Asymmetry-in-Earnings-Returns-Relations-The-Case-o

AsymmetryinEarnings-ReturnsRelations:TheCaseofChinaChi-WenJevonsLeeA.B.FreemanSchoolofBusiness,TulaneUniversitySchoolofEconomicsandManagement,TsinghuaUniversityYanCaoWilliamE.SimonGraduateSchoolofBusinessAdministration,UniversityofRochesterJanuary1,2002AbstractTheearnings-returnsrelationasymmetryindicatesthechangingrelationbetweenearningsandreturnswhenthenatureofearningsinformationdiffersinacertainway.Literaturehasdocumentedavarietyofasymmetricrelationsandprovidedawiderangeofexplanations.Hayn(1995)accountedforthelowerERCforlossbyAbandonmentOptionTheory.Basu(1997)synthesizedaseriesofasymmetricfindingsandattributedthemtoaccountingconservatism.BurgstahlerandDichev(1997)documentedtheasymmetricdistributionsofscaledearningsandearningschangesasresultsofearningsmanagement.AllthesestudiesintendedtoofferanexplanationtocertainfindingsbasedontheU.S.data.Inthispaper,weproposesevenwaystomeasurevariousaspectsofasymmetryinearnings-returnsrelationsinChina.Ourfindingssuggestthat(1)asymmetryinearnings-returnsrelationisubiquitous,butthenatureofasymmetryvariesfromcasetocase,(2)themeasurementofasymmetrycruciallydependsonthespecificationofasymmetrythreshold,(3)theremaynotbeauniversalexplanationtothisasymmetry,(4)earnings-returnsrelationmayberatheridiosyncratic,and(5)theasymmetricinearnings-returnsrelationseemsassociatedwiththeregulationonrightofferinginChina.*WeacknowledgethecommentsfromKatherineSchipperandJenniferFrancis,andparticipantsinTheSecondChinaAccountingandFinanceReviewConferenceandaccountingseminarsatShanghaiUniversityofFinanceandEconomicsandTsinghuaUniversity.1AsymmetryinEarnings-ReturnsRelations:TheCaseofChina.1.IntroductionTheearnings-returnsrelationasymmetryindicatesthechangingrelationbetweenearningsandreturnwhenthenatureofinformationdiffersinacertainway.Thispapersuggestssevenwaystomeasurethisasymmetry:(1)accountingrecognitioncoefficient(ARC)asymmetry,(2)earningsautocorrelation(EA)asymmetry,(3)short-windowearningsresponsecoefficient(SERC)asymmetry,(4)long-windowearningsresponsecoefficient(LERC)asymmetry,(5)earnings-returnsmapping(ERM)asymmetry,(6)R2asymmetry,and(7)earningsdistribution(ED)asymmetry.Mostofabovemeasureshavebeenadoptedintheliteratureinvarioussettingandinterpretedinassortedways.MoststudiesintheliteraturesuggestedatheoryforthefindingonpartofsevenmeasuresusingtheU.S.data.ThispaperexaminesallthesevenmeasureswiththedataofChinastockmarket.Wetrytosynthesizethefindingsofsevenmeasuresandprovideacheckofexternalvaliditytotheliterature.Asaresult,wegaininterestinginsightontheissueofearnings-returnsrelationasymmetry.Literaturehasidentifiedabundantevidencesofasymmetryinearnings-returnsrelations.FreemanandTse(1992)andDasandLev(1992)foundthatstockpriceresponseisnonlinearwiththemagnitudeoftheearningschanges,withweakerresponseassociatedwithextremeearningsobservations.Hayn(1995)showedsmallerinformationcontentoflossesembeddedinstockpricethanthatofprofits.Shepositedthatreportedlossesareperceivedbyinvestorsastemporary,hencearemoreweaklyassociatedwithreturnsthanprofits.ApplyingtheAbandonmentOptionTheory,Haynstatedthatlossesarelesslikelytoperpetuatebecauseshareholderscanliquidatethefirmwhenperceivingafuturelong-termloss.Literaturehasalsoobservedasymmetryinthetime-seriespropertiesofearnings.Whilerandomwalkmodelisgenerallyrecognizedafairpresentationofearnings’time-seriesbehavior,forcertaintypeofearningsinformation,earningsandearningschangesdoexhibitamean-2revertingtendency.1Hayn(1995)andBasu(1997)pointedoutthatthismean-revertingpropertymightbeassociatedwiththeearnings-returnsrelationasymmetry.Basu(1997)arguedthathisfindingofasymmetryinARC,inearningspersistency,andinshort-windowERCcanbeexplainedbyaccountingconservatism.ApplyingBasu’s(1997)argument,manystudiesusedvariousasymmetrymeasurestogaugeconservatismforinvestigatingotherissues.2Inthispaper,weusethecaseofChinastockmarkettosystematicallyexaminesevenmeasuresofasymmetry.Weshowthatthenatureofearnings-returnsrelationasymmetrymayvaryfromtimetotimeandfromcasetocase.Whilemanyasymmetrymeasuresmayassistustoevaluateconservatism,theymaybealsorelatedtootherfactors.Earnings-returnsrelationasymmetrymaybequiteidiosyncraticandmaybeassociatedwiththeinstitutionalsetting.ThecaseofChinastockmarket,whichisdrasticallydifferentfromthecaseofU.S.wheremostempiricalresearchesarebasedon,providesaninterestingcheckofexternalvaliditytotheliterature.Chinesestockmarketisstillininfancy.Marketregulationsareeverchangingandevolving.Governmentoftenusesbruteforceandadministrativedecreetointervenemarketactivities.Forexample,ChineseSecuritiesRegulatoryCommission(CRSC)usesthereturnsonequity(ROE)asadecisioncriterionforIPOandforrightoffering.3Rightofferingisacrucial(almosttheonlyfeasible)financialinstrumentformostlistedcompanies.Usingasingleaccountingnumberaspolicyinstrumentformarketregulationisboundtoaffectthewaythestockmarketassessaccountinginformation.Thechangingregulationcreatedthechanginginformationenvironment.ThechanginginformationenvironmentinChinaprovidesrichdataforexploringtheinstitutionalfactorsbehindtheasymmet