The economic performance of a firm is not directly observable. Prior research has shown that accounting earnings and cash flows measure the otherwise unobservable economic performance. However, these measures of performance are noisy and other variables can help us learn about economic performance. We argue that changes in financial leverage provide information about performance beyond what is available from earnings and cash flows. This concept is different from the traditional view in which financial leverage is a measure of risk. We show that changes in financial leverage are value-relevant beyond accounting earnings. As part of this analysis, we also provide evidence on the value-relevance of growth in assets. For both changes in financial leverage and growth in assets, we document that the information in these variables is incremental to the information in earnings, operating cash flows, and accruals. Although our focus is on contemporaneous returns, we also find that the market does not impound available information in changes in financial leverage in a timely fashion.
BallR.BrownP.. 1968. “An Empirical Evaluation of Accounting Income Numbers”. Journal of Accounting Research, 6: 159–178.
2.
BeaverW.1968. “The Information Content of Annual Earnings Announcements”. Journal of Accounting Research, 6 (Supplement): 67–92.
3.
BeaverW.2002. “Perspectives on Recent Capital Market Research”. The Accounting Review, 77: 453–474.
4.
BernardV.ThomasJ.. 1989. “Post-Earnings Announcement Drift: Delayed Price Response or Risk Premium?”Journal of Accounting Research, 27: 1–48.
5.
BernardV.ThomasJ.. 1990. “Evidence That Stock Prices Do Not Fully Reflect the Implications of Current Earnings for Future Earnings”. Journal of Accounting and Economics, 13: 301–340.
6.
BhandariL.1988. “Debt/Equity Ratio and Expected Common Stock Returns: Empirical Evidence”. Journal of Finance, 43: 507–528.
7.
BradshawM.RichardsonS.SloanR.. 2006. “The Relation between Corporate Financing Activities, Analysts' Forecasts and Stock Returns”. Journal of Accounting and Economics, 42: 53–85.
8.
CohenD.LysT.. 2006. “Weighting the Evidence on the Relation between External Corporate Financing Activities, Accruals, and Stock Returns”. Journal of Accounting and Economics, 42: 87–105.
9.
CollinsD.KothariS. P.ShankenJ.SloanR.. 1994. “Lack of Timeliness and Noise as Explanation for the low Contemporaneous Return-Earnings Association”. Journal of Accounting and Economics, 18: 289–324.
10.
CollinsD.MaydewE.WeissI.. 1997. “Changes in the Value-Relevance of Earnings and Book Values over the Past Forty Years”. Journal of Accounting and Economics, 24: 39–67.
11.
CooperM.GulenH.SchillM.. 2007. “Asset growth and the Cross-Section of Stock Returns”Journal of Finance (forthcoming).
12.
DichevI.PiotroskiJ.. 1999. “The Performance of Long-Run Stock Returns Following Issues of Public and Private Debt”. Journal of Business Finance and Accounting, 26: 1103–1132.
13.
EckboE.1986. “The Valuation Effects of Corporate Debt Offerings”. Journal of Financial Economics, 15: 199–152.
14.
ErtimurY.LivnatJ.MartikainenM.. 2003. “Differential Reactions to Revenue and Expense Surprises”. Review of Accounting Studies, 8: 185–211.
15.
FairfieldP.WhisenantS.YohnT., 2003. “Accrued Earnings and Growth: Implications for Future Profitability and Market Mispricing”. The Accounting Review, 78: 353–371.
16.
FamaE.FrenchK.. 1992. “The Cross Section of Expected Stock Returns”. Journal of Finance, 47: 427–466.
17.
FamaE.MacBethJ.. 1973. “Risk, Return, and Equilibrium: Empirical Tests”. Journal of Political Economy, 81: 607–636.
18.
GuZ.JainP. C.RamnathS.. 2007. “In-Sync or Out-of-Sync? The Joint Information in Revenues and Expenses”. Working paper, Carnegie Mellon University and Georgetown University.
19.
HamadaR. S.1972. “The Effect of the Firm's Capital Structure on the Systematic Risk of Common Stocks”. Journal of Finance, 27: 435–452.
20.
HolthausenR.WattsR.. 2001. “The Relevance of the Value-Relevance Literature for Financial Accounting Standard Setting”. Journal of Accounting and Economics, 31: 3–75.
21.
JegadeeshN.LivnatJ.. 2006. “Revenue Surprises and Stock Returns”. Journal of Accounting and Economics, 41: 147–171.
22.
KothariS. P.2001. “Capital Market Research in Accounting”. Journal of Accounting and Economics, 31: 105–231.
23.
LakonishokJ.ShleiferA.VishnyR.. 1994. “Contrarian Investment, Extrapolation, and Risk”. Journal of Finance, 49: 1541–1578.
24.
LivnatJ.ZarowinP.. 1990. “The Incremental Information Content of Cash Row Components”. Journal of Accounting and Economics, 13: 25–46.
25.
LoughranT.RitterJ. R.. 1995. “The New Issue Puzzle”. Journal of Finance, 50: 23–51.
26.
McConnellJ.MuscarellaC.. 1985. “Corporate Capital Expenditure Decisions and the Market Value of the Firm”. Journal of Financial Economics, 14: 399–422.
27.
MertonRobert C.1987. “A Simple Model of Capital Market Equilibrium with Incomplete Information”. Journal of Finance, 42: 483–510.
28.
MillerM.RockK.. 1985. “Dividend Policy under Asymmetric Information”. Journal of Finance, 40: 1031–1051.
29.
MulfordC.ComiskeyE.. 2005. Creative Cash Flow Reporting: Uncovering Sustainable Financial Performance.New Jersey: John Wiley and Sons.
30.
MyersS.1984. “The Capital Structure Puzzle”. Journal of Finance, 39: 575–592.
31.
MyersS.MajlufN.. 1984. “Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have”. Journal of Financial Economics, 13: 187–221.
32.
RayburnJ.1986. “The Association of Operating Cash Flow and Accruals with Security Returns”. Journal of Accounting Research, 24: 112–133.
33.
SloanR.1996. “Do Stock Prices Fully Reflect Information in Accruals and Cash Flows About Future Earnings?”The Accounting Review, 71: 289–315.
34.
SpiessD.Affleck-GravesJ.. 1999. “The Long-Run Performance of Stock Returns Following Debt Offerings”. Journal of Financial Economics, 54: 45–73.
35.
SwaminathanS.WeintropJ.. 1991. “The Information Content of Earnings, Revenues, and Expenses”. Journal of Accounting Research, 29: 418–427.
36.
TitmanS.WeiK. C.XieF.. 2004. “Capital Investments and Stock Returns”. Journal of Financial and Quantitative Analysis, 39: 677–700.
