Abstract: We identify a new channel - market makers'' attention constraints - through which earnings announcements for one stock affect the liquidity of other stocks. When some stocks handled by a designated market maker have earnings announcements, liquidity is lower for non-announcement stocks handled by the same market maker, with the largest effects coming from earnings surprises and stocks with high earnings response coefficients. Half of the liquidity decline reflects attention constraints binding on the individual market maker, and the other half is explained by the market maker''s inventory. We further find that a market design change that increases automation alleviates the liquidity effect of attention constraints, despite an increase in the number of stocks allocated to each market maker. [Copyright &y& Elsevier]
Accounting discretion, loan loss provisioning, and discipline of Banks' risk-taking
Bushman, Robert M., Williams, Christopher D.
Vol 54, Issue 1, 1-18 (2012)
Abstract: Examining banks across 27 countries, we estimate two measures of the forward-looking orientation reflected in discretionary loan provisioning practices within a country. We document that forward-looking provisioning designed to smooth earnings dampens discipline over risk-taking, consistent with diminished transparency inhibiting outside monitoring. In contrast, forward-looking provisioning reflecting timely recognition of expected future loan losses is associated with enhanced risk-taking discipline. Thus, proposals to change loan loss accounting embed significant risks of unintended consequences, as gains from reducing pro-cyclicality may be swamped by losses in transparency that dampen market discipline and increase the scope for less prudent risk-taking by banks. [Copyright &y& Elsevier]
Discussion of "Financial reporting opacity and informed trading by international institutional investors"
Bushee, Brian J.
Vol 54, Issue 2/3, 221-228 (2012)
Abstract: Maffett (this issue) finds that the opacity of a firm''s information environment affects the degree of informed trade by institutional investors. In this discussion, I address the key research design choices involved in studies of opacity and informed trading and I relate the results to the literature on institutional investor performance and stock selection. I suggest that future work investigate the role of discretionary opacity in facilitating informed trade as part of the cost-benefit trade-off of the opacity decision maker (e.g., managers, analysts); test the relative effects of opacity on private information, liquidity, and price correction speed; and examine how institutional investors select which opaque firms to hold. [Copyright &y& Elsevier]
Discussion of "Analysts' industry expertise"
Bradshaw, Mark T.
Vol 54, Issue 2/3, 121-131 (2012)
Abstract: Kadan et al. (this issue) examine whether financial analysts exhibit industry expertise. It is not obvious from the title, but the study actually examines two different types of analysts: firm-specific analysts that have been examined extensively in prior research, and the rarer industry analysts who provide outlooks on whole industries. This study is the first to examine a large sample of explicit industry recommendations, and provides a fresh insight into an important aspect of financial research--industry expertise. In this discussion, I assess the motivation, contribution and empirical procedures within the context of capital markets research on sell-side analysts [Copyright &y& Elsevier]
Evidence on the determinants and economic consequences of delegated monitoring
Beatty, Anne, Liao, Scott, Weber, Joseph
Vol 53, Issue 3, 555-576 (2012)
Abstract: We investigate delegated monitoring by examining the determinants and effects of including cross-acceleration provisions in public debt contracts. We find that cross-acceleration provision use depends on borrowers'' going concern relative to liquidation values, debt repayment structures, credit quality, and financial reporting quality. This suggests that the use of cross-acceleration provisions increases when the costs of cascading defaults are lower, the conflicts between creditor classes are higher, and the benefits of delegating monitoring to banks are higher. We also find a lower interest rate on public debt contracts with cross-acceleration provisions, but the rate reduction depends on borrowers'' financial reporting quality. [Copyright &y& Elsevier]
Who, if anyone, reacts to accrual information?
Battalio, Robert H., Lerman, Alina, Livnat, Joshua, Mendenhall, Richard R.
Vol 53, Issue 1/2, 205-224 (2012)
Abstract: We show that the vast majority of investors ignore value-relevant accruals information when it is first released, but that investors who initiate trades of at least 5,000 shares tend to transact in the proper direction. These investors trade on accruals information only when the previously-announced earnings signal is non-negative. Unconditionally, those investors initiating the smallest trades appear to respond to accruals in the wrong direction, but further investigation suggests this behavior is explained by their attraction to attention-grabbing stocks. Finally, we find that those who trade on accruals information have insufficient market power to mitigate the accruals anomaly. [Copyright &y& Elsevier]
Are IFRS-based and US GAAP-based accounting amounts comparable?
