Private lenders’ demand for audit

Anticipatory income smoothing: a re-examination

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Anticipatory income smoothing: a re-examination

Elgers, Pieter T., Pfeiffer, Jr., Porter, Susan L.

Vol 35, Issue 3, 405-422 (2003)

This paper reassesses evidence of anticipatory income smoothing reported in DeFond and Park (DP) (J. Accounting Econom. 23 (1997) 115) in light of knowledge about measurement error in discretionary accrual estimates. We argue that the method DP use to measure un-managed earnings mechanically biases the evidence in a manner consistent with anticipatory income smoothing. Using an approximate randomization approach, we find that DP''s results cannot be distinguished from those achieved when discretionary accruals are randomly assigned to firm-years in our sample. Overall, these results show that the 'backing out' approach to measuring un-managed earnings is ineffective in testing earnings management hypotheses. [Copyright &y& Elsevier]

Public versus private governance: a study of incentives and operational performance

Eldenburg, Leslie, Krishnan, Ranjani

Vol 35, Issue 3, 377-404 (2003)

This study explores incentives and performance in organizations governed by publicly elected boards of directors and subsidized by taxes. Such organizations are likely to underpay Chief Executive Officers (CEOs), resulting in selection and incentive problems and hence poor operating performance. We compare municipal district hospitals to private nonprofit hospitals. CEO compensation in district hospitals is significantly lower than in the nonprofits. Operating margins in district hospitals are lower and deteriorate more rapidly over time. We rule out a number of other factors that could explain differences in performance. We conclude that the weak governance structure hampers district hospitals. [Copyright &y& Elsevier]

Is a dividend tax penalty incorporated into the return on a firm's common stock?

Dhaliwal, Dan, Zhen Li, Oliver, Trezevant, Robert

Vol 35, Issue 2, 155-NA (2003)

We find that a firm''s dividend yield has a positive impact on its common stock return that is decreasing in the level of institutional and corporate ownership, our indicator of whether the marginal investor in a firm''s common stock is more likely to be a low-tax or a high-tax investor. These results suggest that (1) a dividend tax penalty is incorporated into the return on a firm''s common stock and (2) both a firm''s dividend policy and its ownership structure impact the size of the dividend tax penalty. [Copyright &y& Elsevier]

Are shareholder dividend taxes on corporate retained earnings impounded in equity prices? Additional evidence and analysis

Dhaliwal, Dan, Erickson, Merle, Frank, Mary Margaret, Banyi, Monica

Vol 35, Issue 2, 179-NA (2003)

The purpose of this paper is to evaluate the model used by Harris and Kemsley (J. Acc. Res. 37 (1999) 275), Harris et al. (J. Public Econ. 79 (2001) 569) and Collins and Kemsley (Acc. Rev. 75 (2000) 405), hereafter CHHK, and to investigate their empirical results. We demonstrate that the model underlying CHHK is flawed, and show that their interpretation of the data is incorrect. Finally, we find that after controlling for market to book ratio, Harris and Kemsley''s first main result vanishes. In total, we reject CHHK''s conclusions that equity prices are discounted for shareholder dividend taxes on retained earnings. [Copyright &y& Elsevier]

An empirical analysis of analysts' cash flow forecasts

DeFond, Mark L., Hung, Mingyi

Vol 35, Issue 1, 73-100 (2003)

This study investigates the recent trend in analysts disseminating operating cash flow forecasts. We find that analysts tend to forecast cash flows for firms where accounting, operating and financing characteristics suggest that cash flows are useful in interpreting earnings and assessing firm viability. Specifically, we find that analysts tend to forecast cash flows for firms with (1) large accruals, (2) more heterogeneous accounting choices relative to their industry peers, (3) high earnings volatility, (4) high capital intensity, and (5) poor financial health. These findings are consistent with financial analysts responding to market-based incentives to provide market participants with value-relevant information. [Copyright &y& Elsevier]

Rounding-up in reported EPS, behavioral thresholds, and earnings management

Das, Somnath, Zhang, Huai

Vol 35, Issue 1, 31-50 (2003)

