Knowledge that Transforms

This study tests assertions that Economic Value Added (EVA®) is more highly associated with stock returns and firm values than accrual earnings, and evaluates which components of EVA, if any, contribute to these associations. Relative information content tests reveal earnings to be more highly associated with returns and firm values than EVA, residual income, or cash flow from operations. Incremental tests suggest that EVA components add only marginally to information content beyond earnings. Considered together, these results do not support claims that EVA dominates earnings in relative information content, and suggest rather that earnings generally outperforms EVA.

I investigate factors affecting firms' uses of three types of performance metrics to evaluate division mangers: division accounting metrics, firm accounting metrics and firm stock price. Survey data reveal that division accounting metric use increases with the divisions' industry's price–earnings correlation and decreases with divisional growth opportunities; firm accounting metric use increases with the manager's impact on other divisions and decreases with growth opportunities and other managers' impact on that division; and firm stock price use increases with relative division size and the correlation between firm stock returns and market-wide returns.

This study examines discretionary disclosures and stock price effects for 81 UK firms that received first-time modified audit reports during 1982–1990. Results indicate that these firms' managers are forthcoming about adverse developments, and appear to perceive the advantages of withholding negative news to be minimal. However, managers of many of the 58 stressed sample firms make disclosures about expected future performance that are overly optimistic relative to financial outcomes. As expected, stock market participants discount these stressed firms' positive tone disclosures. Evidence in this study confirms that there is a strong incentive problem with voluntary disclosure.

Rendleman, Jones, and Latané (1987) and Bernard and Thomas (1990) hypothesize and report evidence that investors use a ‘naive’ seasonal random walk model, at least in part, for quarterly earnings. We show that the market acts as if it: (1) does not use a simple seasonal random walk model; (2) does exploit serial correlation at lags 1–4 in seasonally-differenced quarterly earnings; (3) does use the correct signs in exploiting serial correlation at each lag; but (4) underestimates the magnitude of serial correlation by approximately 50% on average. We discuss the consistency of alternative hypotheses with our evidence.

We document that tax considerations influence whether and when a firm withdraws excess assets in its defined benefit pension plan through a reversion. Since a reversion impacts taxable income over many years and alternative methods of withdrawing excess assets exist, we argue that the economically relevant tax-based decision criterion is its ‘differential tax benefit’, defined as the difference between the discounted tax savings of reversion versus those of the best alternative withdrawal method. We develop a technique for directly estimating this decision criterion and document that differential tax benefits are strongly correlated with the reversion decision and its timing.

Much management accounting research focuses on design of incentive compensation contracts. A basic assumption in these contracts is that performance-based incentives improve employee performance. This paper reports on a field test of the multi-period incentive effects of a performance-based compensation plan on the sales of a retail establishment. Analysis of panel data for 15 retail outlets over 66 months indicates a sales increase when the plan is implemented, an effect that persists and increases over time. Sales gains are significantly lower in the peak selling season when more temporary workers are employed.

This paper examines the value relevance of fair value data disclosed under SFAS 107 by banks for 1992 and 1993. Collectively, the evidence suggests differences between fair and book values of financial instruments are associated with market-to-book ratios. However, fair value disclosures for financial instruments other than securities are value-relevant only in limited settings. In addition, only in 1992 are fair value variables associated with market-to-book ratios after incorporating existing historical cost information. Further analysis suggests the weaker 1993 results are not necessarily due to increased measurement error in fair value numbers.

We examine the value-relevance to investors of financial (accounting) and nonfinancial information of independent cellular companies and find that, on a stand-alone basis, financial information (earnings, book values, and cash flows) are largely irrelevant for security valuation. Nonfinancial indicators, such as POPS (a growth proxy) and Market Penetration (an operating performance measure), are highly value-relevant. However, combined with nonfinancial information, earnings do contribute to the explanation of prices. The complementarity between financial and nonfinancial data is highlighted in this study.

Using confidential data of executive-specific short-term bonus plans, we investigate the extent to which executives manipulate earnings to maximize the present value of bonus plan payments. As such, this paper extends the work of Healy (1985). Like Healy, we find evidence consistent with the hypothesis that managers manipulate earnings downwards when their bonuses are at their maximum. Unlike Healy, we find no evidence that managers manipulate earnings downwards when earnings are below the minimum necessary to receive any bonus. We demonstrate that Healy's results at the lower bound are likely to be induced by his methodology.

We examine whether the structure of compensation for the divisional CEO is related to subsequent innovative activity within the division, and whether the divisional CEO's compensation is structured as a function of the expected innovation opportunity set facing the division. Both the expected innovation opportunity set and the divisional executive's compensation contract are treated as endogenous variables by adopting a simultaneous equation approach. We find modest evidence that the proportion of total compensation tied to long-term components has a positive relation with future innovation, but no evidence that this proportion has a positive relation with the expected innovation opportunity set.