Martikainen, Minna (1998). Accounting losses, investors' growth expectations and the association between stock retums and accounting earnings. Acta Wasaensia No. 61, 129 p.

This thesis investigates how accounting losses affect investors' growth expectations for firms and consequently dampen the observed relationship between stock returns and accounting earnings, i.e. earnings response coefficients (ERCs). The theoretical analysis explains why accounting losses and profits may be valuated differently in the market, losses being insignificant in creating cash flow expectations. Moreover, it shows that ERCs are different for different types of firms. The empirical analysis indicates that in a sample of New York Stock Exchange (NYSE) firms between 1975 and 1990, the relationship between accounting losses and market-implied growth opportunities is not positive. This is consistent with the hypothesis that accounting losses are not reflected in investors' cash flow expectations. The relationship exists between profits and growth expectations, however. Moreover, it appears that the exclusion of accounting losses improves the observed ERCs significantly. Consistent with the theoretical analysis, the impact of losses on ERCs is highest in the subgroup of firms having highest growth opportunities and least financial leverage. Finally, it is reported that, because the amount of losses varies over time and across industries, the ERCs are dampened in different periods of time in different industries. Taken together, the findings of this study show that the existence of accounting losses increases the temporary nature of accounting earnings. This takes place differently for different types of firms and in different years. The phenomenon should be recognized in Financial analyses using eamings information.

Minna Martikainen (neé Ojakippola), Department of Accounting and Finance, Graduate School of Finance and Financial Accounting, University of Vaasa, Wolffintie 34, FIN-65200 Vaasa, Finland.

Key words: accounting earnings, accounting losses, stock returns, growth opportunities, leverage, industries.