The Effect of Regulation on the Relationship between Earnings and Stock Returns

Abstract

We document that disclosure and analyst regulatory changes made between 2000 and 2003 significantly diminished the magnitude of the relationship between earnings and market returns. While we observe no significant change in the relationship between returns and earnings components (i.e. cash-flows and accruals), earnings components’ persistence has significantly declined post-regulation. We interpret this as evidence that a decrease in earnings quality impacted the strength of the earnings-returns relation. We find no significant change when using an international sample control group, which strengthens the claim that the weakened earnings-returns relation found for the U.S. firms is due to regulatory changes.