Do Stock Prices Fully Reflect Information in Current Earnings, Cash Flows Accruals?: Evidence From Quarterly Data

Recent studies have documented that stock prices behave as if investors do not fully impound information contained in earnings and earnings components in predicting future earnings. In particular, Sloan (1996) provides evidence that stock prices do not fully reflect information about future annual earnings contained in the accrual and cash flow components of current annual earnings. His findings reinforce the idea that stock prices fail to fully reflect available information. The purpose of this paper is to investigate whether stock prices fully reflect information contained in quarterly earnings and the cash flow and accrual components of quarterly earnings using the rational expectation framework developed by Mishkin (1983). This investigation is useful because quarterly variables are the basis for much contemporary accounting research. Furthermore, quarterly reports need not be audited. Therefore, one might expect more earnings management during quarters early in the year. This in turn suggests that more prominent accrual anomaly may stem from the first three quarters than the fourth quarter. The main findings of this study are as follows: (1) The security market fails to adequately consider the implication of current earnings for future earnings, (2) The security market fails to adequately consider the cash flow and accrual components of current earnings in predicting future earnings, and (3) More prominent accrual anomaly stems from the first three quarters than from the fourth quarter.