Earnings Quality Proxies An Empirical Study on Indian Companies

Abstract

Earnings quality means decision usefulness of reported earnings to different stakeholders of firms. Past researchers in this field have come up with more than twenty different measures of earnings quality (earnings quality proxies). In this study, an overview of these proxies is done. From among them, eleven prominent proxies of earnings quality are computed for a sample of sixty nine Indian companies. They are earnings persistence, earnings predictability, abnormal accruals, earnings smoothness, accruals smoothness, quarterly earnings variability, annual earnings variability, cash flow from operations variability, accruals erraticism and cash flow predictability. This study also empirically analysed the linkages between proxies of earnings quality (EQPs) and returns earnings association. This linkage was studied using the five factor model from Francis et al (2004). For this purpose, quarterly profit after tax is used to represent earnings. Quarterly stock market returns of each company are used to represent market returns. This study is done for the same sample of Indian companies over a seventeen-year period.. Factor analysis is also done and four factors emerged as significant. Five factor model of Francis et al (2004) was done to identify the earnings quality proxy that influences returns earnings association. It was found that, only three had significant linkage with returns earnings association. These proxies are earnings persistence, earnings predictability and earnings smoothness. All the eleven proxies were computed industry wise too and compared. Eight industries are compared with respect to different earnings quality proxies. Another part of this research is comparison of earnings quality proxies of the same companies in two different time periods. These time periods are pre-financial crisis period (2000 2009) and post financial crisis period (2010-2016). This research is expected to contribute to the following bodies of knowledge including comparative significance of different measures or indicators