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Stock returns, earnings classification and persistence

Research output: Working paper

Publication date1997
Place of PublicationLancaster University
PublisherThe Department of Accounting and Finance
<mark>Original language</mark>English

Publication series

NameAccounting and Finance Working Paper Series


The paper extends previous research on earnings persistence by (i) studying earnings persistence and market responses pertaining to earnings inclusive and exclusive of extraordinary items (EI), and (ii) establishing the dominating influence exerted by the existence of EI. Using data related to 75 Canadian firms listed on the Toronto Stock Exchange, we found, prior to the change introduced in CICA Section 3480 restricting the classification of EI, that the stock market responded more readily to earnings exclusive of EI than to the all inclusive earnings. Adjusting earnings surprises for the degree of earnings persistence, in order to capture different market responses, is relevant only when there is no extraordinary event. The presence of EI, and whether it is an extraordinary gain or loss, has unpredictable and dramatic influence on the stock market. The change in CICA Section 3480, and similar developments elsewhere internationally, has the effect of eliminating EI and forcing the convergence of the all inclusive earnings and ordinary income streams. Based on the results obtained in this study, we argue that such a move is unwise, and may have reduced the informativeness of financial reporting