TY - JOUR

T1 - Earnings less risk-free interest charge (ERIC) and stock returns: ERIC’s relative and incremental information content in a European sample

AU - Griskaite, Aurelija

AU - Lueg, Rainer

N1 - This publication was funded by the German Research Foundation (DFG)

PY - 2023/2/13

Y1 - 2023/2/13

N2 - This study tests the information content of earnings less risk-free interest charge (ERIC) and analyses its ability to explain fluctuations in market-adjusted stock returns. Following Biddle et al. (1997) study design, we perform relative and incremental information content tests. Relative information content tests reveal that mandatory reporting metrics — such as earnings before extraordinary items (EBEI), cash flow from operations (CFO), and total comprehensive income (TCI) — are more highly associated with stock returns and firm values than ERIC or residual income (RI). A number of sensitivity analyses support our findings. To test incremental information content, we split ERIC into five components. Primary results indicated that components specific to ERIC — changes of net assets, after-tax interest expenses, and capital charge — do not add relative information content. Yet, sensitivity tests suggest that some ERIC components add incremental information, especially when accounting for market expectations. However, these findings are not economically substantial compared to CFO and EBEI. Overall, we conclude that mandatory metrics generally outperform ERIC and residual income. Our unique contribution lies in applying the established methodology of measuring economic value added (EVA’s) relative and incremental information content to ERIC

AB - This study tests the information content of earnings less risk-free interest charge (ERIC) and analyses its ability to explain fluctuations in market-adjusted stock returns. Following Biddle et al. (1997) study design, we perform relative and incremental information content tests. Relative information content tests reveal that mandatory reporting metrics — such as earnings before extraordinary items (EBEI), cash flow from operations (CFO), and total comprehensive income (TCI) — are more highly associated with stock returns and firm values than ERIC or residual income (RI). A number of sensitivity analyses support our findings. To test incremental information content, we split ERIC into five components. Primary results indicated that components specific to ERIC — changes of net assets, after-tax interest expenses, and capital charge — do not add relative information content. Yet, sensitivity tests suggest that some ERIC components add incremental information, especially when accounting for market expectations. However, these findings are not economically substantial compared to CFO and EBEI. Overall, we conclude that mandatory metrics generally outperform ERIC and residual income. Our unique contribution lies in applying the established methodology of measuring economic value added (EVA’s) relative and incremental information content to ERIC

KW - Management studies

KW - earnings less risk-free interest charge

KW - relative information content

KW - incremental information content

KW - Economic Value Added

KW - Shareholder Value

KW - Value-Based Management

U2 - 10.22495/cocv20i2art14

DO - 10.22495/cocv20i2art14

M3 - Journal articles

VL - 20

SP - 166

EP - 181

JO - Corporate Ownership and Control

JF - Corporate Ownership and Control

SN - 1727-9232

IS - 2

ER -