Private lenders’ demand for audit

Corporate-sponsored foundations and earnings management

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Corporate-sponsored foundations and earnings management

Petrovits, Christine M.

Vol 41, Issue 3, 335-362 (2006)

Abstract: This study examines the strategic use of corporate philanthropy programs to achieve financial reporting objectives. Corporate-sponsored foundations allow managers to maintain stable levels of giving to charitable causes while providing substantial discretion as to the amount of contribution expense recorded on the income statement in any given period. I find that firms reporting small earnings increases make income-increasing discretionary foundation funding choices. This result is associated with firms that have strong equity market incentives to manage earnings. The evidence presented in this paper is consistent with firms using their charitable foundations as off-balance sheet reserves. [Copyright &y& Elsevier]

Why is the accrual anomaly not arbitraged away? The role of idiosyncratic risk and transaction costs

Mashruwala, Christina, Rajgopal, Shivaram, Shevlin, Terry

Vol 42, Issue 1/2, 3-33 (2006)

Abstract: We show that the accrual anomaly documented by Sloan (1996) [Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review 71: 289-315] is concentrated in firms with high idiosyncratic stock return volatility making it risky for risk-averse arbitrageurs to take positions in stocks with extreme accruals. Moreover, the accrual anomaly is found in low-price and low-volume stocks, suggesting that transaction costs impose further barriers to exploiting accrual mispricing. [Copyright &y& Elsevier]

Cross listing, bonding and firms' reporting incentives: A discussion of Lang, Raedy and Wilson (2006)

Leuz, Christian

Vol 42, Issue 1/2, 285-299 (2006)

Abstract: Lang, Raedy and Wilson (henceforth LRW) (2006) compare the properties of U.S. GAAP accounting numbers across cross-listed and U.S. firms. Using a wide range of properties, LRW show that accounting data are not comparable, even though sample firms use the same accounting standards. I discuss how these findings advance the literature and what they imply for the effectiveness of cross listing as a bonding mechanism. My discussion highlights that documented differences cannot be solely attributed to weak U.S. legal enforcement. I emphasize that accounting standards provide discretion and that cross-listed and U.S. firms are likely to have differential incentives to use this discretion. To illustrate, I document that cross-listed and U.S. firms differ in ownership concentration and that these differences are associated with the level of earnings management. I also provide evidence that home-country institutions continue to influence cross-listed firms' reporting behavior. [Copyright &y& Elsevier]

Asymmetric sensitivity of CEO cash compensation to stock returns

Leone, Andrew J., Wu, Joanna Shuang, Zimmerman, Jerold L.

Vol 42, Issue 1/2, 167-192 (2006)

Abstract: We document that CEO cash compensation is twice as sensitive to negative stock returns as it is to positive stock returns. Since stock returns include both unrealized gains and unrealized losses, we expect cash compensation to be less sensitive to stock returns when returns contain unrealized gains (positive returns) than when returns contain unrealized losses (negative returns). This is consistent with boards of directors exercising discretion to reduce costly ex post settling up in cash compensation paid to CEOs. [Copyright &y& Elsevier]

The informativeness of earnings and management's issuance of earnings forecasts

Lennox, Clive S., Park, Chul W.

Vol 42, Issue 3, 439-458 (2006)

Abstract: Theory suggests that managers issue earnings forecasts to reduce information asymmetry. An earnings forecast is more effective in reducing information asymmetry if it contains earnings news that is relatively more informative about the firm''s value. We hypothesize that a manager is more likely to issue an earnings forecast if investors perceive that earnings are more informative. We measure earnings informativeness by estimating the firm''s earnings response coefficient (ERC) in quarters prior to the forecast issuance decision. Consistent with our hypothesis, we find that the firm''s historic ERC is positively associated with management''s issuance of earnings forecasts. [Copyright &y& Elsevier]

Earnings management and cross listing: Are reconciled earnings comparable to US earnings?