Barth, Mary E., Landsman, Wayne R., Lang, Mark, Williams, Christopher
Vol 54, Issue 1, 68-93 (2012)
Abstract: This study examines whether application of IFRS by non-US firms results in accounting amounts comparable to those resulting from application of US GAAP by US firms. IFRS firms have greater accounting system and value relevance comparability with US firms when IFRS firms apply IFRS than when they applied domestic standards. Comparability is greater for firms that adopt IFRS mandatorily, firms in common law and high enforcement countries, and in more recent years. Earnings smoothing, accrual quality, and timeliness are potential sources of the greater comparability. Although application of IFRS has enhanced financial reporting comparability with US firms, significant differences remain. [Copyright &y& Elsevier]
Audited financial reporting and voluntary disclosure as complements: A test of the Confirmation Hypothesis
Abstract: We examine the "confirmation" hypothesis that audited financial reporting and disclosure of managers'' private information are complements, because independent verification of outcomes disciplines and hence enhances disclosure credibility. Committing to higher audit fees (a measure of financial statement verification) is associated with management forecasts that are more frequent, specific, timely, accurate and informative to investors. Because private information disclosure and audited financial reporting are complements, their economic roles cannot be evaluated separately. Our evidence cautions against drawing inferences exclusively from market reactions around "announcement periods" because audited financial reporting indirectly affects information released at other times and through other channels. [Copyright &y& Elsevier]
Discretionary accounting choices and the predictive ability of accruals with respect to future cash flows
Badertscher, Brad A., Collins, Daniel W., Lys, Thomas Z.
Vol 53, Issue 1/2, 330-352 (2012)
Abstract: Using a sample of restatement firms and a meet-or-beat model to classify firms as making discretionary accounting choices for opportunistic meet-or-beat (OP-MB) reasons, we show that originally reported earnings and accrual components are less predictive of future cash flows relative to the restated numbers. We find the opposite is true for firms classified as making discretionary accounting choices for non-OP-MB reasons. We consider a number of competing explanations for these latter results. Our findings are most consistent with the informational hypothesis, weakly consistent with conservative-motivated efficient contracting hypotheses, but inconsistent with opportunistic contracting and misapplication/errors of GAAP explanations. [Copyright &y& Elsevier]
The incentives for tax planning
Armstrong, Christopher S., Blouin, Jennifer L., Larcker, David F.
Vol 53, Issue 1/2, 391-411 (2012)
Abstract: We use a proprietary data set with detailed executive compensation information to examine the relationship between the incentives of the tax director and GAAP and cash effective tax rates, the book-tax gap, and measures of tax aggressiveness. We find that the incentive compensation of the tax director exhibits a strong negative relationship with the GAAP effective tax rate, but little relationship with the other tax attributes. We interpret these results as indicating that tax directors are provided with incentives to reduce the level of tax expense reported in the financial statements. [Copyright &y& Elsevier]
Corporate governance and the information environment: Evidence from state antitakeover laws
Armstrong, Christopher S., Balakrishnan, Karthik, Cohen, Daniel
Vol 53, Issue 1/2, 185-204 (2012)
Abstract: We examine the relation between corporate governance and firms'' information environments. We use the passage of state antitakeover laws in the U.S. as a source of exogenous variation in an important governance mechanism to identify changes in firms'' information environments. We find that information asymmetry and private information gathering decreased and that financial statement informativeness increased following the passage of the antitakeover laws. Cross-sectional analyses indicate that the increased level of financial statement informativeness is attributable to firms that are most likely to access equity markets rather than managerial entrenchment, managerial career concerns, or managers'' pursuit of the quiet life. [Copyright &y& Elsevier]
Nonprofit boards: Size, performance and managerial incentives
Aggarwal, Rajesh K., Evans, Mark E., Nanda, Dhananjay
Vol 53, Issue 1/2, 466-487 (2012)
Abstract: We examine relations between board size, managerial incentives and enterprise performance in nonprofit organizations. We posit that a nonprofit''s demand for directors increases in the number of programs it pursues, resulting in a positive association between program diversity and board size. Consequently, we predict that board size is inversely related to managerial pay-performance incentives and positively with overall organization performance. We find empirical evidence consistent with our hypotheses. The number of programs is positively related to board size. Board size is associated negatively with managerial incentives, positively with program spending and fundraising performance, and negatively with commercial revenue, in levels and changes. [Copyright &y& Elsevier]
The valuation impact of reconciling pro forma earnings to GAAP earnings
Zhang, Huai, Zheng, Liu
Vol 51, Issue 1/2, 186-202 (2011)
