Investment Dynamics and Earnings-Return Properties: A Structural Approach

75 Pages Posted: 12 Jan 2017 Last revised: 10 Jan 2019

See all articles by Matthias Breuer

Matthias Breuer

Columbia University

David Windisch

University of Amsterdam

Multiple version iconThere are 2 versions of this paper

Date Written: December 18, 2018

Abstract

We propose the standard neoclassical model of investment under uncertainty with short-run adjustment frictions as a benchmark for earnings-return patterns absent accounting influences. We show that our proposed benchmark generates a wide range of earnings-return patterns documented in accounting research. Notably, our model generates a concave earnings-return relation, similar to that of Basu [1997], and predicts that the earnings-return concavity increases with the volatility of firms’ underlying shock processes and decreases with the level of firms’ investments. We find strong empirical support for these predictions. Overall, our evidence suggests that our proposed benchmark is useful for understanding the joint dynamics of variables of interest to accounting research (e.g., earnings, returns, investment, market-to-book) absent accounting influences, a necessary precondition for inferring the effects of accounting from these dynamics.

Keywords: dynamic investment, earnings, returns, conservatism, earnings-response coefficient, uncertainty

JEL Classification: D25, G31, G10, M40, M41

Suggested Citation

Breuer, Matthias and Windisch, David, Investment Dynamics and Earnings-Return Properties: A Structural Approach (December 18, 2018). Journal of Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2896454 or http://dx.doi.org/10.2139/ssrn.2896454

Matthias Breuer (Contact Author)

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

David Windisch

University of Amsterdam ( email )

Amsterdam Business School
Plantage Muidergracht 12
Amsterdam, 1018 TV
Netherlands

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