Lang, Mark, Smith Raedy, Jana, Wilson, Wendy

Vol 42, Issue 1/2, 255-283 (2006)

Abstract: We compare US firms' earnings with reconciled earnings for cross-listed non-US firms. Non-US firms' earnings exhibit more evidence of smoothing, greater tendency to manage towards a target, lower association with share price and less timely recognition of losses. Firms from countries with weaker investor protection show more evidence of earnings management, suggesting that SEC regulation does not supplant the effect of local environment. There is more evidence of earnings management for firms reconciling to US GAAP than for those preparing local accounts in accordance with US GAAP, but both show more evidence of earnings management than US firms. [Copyright &y& Elsevier]

Capital budgeting for new projects: On the role of auditing in information acquisition

Kim, Doyoung

Vol 41, Issue 3, 257-270 (2006)

Abstract: This article studies capital budgeting for new projects in which information is acquired by managers. When information acquisition costs are small, optimal capital budgeting is not qualitatively different from that for routine projects where managers have pre-existing information. However, the need to provide incentives to acquire information results in more intensive auditing and further distortions in capital allocations. When information acquisition costs are large, optimal capital budgeting differs from that for routine projects. To provide strong incentives for information acquisition, auditing becomes more extensive, and more than the first best amount of capital is allocated whenever auditing occurs. [Copyright &y& Elsevier]

Revenue surprises and stock returns

Jegadeesh, Narasimhan, Livnat, Joshua

Vol 41, Issue 1/2, 147-171 (2006)

Abstract: This paper examines the relation between revenue surprises and contemporaneous and future stock returns. It also investigates whether analysts update their earnings forecasts in response to revenue surprises in a timely and unbiased fashion. Stock price reaction on the earnings announcement date is significantly related to contemporaneous as well as past revenue surprises. After controlling for earnings surprises, we find significant abnormal returns in the post-announcement period for stocks that have large revenue surprises. Although analysts revise their forecasts of future earnings in response to revenue surprises, they are slow to incorporate fully the information in revenue surprises. [Copyright &y& Elsevier]

Stock repurchases as an earnings management device

Hribar, Paul, Jenkins, Nicole Thorne, Johnson, W. Bruce

Vol 41, Issue 1/2, 3-27 (2006)

Abstract: We investigate whether firms use stock repurchases to meet or beat analysts' earnings per share (EPS) forecasts. We identify conditions under which repurchases increase EPS and document the frequency of accretive repurchases from 1988 to 2001. We find a disproportionately large number of accretive stock repurchases among firms that would have missed analysts' forecasts without the repurchase. The repurchase-induced component of earnings surprises appears to be discounted by the market, and this discount is larger when the repurchase seems motivated by EPS management, although using the repurchase to avoid missing analyst forecasts appears to mitigate some of the negative stock price response. [Copyright &y& Elsevier]

Fundamentals of shareholder tax capitalization

Guenther, David A., Sansing, Richard

Vol 42, Issue 3, 371-383 (2006)

Abstract: We investigate how shareholder-level taxes are capitalized into stock prices using a model that incorporates the investment and payout decisions of a firm and the investment alternatives available to investors. Shareholder taxes affect stock prices both indirectly, via the effect of taxes on corporate investment decisions, and directly, by reducing both the mean and variance of after-tax returns. In our model, tax capitalization is not eliminated by the presence of tax-exempt investors, does not depend on whether equity is composed of contributed capital or retained earnings, and does not depend on the tax rate faced by a hypothetical marginal investor. [Copyright &y& Elsevier]

Discussion of an economic framework for conservative accounting and Bushman and Piotroski (2006)

Guay, Wayne, Verrecchia, Robert

Vol 42, Issue 1/2, 149-165 (2006)