Abstract: Regulation G requires all companies to quantitatively reconcile pro forma earnings with GAAP earnings. This paper provides three findings related to the impact of reconciliations on mispricing of pro forma earnings. First, prior to Reg G, we find that mispricing of pro forma earnings is limited to firms with low reconciliation quality. There is no evidence of mispricing for firms with high reconciliation quality. Second, we find no evidence of mispricing after Reg G. Third, there is a cross-Reg G reduction of mispricing for firms whose reconciliation quality improves, and there continues to be no mispricing for firms that have high reconciliation quality both before and after Reg G. Together, our results support the notion that better reconciliations reduce the extent of mispricing. [Copyright &y& Elsevier]
Towards a theory of accounting regulation: A discussion of the politics of disclosure regulation along the economic cycle
Vol 52, Issue 2/3, 228-234 (2011)
Abstract: The paper by endogenizes accounting regulation by a majority-seeking regulator and examines how the economic cycle affects mandatory reporting quality. This discussion puts the paper in the broader context of a theory of accounting regulation. Then, it focuses on crucial assumptions, including the exogenous evolution of the economy, the role of market frictions, the modeling of reporting quality, and the regulatory process and regulatory cycles, and provides suggestions for future research. [Copyright &y& Elsevier]
Isolating the effect of disclosure on information risk
Tang, Vicki Wei
Vol 52, Issue 1, 81-99 (2011)
Abstract: This study examines companies with two classes of shares that entitle their holders to identical cash flow and voting rights but that are available to mutually exclusive sets of investors: A shares to domestic investors and B shares to foreign investors. Price differences between A and B shares are higher in firms with a greater disparity in the disclosures that they make to domestic and foreign investors. This association is more pronounced when the cost (benefit) of information transfer is higher (lower). The results suggest that disclosure disparity creates meaningful differences in investors'' average information precision across A and B shares and thus influences the cross-sectional variation in price differences. [Copyright &y& Elsevier]
Discussion of "Accounting standards and debt covenants: Has the "Balance Sheet Approach" led to a decline in the use of balance sheet covenants?"
Skinner, Douglas J.
Vol 52, Issue 2/3, 203-208 (2011)
Abstract: argues that a shift by U.S. standard setters towards the balance sheet approach reduces the usefulness of balance sheet numbers for contracting. Consistent with this argument, he provides evidence of a decline in the use of balance sheet-based covenants in debt contracts, a useful finding. Nevertheless, I argue that the evolution of standard-setting is more complex than this argument implies, and evaluate the economic basis of Demerjian''s arguments for how debt contracts respond to changes in accounting rules. One conclusion that emerges is that there are still some important open issues regarding the economic determinants of debt contracts. [Copyright &y& Elsevier]
Liquidity risk and accounting information
Vol 52, Issue 2/3, 144-152 (2011)
Abstract: This paper highlights the different avenues through which stock liquidity can potentially transcend into accounting research. Recently, Lang and Maffett show that transparency reduces firm-level liquidity uncertainty, while Ng shows that increased information quality can reduce a firm''s exposure to systematic liquidity risk. These studies respectively suggest that accounting variables can affect firm valuation and cost-of-capital through their impact on different aspects of liquidity. Although some doubt may arise about the economic significance of such effects on average, further evidence from the recent financial crisis presented in this paper confirms the important role of accounting information during liquidity events. [Copyright &y& Elsevier]
Financial reporting quality and idiosyncratic return volatility
Rajgopal, Shiva, Venkatachalam, Mohan
Vol 51, Issue 1/2, 1-20 (2011)
Abstract: document that firms' stock returns have become more volatile in the U.S. since 1960. We hypothesize and find that deteriorating earnings quality is associated with higher idiosyncratic return volatility over 1962-2001. These results are robust to controlling for (i) inter-temporal changes in the disclosure of value-relevant information, sophistication of investors and the possibility that earnings quality can be informative about future cash flows; (ii) stock return performance, cash flow operating performance, cash flow variability, growth, leverage and firm size; and (iii) new listings, high-technology firms, firm-years with losses, mergers and acquisitions and financial distress. [Copyright &y& Elsevier]
The effect of information quality on liquidity risk
Vol 52, Issue 2/3, 126-143 (2011)
Abstract: I investigate whether information quality affects the cost of equity capital through liquidity risk. Liquidity risk is the sensitivity of stock returns to unexpected changes in market liquidity; recent asset pricing literature has emphasized the importance of this systematic risk. I find that higher information quality is associated with lower liquidity risk and that the reduction in cost of capital due to this association is economically significant. I also find that the negative association between information quality and liquidity risk is stronger in times of large shocks to market liquidity. [Copyright &y& Elsevier]
The effect of cash flow forecasts on accrual quality and benchmark beating
McInnis, John, Collins, Daniel W.
