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Investors' pricing of earnings: A model of persistence and the stock price consequences
Andrew C. Call, University of Georgia
Max Hewitt, Indiana University
Terry Shevlin, University of Washington
ABSTRACT. Sloan (1996) investigates whether investors understand the implications of earnings persistence for firms with differentially persistent accrual and cash components of earnings (earnings components). We present a model to demonstrate that earnings persistence is a function of the relative persistence, size, and sign of these two earnings components. Our model describes how these determinants affect earnings persistence. We also construct tests to investigate whether the market incorporates these determinants into stock prices on a timely basis. We show that the pricing of earnings persistence is due to the combined effect of the three determinants of our model, rather than any one of these determinants alone. Contrary to recent research, we provide evidence that suggests investors’ failure to correctly estimate earnings persistence is distinct from the value-glamour anomaly. Our paper lends support for the validity and importance of Sloan’s (1996) findings in security pricing.
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