The Effect of Innate and Discretionary Components of Earnings Quality Properties on Stock Return Volatility in South Africa

Abstract

Previous studies reported that the quality of financial reports, measured by earnings quality properties, is associated with changes in stock return volatility (SRV). However, the properties of earnings quality in previous studies have been examined without separating them into their innate and discretionary components. This study examined the effect of innate and discretionary components of earnings quality properties on the SRV of companies listed in the Johannesburg Stock Exchange (JSE) in South Africa (SA). Using Multilevel linear regression to analyse a sample of 800 firm-year observations, obtained from 80 non-financial companies for the period 2009-2018, the study found that the innate component of each earnings quality property has a greater impact on the SRV (measured by idiosyncratic volatility) than the discretionary component. These findings imply that, in SA, the stock return volatility is mostly driven by the earnings quality properties that emanate from the operating environment and the business model of the companies. The findings may assist investors in the factors to consider when assessing the risks of their investments. In addition, the findings could be useful to regulators in SA in the review or formulation of policies that may make the business environment more stable as these policies influence the operating environment of the companies.