In this paper, (1) we define precisely the terms permanent and transitory earnings; (2) we delineate the effects of the degree of permanence and of accounting recording lag on estimates of the slope coefficient from a returns-earnings regression and (3) we examine the relation between the estimates of the earnings coefficient and observable variables that may indicate (i) the extent to which earnings are more or less permanent, and (ii) the extent to which value relevant events are recorded in accounting earnings in a timely fashion. Our main point is that attributing differences in the returns-earnings relation to one of these effects without controlling for the other may lead to erroneous conclusions.
- Earnings coefficient and value relevance
- Permanent earnings
- Recording lag
- Transitory earnings