Abstract: We offer an economic framework for generating predictions about the demand for conservative accounting reports. We define conservatism as: More timely recognition of losses than gains as a result of the costs and benefits of reporting verifiable information by managers and/or firms being asymmetric. We also discuss Bushman and Piotroski''s interpretation of the speeds of "good news recognition" and "incremental bad news recognition" in "Basu-type" regressions as separate signals about accounting conservatism. Finally, we suggest avenues for future research that seeks to investigate the links between institutions and contracts, and between contracts and conservatism. [Copyright &y& Elsevier]

Determinants of the informativeness of analyst research

Frankel, Richard, Kothari, S. P., Weber, Joseph

Vol 41, Issue 1/2, 29-54 (2006)

Abstract: We examine cross-sectional determinants of the informativeness of analyst research, i.e., their effect on security prices, controlling for endogeneity among the factors affecting informativeness. Analyst reports are more informative when the potential brokerage profits are higher (e.g., high trading volume, high volatility, and high institutional ownership) and lower when information processing costs (e.g., more business segments) are high. We also find that the informativeness of analyst research and informativeness of financial statements are complements. [Copyright &y& Elsevier]

Re-examining the effects of regulation fair disclosure using foreign listed firms to control for concurrent shocks

Francis, Jennifer, Nanda, Dhananjay, Wang, Xin

Vol 41, Issue 3, 271-292 (2006)

Abstract: We re-examine the effects of regulation fair disclosure (Reg FD) using ADRs (who are exempt from Reg FD) to control for confounding events which affected all traded firms. Tests based on public information metrics (returns volatility, informational efficiency and trading volume) and on analyst information metrics (forecast dispersion and accuracy) suggest that Reg FD did not uniquely affect the US information environment. However, analyst report informativeness declined for US firms relative to ADR firms, providing evidence consistent with Reg FD achieving one of its objectives-reducing private information flows to analysts. [Copyright &y& Elsevier]

Dynamic incentives and dual-purpose accounting

Feltham, Gerald, Indjejikian, Raffi, Nanda, Dhananjay

Vol 42, Issue 3, 417-437 (2006)

Abstract: Ongoing employment relationships often give rise to implicit, dynamic incentives. We describe the implications of implicit incentives when firms use information about both an employee''s past performance and his future productivity in a two-period agency model. We show that when an accounting system serves these dual objectives, an employee''s implicit incentives may be beneficial or detrimental to the firm. As a consequence, firms may prefer an accounting system that reports a single metric that combines information about past performance and future productivity, over one that reports two distinct metrics, one for each purpose. [Copyright &y& Elsevier]

Information technology, organizational design, and transfer pricing

Dikolli, Shane S., Vaysman, Igor

Vol 41, Issue 1/2, 201-234 (2006)

Abstract: We show how information technology affects transfer pricing. With coarse information technology, negotiated transfer pricing has an informational advantage: managers agree to prices that approximate the firm''s cost of internal trade more precisely than cost-based transfer prices. With sufficiently rapid offers, this advantage outweighs opportunity costs of managers' bargaining time, and negotiated transfer pricing generates higher profits than the cost-based method. However, as information technology improves, the informational advantage diminishes; the opportunity costs of managers' bargaining eventually dominate, and cost-based methods generate higher profits. Our results explain why firms generally prefer cost-based methods, and when negotiated methods are preferable. [Copyright &y& Elsevier]

Asymmetric sensitivity of CEO cash compensation to stock returns: A discussion

Dechow, Patricia M.

Vol 42, Issue 1/2, 193-202 (2006)

Abstract: Leone, Wu, and Zimmerman [Leone, A., Wu, J., Zimmerman, J., 2005. Asymmetric sensitivity of CEO cash compensation to stock returns. Journal of Accounting and Economics, forthcoming] find that cash compensation (salary and bonus) is more sensitive to price decreases than to price increases. The authors interpret this result as consistent with Boards of Directors exercising discretion to reduce costly ex post settling up in cash compensation. I discuss potential alternative explanations. Specifically, the design of bonus contracts and the placement of the upper bound, and the effect of the Internal Revenue Code Section 162 (m) that limits the deductibility of cash compensation over one million dollars. I also link their results to the managerial power and rent extraction perspective. [Copyright &y& Elsevier]

Which types of analyst firms are more optimistic?

