Knowledge that Transforms

This study provides empirical evidence regarding the effect of annual accounting earnings announcements on investors' trading behavior. We find that the magnitude of trading volume reaction is an increasing function of both the magnitude of the associated price reaction and the level of predisclosure information asymmetry. These results are consistent with Kim and Verrecchia's (1991a) theoretical trading volume proposition.

We assess earning's lack of timeliness and value-irrelavant noise in earnings as explanations for the weak contemporaneous return-earnings assocation. Earnings lack timeliness because objectivity, verifiability, and conservatism conventions underlie the accounting measurement process. Noise in earnings is uncorrelated with returns in all periods. It likely gets introduced when estimates of future cash flows that differ from the market's estimates are included in earnings determined by accounting rules. Consistent with earning lacking timeliness, we find current and future earnings adjusted for expectational errors explain roughly 3–6 times as much of the annual return variation as current earnings alone.

This paper examines how public disclosure affects private inforamtion acquisition activity in a market economy. We analyze a setting where traders with short-term investment horizons are allowed to trade on their private information prior to a public disclosure. We demonstrate in this setting that public disclosure stimulates investment in private information acquisition. This result is shown to have implications for the magnitude of the pre-announcement and announcement price reactions to the disclosure.

The SEC encourages companies to have their quarterly financial information reviewed by an independent accountant prior to filing Forms 10-Q (i.e., timely review). Many companies, however, choose to have their quarterly data reviewed only at year-end. Companies contracting for timely reviews are hypothesized to be seeking a higher level of monitoring because of higher internal and external agency costs. Empirical analyses support this hypothesis. The likelihood that a company purchases timely reviews is significantly associated with several proxies for internal and external agency costs.

We examine the accounting choice decision in the context of the timing of adoption of SFAS 87. Unlike most prior studies, we consider interactions between firm characteristics and the magnitudes of the financial statement effects of an accounting decision. We expect that including interactions will both enhance the ability to explain accounting choice, and facilitate distinction between omitted variables (Ball and Foster, 1982) and hypothesized relations. Results are consistent with these expectations.

This paper studies accounting choice in 76 NYSE firms with persistent losses and dividend reductions (40% forced by binding covenants). We find that managers' accounting choices primarily reflect their firms' financial difficulties, rather than attempts to inflate income. Firms with and without binding covenants exhibit minor accrual differences in the ten years before the dividend reduction. In the dividend reduction and following three years, the full sample exhibits large negative accruals that likely reflect the fact that 87% of sample firms engage in contractual renegotiations -with lenders, unions, government, and/or management-that provide incentives to reduce earnings.

Differences between SIC codes assigned to companies by COMPUSTAT and CRSP are examined. Large differences are observed at two-, three-, and four-digit levels. Correlations of intra-industry monthly stock returns are larger, and variances of intra-industry financial ratios are smaller for industries based on COMPUSTAT codes. Replication of a portion of Freeman and Tse (1992) produces significant results using COMPUSTAT codes, consistent with the original research, but insignificant results for CRSP codes.

We present evidence that 20 percent of the 10-Ks in our sample are filed with the SEC after the 90-day statutory due date. Firms that delay filing their 10-K are not a random sample of firms; up to 25 (10) percent of the firms experiencing unfavorable (favorable) economic events delay their 10-K. Firms that delay their 10-K are, on average, small, have negative accounting rates of return, negative earnings changes, low liquidity, and high financial leverage; they also experience negative market- adjusted stock returns.

Controlled experiments provided evidence that (1) employees are more likely to accept incentive contracts described in bonus terms than contracts that appear identical except for being described in penalty terms, and (2) when employees' judgment of their past performance is dependent on memory, the preference for bonus over penalty contracts increases with experience. These phenomena are explained in terms of the human information processing costs of communicating and evaluating the contract terms, and further implications are drawn for the empirical study of contracting.