The association between earnings quality and firm-specific return volatility: Evidence from Japan
Abstract
Purpose
This paper aims to examine the association between earnings quality and firm-specific return volatility for a large sample of Japanese manufacturing firms.
Design/methodology/approach
This archival research uses idiosyncratic volatility and asynchronicity as two analogous proxies for firm-specific return volatility to investigate its association with earnings quality.
Findings
Using idiosyncratic volatility and asynchronicity as two comparable proxies for firm-specific return volatility, the author finds contradictory results. The author relates this contradiction to another debate in accounting and finance literature about whether firm-specific return volatility captures firm-specific information or noise. Initially, the author obtains conflicting results because the systematic risk, one of the components of asynchronicity, is highly correlated with earnings quality. After controlling for the systematic risk, the author finds that higher earnings quality is associated with lower firm-specific return volatility. This finding is consistent with the noise-based explanation of firm-specific return volatility. The author also separates earnings quality into an innate component driven by economic fundamentals and a discretionary component driven by managerial discretionary behavior and finds that both components have significant impact on firm-specific return volatility but the innate component has significantly stronger effect than the discretionary component.
Originality/value
This is the first research study presenting evidence on the association between earnings quality and firm-specific return volatility in the Japanese setting. The findings of this paper are likely to contribute to the resolution of a well-known debate on whether firm-specific return volatility captures more firm-specific information being impounded in stock prices or noise in stock prices.
Keywords
Acknowledgements
The author wishes to thank his PhD supervisor Professor Kazuhisa Otogawa for his constructive suggestions and guidance at different phases of conducting this study and gratefully acknowledges helpful comments from Dr Janis Zaima (editor) and two anonymous reviewers.
Citation
Mitra, R.K. (2016), "The association between earnings quality and firm-specific return volatility: Evidence from Japan", Review of Accounting and Finance, Vol. 15 No. 3, pp. 294-316. https://doi.org/10.1108/RAF-08-2015-0100
Publisher
:Emerald Group Publishing Limited
Copyright © 2016, Emerald Group Publishing Limited