Earnings Persistence and Market Reaction to Earnings in the International Insurance Industry
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Renê Coppe Pimentel
Abstract
Objective: this paper analyses the earnings persistence and market reaction to earnings in the international insurance industry. Methods: the analysis considers a sample of 307 listed international insurance companies from 2004 to 2019 and assesses several quantitative empirical models and estimations, including panel fixed effects and pooled OLS. Results: results indicate that operating cash flows are highly and strongly persistent when compared to the accruals component of earnings and that reported earnings are informative about companies’ performance. However, these findings vary significantly across insurance sub-segments. Additionally, the association between earnings and returns is significantly affected by specific companies’ performances in the sense that market agents review their expectation in a higher level when a reduction in earnings (bad news) is reported. Results also show that market risk patterns are positively associated with earnings response coefficient, suggesting a numerator effect of risk. Conclusions: overall, this paper provides evidence that economic analysis and scrutiny of earnings persistence and the market reaction to earnings announcements in insurance industry, and its insurance sub-segments, can provide superior assessment of future outcomes by investors, regulators, and academics.
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Pimentel, R. C. (2021). Earnings Persistence and Market Reaction to Earnings in the International Insurance Industry. Journal of Contemporary Administration, 26(3), e200404. https://doi.org/10.1590/1982-7849rac2022200404.en
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Theoretical-empirical Articles
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References
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Alnodel, A. A. (2018). The impact of IFRS adoption on the value relevance of accounting information: Evidence from the insurance sector. International Journal of Business and Management, 13(4), 138-148. https://doi.org/10.5539/ijbm.v13n4p138
Anderson, D. R. (1971). Effects of under and overevaluations in loss reserves. Journal of Risk and Insurance, 38(4), 585–600. https://doi.org/10.2307/251572
Ariff, M., Fah, C. F., & Ni, S. W. (2013). Earnings response coefficients of OECD banks: Tests extended to include bank risk factors. Advances in Accounting, 29(1), 97-107. https://doi.org/10.1016/j.adiac.2013.03.003
Baginski, S. P., Lorek, K. S., Willinger, G. L., & Branson, B. C. (1999). The relationship between economic characteristics and alternative annual earnings persistence measures. The Accounting Review, 74(1), 105-120. https://doi.org/10.2308/accr.1999.74.1.105
Ball, R., Kothari, S., & Watts, R. L. (1993). Economic determinants of the relation between earnings changes and stock returns. Accounting Review, 68(3), 622-638. Retrieved from https://www.jstor.org/stable/248205
Ballotta, L., Esposito, G., & Haberman, S. (2006). The IASB insurance project for life insurance contracts: Impact on reserving methods and solvency requirements. Insurance: Mathematics and Economics, 39(3), 356-375. https://doi.org/10.1016/j.insmatheco.2006.04.004
BarNiv, R. (1990). Accounting procedures, market data, cash-flow figures, and insolvency classification: The case of the insurance industry. The Accounting Review, 65(3), 578-604. Retrieved from https://www.jstor.org/stable/247951
Basu, S. (1997). The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics, 24(1), 3-37. https://doi.org/10.1016/S0165-4101(97)00014-1
Beaver, W. H., & McNichols, M. F. (1998). The characteristics and valuation of loss reserves of property casualty insurers. Review of Accounting Studies, 3(1), 73-95. https://doi.org/10.1023/A:1009676300318
Beaver, W. H., & M. F. McNichols. (2001). Do stock prices of property casualty insurers fully reflect information about earnings, accruals, cash flows and development? Review of Accounting Studies, 6(2-3), 197-220. https://doi.org/10.1023/A:1011662825164
Beaver, W. H., McNichols, M. F., & Nelson, K. K. (2003). Management of the loss reserve accrual and the distribution of earnings in the property-casualty insurance industry. Journal of Accounting and Economics, 35(3), 347-376. https://doi.org/10.1016/S0165-4101(03)00037-5