Reported earnings per share (EPS) are frequently rounded to the nearest cent. This paper provides evidence that firms manipulate earnings so that they can round-up and report one more cent of EPS. Specifically, we examine the digit immediately right of the decimal in the calculated EPS number expressed in cents. Evidence is presented that firms are more likely to round-up when managers ex ante expect rounding-up to meet analysts' forecasts, report positive profits, or sustain recent performance. Further investigation provides evidence that working capital accruals are used to round-up EPS. [Copyright &y& Elsevier]

Market valuations in the New Economy: an investigation of what has changed

Core, John E., Guay, Wayne R., Van Buskirk, Andrew

Vol 34, Issue 1-3, 43-67 (2003)

We find mixed support for the hypothesis that a "New Economy" subperiod occurred in the late 1990s in which the relation between equity value and traditional financial variables differs from previous periods. We examine a regression model of equity value on financial variables over 25 years for a broad firm sample and for firm subsamples thought to be emblematic of the New Economy. We find the regression model''s explanatory power declined in the New Economy subperiod for all firm subsamples. However, for all subsamples, the regression model''s structure during the New Economy subperiod is not unusual compared to other subperiods. [Copyright &y& Elsevier]

A note on analysts' earnings forecast errors distribution

Cohen, Daniel A., Lys, Thomas Z.

Vol 36, Issue 1-3, 147-NA (2003)

Abarbanell and Lehavy provide evidence that analysts' forecast errors are not normally distributed exhibiting a high occurrence of extreme negative forecast errors (left-tail asymmetry) and a high occurrence of small positive forecast errors (middle asymmetry). This is important for researchers who rely on techniques that are sensitive to the distributional assumptions of analysts' forecast errors. Many of the conclusions drawn by Abarbanell and Lehavy, however, are based on visual impressions (as opposed to formal empirical tests) or based on methods that are very sensitive to the empirical methods used (e.g., whether the serial correlation of forecast errors is caused by the left-tail asymmetry). [Copyright &y& Elsevier]

Dynamic incentives and responsibility accounting: a comment

Christensen, Peter O., Feltham, Gerald A., Florin, x105e, abac

Vol 35, Issue 3, 423-436 (2003)

Indjejikian and Nanda (J. Accounting and Economics 27 (1999) 177) establish that "lack of commitment" results in an expected economic loss, relative to a long-term full-commitment contract, if there is inter-period correlation of performance measures. They attribute this loss to a "ratchet effect". We demonstrate the following. First, their proposed equilibrium is not sustained unless there is some form of limited commitment. Second, these limited commitment assumptions need not induce a "ratchet effect". Third, the "ratchet effect" is neither necessary nor sufficient for an expected economic loss to occur--the loss is due to the principal''s inability to commit ex ante to the second-period incentive rate. [Copyright &y& Elsevier]

The consequences of the FASB's 1998 proposal on accounting for stock option repricing

Carter, Mary Ellen, Lynch, Luann J.

Vol 35, Issue 1, 51-72 (2003)

We examine repricing activity surrounding the FASB''s 1998 announcement regarding accounting for repriced options. We find that repricing increases during, and decreases after, the 12-day window between the announcement and proposed effective dates, consistent with firms timing repricings to avoid recording an expense. We find that firms experiencing increasing earnings patterns, firms with earnings around zero, and growth firms are more likely to reprice in the window, but having repriced recently decreases the likelihood of doing so. The evidence suggests that firms trade off financial reporting benefits against reputation costs in decisions to time repricings to get favorable accounting treatment. [Copyright &y& Elsevier]

Open versus closed conference calls: the determinants and effects of broadening access to disclosure

Bushee, Brian J., Matsumoto, Dawn A., Miller, Gregory S.

Vol 34, Issue 1-3, 149-180 (2003)

Recent advances in information technology allow firms to provide broader access to their disclosures. We examine the determinants and effects of the decision to provide unlimited real-time access to conference calls (i.e., "open" conference calls). Our evidence suggests that the decision to provide open calls is associated with the composition of a firm''s investor base and, to some degree, the complexity of its financial information. We also find that open calls are associated with a greater increase in small trades (consistent with individuals trading on information released during the call) and higher price volatility during the call period. [Copyright &y& Elsevier]

Empirical research on CEO turnover and firm-performance: a discussion

Brickley, James A.

