In this paper, I examine a new approach for measuring earnings quality, defined as the closeness of reported earnings to “permanent earnings,” based on firm decisions with regard to capital and labor investments. Specifically, I measure earnings quality as the contemporaneous association between changes in the levels of capital and labor investment and the change in reported earnings. This approach follows the reasoning that (1) firms make investment decisions based on the net present value (NPV) of investment projects and (2) reported earnings with higher quality should more closely associate with real investment decisions. I find that measures of earnings quality based on managerial labor and capital decisions correlate positively with earnings persistence and have incremental explanatory power relative to earnings-quality measures used in the accounting literature. Furthermore, investment-based earnings-quality measures are less informative when managers tend to overinvest.

This paper examines the information content of the forward‐looking statements (FLS) in the Management Discussion and Analysis section (MD&A) of 10‐K and 10‐Q filings using a Naïve Bayesian machine learning algorithm. I find that firms with better current performance, lower accruals, smaller size, lower market‐to‐book ratio, less return volatility, lower MD&A Fog index, and longer history tend to have more positive FLSs. The average tone of the FLS is positively associated with future earnings even after controlling for other determinants of future performance. The results also show that, despite increased regulations aimed at strengthening MD&A disclosures, there is no systematic change in the information content of MD&As over time. In addition, the tone in MD&As seems to mitigate the mispricing of accruals. When managers “warn” about the future performance implications of accruals (i.e., the MD&A tone is positive (negative) when accruals are negative (positive)), accruals are not associated with future returns. The tone measures based on three commonly used dictionaries (Diction, General Inquirer, and the Linguistic Inquiry and Word Count) do not positively predict future performance. This result suggests that these dictionaries might not work well for analyzing corporate filings.

We investigate the use of a warrant‐pricing approach to incorporate employee stock options (ESOs) into equity valuation and to account for the dilutive effect of ESOs in the valuation of option grants for financial reporting purposes. Our valuation approach accounts for the jointly determined nature of ESO and shareholder values. The empirical results show that our stock price estimate exhibits lower prediction errors and higher explanatory powers for actual share price than does the traditional stock price estimate. We use our valuation approach to assess the implications of dilution on the fair‐value estimates of ESO grants. We find that the fair value is overstated by 6% if we ignore the dilutive feature of ESOs. Furthermore, this bias is larger for firms that are heavy users of ESOs, small, and R&D intensive, and for firms that have a broad‐based ESO compensation plan.

We examine whether auditors exercise professional skepticism about management earnings forecasts when making going‐concern decisions. Using publicly issued management earnings forecasts as a proxy for earnings forecasts provided by managers to auditors, we find that management earnings forecasts are negatively associated with both auditors’ going‐concern opinions and subsequent bankruptcy. The weight auditors put on management forecasts in the going‐concern decision is not significantly different from the weight implied in the bankruptcy prediction model. Moreover, compared with the bankruptcy model, auditors assign a lower weight to management forecasts they perceive as being less credible, including those (1) issued by managers who issued optimistic forecasts in the previous two years, and (2) predicting high earnings increases or high earnings. Taken together, our evidence is consistent with auditors being professionally skeptical about management earnings forecasts when making going‐concern decisions.

In this paper we develop a measure of competition based on management's disclosures in their 10‐K filing and find that firms’ rates of diminishing marginal returns on new and existing investment vary significantly with our measure. We show that these firm‐level disclosures are related to existing industry‐level measures of disclosure (e.g., Herfindahl index), but capture something distinctly new. In particular, we show that the measure has both across‐industry variation and within‐industry variation, and each is related to the firm's future rates of diminishing marginal returns. As such, our measure is a useful complement to existing measures of competition. We present a battery of specification tests designed to explore the boundaries of our measure and how it varies with the definition of industry and the presence of other measures of competition.