Implications of Deferred Revenue Changes for Future Financial Performance and Market Underreaction

This study found that changes in current deferred revenues (ΔDRC) are positively associated with sales growth, gross profit margin, profit margin and return on assets of the next two years. The evidence suggests that deferred revenue changes can serve as a valid leading indicator for a firm’s future financial performance. It also identified a positive relationship between a firm’s ΔDRC and its market valuation, indicating that market participants (at least partially) incorporate the future performance implications of deferred revenue changes into their valuation decisions. While prior research suggested mismatch of revenues and expenses (Prakash and Sinha 2013) as the potential explanation for the abnormal stock returns in reporting firms, the empirical evidence in this study supports an alternative explanation: investors’ underreaction to the information content of deferred revenue changes.