Vol 36, Issue 1-3, 227-NA (2003)

Engel/Hayes/Wang and Farrell/Whidbee provide new evidence on how firms weight alternative performance measures in making CEO retention and replacement decisions. While their results are statistically significant, firm performance continues to explain very little of the variation in CEO turnover. I argue we have probably reached a point of diminishing returns in estimating logit models that focus on the relation between CEO turnover and firm performance measures. We will have to consider other less-explored issues to increase our understanding of CEO turnovers and replacements. Analyzing age-related issues is one example. [Copyright &y& Elsevier]

A discussion of 'Assessing the relative informativeness and permanence of pro forma earnings and GAAP operating earnings'

Bradshaw, Mark T.

Vol 36, Issue 1-3, 321-NA (2003)

By analyzing a carefully constructed earnings announcements sample that discloses a 'pro forma' earnings number, Bhattacharya et al. (J. Account. Econom. 36 (1-3) (2003)) contribute to recent research documenting increasing differences between earnings as defined by generally accepted accounting principles (GAAP) and alternative earnings definitions followed by capital markets. The paper provides interesting descriptive data on pro forma earnings per share relative to both GAAP earnings per share and actual earnings per share as tracked by I/B/E/S. Also, the authors conduct tests of the relative informativeness and persistence of these three earnings measures. Econometric and data limitations inhibit the inferences that can be drawn from some of these tests. [Copyright &y& Elsevier]

What insiders know about future earnings and how they use it: Evidence from insider trades

Bin, Ke, Huddart, Steven, Petroni, Kathy

Vol 35, Issue 3, 315-346 (2003)

This paper provides evidence that insiders possess, and trade upon, knowledge of specific and economically significant forthcoming accounting disclosures as long as 2 years prior to the disclosure. Stock sales by insiders increase three to nine quarters prior to a break in a string of consecutive increases in quarterly earnings. Insider stock sales are greater for growth firms, before a longer period of declining earnings, and when the earnings decline at the break is greater. Consistent with avoiding an established legal jeopardy, there is little abnormal selling in the two quarters immediately prior to the break. [Copyright &y& Elsevier]

Assessing the relative informativeness and permanence of pro forma earnings and GAAP operating earnings

Bhattacharya, Nilabhra, Black, Ervin L., Christensen, Theodore E., Larson, Chad R.

Vol 36, Issue 1-3, 285-NA (2003)

This study investigates whether market participants perceive pro forma earnings to be more informative and more persistent than GAAP operating income by analyzing a sample of 1,149 actual pro forma press releases. We find that pro forma announcers report frequent GAAP losses and are mostly concentrated in the service and high-tech industries. Our analyses of short-window abnormal returns and revisions in analysts' one-quarter-ahead earnings forecasts indicate that pro forma earnings are more informative and more permanent than GAAP operating earnings. Our evidence suggests that market participants believe pro forma earnings are more representative of "core earnings" than GAAP operating income. [Copyright &y& Elsevier]

Discussion of "Anomalous stock returns around internet firms' earnings announcements"

Berger, Philip G.

Vol 34, Issue 1-3, 273-281 (2003)

Trueman, Wong, and Zhang (TWZ) investigate an apparent anomaly in the pricing of internet firms around their earnings announcements, which they attribute to price pressure. The discussion addresses three concerns. The paper is unusual in choosing an event (earnings announcements) that does not appear to have an obvious non-information-related reason for triggering unjustified changes in demand for the firm''s shares. Relatedly, there are limitations to the tests made of the price pressure hypothesis. Finally, the discussion elaborates on TWZ''s brief mention of the difficulties with implementing a profitable trading strategy based on the stock return pattern they document. [Copyright &y& Elsevier]

Employee stock options, EPS dilution, and stock repurchases

Bens, Daniel A., Nagar, Venky, Skinner, Douglas J., Wong, M. H. Franco

Vol 36, Issue 1-3, 51-NA (2003)

We investigate whether corporate executives' stock repurchase decisions are affected by their incentives to manage diluted earning per share (EPS). We find that executives increase the level of their firms' stock repurchases when: (1) the dilutive effect of outstanding employee stock options (ESOs) on diluted EPS increases, and (2) earnings are below the level required to achieve the desired rate of EPS growth. We also find that executives' repurchase decisions are not associated with actual ESO exercises, suggesting that they are driven by incentives to manage diluted but not basic EPS, and strengthening our earnings management interpretation. [Copyright &y& Elsevier]

Management of the loss reserve accrual and the distribution of earnings in the property-casualty insurance industry

Beaver, William H., McNichols, Maureen F., Nelson, Karen K.

