Abstract This paper uses stock market data to investigate the popular claim that investors are misled by the “pro forma” earnings numbers conspicuously featured in the press releases of some U.S. firms. We first document the frequency and magnitude of pro forma earnings in press releases issued during June through August 2000, and describe the 433 firms that engaged in this financial disclosure strategy. Our test period predates public expressions of concern by trade associations and regulators that pro forma earnings may mislead investors and the subsequent issuance of guidelines and rules on the disclosure of pro forma earnings numbers. We use two complementary approaches to determine whether the share prices that investors assign to pro forma firms are systematically higher than the prices assigned to other firms. Our market‐multiples tests for differences in price levels find some evidence suggesting that pro forma firms may be priced higher than firms that do not use the disclosure strategy. This apparent overpricing is not, however, related to the pro forma earnings numbers themselves. Our narrow‐window stock returns tests reveal no evidence of a stock return premium for pro forma firms at the quarterly earnings announcement date. Collectively, the results cast doubt on the notion that investors are, on average, misled by pro forma earnings disclosures despite the widespread concern expressed in the financial press and by regulators.

Abstract We demonstrate analytically and empirically that valuing a firm with foreign operations in the presence of exchange rate uncertainty requires information on the foreign operating cash flows disaggregated by currency and persistence. In particular, given consolidated earnings, investors need information on the exchange gain or loss on permanent foreign operating cash flows. We extend the model to show how the permanent foreign cash flows can be used to condition the change in the translation adjustment to make it value‐relevant; however, using the permanent foreign cash flows directly is superior for valuation purposes. The empirical tests support our hypothesis that the market response to exchange rate movements is sensitive to the relative magnitudes of revenues and costs denominated in each foreign currency in which a firm has transactions. Disclosure of cash flows by currency should enhance the valuation of firms with foreign operations.

Abstract This paper investigates the relation between disclosure policy and market liquidity. Our tests examine two key aspects of market liquidity, the effective bid‐ask spread and quoted depth, and how they relate to financial analysts' ratings of firms' disclosure policies. We introduce a method of combining order sizes and depth quotes to yield more precise estimates of effective spreads on trades likely constrained by quoted depth. We find that while firms with higher rated disclosures are charged lower effective spreads, they are also quoted lower depth, consistent with the notion that better disclosures reduce information asymmetry but also cause some liquidity suppliers to exit the market. Therefore, a simple examination of spreads and depths yields ambiguous inferences on the relation between disclosure policy and market liquidity. We resolve this ambiguity by estimating depth‐adjusted effective spreads, and find that firms with higher rated disclosures have lower depth‐adjusted effective spreads across all trade sizes. Consequently, our results reveal a robust inverse relation between disclosure ratings and effective trading costs. This implies that a policy of enhanced financial disclosure is related to improved market liquidity.

Abstract This study uses experimental markets to investigate how moral reasoning influences auditor reporting under different levels of economic incentives. In each multiperiod market, auditor subjects could either (1) misreport low observed outcomes as high and thereby reap economic advantages at the expense of third‐party investors, or (2) truthfully report low observed outcomes as low but thereby forgo the economic advantages of misreporting. We extend the Calegari, Schatzberg, and Sevcik 1998 experimental‐markets setting to incorporate moral reasoning, and test hypotheses based on the economic model of Magee and Tseng 1990 and the neo‐Kohlbergian moral reasoning framework of Rest, Narvaez, Bebeau, and Thoma 1999. We document a significant effect of moral reasoning on auditor behavior. Specifically, we find that misreporting and premium fees are more likely with higher than with lower moral reasoning subjects, and the moral reasoning effect diminishes as economic penalties increase in the market. These findings provide valuable insights for specifying the determinants of auditor misreporting, the observable behaviors that signal its existence, and the institutions that can prevent its occurrence in the market. We conclude that the relation between moral reasoning and behavior is more complex than commonly assumed in the accounting literature, and identify directions for future research.