In financial economics, finance, and accounting, the earnings response coefficient, or ERC, is the estimated relationship between equity returns and the unexpected portion of (i.e., new information in) companies' earnings announcements.

Development

Arbitrage pricing theory describes the theoretical relationship between information that is known to market participants about a particular equity (e.g., a common stock share of a particular company) and the price of that equity. Under the strong form of the efficient market hypothesis, equity prices are expected in the aggregate to reflect all relevant information at a given time. Market participants with superior information are expected to exploit that information until share prices have effectively impounded the information. Therefore, in the aggregate, a portion of changes in a company's share price is expected to result from changes in the relevant information available to the market. The ERC is an estimate of the change in a company's stock price due to the information provided in a company's earnings announcement. The ERC is expressed mathematically as follows: Earnings response coefficient research attempts to identify and explain the differential market response to earnings information of different firms. An Earnings response coefficient measures the extent of security’s abnormal market return in response to the unexpected component of reported earnings of the firm issuing that security. and The relationship between stock returns to profit to determine the extent of the response that occurs to as the Earnings Response Coefficient (ERC). Some studies reveal there are four factors that affect Earnings Response Coefficient (ERC), namely : beta, capital structure, persistence and growth.

Reasons

Reasons for differential market response:

Use & Debate

ERCs are used primarily in research in accounting and finance. In particular, ERCs have been used in research in positive accounting, a branch of financial accounting research, as they theoretically describe how markets react to different information events. Research in Finance has used ERCs to study, among other things, how different investors react to information events. and There is some debate concerning the true nature and strength of the ERC relationship. As demonstrated in the above model, the ERC is generally considered to be the slope coefficient of a linear equation between unexpected earnings and equity return. However, certain research results suggest that the relationship is nonlinear. and