Abstract

Considerable efforts have been made by accounting researchers in the last three decades to investigate whether there is a stable and significant association between stock prices and accounting earnings. This study seeks to shed light on this issue by adding to the price-earnings regression accounting earnings from both past and future periods. The pattern of response coefficients is expected to be different for past versus future earnings, and different firms that are operating in different informational and institutional environments. This study applies the analysis of changes in regression coefficients to a comparative study between the U.S. and Japan. Two aspects of information asymmetry between investors and management are identified and proxied in this study: (1) the availability of information, and (2) the willingness, resources, and ability to process the available information. The models used to test the above-mentioned proxies of information asymmetry are developed from the notion that current stock prices are associated with both current and future earnings, and accounting earnings include a surprise component and a stale component. The resulting indefinite lead/lag combined model is operationalized into two definite lead/lag models and an autoregressive model. The study finds that the U.S. and Japanese information environments are significantly different, evidenced by systematic differences in the patterns of coefficients from different samples and subsamples. It is also found that in general, investors in large firms are better informed about firms' future opportunities than those investing in small firms. The same phenomenon is also observed for institutional versus individual investors, and for Japanese versus U.S. investors. The U.S. markets are characterised by the availability of abundant information from competing sources, especially for large firms, and by the capability of investment institutions. On the other hand, the Japanese investors seemingly have more confidence in the persistence of the reported earnings than U.S. investors.