What do we learn from two new accounting-based stock market anomalies?
Vol 38, Issue 1-3, 333-348 (2004)
Hirshleifer et al. (J. Account. Econom. 38 (2004)) and Taffler, Lu and Kausar (J. Account. Econom. 38 (2004)) document large and statistically significant abnormal returns from trading on balance sheet data and audit opinions. However, the statistical tests ignore high transactions costs, especially for selling short, that would likely make the trading strategies unprofitable. The accounting anomalies literature is adding little to what we know about how and why markets operate more or less efficiently. I identify some research questions and opportunities, highlighting those with accounting and auditing implications. [ABSTRACT FROM AUTHOR]
Investor protection under unregulated financial reporting
Barton, Jan, Waymire, Gregory
Vol 38, Issue 1-3, 65-116 (2004)
We examine whether availability of higher quality financial information lessens investor losses during a period seen as a stock market crash. We focus on October 1929, which partly motivated sweeping financial reporting regulations in the l930s. Using a sample of 540 common stocks traded on the New York Stock Exchange during October 1929, we find that the quality of firms' financial reporting increases with managers' incentives to supply higher quality financial information demanded by investors. Moreover, firms with higher quality financial reporting before October 1929 experienced smaller stock price declines during the market crash. [ABSTRACT FROM AUTHOR]
Benefits of a slanted view: a discussion of 'disclosure bias'
Arya, Anil, Mittendorf, Brian
Vol 38, Issue 1-3, 251-262 (2004)
Fischer and Verrecchia (J. Account. Econom. (2004), forthcoming) studies a model of imperfect competition in which firms' disclosures are affected by biased information processing. They find that optimism can add punch to a firm's actions. When facing an optimist, a rival is forced to soften its competitive posture, thereby rendering such biases viable. Although the setting provides a cogent explanation for disclosure bias, its reliance on imperfect information processing introduces some questions. One concern is the ease with which polar results can be obtained when the rules-of-the-game are sufficiently relaxed. The discussion provides examples illustrating this and related issues. [ABSTRACT FROM AUTHOR]
Board characteristics, accounting report integrity, and the cost of debt
Anderson, Ronald C., Mansi, Sattar A., Reeb, David M.
Vol 37, Issue 3, 315-342 (2004)
Creditor reliance on accounting-based debt covenants suggests that debtors are potentially concerned with board of director characteristics that influence the integrity of financial accounting reports. In a sample of S&P 500 firms, we find that the cost of debt is inversely related to board independence and board size. We also find that fully independent audit committees are associated with a significantly lower cost of debt financing. Similarly, yield spreads are also negatively related to audit committee size and meeting frequency. Overall, these results provide market-based evidence that boards and audit committees are important elements affecting the reliability of financial reports. [ABSTRACT FROM AUTHOR]
Anomalous stock returns around internet firms' earnings announcements
Trueman, Brett, Wong, M. H. Franco, Zhang, Xiao-Jun
Vol 34, Issue 1-3, 249-271 (2003)
This paper presents evidence of anomalies in internet firms' stock returns surrounding their quarterly earnings announcements. There is a general runup in prices in the days prior to the earnings announcements, followed by a price reversal lasting for several days. The magnitude of the market-adjusted returns associated with these price movements exceeds 11 percent over a 10-day period. We find little evidence to suggest that these returns can be explained either by the earnings news disclosed or by risk changes. Additional analyses suggest that these return patterns are driven, at least in part, by price pressure. [Copyright &y& Elsevier]
Should firms disclose everything to everybody? A discussion of "Open vs. closed conference calls: the determinants and effects of broadening access to disclosure"
Skinner, Douglas J.
Vol 34, Issue 1-3, 181-187 (2003)
Bushee et al. (J. Accounting Econom. 34 (2003) 149-180) is a timely study in an area--corporate disclosure policy--that is increasingly important to regulators, corporate managers, and academics. The authors report several results that will be of interest to these groups. I describe the corporate disclosure issues that make the authors' research questions of broader relevance than their specific topic might suggest. I then provide comments on theoretical and empirical aspects of the study. Overall, the study is likely to be useful in helping us understand some of the forces at work as corporate disclosure becomes more rapid, more comprehensive, and more open. [Copyright &y& Elsevier]
On the trade-off between the future benefits and riskiness of R&D: a bondholders' perspective
Vol 35, Issue 2, 227-NA (2003)
Existing studies on the value-relevance of R&D tend to overstate the R&D benefits and shed little light on the trade-off between the R&D benefits (mean effect) and their riskiness (variance effect). This study shows that the variance effect of R&D is on average more significant than their mean effect in bond valuation. Hence, for creditors, the R&D risk dominates their benefits. Furthermore, this study documents that R&D measures alone explain approximately 80% of cross-sectional variations in bond ratings and risk premium. These findings contribute to the debate over R&D accounting and the bond pricing literature. [Copyright &y& Elsevier]
An evaluation of alternative measures of corporate tax rates
Plesko, George A.
