Cost Structure and the Usefulness of Earnings

We investigate the relation between the usefulness of earnings and firm cost structure. We document that the usefulness of earnings to external users decreases in the degree of operating leverage, which measures the proportion of fixed to variable costs, and that this decline extends at least partially from the relation between the degree of operating leverage and two earnings properties: aggressive revenue recognition to meet an earnings target and earnings volatility. Our results illustrate how firm fundamentals influence a firm’s information environment and thereby the usefulness of earnings to external users.

Duke Scholars

Author Elia Ferracuti Fuqua School of Business