Vol 35, Issue 3, 347-376 (2003)

We document that property-casualty insurers with small positive earnings understate loss reserves relative to insurers with small negative earnings. Furthermore, loss reserves are managed across the entire distribution of earnings, with the most income-increasing reserve accruals reported by small profit firms, and the most income-decreasing reserve accruals reported by firms with the highest earnings. We analyze this pattern separately for public, private, and mutual companies, and find that public companies and mutuals manage loss reserves to avoid losses, but that private companies do not. We also find evidence of reserve management to avoid losses by financially healthy and distressed firms. [Copyright &y& Elsevier]

Discussion of "Compensation policy and discretionary disclosure"

Barth, Mary E.

Vol 34, Issue 1-3, 311-318 (2003)

Nagar et al. (J. Accounting Econom. 34 (2003)) posits that stock-based compensation motivates managers to increase public disclosure of their private information. The hypothesis is intriguing and new to the literature, and the findings are consistent with it. However, developing the hypothesis depends on some unsupported assumptions and the link between the hypothesis and the empirical evidence is indirect, raising concerns about the validity of the study''s inferences about the effects on disclosure of stock-based compensation. [Copyright &y& Elsevier]

The public accounting industry production function

Banker, Rajiv D., Chang, Hsihui, Cunningham, Reba

Vol 35, Issue 2, 255-NA (2003)

A translog function is specified to represent the relation between revenue and human resource inputs in public accounting firms. Estimation of the model using a balanced panel of annual data for 64 large CPA firms for the period 1995-1999 indicates that increasing returns to scale prevail in the public accounting industry, justifying recent merger and acquisition activities among accounting firms. Average marginal revenue product of partners increased monotonically from 1995 to 1998, decreased slightly in 1999, and was about nine times that of other professionals during 1995-1999. The public accounting industry exhibited continuing improvement in productivity over the 5 years. [Copyright &y& Elsevier]

Incentives versus standards: properties of accounting income in four East Asian countries

Ball, Ray, Robin, Ashok, Wu, Joanna Shuang

Vol 36, Issue 1-3, 235-NA (2003)

The East Asian countries Hong Kong, Malaysia, Singapore and Thailand provide rare insight into the interaction between accounting standards and the incentives of managers and auditors. Their standards derive from common law sources (UK, US, and IAS) that are widely viewed as higher quality than code law standards. However, their preparers' incentives imply low quality. We show their financial reporting quality is not higher than under code law, with quality operationalized as timely recognition of economic income (particularly losses). It is misleading to classify countries by standards, ignoring incentives, as is common in international accounting texts, transparency indexes, and IAS advocacy. [Copyright &y& Elsevier]

Biased forecasts or biased earnings? The role of reported earnings in explaining apparent bias and over/underreaction in analysts' earnings forecasts

Abarbanell, Jeffery, Lehavy, Reuven

Vol 36, Issue 1-3, 105-NA (2003)

The extensive literature that investigates whether analysts' earnings forecasts are biased and/or inefficient has produced conflicting evidence and no definitive answers to either question. This paper shows how two relatively small but statistically influential asymmetries in the tail and the middle of distributions of analysts' forecast errors can exaggerate or obscure evidence consistent with analyst bias and inefficiency, leading to inconsistent inferences. We identify an empirical link between firms' recognition of unexpected accruals and the presence of the two asymmetries in distributions of forecast errors that suggests that firm reporting choices play an important role in determining analysts' forecast errors. [Copyright &y& Elsevier]

Editorial data

Watts, Ross L., Zimmerman, Jerold L., Kothari, S. P., Lys, Thomas Z., Skinner, Douglas J.