Call, A. C., Hewitt, M., Shevlin, T., & Yohn, T. L. (2016). Firm-specific estimates of differential persistence and their incremental usefulness for forecasting and valuation. The Accounting Review, 91(3), 811-833. https://doi.org/10.2308/accr-51233
Chambers, D. J., Freeman, R. N., & Koch, A. S. (2005). The effect of risk on price responses to unexpected earnings. Journal of Accounting, Auditing & Finance, 20(4), 461-482. https://doi.org/10.1177/0148558X0502000408
Chen, C. (2013). Time‐varying earnings persistence and the delayed stock return reaction to earnings announcements. Contemporary Accounting Research, 30(2), 549-578. https://doi.org/10.1111/j.1911-3846.2012.01165.x
Clubb, C., & Wu, G. (2014). Earnings volatility and earnings prediction: Analysis and UK evidence. Journal of Business Finance & Accounting, 41(1-2), 53-72. https://doi.org/10.1111/jbfa.12055
Conrad, J., Cornell, B., & Landsman, W. R. (2002). When is bad news really bad news? The Journal of Finance, 57(6), 2507-2532. https://doi.org/10.1111/1540-6261.00504
Dechow, P. M., & Ge, W. (2006). The persistence of earnings and cash flows and the role of special items: Implications for the accrual anomaly. Review of Accounting Studies, 11(2), 253-296. https://doi.org/10.1007/s11142-006-9004-1
Dechow, P., Ge, W., & Schrand, C. (2010). Understanding earnings quality: A review of the proxies, their determinants and their consequences. Journal of Accounting and Economics, 50(2–3), 344-401. https://doi.org/10.1016/j.jacceco.2010.09.001
Dichev, I. D., & Tang, V. W. (2009). Earnings volatility and earnings predictability. Journal of Accounting and Economics, 47(1-2), 160-181. https://doi.org/10.1016/j.jacceco.2008.09.005
Ding, K., Lev, B., Peng, X., Sun, T., & Vasarhelyi, M. A. (2020). Machine learning improves accounting estimates: Evidence from insurance payments. Review of Accounting Studies, 25, 1098-1134. https://doi.org/10.1007/s11142-020-09546-9
Easton, P. D., & Zmijewski, M. E. (1989). Cross-sectional variation in the stock market response to accounting earnings announcements. Journal of Accounting and Economics, 11(2-3), 117-141. https://doi.org/10.1016/0165-4101(89)90003-7
Eckles, D. L., Halek, M., He, E., Sommer, D. W., & Zhang, R. (2011). Earnings smoothing, executive compensation, and corporate governance: Evidence from the property–liability insurance industry. Journal of Risk and Insurance, 78(3), 761-790. https://doi.org/10.1111/j.1539-6975.2011.01417.x
Ellul, A., Jotikasthira, C., Lundblad, C. T., & Wang, Y. (2014). Mark-to-market accounting and systemic risk: Evidence from the insurance industry. Economic Policy, 29(78), 297-341. https://doi.org/10.1111/1468-0327.12030
Frankel, R., & Litov, L. (2009). Earnings persistence. Journal of Accounting and Economics, 47(1-2), 182-190. https://doi.org/10.1016/j.jacceco.2008.11.008
Freeman, R. N., & Tse, S. Y. (1992). A nonlinear model of security price responses to unexpected earnings. Journal of Accounting Research, 30(2), 185-209. https://doi.org/10.2307/2491123
Freeman, R. N., Koch, A., & Li, H. (2011). Can historical returns-earnings relations predict price responses to earnings news? Review of Quantitative Finance and Accounting, 37(1), 35-62. https://doi.org/10.1007/s11156-010-0194-z
Gaver, J. J., & Paterson, J. S. (2004). Do insurers manipulate loss reserves to mask solvency problems? Journal of Accounting and Economics, 37(3), 393–416. https://doi.org/10.1016/j.jacceco.2003.10.010
Grace, E. V. (1990). Property-liability insurer reserve errors: A theoretical and empirical analysis. The Journal of Risk and Insurance, 57(1), 28–46. https://doi.org/10.2307/252923
Grace, M. F., & Leverty, J. T. (2012). Property–liability insurer reserve error: Motive, manipulation, or mistake. Journal of Risk and Insurance, 79(2), 351-380. https://doi.org/10.1111/j.1539-6975.2011.01434.x
Harrington, S. E. (2009). The financial crisis, systemic risk, and the future of insurance regulation. Journal of Risk and Insurance, 76(4), 785-819. https://doi.org/10.1111/j.1539-6975.2009.01330.x
Hayn, C. (1995). The information content of losses. Journal of Accounting and Economics, 20(2), 125-153. https://doi.org/10.1016/0165-4101(95)00397-2
