Imagine you’re deciding to invest in a company. You want assurance that its performance isn’t a fluke—that it can deliver stable, reliable results over time. This idea is at the heart of what researchers call “earnings persistence.” But how does this consistency influence stock prices? And what role do economic growth and a company’s financial decisions play?
A recent study explored these questions, focusing on companies listed on the Indonesia Stock Exchange from 2011 to 2021. The findings provide valuable insights for investors, business leaders, and policymakers, especially in volatile markets like Indonesia’s.
What is the earnings response coefficient?
Before diving into the findings, let’s decode a key term: the Earnings Response Coefficient (ERC). ERC measures how much a company’s stock price changes in response to its earnings announcements. Think of it as the market’s way of saying, “This company’s earnings are worth paying attention to.” A high ERC means investors are confident the earnings reflect real value. But not all earnings are created equal. Investors trust earnings that persist over time—what researchers call earnings persistence—more than erratic profits.
The power of consistent earnings
The study found a clear link between earnings persistence and ERC. Companies with stable earnings enjoyed higher ERCs, meaning their stock prices responded more positively to earnings announcements. Why? Because consistent earnings signal reliability and reduce uncertainty, making investors more willing to bet on the company’s future.
Take, for example, a retail company that has consistently increased its profits year after year. Investors see this track record as proof of strong management and a solid business model. In contrast, a company with wild profit swings may raise red flags, even with high overall earnings.
When risks enter the picture
Not all companies benefit equally from earnings persistence. The study revealed that a company’s capital structure—its mix of debt and equity—plays a big role. Firms with high debt levels saw the positive effects of earnings persistence weaken. Why? Because heavy debt increases financial risk, making even reliable earnings less reassuring to investors.
Imagine a tech company with a promising product and consistent profits. Investors may worry it won’t survive an economic downturn if it’s also burdened with massive debt. In such cases, even strong earnings might not translate into high ERCs.
The economy’s role
Economic growth is another key factor. During periods of strong GDP growth, companies with persistent earnings saw their ERCs climb even higher. A booming economy boosts investor confidence, making reliable earnings even more attractive.
For instance, during Indonesia’s economic expansion in the mid-2010s, companies with consistent profits likely benefited from increased consumer spending and investor optimism. Conversely, even these firms faced more muted market reactions in slower economic periods.
Lessons for investors
So, what does this mean for you as an investor? Here are a few takeaways:
- Focus on consistency: Companies with stable earnings histories are safer bets, especially in volatile markets. Look for firms that have weathered economic ups and downs without major profit fluctuations.
- Consider debt levels: A company’s debt load can significantly affect its financial health and investor perception. Even consistent earnings might not offset the risks of high leverage.
- Watch the economy: Pay attention to broader economic trends. During periods of strong growth, firms with stable earnings may offer particularly attractive opportunities.
Recommendations for businesses
For corporate leaders, the study offers valuable insights into building investor trust and market value:
- Maintain earnings stability: Focus on long-term strategies that deliver consistent profits, such as diversifying revenue streams or optimizing operations.
- Manage debt wisely: Avoid over-leveraging your company. A balanced capital structure not only reduces risk but also amplifies the benefits of stable earnings.
- Communicate effectively: Transparent financial reporting and clear communication about strategies to maintain earnings stability can boost investor confidence.
Recommendations for governments and industry bodies
- Promote financial transparency: Companies must disclose consistent and accurate earnings reports, ensuring investor trust and market stability.
- Support sustainable debt management: Implement policies that incentivize businesses to maintain balanced capital structures, such as offering tax benefits for low-leverage strategies.
- Foster an inclusive economic environment: Advance fair trade policies and create equitable business opportunities in emerging markets, promoting global economic justice.
- Encourage sustainable business practices: Collaborate with international organizations to set ethical governance and environmental stewardship standards, addressing investor confidence and broader global justice.
Implications for policymakers
The findings also have broader implications for Indonesia’s economic policies. By fostering a stable macroeconomic environment, policymakers can enhance investor confidence and encourage more robust market responses to earnings announcements. This includes:
- Promoting transparency and good governance practices.
- Ensuring economic stability through prudent fiscal and monetary policies.
- Supporting companies in building sustainable business models.
A look ahead
The relationship between earnings persistence and ERC highlights the intricate dance between company performance, financial decisions, and broader economic conditions. These dynamics are especially critical in emerging markets like Indonesia, where information transparency and investor trust are still evolving. Understanding these factors will remain vital for navigating the complex world of investments as global and local economies continue to shift. Whether you’re an individual investor, a corporate leader, or a policymaker, these insights offer a roadmap for making informed decisions in an ever-changing financial landscape.
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Journal reference
Sandy, R. M., & Mulya, A. S. (2025). Earnings Response Coefficient: Earnings persistence moderated by capital structure and economic growth. Cogent Business & Management, 12(1), 2441475. https://doi.org/10.1080/23311975.2024.2441475
