The Effect of Product Market Competition on Persistence of Earnings Components and Valuation of the Retained Cash Component of Earnings

• In Event: Earnings Management and Quality
  In Paper Session: Research in Earnings Management and Quality

Abstract

This study provides evidence regarding the impact of product market competition on the persistence of the various components of earnings. To that end, we first decompose earnings into accruals, distributions to debtholders, distributions to equity holders, normal change in cash, and abnormal change in cash. Using product market fluidity (Hoberg et al. 2014) and an alternative proxy for product market competition, we show that accruals, distributions to debtholders and abnormal increase in cash are less persistent at higher level of competition than they are at lower level of competition. We also find that investors place higher marginal value on abnormal change in cash at higher level of competition than they do at lower levels of competition and that the premium is not a reflection of mispricing of the change in cash component of earnings. Overall, our findings show that product market competition has an important effect on persistence of earnings components. Importantly, we document that investors recognize the strategic role of increase in internal liquidity, and that they reward firms for abnormal increase in cash despite its lower persistence.

Authors

• Gordian A Ndubizu, Drexel University

• Stu Sallehu, Eastern Illinois University