditional ERC regression by including current period forecast revisions of future period earnings. Relative to the traditional regression, the full specification increases R2 substantially, reduces the bias in coefficient estimates (caused by omitted correlated variables), and mutes the three unusual features mentioned above.

JEL Classification: G12, G14, M41

Suggested Citation

Liu, Jing and Thomas, Jacob, Stock Returns and Accounting Earnings (October 1998). Available at SSRN: or

Jing Liu

The Cheung Kong Graduate School of Business ( email )

1 East Changan Avenue, Oriental Plaza

Jacob Thomas (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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