Abstract Studies the effects of the disclosure of nonpublic information to explain target firms' runups prior to mergers. Criticisms on the disclosure system; US Securities and Exchange Commission's disclosure laws; Effects of ownership control structure on the dissemination of firms' acquisition-related information.

Income measurement, Historical cost earnings, ASR No. 190, SFAS No. 33

[In this article, we explore the ability of publicly available information to explain target firms' market "runups" prior to mergers and tender offers. Critics of the disclosure system argue that market runups before acquisition announcements indicate a failure of the disclosure system to guarantee equal access to information for all investors. However, the focus on acquisition announcement dates ignores that investors often have access to more timely sources of public information, including preliminary negotiation announcements, disclosures of the purchase of small blocks of stock, and published rumors. Thus, in assessing the market's use of non-public information, we concentrate on those runups that occur prior to the earliest possible public disclosure dates. Our emphasis on preliminary merger information parallels current legal and regulatory developments. Recent court decisions define preliminary merger negotiations as material information that is subject to Securities and Exchange Commission (SEC) disclosure laws. Also, the SEC now requires (with certain exemptions) the disclosure of preliminary merger negotiations in the Management Discussion and Analysis (MD&A) of forms 10-K and 10-Q. A second empirical question explored is whether market price movement prior to the release of merger information varies with firms' ownership structure (manager-controlled and owner-controlled firms). Since acquisitions often provide more attractive payoffs for owners as opposed to managers, ownership control structure may affect dissemination of firms' acquisition-related information. Therefore, we test whether presumed differences in target firms' information production are associated with distinct patterns of market runups. An event-type methodology is used for testing both questions. To test the event period, weekly residual returns are computed from CRSP for the period starting 20 weeks prior, and ending three weeks after, the first public disclosure date. For the 121 sample firms, the test statistics are based on the standardized average cumulative abnormal returns. Results indicate that substantial market activity occurs prior to what we could identify as the first public disclosure of any information about potential acquisition. This implies that such movements reflect nonpublic information or public information appearing in sources other than The Wall Street Journal and the Funk and Scott Index. We also found that market price runups occurred earlier for owner-controlled firms for both mergers and tender offers. The price runups were similar irrespective of whether the first public disclosure was definitive or hypothetical. Sensitivity tests indicate that the early price runups of owner-controlled firms are not explained by a few extreme values. The association between the timing of price runups and ownership structure reflects the expected differences in information production give firms' ownership control structure. This finding is consistent with the emphasis placed by the new auditing standards on firms' control environment including ownership structure.]

Under the 1996-98 security regulations in China, the accounting rate of return on equity (ROE) has to be greater than 10 percent for three "consecutive" years for a firm to qualify for stock rights offers. Despite declining economic conditions during this period, the percentage of firms reporting ROE between 10 and 11 percent is about "three" times that for 1994-95. This unique regulatory environment provides a natural experimental setting for the empirical assessment of earnings-management behavior and its consequences. This study examines whether listed Chinese firms manage earnings to meet regulatory benchmarks and whether regulators and investors consider the quality of earnings in their respective regulatory and investment decisions. On the basis of a sample of listed Chinese firms from 1996 to 1998, we observe that managers execute transactions involving below-the-line items and use income-increasing accounting accruals to meet regulatory ROE targets for stock rights offerings. The firms that apply for, but fail to receive, regulatory approval manage earnings more significantly than do firms that receive approval and pair-matched control firms. Our market study also suggests that investors differentiate the quality of earnings and put less value on earnings suspected of a greater degree of management. Overall, our results imply that the regulatory bodies and investors to some extent make rational adjustments for the quality of earnings.

Implementation methods mandated by the FASB allow firms to report equity-increasing changes as income and equity-decreasing changes as adjustments to stockholders' equity. These findings are consistent with the argument that the FASB, to reduce its political costs, attempts to minimize firms' costs of implementation. We find that the FASB permits flexibility in timing of adoption of mandated changes. Firms experiencing lower changes in return on assets (ROA) before adoption and expecting higher adoption income effects accelerate implementation. Early adopters select the year of adoption when their change in ROA is lowest and their change in leverage is highest.

Abstract Under the 1996‐98 security regulations in China, the accounting rate of return on equity (ROE) has to be greater than 10 percent for three "consecutive" years for a firm to qualify for stock rights offers. Despite declining economic conditions during this period, the percentage of firms reporting ROE between 10 and 11 percent is about "three" times that for 1994‐95. This unique regulatory environment provides a natural experimental setting for the empirical assessment of earnings‐management behavior and its consequences. This study examines whether listed Chinese firms manage earnings to meet regulatory benchmarks and whether regulators and investors consider the quality of earnings in their respective regulatory and investment decisions. On the basis of a sample of listed Chinese firms from 1996 to 1998, we observe that managers execute transactions involving below‐the‐line items and use income‐increasing accounting accruals to meet regulatory ROE targets for stock rights offerings. The firms that apply for, but fail to receive, regulatory approval manage earnings more significantly than do firms that receive approval and pair‐matched control firms. Our market study also suggests that investors differentiate the quality of earnings and put less value on earnings suspected of a greater degree of management. Overall, our results imply that the regulatory bodies and investors to some extent make rational adjustments for the quality of earnings.

ABSTRACT This study provides evidence of the role of both legal and extra‐legal institutions in limiting the income management induced by the detachment of control rights from the cash flow rights of ultimate owners. The tests use a unique, comprehensive data set for firm‐level control and ownership structures from 9 East Asian and 13 Western European countries. Univariate regressions show that income management that is induced by the wedge between control rights and cash flow rights is significantly limited in countries with high statutory protection of minority rights (proxied by legal tradition, minority rights protection, the efficiency of the judicial system, or disclosure standards) and effective extra‐legal institutions (proxied by the effectiveness of competition laws, diffusion of the press, and tax compliance). Furthermore, multiple regression results show that a common law tradition and an efficient judicial system subsume the effects of the other legal institutions, and that a high rate of tax compliance subsumes the effects of the other extra‐legal institutions in curbing insider income management. It is surprising that a high rate of tax compliance ultimately has a greater effect than legal tradition and the efficiency of the judicial system. Although this finding is unexpected, given prior evidence on the dominant roles of legal institutions in macroeconomic issues and corporate policies, it is consistent with the recent argument that effective tax enforcement is like a public good in that it can reduce insiders' private control benefits. An implication of this finding is that closer attention to extra‐legal institutions has the potential to enhance our understanding of the institutional reforms needed to limit insider private control benefits.