Vol 35, Issue 2, 201-NA (2003)
This paper examines the ability of financial statement measures of average and marginal tax rates (MTR) to capture tax attributes utilizing firm-level tax and financial data. The results suggest commonly used average tax rate measures provide little insight about statutory tax burdens, and may introduce substantial bias into analyses of tax incidence. Financial statement-based proxies for MTR, particularly those based on simulation methods, are found to perform well in estimating current year tax rates. Both current year and present value MTR are found to be highly correlated with an easily constructed binary proxy of firms' tax status. [Copyright &y& Elsevier]
Discretionary disclosure and stock-based incentives
Nagar, Venky, Nanda, Dhananjay, Wysocki, Peter
Vol 34, Issue 1-3, 283-309 (2003)
We examine the relation between managers' disclosure activities and their stock price-based incentives. Managers are privy to information that investors demand and are reluctant to publicly disseminate it unless provided appropriate incentives. We argue that stock price-based incentives in the form of stock-based compensation and share ownership mitigate this disclosure agency problem. Consistent with this prediction, we find that firms' disclosures, measured both by management earnings forecast frequency and analysts' subjective ratings of disclosure practice, are positively related to the proportion of CEO compensation affected by stock price and the value of shares held by the CEO. [Copyright &y& Elsevier]
Stock-based pay in new economy firms
Murphy, Kevin J.
Vol 34, Issue 1-3, 129-147 (2003)
Ittner, Lambert, and Larcker (J. Accounting Economics (2003) this issue) present compelling evidence that new economy firms rely more on stock-based compensation than do old economy firms, based on 1998 and 1999 data from a proprietary sample of companies. I complement the ILL results by analyzing data over a longer time period (1992-2001) and, more importantly, document the effect of the 2000 market crash on stock-based pay in new economy firms. Finally, I offer evidence supporting the conjecture that differences in pay practices between new and old economy firms reflect accounting considerations, perceived costs, and competitive inertia. [Copyright &y& Elsevier]
The effect of experience on security analyst underreaction
Mikhail, Michael B., Walther, Beverly R., Willis, Richard H.
Vol 35, Issue 1, 101-116 (2003)
We examine if analysts more fully incorporate prior earnings and returns information in their current quarter forecasts as their experience following a firm increases. We measure analyst firm-specific forecasting experience as the number of prior quarters for which the analyst has issued an earnings forecast for the firm. We find that analysts underreact to prior earnings information less as their experience increases, suggesting one reason why analysts become more accurate with experience. [Copyright &y& Elsevier]
Economic consequences of regulated changes in disclosure: the case of executive compensation
Vol 35, Issue 3, 285-314 (2003)
The 1992 revision of executive compensation disclosure rules in the U.S. could have benefited shareholders by inducing corporate governance improvements or harmed them by increasing disclosure costs. Consistent with the governance improvement hypothesis, companies that lobbied against the regulation had, relative to control firms: (i) return-on-assets and return-on-equity that improved by 0.5% and 3%, respectively; and (ii) excess stock returns of 6% over the 8-month period between the announcement and the adoption of the proposed regulation. Also, firms lobbying more vigorously against the proposal had more positive abnormal stock returns during events that increased the probability of regulation. [Copyright &y& Elsevier]
Discussion of "The Internet downturn: Finding valuation factors in Spring 2000"
Vol 34, Issue 1-3, 237-247 (2003)
This article reviews 'The Internet downturn: Finding valuation factors in Spring 2000' by Keating, Lys, and Magee (KLM). Their paper contributes to a growing literature on the valuation of Internet firms, finding strong relations among market prices, accounting variables, and assorted 'new economy' measures of performance. I argue that their results tell us more about investors' (mis-)perceptions in Spring 2000 than about the underlying economics of Internet firms. Moreover, the valuations seem unlikely to repeat. KLM''s findings may not generalize to other firms or time periods. [Copyright &y& Elsevier]
Discussion of "are executive stock options associated with future earnings?"
Larcker, David F.
Vol 36, Issue 1-3, 91-NA (2003)
Hanlon, Rajgopal, and Shevlin conclude that grant of stock options to executives is associated with a positive impact on future operating performance. This discussion comment examines the impact of endogeneity, model structure, and the choice of a benchmark model on this conclusion. While some results indicate that there is a position relation between stock option grants and operating performance, alternative econometric approaches produce distinctly different results. [Copyright &y& Elsevier]
Discussion of "employee stock options, EPS dilution, and stock repurchases"
Larcker, David F.
