Knowledge that Transforms

This paper analyzes economic characteristics of firms that correct previously reported quarterly earnings. The basic findings are that, relative to their industry, the sample (correcting) firms are smaller, less profitable, have higher debt, are slower growing, and face more serious uncertainties. Their average stock returns between the issuance of erroneous quarterly reports and their correction are negative. Also, correction disclosure frequently precedes SEC or stockholder suits against firm management. Results are consistent with predictions based on the economic interests of management and their auditors.

This paper develops a model of information collection about publicly traded firms in an economy. The supply noise is modeled as the variability of liquidity-motivated trading in the shares of the firm. The paper theoretically examines the influence of various firm characteristics on the amount of information collected about a firm and on the marginal information content of announcements made by it. Empirical work focuses on the marginal information content of quarterly earnings announcements made by firms. The empirical results are generally consistent with the model's predictions.

This study analyzes excess returns to shareholders at announcement of a change in senior management of distressed firms. Excess returns are significantly positive, which is consistent with the internal corporate control hypothesis that management change following poor performance is associated with gains to shareholders. Cross-sectional tests of the effects reveal a significant title effect and significant interactions between title and appointment of an outside successor and title and firm size. These findings present new insights into the circumstances in which external vs. internal markets for managers will affect shareholder wealth.

This paper documents the empirical distributions of daily trading volume prediction errors for several commonly used volume measures and expectation models for individual firms and for portfolios. The prediction errors for raw volume measures are significantly positively skewed, with thin left tails and fat right tails. However, natural log transformations of the volume measures are approximately normally distributed. For longer than one-day prediction intervals, recognition of autocorrelation in daily trading volume is advantageous for detecting abnormal trading. Results of analysis for clustering of events and for different size firms are also presented.

This paper examines the Beaver, Lambert, and Morse (1980) valuation model that capitalizes ‘ungarbled’ earnings. The analysis identifies the model's unspecified capitalization factor, and it emphasizes that a complete model of ungarbled earnings must focus on the joint stochastic behavior of earnings and dividends. It is shown that expected ungarbled earnings, scaled for a constant, equal expected dividends. Except for the scale factor, no apparent economic reasons suggest that ungarbled earnings are any different from dividends.

This paper performs a financial statement analysis that combines a large set of financial statement items into one summary measure which indicates the direction of one-year-ahead earnings changes. Positions are taken in stocks on the basis of this measure during the period 1973–1983, which involve canceling long and short positions with zero net investment. The two-year holding-period return to the long and short positions is in the order of 12.5%. After adjustment for ‘size effects’ the return is about 7.0%. These returns cannot be explained by nominated firm risk characteristics.

Financial and pension variables are analyzed to test predictions of a number of explanation for the recent surge in reversions of excess assets from terminations of overfunded pension plans. Terminations are apparently motivated by cash needs, rather than tax, accounting, or wealth transfer considerations. These cash needs arise from large unexpected declines in funds from operations or financial restructuring subsequent to hostile takeover attempts. However, terminations appear to be a costly source of funds, since firms seek funds from numerous other sources (dividend cuts, ‘slow’ withdrawals of pension assets, and investment cuts) before resorting to terminations.

This study examines the economic consequences of Statement of Financial Accounting Standards No. 8 (SFAS No. 8). Compared to a matched control group, both early adopters and late adopters of SFAS No. 8 exhibited significantly negative excess returns in the Exposure Draft release period, even after adjusting for a size effect in January. Weighted least-squares and ordinary least-squares cross-sectional regressions were compared. The late adopter regressions weakly support contracting and political cost theories.

The effect that voluntarily disclosed managers' earnings forecasts have on the security prices of the announcing firms and other firms in the same industry is examined. The results are consistent with information content in managers' forecasts and with information transfer between forecast firms and other firms in the industry. These inferences are drawn from firms' abnormal returns computed from single- and two-index pricing models - where the latter includes market and industry indexes. Interestingly, while a positive information transfer is evident with market model residuals, once industry cross-sectional covariation in firms' returns is removed, no directional relation is apparent.

Studies of the information content of accounting earnings typically assume earnings response coefficients do not vary across firms. Valuation models relating earnings to security prices, however, predict that earnings response coefficients are positively associated with revision coefficients (coefficients relating current earnings to future earnings) and negatively associated with expected rates of return. A random coefficient regression model provides evidence consistent with these predictions. This evidence has implications for interpreting multiple regression models that relate abnormal returns to unexpected earnings and other information variables.