Hui, K. W., Nelson, K. K., & Yeung, P. E. (2016). On the persistence and pricing of industry-wide and firm-specific earnings, cash flows, and accruals. Journal of Accounting and Economics, 61(1), 185-202. https://doi.org/10.1016/j.jacceco.2015.06.003
Kothari, S. P. (2001). Capital markets research in accounting. Journal of Accounting and Economics, 31(1–3), 105-231. https://doi.org/10.1016/S0165-4101(01)00030-1
Lewellen, J., & Resutek, R. J. (2019). Why do accruals predict earnings? Journal of Accounting and Economics, 67(2-3), 336-356. https://doi.org/10.1016/j.jacceco.2018.12.003
Livnat, J., & Santicchia, M. (2006). Cash flows, accruals, and future returns. Financial Analysts Journal, 62(4), 48-61. https://doi.org/10.2469/faj.v62.n4.4186
Mian, G. M., & Sankaraguruswamy, S. (2012). Investor sentiment and stock market response to earnings news. The Accounting Review, 87(4), 1357-1384. https://doi.org/10.2308/accr-50158
Ohlson, J. A. (1995). Earnings, book values, and dividends in equity valuation. Contemporary Accounting Research, 11(2), 661-687. https://doi.org/10.1111/j.1911-3846.1995.tb00461.x
Petroni, K. R. (1992). Optimistic reporting in the property-casualty insurance industry. Journal of Accounting and Economics, 15(4), 485-508. https://doi.org/10.1016/0165-4101(92)90003-K
Pimentel, R. C., & Lima, I. S. (2010). Is the annual earnings response coefficient statitically significant in Brazil. Latin American Business Review, 11(3), 267-291. https://doi.org/10.1080/10978526.2010.513273
Pimentel, R. C., & Aguiar, A. B. (2016). The role of earnings persistence in valuation accuracy and the time horizon. Revista de Administração de Empresas, 56(1), 71-86. https://doi.org/10.1590/S0034-759020160107
Pimentel, R. C., & Malacrida, M. J. C. (2020). Quarterly earnings, operating cash flow, and accruals in future performance assessment. Brazilian Administration Review, 17(4), e190115. Retrieved from https://bar.anpad.org.br/index.php/bar/article/view/504
Polonchek, J., & Miller, R. K. (1999). Contagion effects in the insurance industry. The Journal of Risk and Insurance, 66(3), 459–475. https://doi.org/10.2307/253556
Post, T., Gründl, H., Schmidl, L., & Dorfman, M. S. (2007). Implications of IFRS for the European insurance industry—insights from capital market theory. Risk Management and Insurance Review, 10(2), 247-265. https://doi.org/10.1111/j.1540-6296.2007.00117.x
Sloan, R. G. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71(3), 289-315. Retrieved from https://www.jstor.org/stable/248290
Thesing, J., & Velte, P. (2021). Do fair value measurements affect accounting-based earnings quality? A literature review with a focus on corporate governance as moderator. Journal of Business Economics, 91, 965-1004. https://doi.org/10.1007/s11573-020-01025-6
Wagner, J., & Zemp, A. (2012). Comparison of stakeholder perspectives on current regulatory and reporting reforms. Risk Management and Insurance Review, 15(2), 225-254. https://doi.org/10.1111/j.1540-6296.2012.01218.x
Weiss, M. (1985). A multivariate analysis of loss reserving estimates in property-liability insurers. The Journal of Risk and Insurance, 52(2), 199–221. https://doi.org/10.2307/252512
White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica, 48(4), 817-838. https://doi.org/10.2307/1912934
Alnodel, A. A. (2018). The impact of IFRS adoption on the value relevance of accounting information: Evidence from the insurance sector. International Journal of Business and Management, 13(4), 138-148. https://doi.org/10.5539/ijbm.v13n4p138
Anderson, D. R. (1971). Effects of under and overevaluations in loss reserves. Journal of Risk and Insurance, 38(4), 585–600. https://doi.org/10.2307/251572
Ariff, M., Fah, C. F., & Ni, S. W. (2013). Earnings response coefficients of OECD banks: Tests extended to include bank risk factors. Advances in Accounting, 29(1), 97-107. https://doi.org/10.1016/j.adiac.2013.03.003
Baginski, S. P., Lorek, K. S., Willinger, G. L., & Branson, B. C. (1999). The relationship between economic characteristics and alternative annual earnings persistence measures. The Accounting Review, 74(1), 105-120. https://doi.org/10.2308/accr.1999.74.1.105
Ball, R., Kothari, S., & Watts, R. L. (1993). Economic determinants of the relation between earnings changes and stock returns. Accounting Review, 68(3), 622-638. Retrieved from https://www.jstor.org/stable/248205
