Down but not out: Investigating Returns for Negative Retained Earnings Firms

• In Event: SESSION 5D: Earnings Announcements and Returns

Abstract

We investigate the performance of firms reporting a negative balance in retained earnings on their annual balance sheet (“NRE firms”). NRE firms report surprisingly high average annual abnormal returns of 12%, suggesting that the market significantly discounts these firms. Further, using fundamental analysis to distinguish “winner” NRE firms from “loser” firms, we report average annual abnormal returns of 22% for projected future winners and average abnormal returns of 11% for projected losers. We argue that high abnormal returns to NRE firms represent both compensation for risk and market mispricing because the market is unable to fully distinguish firms that have experienced temporary underperformance from firms that are unable to survive.

Authors

• Kevin Kim, Texas Tech University

• Derek K Oler, Texas Tech University

• Mitchell J Oler, Virginia Tech University