Capital Investment, Earnings, and Annual Stock Returns: Causality Relationships in China

Eurasian Economic Review, Vol. 1, No. 2, pp. 95-125, 2011

Posted: 29 Nov 2012

Date Written: 2011

Abstract

The Granger-causality effects between earnings, cash flow, and capital investment as well as on subsequent annual stock returns are examined for China in an international framework. Overall, there is a Granger causality relationship from earnings to capital investment. Furthermore, there is strong causality in the reverse direction as well. Capital investment causes positive subsequent stock returns while earnings have a more direct and contemporaneous impact on stock prices. Regulatory mechanisms, managerial monitoring, state capitalism controls work best during expansions and non-crisis periods. The causality relationships diminish during recessions and crisis periods, such as the Asian Crisis. The results observed in China are different from the results for G7 countries, or the results for other non-G7 countries. Using cash flows instead of earnings confirms the conclusions. Insider ownership is not necessarily as effective as other control mechanisms in China.

Keywords: Earnings, Capital Investment, Annual Stock Returns

JEL Classification: G30, G31, G34

Suggested Citation

Inci, Ahmet Can, Capital Investment, Earnings, and Annual Stock Returns: Causality Relationships in China (2011). Eurasian Economic Review, Vol. 1, No. 2, pp. 95-125, 2011, Available at SSRN: https://ssrn.com/abstract=2182356

Ahmet Can Inci (Contact Author)

Bryant University ( email )

1150 Douglas Pike
Smithfield, RI 02917
United States

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