Researchers have used various measures as indications of "earnings quality" including persistence, accruals, smoothness, timeliness, loss avoidance, investor responsiveness, and external indicators such as restatements and SEC enforcement releases. For each measure, we discuss causes of variation in the measure as well as consequences. We reach no single conclusion on what earnings quality is because "quality" is contingent on the decision context. We also point out that the "quality" of earnings is a function of the firm's fundamental performance. The contribution of a firm's fundamental performance to its earnings quality is suggested as one area for future work.

/pdf/understanding-earnings-quality-a-review-of-the-proxies-their-1r9rjtuq8l.pdf

Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences

https://repository.upenn.edu/cgi/viewcontent.cgi?article=1004&context=accounting_papers

Capital markets research in accounting

The corporate information environment develops endogenously as a consequence of information asymmetries and agency problems between investors, entrepreneurs, and managers. We provide a framework for analyzing the three main decisions that shape the corporate information environment in a capital markets setting: (1) managers’ voluntary reporting and disclosure decisions, (2) reporting and disclosures mandated by regulators, and (3) reporting decisions by third-party intermediaries (analysts). We review current research on disclosure regulation, information intermediaries, and the determinants and economic consequences of corporate disclosure and financial reporting decisions. We conclude that in the last ten years, research has generated a number of useful insights. Despite this progress, we call for researchers to consider interdependencies between the various decisions that shape the corporate information environment and highlight changes in the economic financial environment that raise new and interesting issues for researchers to address.

The Financial Reporting Environment: Review of the Recent Literature

We define higher audit quality as greater assurance of high financial reporting quality. Researchers use many proxies for audit quality, with little guidance on choosing among them. We provide a framework for systematically evaluating their unique strengths and weaknesses. Because it is inextricably intertwined with financial reporting quality, audit quality also depends on firms’ innate characteristics and financial reporting systems. Our review of the models commonly used to disentangle these constructs suggests the need for better conceptual guidance. Finally, we urge more research on the role of auditor and client competency in driving audit quality.

A Review of Archival Auditing Research

Earnings skewness and analyst forecast bias

Given the recent controversy over deviations of street earnings from GAAP earnings, we show that the nonrecurring items that analysts include in street earnings are more persistent and have higher valuation multiples than those items they exclude from street earnings. In addition, we find no evidence that the pricing differential between the included and excluded items leads to future abnormal returns. If, as analysts claim, the primary use of street earnings is to value a stock, then our results suggest that analysts do have expertise in processing earnings information and that certain items appear justifiably excluded.

Analysts' Treatment of Nonrecurring Items in Street Earnings

Analysts’ treatment of nonrecurring items in street earnings ☆

Statistically optimal forecasts need not be unbiased. If analysts' objective is to provide the most accurate forecast through minimizing the mean absolute forecast error, the optimal forecast is the median instead of the mean earnings. When earnings distribution is skewed, the median is different from the mean and forecast bias is observed. Thus, analyst forecast bias could be a natural result of analysts' effort to improve forecast accuracy combined with skewed distribution of earnings. We find that earnings skewness explains a significant amount of variation in analyst forecast bias across firms, across fiscal quarters and across time. Moreover, the market appears to understand at least part of the skewness-induced bias and adjusts accordingly. One salient feature of our explanation is that we predict not only forecast optimism for firms with negatively skewed earnings, but also pessimism for firms with positively skewed earnings, thus providing a more coherent explanation of analyst forecast bias.

Earnings Skewness and Analyst Forecast Bias

We show that firms reporting sustained increases in both earnings and revenues have (1) higher quality earnings and (2) larger earnings response coefficients (ERCs) in comparison to firms reporting sustained increases in earnings alone. With respect to earnings quality, firms with revenue-supported increases in earnings have more persistent earnings, exhibit less susceptibility to earnings management, and have higher future operating performance. With respect to response coefficients, firms with revenue-supported increases in earnings have both higher ERCs and lower book value response coefficients, consistent with the implications of the Ohlson (1995) model.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID562463_code230819.pdf?abstractid=404840&mirid=1

Zhaoyang Gu

Papers

Earnings skewness and analyst forecast bias

Analysts' Treatment of Nonrecurring Items in Street Earnings

Analysts’ treatment of nonrecurring items in street earnings ☆

Earnings Skewness and Analyst Forecast Bias

Sustained Earnings and Revenue Growth, Earnings Quality, and Earnings Response Coefficients