Vol 36, Issue 1-3, 45-NA (2003)
Bens, Nagar, Skinner, and Wong conclude that stock repurchase decisions are related to the impact of stock options on the ability of firms to meet historical EPS growth targets. Although this is a provocative conclusion, this interpretation is questionable because managers are assumed to be extremely myopic, the results are highly sensitive to the choice of EPS growth target, firms with a high P/E ratio produce results that are completely inconsistent with the research hypothesis, and alternative explanations that are unrelated to earnings management are not considered. [Copyright &y& Elsevier]
This paper discusses Hirshleifer and Teoh's modeling and analysis of "inattentive investors", stock price valuation, and accounting recognition rules and disclosures. The paper derives many plausible empirical predictions from an equilibrium model in which some investors do not process information "fully" or correctly. My discussion focuses on the underlying features of the analysis that drive these results, and speculates as to the robustness of key results. In particular, the systematic "mis-pricing" that persists for long periods of time in the model is very controversial. [Copyright &y& Elsevier]
Time-series coefficient variation in value-relevance regressions: a discussion of Core, Guay, and Van Buskirk and new evidence
Kothari, S. P., Shanken, Jay
Vol 34, Issue 1-3, 69-87 (2003)
Many claim that GAAP financial information has become largely irrelevant to explaining valuations. Core et al. compare financial information''s value relevance for the New Economy stocks with other stocks. We supplement their analysis with new evidence on the economic determinants of the time-series variation in the coefficients mapping financial information into prices. We document significant variation in the coefficients related to proxies for changing market growth expectations and discount rates and additional variation consistent with time-varying correlated omitted variables. Such findings make it difficult to draw unambiguous inferences about the relevance and reliability of financial information from value-relevance regressions. [Copyright &y& Elsevier]
Internet downturn: finding valuation factors in Spring 2000
Keating, Elizabeth K., Lys, Thomas Z., Magee, Robert P.
Vol 34, Issue 1-3, 189-236 (2003)
During Spring 2000, the Internet Stock Index declined 45%. Using a sample of internet firms, this paper investigates whether this decline was associated with new disclosures, such as earnings, analyst forecast revisions, and web-traffic measures, or to a "reassessment" by investors of pre-existing information. We find only modest evidence that the decline was associated with new disclosures. However, returns and post-decline stock prices are significantly explained by 1999 annual report data. When earnings are decomposed into gross profit and various expenses, traditional financial information contributes significantly more in explaining the cross-sectional returns and price levels than non-financial information. [Copyright &y& Elsevier]
Discussion of "Information distribution within firms: evidence from stock option exercises"
Vol 34, Issue 1-3, 33-41 (2003)
Huddart and Lang (J. Accounting Econom. 34 (2003)) documents that higher level of employee option exercise during a particular month is associated with lower returns in subsequent months, suggesting employees exploit private information in their exercise decisions. While the paper extends the insider trading literature that has focused on top executives, a number of inconsistencies with prior studies remain unresolved. Moreover, the study does not establish a direct link to the private information employees supposedly exploit. Establishing such a link is warranted here in the light of the surprising finding that exercises by senior employees are no more informative than those by lower rank employees. [Copyright &y& Elsevier]
The structure and performance consequences of equity grants to employees of new economy firms
Ittner, Christopher D., Lambert, Richard A., Larcker, David F.
Vol 34, Issue 1-3, 89-127 (2003)
The paper examines the determinants and performance consequences of equity grants to senior-level executives, lower-level managers, and non-exempt employees of "new economy" firms. We find that the determinants of equity grants are significantly different in new versus old economy firms. We also find that employee retention objectives, which new economy firms rank as the most important goal of their equity grant programs, have a significant impact on new hire grants, but not subsequent grants. Our exploratory performance tests indicate that lower than expected grants and/or existing holdings of options are associated with poorer performance in subsequent years. [Copyright &y& Elsevier]
Reply to: dynamic incentives and responsibility accounting: a comment
Indjejikian, Raffi, Nanda, Dhananjay
Vol 35, Issue 3, 437-441 (2003)
Christensen et al. (Dynamic incentives and responsibility accounting: a comment, J. Account. Econ. 35 (2003) 423) examine Indjejikian and Nanda (J. Account. Econ. 27 (1999) 177) and suggest that our characterization of the inefficiency arising from limited commitment as a "ratchet effect" phenomenon is misplaced. In this reply, we describe the ratchet effect as commonly understood in the literature, clarify the role of contractual commitments in our analysis, and then illustrate why both the substance and interpretation of our original results continue to be appropriate. [Copyright &y& Elsevier]
Information distribution within firms: evidence from stock option exercises
Huddart, Steven, Lang, Mark
Vol 34, Issue 1-3, 3-31 (2003)
We examine the stock option exercise decisions of over 50,000 employees at seven corporations to provide evidence on the distribution of price-relevant non-public information among employees. When option exercise (adjusted for other factors affecting exercise) is low, stock returns in the coming 6 months are 10% higher than when option exercise is high. The exercise decisions of relatively junior employees contain at least as much price-relevant information as the exercise decisions of more senior employees. [Copyright &y& Elsevier]
Testing the relative power of accounting standards versus incentives and other institutional features to influence the outcome of financial reporting in an international setting
Holthausen, Robert W.
