Separating Information About Cash Flows from Information About Risk in Losses

Prior literature interprets the weak earnings response coefficient (ERC) of accounting losses as a manifestation either lack forward-looking information in or market mispricing losses. Based on return decomposition theory, I predict that contain not only about future cash flows (i.e., flow news) but also, risk expected returns and discount rate news). However, these informational components have offsetting valuation effects, resulting muted ERC. Consistent with prediction, show that, after controlling for (mainly returns), ERC becomes statistically significant more negative larger when are measured annually around announcements. Moreover, loss firms will continue to poor operating flows, associated analyst forecast revisions loss-reporting year. also document provide they because research development expensing, trigger operational curtailments, less likely reverse profits. Further tests confirm robustness my findings considering drifts/reversals, alternative proxies news, test portfolios, model specifications. Overall, paper provides new insights into content This was accepted by Suraj Srinivasan, accounting.