Knowledge that Transforms

This paper adopts a rational market structure to examine the link between the cash flow effects of management policy decisions and the resulting stock price reactions. The focus is on testing cross-sectional associations between cash flow effects and the underlying characteristics of affected firms. We find that it is not possible to infer the sign of association between the stock price reaction and any characteristics of the firm that are observable before management announces its decision. Our methodological suggestions involve exploiting either a priori assumptions or sample information about the probability distribution of unobservable decision variables underlying the management decision process.

This paper examines the corporate reaction to a major U.K. accounting proposal, the 1976 exposure draft which called for the introduction of current cost accounting as the primary accounting convention. Written submissions to the U.K. rule-making body are analyzed and four categories of preference identified. Probit analysis reveals that the expected cost of compliance is the most significant factor in shaping corporate preference. In addition, firms at risk of government investigation are more likely to support and service sector firms are more likely to oppose the proposed standard.

I examine three composite analyst forecast of earnings per share as proxies for expected earnings. The most current forecast weakly dominates the mean and median forecasts in accuracy. This is evidence that forecast dates are more relevant for determining accuracy than individual error. Consistent with previous research, I find analysts more accurate than time-series models. However prior knowledge of forecast errors from a quarterly autoregressive model predicts excess stock returns better than prior knowledge of analysts' errors. This is inconsistent with previous research, and is anomalous given analysts' greater accuracy.

In this paper we present and estimate a model of economic depreciation consistent with producer's optimization. The estimated economic depreciation, which is a function of the rate of utilization and level of maintenance, is about half of that used according to tax (accounting) depreciation. The difference between the economic and tax rates of depreciation results in a subsidy and earlier capital replacement. The implicit maximum net tax subsidy expressed as a proportion of the acquisition price of the asset is 13.3% for a sample of Canadian trucking firms.

We examine capital structure changes to investigate the impact of SFAS No. 13 on lessees. While this accounting standard essentially rearranged capital lease disclosures (from footnotes to the balance sheet), mandated capitalization substantially altered key accounting ratios. Our results document a systematic substitution from capital leases to operating leases and nonleases sources of financing. In addition, lessees appear to reduce book leverage by increasing equity and reducing conventional debt. The magnitudes of these responses are cross-sectionally related to preadoption levels of footnoted capital leases.

This study examines the association between abnormal returns and five alternative proxies for the market's assessment of unexpected quarterly earnings. We examine the role that measurement error potentially has in multiple regression tests of abnormal returns (occuring around the time of earnings announcements) on an unexpected earnings proxy and other non-earnings variables. The results indicate a potential measurement error interpretation of such multiple regression tests. We examine three procedures which reduce, to an unknown degree, the measurement error problem. Our procedures appear to be more (less) effective at reducing measurement error for small (large) firms and recent (non-recent) forecasts.

During the latter half of the 1930s Australian taxation law changes induced companies to adopt a holding company legal structure which increased agency costs associated with external financing. This paper argues that contracting practices designed to minimize these costs played an important part in the evolution of consolidated financial reporting. Consistent with this view the likelihood of consolidation is found to be a function of the presence of cross-guarantees, management's share of a firm's equity, and the number and type of subsidiaries.

This paper examines cross-sectional analysis procedures common to many market-based accounting research papers. Both the economic and econometric properties of ‘levels’ and ‘returns’ studies are discussed. Topics covered include the relations between the accounting studies and cash flow valuation models, the role of expectations of accounting variables, deflators, spurious inference, risk adjustment and its relation to growth, size and leverage, residual dependence, dependence among explanatory variables, and the effect of scale differences across firms. Major conclusions are that market value is the correct deflator in returns studies, and that levels and returns studies are economically but not econometrically equivalent.

Beaver, Lambert and Morse (1980) suggest that prices may be useful in forecasting future earnings. We explore the information content of prices with respect to earnings by focusing on firm size and its relation to the predictive accuracy of price-based earnings forecasts. Firm size proxies for the amount of information and for the number of traders and professional analysts processing the available information about an enterprise. Our empirical results are consistent with the hypothesis that price-based earnings will outperform univariate time series forecasts by a greater margin for larger firms than for smaller firms.

This paper examines the effect of accounting procedure changes on cash salary and bonus compensation to CEOs. We estimate whether there is an adjustment to the statistical relation between compensation and corporate earnings following changes that lower earnings (FIFO to LIFO inventory valuation) and that raise earnings (accelerated to straight-line depreciation). The results indicate that (1) subsequent to these changes salary and bonus payments are based on reported earnings, rather than earnings under the original accounting method, and (2) the potential compensation effect of the changes is small compared to the effect of economy- or industry-wide changes in compensation.