The Effect of Earning Persistence and Components of Earning on the Predictability of Earning: Evidence from an Emerging Market
Oct 10, 2018
Published in: Journal
Publisher: International Journal of Economic & Business Research
This study investigates the relationship between persistence of earning and the components of earning on the predictability of earning in an emerging market after the adoption of International Financial Reporting Standards IFRS during 2008-2015. The sample firms consist of 143 nonfinancial firms listed on the Egyptian stock exchange for the period 2008-2015 as extracted from Gale Business Insights: Global by Thomson Reuters and from financial statements published on the company’s websites. The current study uses three models. In the first model, future earning has been regressed on current earning to investigate the persistence of aggregate earning. The second model measured total accrual in terms of operating accrual using information from the balance sheet and income statement. Then, the third model was disaggregated accrual into working capital accrual, noncurrent operating accrual and financial accrual to examine the differential persistence of accrual components. The results of the study confirm the persistence of earning for the sample firms. However, the accrual component has more persistence than the cash flow component. This could be interpreted by the accrual anomalies, supported by the weakness of the institutional and legal environments, which seem to be encouraged by firms presenting their financial statements under IFRS. Moreover, the enhancement of professional judgment in the accounting environment after the adoption of IFRS, which is principles based standards, may provide another justification for the aforementioned result. The results also imply that the persistence of accrual is affected by their faithful representation as less faithful representational accrual components have lower persistence than more faithful representational accrual components. This paper evaluates the predictability of earning attributed to persistence of earning components in an emerging market. Most prior studies have tested the phenomenon in developed markets. The paper extends the literature that addresses the second fundamental quality of qualitative characteristics of accounting information, (i.e., faithful representation and its effect on accounting numbers). This study also considers the effect of IFRS on the predictability of earnings in an emerging market as it is assumed to increase the level of judgment available to firms as they develop principles-based standards.