Vol 33, Issue 1, 1-1 (2002)

Presents data summarizing the distribution of manuscripts received by the "Journal of Accounting and Economics" for the 12 months ending November 2001.

Voluntary disclosure of balance sheet information in quarterly earnings announcements

Shuping Chen, Joseph, DeFond, Mark L., Park, Chul W.

Vol 33, Issue 2, 229-251 (2002)

We investigate a pervasive voluntary disclosure practice--managers including balance sheets with quarterly earnings announcements. Consistent with expectations, we find that managers voluntarily disclose balance sheets when current earnings are relatively less informative, or when future earnings are relatively more uncertain. Specifically, balance sheet disclosures are more likely among firms: (1) in high technology industries; (2) reporting losses; (3) with larger forecast errors; (4) engaging in mergers or acquisitions; (5) that are younger; and (6) with more volatile stock returns. This is consistent with managers disclosing balance sheets in response to investor demand for value relevant information to supplement earnings. [ABSTRACT FROM AUTHOR]

Litigation risk and audit fees: evidence from UK firms cross-listed on US markets

Seetharaman, Ananth, Gul, Ferdinand A., Lynn, Stephen G.

Vol 33, Issue 1, 91-115 (2002)

Two ingredients necessary to examine the relation between litigation risk and audit pricing are (a) a litigious legal environment, and (b) publicly disclosed auditor remuneration. We combine both ingredients by focusing on UK firms offering to sell their securities publicly in the United States. We find that UK auditors charge higher fees for their services when their clients access US, but not non-US, capital markets. Further, we show that the higher fees cannot be fully explained by the SEC's extensive disclosure requirements. Rather, these findings are consistent with audit fees reflecting risk differences across liability regimes. [ABSTRACT FROM AUTHOR]

Empirical evidence on the relation between stock option compensation and risk taking

Rajgopal, Shivaram, Shevlin, Terry

Vol 33, Issue 2, 145-171 (2002)

We examine whether executive stock options (ESOs) provide managers with incentives to invest in risky projects. For a sample of oil and gas producers, we examine whether the coefficient of variation of future cash flows from exploration activity (our proxy for exploration risk) increases with the sensitivity of the value of the CEO's options to stock return volatility (ESO risk incentives). Both ESO risk incentives and exploration risk are treated as endogenous variables by adopting a simultaneous equations approach. We find evidence that ESO risk incentives has a positive relation with future exploration risk taking. Additional tests indicate that ESO risk incentives exhibits a negative relation with oil price hedging in a system of equations where ESO risk incentives and hedging are allowed to be endogenously determined. Overall, our results are consistent with ESOs providing managers with incentives to mitigate risk-related incentive problems. [ABSTRACT FROM AUTHOR]

Discretionary disclosure, efficiency, and signal informativeness

Pae, Suil

Vol 33, Issue 3, 279-NA (2002)

This paper studies a competitive asset market characterized by an adverse selection problem. The analysis focuses on the link between the market participants' productive activities and discretionary disclosures. While informed parties' discretion over disclosure allows them to earn private gains, it leads to an inefficient allocation of resources. A more informative signal makes the informed parties better off, but reduces the uninformed parties' welfare. Nonetheless, it improves the economy's allocative efficiency. The paper also shows that when the signal quality is endogenous, the informed parties over-invest in the signal informativeness relative to the level that maximizes social welfare. [ABSTRACT FROM AUTHOR]

Empirical tests of budget ratcheting and its effect on managers' discretionary accrual choices

Leone, Andrew J., Rock, Steve

Vol 33, Issue 1, 43-67 (2002)

In this paper, we investigate whether budgets ratchet. Using business-unit data from a large multinational corporation, we find evidence consistent with ratcheting where favorable budget variances result in performance budget increases that are larger than decreases associated with unfavorable variances of the same magnitude. We argue that under ratcheting, the cost of reporting positive transitory earnings surprises outweigh the short-term benefits of the current-period bonus. Consequently, we hypothesize that managers make income-decreasing discretionary accruals to offset transitory earnings surprises beyond the level expected under fixed budgets. Using a proxy for transitory earnings surprise, we find evidence consistent with this hypothesis. [ABSTRACT FROM AUTHOR]

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