Ballotta, L., Esposito, G., & Haberman, S. (2006). The IASB insurance project for life insurance contracts: Impact on reserving methods and solvency requirements. Insurance: Mathematics and Economics, 39(3), 356-375. https://doi.org/10.1016/j.insmatheco.2006.04.004
BarNiv, R. (1990). Accounting procedures, market data, cash-flow figures, and insolvency classification: The case of the insurance industry. The Accounting Review, 65(3), 578-604. Retrieved from https://www.jstor.org/stable/247951
Basu, S. (1997). The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics, 24(1), 3-37. https://doi.org/10.1016/S0165-4101(97)00014-1
Beaver, W. H., & McNichols, M. F. (1998). The characteristics and valuation of loss reserves of property casualty insurers. Review of Accounting Studies, 3(1), 73-95. https://doi.org/10.1023/A:1009676300318
Beaver, W. H., & M. F. McNichols. (2001). Do stock prices of property casualty insurers fully reflect information about earnings, accruals, cash flows and development? Review of Accounting Studies, 6(2-3), 197-220. https://doi.org/10.1023/A:1011662825164
Beaver, W. H., McNichols, M. F., & Nelson, K. K. (2003). Management of the loss reserve accrual and the distribution of earnings in the property-casualty insurance industry. Journal of Accounting and Economics, 35(3), 347-376. https://doi.org/10.1016/S0165-4101(03)00037-5
Call, A. C., Hewitt, M., Shevlin, T., & Yohn, T. L. (2016). Firm-specific estimates of differential persistence and their incremental usefulness for forecasting and valuation. The Accounting Review, 91(3), 811-833. https://doi.org/10.2308/accr-51233
Chambers, D. J., Freeman, R. N., & Koch, A. S. (2005). The effect of risk on price responses to unexpected earnings. Journal of Accounting, Auditing & Finance, 20(4), 461-482. https://doi.org/10.1177/0148558X0502000408
Chen, C. (2013). Time‐varying earnings persistence and the delayed stock return reaction to earnings announcements. Contemporary Accounting Research, 30(2), 549-578. https://doi.org/10.1111/j.1911-3846.2012.01165.x
Clubb, C., & Wu, G. (2014). Earnings volatility and earnings prediction: Analysis and UK evidence. Journal of Business Finance & Accounting, 41(1-2), 53-72. https://doi.org/10.1111/jbfa.12055
Conrad, J., Cornell, B., & Landsman, W. R. (2002). When is bad news really bad news? The Journal of Finance, 57(6), 2507-2532. https://doi.org/10.1111/1540-6261.00504
Dechow, P. M., & Ge, W. (2006). The persistence of earnings and cash flows and the role of special items: Implications for the accrual anomaly. Review of Accounting Studies, 11(2), 253-296. https://doi.org/10.1007/s11142-006-9004-1
Dechow, P., Ge, W., & Schrand, C. (2010). Understanding earnings quality: A review of the proxies, their determinants and their consequences. Journal of Accounting and Economics, 50(2–3), 344-401. https://doi.org/10.1016/j.jacceco.2010.09.001
Dichev, I. D., & Tang, V. W. (2009). Earnings volatility and earnings predictability. Journal of Accounting and Economics, 47(1-2), 160-181. https://doi.org/10.1016/j.jacceco.2008.09.005
Ding, K., Lev, B., Peng, X., Sun, T., & Vasarhelyi, M. A. (2020). Machine learning improves accounting estimates: Evidence from insurance payments. Review of Accounting Studies, 25, 1098-1134. https://doi.org/10.1007/s11142-020-09546-9
Easton, P. D., & Zmijewski, M. E. (1989). Cross-sectional variation in the stock market response to accounting earnings announcements. Journal of Accounting and Economics, 11(2-3), 117-141. https://doi.org/10.1016/0165-4101(89)90003-7
Eckles, D. L., Halek, M., He, E., Sommer, D. W., & Zhang, R. (2011). Earnings smoothing, executive compensation, and corporate governance: Evidence from the property–liability insurance industry. Journal of Risk and Insurance, 78(3), 761-790. https://doi.org/10.1111/j.1539-6975.2011.01417.x
Ellul, A., Jotikasthira, C., Lundblad, C. T., & Wang, Y. (2014). Mark-to-market accounting and systemic risk: Evidence from the insurance industry. Economic Policy, 29(78), 297-341. https://doi.org/10.1111/1468-0327.12030
Frankel, R., & Litov, L. (2009). Earnings persistence. Journal of Accounting and Economics, 47(1-2), 182-190. https://doi.org/10.1016/j.jacceco.2008.11.008
Freeman, R. N., & Tse, S. Y. (1992). A nonlinear model of security price responses to unexpected earnings. Journal of Accounting Research, 30(2), 185-209. https://doi.org/10.2307/2491123