Cowen, Amanda, Groysberg, Boris, Healy, Paul

Vol 41, Issue 1/2, 119-146 (2006)

Abstract: Research optimism among securities analysts has been attributed to incentives provided by underwriting activities. We examine how analysts' forecast and recommendation optimism varies with the business activities used to fund research. We find that analysts at firms that funded research through underwriting and trading activities actually made less optimistic forecasts and recommendations than those at brokerage houses, who performed no underwriting. Optimism was particularly low for bulge underwriter firm analysts, implying that firm reputation reduces research optimism. There is also evidence that analysts at retail brokerage firms are more optimistic than those serving only institutional investors. We conclude that analyst optimism is at least partially driven by trading incentives. [Copyright &y& Elsevier]

Agency problems of excess endowment holdings in not-for-profit firms

Core, John E., Guay, Wayne R., Verdi, Rodrigo S.

Vol 41, Issue 3, 307-333 (2006)

Abstract: We examine three alternative explanations for excess endowments in not-for-profit firms: (1) growth opportunities, (2) monitoring, or (3) agency problems. Inconsistent with growth opportunities, we find that most excess endowments are persistent over time, and that firms with persistent excess endowments do not exhibit higher growth in program expenses or investments. Inconsistent with better monitoring, program expenditures toward the charitable good are lower for firms with excess endowments, and CEO pay and total officer and director pay are greater for firms with excess endowments. Overall, we find that excess endowments are associated with greater agency problems. [Copyright &y& Elsevier]

Asymmetric treatment of reported pension expense and income amounts in CEO cash compensation calculations

Comprix, Joseph, Muller, Karl A.

Vol 42, Issue 3, 385-416 (2006)

Abstract: We provide evidence that CEO cash compensation is relatively less sensitive to pension expense than pension income, suggesting that compensation committees shield CEO cash compensation from pension expense amounts. We also provide evidence that managers use relatively higher expected rate of return estimates when reporting pension income, suggesting that managers select income-increasing accounting estimates in response to compensation committees' greater emphasis on pension income in CEO cash compensation determinations. Pension cost amounts represent a unique setting to examine such behavior as their effect on CEO cash compensation can be detrimental or beneficial, but arise from the same underlying economic activity. [Copyright &y& Elsevier]

Earnings management around employee stock option reissues

Coles, Jeffrey L., Hertzel, Michael, Kalpathy, Swaminathan

Vol 41, Issue 1/2, 173-200 (2006)

Abstract: We investigate market behavior in a setting where managerial incentives to manipulate earnings and market price should be apparent ex ante to market participants. We find evidence of abnormally low discretionary accruals in the period following announcements of cancellations of executive stock options up to the time the options are reissued. Nevertheless, analysts and investors are not misled. Discretionary accruals have little power in explaining stock price performance during this period. Moreover, discretionary accruals do not explain subsequent analyst forecast errors. Thus, our findings suggest that, in this transparent setting, analysts and investors do not respond to earnings management. [Copyright &y& Elsevier]

Weighing the evidence on the relation between external corporate financing activities, accruals and stock returns

Cohen, Daniel A., Lys, Thomas Z.

Vol 42, Issue 1/2, 87-105 (2006)

Abstract: Bradshaw, Richardson, and Sloan (BRS) find a negative relation between their comprehensive measure of corporate financing activities and future stock returns and future profitability. Noticing that accounting accruals are increases in net operating assets on a company''s balance sheet, we question whether it is possible to distinguish between the 'external financing anomaly' documented by BRS and the 'accrual anomaly' first documented by Sloan [1996. Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review 71, 289-315]. We show that once controlling for total accruals, the relation between external financing activities and future stock returns is attenuated and not statistically significant. These findings are consistent with Richardson and Sloan [2003. External financing, capital investment and future stock returns. Working Paper, University of Pennsylvania and University of Michigan]. [Copyright &y& Elsevier]

Financial reporting incentives for conservative accounting: The influence of legal and political institutions

Bushman, Robert M., Piotroski, Joseph D.