Vol 36, Issue 1-3, 271-NA (2003)
Ball, Robin and Wu (Journal of Accounting and Economics, 2003, this issue) investigate the relationship between accounting standards and the structure of other institutions on the attributes of the financial reporting system. They find evidence consistent with the hypothesis that beyond accounting standards, the structure of other institutions, such as incentives of preparers and auditors, enforcement mechanisms and ownership structure affects the outcome of the financial reporting system. However, interpretation of the evidence with respect to the notion of quality of the financial reporting system and the quality of accounting standards that the authors introduce is problematic. [Copyright &y& Elsevier]
Limited attention, information disclosure, and financial reporting
Hirshleifer, David, Teoh, Siew Hong
Vol 36, Issue 1-3, 337-NA (2003)
This paper models firms' choices between alternative means of presenting information, and the effects of different presentations on market prices when investors have limited attention and processing power. In a market equilibrium with partially attentive investors, we examine the effects of alternative: levels of discretion in pro forma earnings disclosure, methods of accounting for employee option compensation, and degrees of aggregation in reporting. We derive empirical implications relating pro forma adjustments, option compensation, the growth, persistence, and informativeness of earnings, short-run managerial incentives, and other firm characteristics to stock price reactions, misvaluation, long-run abnormal returns, and corporate decisions. [Copyright &y& Elsevier]
Are executive stock options associated with future earnings?
Hanlon, Michelle, Rajgopal, Shivaram, Shevlin, Terry
Vol 36, Issue 1-3, 3-NA (2003)
We estimate the relation between stock option (ESO) grants to the top five executives and future earnings to examine whether incentive alignment or rent extraction by top managers explains option granting behavior. The future operating income associated with a dollar of Black-Scholes value of an ESO grant is
Dividend taxes and firm valuation:: a re-examination
Hanlon, Michelle, Myers, James N., Shevlin, Terry
Vol 35, Issue 2, 119-NA (2003)
Harris and Kemsley (J. Account. Res. (1999) 275) suggest that shareholder-level dividend taxes on retained earnings are fully impounded into stock prices at the top statutory rate. Harris and Kemsley base their empirical tests on Ohlson (Contemp. Account. Res. (1995) 661) with the addition of dividend taxes. We analyze Harris and Kemsley''s extended Ohlson model and evidence. We show that the model, tests, and results in Harris and Kemsley are non-diagnostic regarding dividend tax capitalization. [Copyright &y& Elsevier]
Earnings skewness and analyst forecast bias
Gu, Zhaoyang, Wu, Joanna Shuang
Vol 35, Issue 1, 5-29 (2003)
We argue that if analysts' objective is to provide the most accurate forecast by minimizing the mean absolute forecast error, then the optimal forecast is the median instead of the mean earnings. Forecast bias is observed when the median is different from the mean in a skewed earnings distribution. Thus, part of the observed analyst forecast bias could be a result of analysts' efforts to improve forecast accuracy when the earnings distribution is skewed. We find that earnings skewness is significantly related to analyst forecast bias. We also provide evidence that the market adjusts for part of the skewness-induced bias. [Copyright &y& Elsevier]
Impact of firm performance expectations on CEO turnover and replacement decisions
Farrell, Kathleen A., Whidbee, David A.
Vol 36, Issue 1-3, 165-NA (2003)
Our analysis suggests that boards focus on deviation from expected performance, rather than performance alone, in making the CEO turnover decision, especially when there is agreement (less dispersion) among analysts about the firm's earnings forecast or there are a large number of analysts following the firm. In addition, our results suggest that boards are more likely to appoint a CEO that will change firm policies and strategies (i.e., an outsider) when forecasted 5-year EPS growth is low and there is greater uncertainty (more dispersion) among analysts about the firm's long-term forecasts. [Copyright &y& Elsevier]
CEO turnover and properties of accounting information
Engel, Ellen, Hayes, Rachel M., Wang, Xue
Vol 36, Issue 1-3, 197-NA (2003)
Multiple performance-measure agency models predict that optimal contracts should place greater reliance on performance measures that are more precise and more sensitive to the agent's effort. We apply these predictions to CEO retention decisions. First, we develop an agency model to motivate proxies for signal and noise in firm-level performance measures. We then document that accounting information appears to receive greater weight in turnover decisions when accounting-based measures are more precise and more sensitive. We also present evidence suggesting that market-based performance measures receive less weight in turnover decisions when accounting-based measures are more sensitive or market returns are more variable. [Copyright &y& Elsevier]