Earnings quality on the street
Urooj Khan, Venkat Peddireddy, Shiva Rajgopal
Contemporary Accounting Research · 2024 · Volume 41 · Issue 4
Abstract
We develop a composite firm-year earnings quality score (EQSCORE) that uses signals based on fundamental analysis. We obtain a proprietary data set of 613 reports about aggressive reporting practices over 2004–2009 for 230 unique firms from a research firm (RF). From these reports, we identify red flags of poor earnings quality relating to (1) sales quality, (2) margin quality, (3) cash flow quality, (4) corporate governance, (5) audit, and (6) others. We construct theEQSCOREusing 51 signals employed by the RF and a novel approach that imitates the RF's process for discovering earnings quality. TheEQSCOREoutperforms existing composite models of earnings quality in identifying accounting and auditing enforcement releases and restated firm-years and predicts future stock returns. The corporate governance–related and audit-related red flags included in theEQSCOREcomplement accounting-based red flags and enhance the ability of theEQSCOREto identify firms with poor earnings quality.
Keywords
AAERs, earnings quality, EQSCORE, FSCORE, fundamental analysis, restatements, AAER, analyse fondamentale, EQSCORE, FSCORE, qualité des résultats, retraitements
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