Freeman, R. N., Koch, A., & Li, H. (2011). Can historical returns-earnings relations predict price responses to earnings news? Review of Quantitative Finance and Accounting, 37(1), 35-62. https://doi.org/10.1007/s11156-010-0194-z
Gaver, J. J., & Paterson, J. S. (2004). Do insurers manipulate loss reserves to mask solvency problems? Journal of Accounting and Economics, 37(3), 393–416. https://doi.org/10.1016/j.jacceco.2003.10.010
Grace, E. V. (1990). Property-liability insurer reserve errors: A theoretical and empirical analysis. The Journal of Risk and Insurance, 57(1), 28–46. https://doi.org/10.2307/252923
Grace, M. F., & Leverty, J. T. (2012). Property–liability insurer reserve error: Motive, manipulation, or mistake. Journal of Risk and Insurance, 79(2), 351-380. https://doi.org/10.1111/j.1539-6975.2011.01434.x
Harrington, S. E. (2009). The financial crisis, systemic risk, and the future of insurance regulation. Journal of Risk and Insurance, 76(4), 785-819. https://doi.org/10.1111/j.1539-6975.2009.01330.x
Hayn, C. (1995). The information content of losses. Journal of Accounting and Economics, 20(2), 125-153. https://doi.org/10.1016/0165-4101(95)00397-2
Hui, K. W., Nelson, K. K., & Yeung, P. E. (2016). On the persistence and pricing of industry-wide and firm-specific earnings, cash flows, and accruals. Journal of Accounting and Economics, 61(1), 185-202. https://doi.org/10.1016/j.jacceco.2015.06.003
Kothari, S. P. (2001). Capital markets research in accounting. Journal of Accounting and Economics, 31(1–3), 105-231. https://doi.org/10.1016/S0165-4101(01)00030-1
Lewellen, J., & Resutek, R. J. (2019). Why do accruals predict earnings? Journal of Accounting and Economics, 67(2-3), 336-356. https://doi.org/10.1016/j.jacceco.2018.12.003
Livnat, J., & Santicchia, M. (2006). Cash flows, accruals, and future returns. Financial Analysts Journal, 62(4), 48-61. https://doi.org/10.2469/faj.v62.n4.4186
Mian, G. M., & Sankaraguruswamy, S. (2012). Investor sentiment and stock market response to earnings news. The Accounting Review, 87(4), 1357-1384. https://doi.org/10.2308/accr-50158
Ohlson, J. A. (1995). Earnings, book values, and dividends in equity valuation. Contemporary Accounting Research, 11(2), 661-687. https://doi.org/10.1111/j.1911-3846.1995.tb00461.x
Petroni, K. R. (1992). Optimistic reporting in the property-casualty insurance industry. Journal of Accounting and Economics, 15(4), 485-508. https://doi.org/10.1016/0165-4101(92)90003-K
Pimentel, R. C., & Lima, I. S. (2010). Is the annual earnings response coefficient statitically significant in Brazil. Latin American Business Review, 11(3), 267-291. https://doi.org/10.1080/10978526.2010.513273
Pimentel, R. C., & Aguiar, A. B. (2016). The role of earnings persistence in valuation accuracy and the time horizon. Revista de Administração de Empresas, 56(1), 71-86. https://doi.org/10.1590/S0034-759020160107
Pimentel, R. C., & Malacrida, M. J. C. (2020). Quarterly earnings, operating cash flow, and accruals in future performance assessment. Brazilian Administration Review, 17(4), e190115. Retrieved from https://bar.anpad.org.br/index.php/bar/article/view/504
Polonchek, J., & Miller, R. K. (1999). Contagion effects in the insurance industry. The Journal of Risk and Insurance, 66(3), 459–475. https://doi.org/10.2307/253556
Post, T., Gründl, H., Schmidl, L., & Dorfman, M. S. (2007). Implications of IFRS for the European insurance industry—insights from capital market theory. Risk Management and Insurance Review, 10(2), 247-265. https://doi.org/10.1111/j.1540-6296.2007.00117.x
Sloan, R. G. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71(3), 289-315. Retrieved from https://www.jstor.org/stable/248290
Thesing, J., & Velte, P. (2021). Do fair value measurements affect accounting-based earnings quality? A literature review with a focus on corporate governance as moderator. Journal of Business Economics, 91, 965-1004. https://doi.org/10.1007/s11573-020-01025-6
Wagner, J., & Zemp, A. (2012). Comparison of stakeholder perspectives on current regulatory and reporting reforms. Risk Management and Insurance Review, 15(2), 225-254. https://doi.org/10.1111/j.1540-6296.2012.01218.x
Weiss, M. (1985). A multivariate analysis of loss reserving estimates in property-liability insurers. The Journal of Risk and Insurance, 52(2), 199–221. https://doi.org/10.2307/252512
White, H. (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica, 48(4), 817-838. https://doi.org/10.2307/1912934