Vol 42, Issue 1/2, 107-148 (2006)

Abstract: This paper explores financial reporting incentives created by an economy''s institutional structure. The underlying premise of our analysis is that a country''s legal/judicial system, securities laws, and political economy create incentives that influence the behavior of corporate executives, investors, regulators and other market participants. Further, such incentives ultimately shape the properties of reported accounting numbers. We empirically analyze relations between key characteristics of country-level institutions and the asymmetric recognition of economic gains and losses into earnings (i.e., conditional conservatism). We also provide evidence on channels through which specific institutions manifest their influence on observed conservatism. [Copyright &y& Elsevier]

The relation between corporate financing activities, analysts' forecasts and stock returns

Bradshaw, Mark T., Richardson, Scott A., Sloan, Richard G.

Vol 42, Issue 1/2, 53-85 (2006)

Abstract: We develop a comprehensive and parsimonious measure of corporate financing activities and document a negative relation between this measure and both future stock returns and future profitability. The economic and statistical significance of our results is stronger than in previous research focusing on individual categories of corporate financing activities. To discriminate between risk versus misvaluation as explanations for this relation, we analyze the association between our measure of external financing and sell-side analysts' forecasts. Consistent with the misvaluation explanation, our measure of external financing is positively related to overoptimism in analysts' forecasts. [Copyright &y& Elsevier]

An introduction to the governance and taxation of not-for-profit organizations

Bolton, Patrick, Mehran, Hamid

Vol 41, Issue 3, 293-305 (2006)

Abstract: This paper provides a brief overview of the current state of the not-for-profit sector and discusses specific governance issues in not-for-profit organizations. We offer an in-depth analysis of the issues that arise when not-for-profit organizations compete against for-profit firms in the same markets. We argue that while competition by for-profit firms can discipline not-for-profit firms and mitigate their governance problems, the effects of this competition are distorted by the not-for-profits' corporate income tax exemptions. Based on a simple general equilibrium analysis, we argue that there is little justification for such exemptions. [Copyright &y& Elsevier]

Differential properties in the ratings of certified versus non-certified bond-rating agencies

Beaver, William H., Shakespeare, Catherine, Soliman, Mark T.

Vol 42, Issue 3, 303-334 (2006)

Abstract: We examine whether the properties of bond ratings from certified agencies (designated by the Securities and Exchange Commission (SEC)) differ from those of non-certified bond-rating agencies. Bond ratings from non-certified agencies are used solely for investment advice. Certified ratings are used by a variety of constituents, many of whom write contracts incorporating these ratings. We find that the properties of the ratings from the two agency types differ in predictable ways. Our results show that the non-certified agency''s ratings are consistent with their role of providing information to investors. The certified agency is generally more conservative, consistent with their significant role in contracting. [Copyright &y& Elsevier]

Buys, holds, and sells: The distribution of investment banks' stock ratings and the implications for the profitability of analysts' recommendations

Barber, Brad M., Lehavy, Reuven, McNichols, Maureen, Trueman, Brett

Vol 41, Issue 1/2, 87-117 (2006)

Abstract: This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines whether these distributions can predict the profitability of analysts' recommendations. We document that the percentage of buys decreased steadily starting in mid-2000, likely due, at least partly, to the implementation of NASD Rule 2711, requiring the public dissemination of ratings distributions. Additionally, we find that a broker''s ratings distribution can predict recommendation profitability. Upgrades to buy (downgrades to hold or sell) issued by brokers with the smallest percentage of buy recommendations significantly outperformed (underperformed) those of brokers with the greatest percentage of buys. [Copyright &y& Elsevier]

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