Residual income, non-earnings information, and information content

We extend Ohlson's (1995) model and examine the relationship between returns and residual income that incorporate analysts' earnings forecasts and other non-earnings information variables in the balance sheet, namely default probability and agency cost of a debt covenant contract. We further divide the sample based on bankruptcy (agency) costs, earnings components and growth opportunities of a fi rm to explore how these factors affect the returns-residual in come link. We fi nd that the relative predictive ability for contemporaneous stock price by considering other earnings and non-earnings information is better than that of models without non-earnings information. If the bankruptcy (agency) cost of a fi rm is higher, its information role in the fi rm's equity valuation becomes more important and the accuracy of price prediction is therefore higher. As for non-earnings information, if bankruptcy (agency) cost is lower, the information role becomes more relevant, and the earnings response coeffi cient is hence higher. Moreover, the decomposition of unexpected residual income into permanent and transitory components induces more information than that of the unexpected residual income alone. The permanent component has a larger impact than the transitory component in explaining abnormal returns. The market and industry properties and growth opportunity also have incremental explanatory power in valuation.