Vol 51, Issue 3, 219-239 (2011)
Abstract: When analysts provide forecasts of both earnings and operating cash flow, they also implicitly provide a forecast of total operating accruals. We posit that this increases the transparency and the expected costs of accrual manipulations used to manage earnings. As a consequence, we predict and find that accrual quality improves and firms' propensity to meet or beat earnings benchmarks declines following the provision of cash flow forecasts. We also predict and find that firms turn to other benchmark-beating mechanisms, such as real activities manipulation and earnings guidance in response to the provision of cash flow forecasts. [Copyright &y& Elsevier]
Transparency and liquidity uncertainty in crisis periods
Lang, Mark, Maffett, Mark
Vol 52, Issue 2/3, 101-125 (2011)
Abstract: We document, for a global sample, that firms with greater transparency (based on accounting standards, auditor choice, earnings management, analyst following and forecast accuracy) experience less liquidity volatility, fewer extreme illiquidity events and lower correlations between firm-level liquidity and both market liquidity and market returns. Results are robust to numerous sensitivity analyses, including controls for endogeneity and propensity matching. Results are particularly pronounced during crises, when liquidity variances, covariances and extreme illiquidity events increase substantially, but less so for transparent firms. Finally, liquidity variance, covariance and the frequency of extreme illiquidity events are all negatively correlated with Tobin''s Q. [Copyright &y& Elsevier]
Consistency in meeting or beating earnings expectations and management earnings forecasts
Kross, William J., Ro, Byung T., Suk, Inho
Vol 51, Issue 1/2, 37-57 (2011)
Abstract: This paper provides evidence that firms that have consistently met or beaten analysts' earnings expectations (MBE) provide more frequent "bad news" management forecasts than firms with no established string of MBE, particularly when existing analyst forecasts are optimistic. This suggests that firms with a consistent MBE record are more likely to guide analysts' expectations downward to avoid breaking the consistency. Subsequent analyst forecast revisions following bad news management forecasts issued by these firms are dampened, implying that analysts suspect that these forecasts may be opportunistic. The relation between management forecasts and MBE consistency is stronger after Regulation FD. [Copyright &y& Elsevier]
Mark-to-market regulatory accounting when securities markets are stressed: Lessons from the financial crisis of 2007-2009
Kolasinski, Adam C.
Vol 52, Issue 2/3, 174-177 (2011)
Abstract: While market prices can be useful tools for bank regulation, recent theoretical work argues that reliance on prices can be counterproductive when secondary markets are stressed and illiquid. Evidence from the financial crisis unearthed by provides empirical validation of these arguments. Though Bhat et al. do not fully acknowledge it, their findings suggest that forcing banks to count liquidity-induced unrealized losses in securities holdings against regulatory capital destroys value and exposes bank creditors, including taxpayers, to more risk. Policy makers contemplating greater regulatory reliance on market prices ignore these findings at their peril. [Copyright &y& Elsevier]
Do the SEC's enforcement preferences affect corporate misconduct?
Kedia, Simi, Rajgopal, Shiva
Vol 51, Issue 3, 259-278 (2011)
Abstract: Recent frauds have questioned the efficacy of the SEC''s enforcement program. We hypothesize that differences in firms'' information sets about SEC enforcement and constraints facing the SEC affect firms'' proclivity to adopt aggressive accounting practices. We find that firms located closer to the SEC and in areas with greater past SEC enforcement activity, both proxies for firms'' information about SEC enforcement, are less likely to restate their financial statements. Consistent with the resource-constrained SEC view, the SEC is more likely to investigate firms located closer to its offices. Our results suggest that regulation is most effective when it is local. [Copyright &y& Elsevier]
Endogenous overconfidence in managerial forecasts
Hilary, Gilles, Hsu, Charles
Vol 51, Issue 3, 300-313 (2011)
Abstract: We examine whether attribution bias leads managers who have experienced short-term forecasting success to become overconfident in their ability to forecast future earnings. Importantly, this form of overconfidence is endogenous and dynamic. We also examine the effect of this cognitive bias on the managerial credibility. Consistent with the existence of dynamic overconfidence, managers who have predicted earnings accurately in the previous four quarters are less accurate in their subsequent earnings predictions. These managers also display greater divergence from the analyst consensus and are more precise. Lastly, investors and analysts react less strongly to forecasts issued by overconfident managers. [Copyright &y& Elsevier]
Does board gender diversity improve the informativeness of stock prices?
Gul, Ferdinand A., Srinidhi, Bin, Ng, Anthony C.
Vol 51, Issue 3, 314-338 (2011)
Abstract: We show that stock prices of firms with gender-diverse boards reflect more firm-specific information after controlling for corporate governance, earnings quality, institutional ownership and acquisition activity. Further, we show that the relationship is stronger for firms with weak corporate governance suggesting that gender-diverse boards could act as a substitute mechanism for corporate governance that would be otherwise weak. The results are robust to alternative specifications of informativeness and gender diversity and to sensitivity tests controlling for time-invariant firm characteristics and alternative measures of stock price informativeness. We also find that gender diversity improves stock price informativeness through the mechanism of increased public disclosure in large firms and by encouraging private information collection in small firms. [Copyright &y& Elsevier]