Earnings Predictability, Value Relevance, and Employee Expenses

Employees are an important firm resource and a source of intellectual capital; hence, they drive firm performance. Employee expenses capture information about employees and are one of the largest earnings components. We analyze whether this earnings component contributes incremental information content over and above that of earnings alone. Our results confirm the importance of employee expenses from an accounting perspective and show that they indeed add to the prediction of future firm performance. Analyses are based on a sample of 938 U.K. firms that mandatorily report employee expenses, resulting in 5039 observations within a time period ranging from 1999 to 2010. Results are consistent across industries, years, and different sample selections. We further provide evidence that there are underlying determinants that influence the incremental information content of employee expenses. Specifically, more persistent employee expenses are associated with higher earnings predictability and value relevance. For firms with a higher proportion of loss years, employee expenses contribute more strongly to the prediction of future performance. We interpret this finding to support the role of employees as a firm resource which can be allocated to more profitable activities in the case of loss years.