Knowledge that Transforms

A number of studies have tested for information content in the ASR 190 disclosure by comparing the conditional and unconditional distribution of abnormal security returns around the time of disclosure. Since no differences were observed, it was concluded that ASR 190 had no information content. The study reported below performs a similar test by estimating the regression function of the conditional distribution of abnormal returns. This test procedure controls for the information content in contemporaneous historical cost disclosure and uses a conditioning variable not considered in earlier tests. It finds statistically significant stock price effects. However, because most of the effects appear to precede the official announcement date by several months, it is unclear whether stock prices were responding to the leakage of the information content of ASR 190 prior to disclosure, to private production of information contained in ASR 190 or to a variable omitted from the study which happens to be correlated with replacement costs.

The specification of the market expectation of accounting numbers is a common feature of many empirical studies in accounting and finance. Givoly and Lakonishok (1979) found that financial analysts' forecasts have information content. This study evaluates the quality of analysts' forecasts as surrogates for the market expectation of earnings and compares it with that of prediction models commonly used in research. Results indicate that prediction errors of analysts are more closely associated with security price movements, suggesting that analysts' forecasts provide a better surrogate for market expectations than forecasts generated by time-series models. The study also identifies factors that might contribute to the performance of the financial analysts'forecasts. The broadness of the information set employed by analysts and, to a lesser extent, their reliance on information released after the end of the fiscal year appear to be important contributors to their performance.

This paper examines the relationship between the ownership control status of firms and the accounting methods they adopt. The arguments of Watts and Zimmerman's positive theory are integrated with those of managerial economists to generate the prediction that management controlled firms are more likely than owner controlled firms to adopt accounting methods which increase reported earnings. This prediction is inconsistent with Fama's hypothesis that the market for managerial talent will prevent management controlled firms from acting differently than owner controlled firms. This paper compares the depreciation methods used by a sample of management and owner controlled firms for financial reporting purposes. The comparison considers and controls for the factors of firm size, leverage, and the depreciation method used for tax reporting purposes. The comparison reveals that there is a significant difference in the depreciation methods adopted by management controlled and owner controlled firms for financial reporting purposes.

The study explores the incremental explanatory power of replacement cost earnings variables (derived from ASR 190 data) with respect to explaining cross sectional differences in security returns. As such, the study is a natural extension of previous research, including analyses of the effect of security returns of ASR 190 data at the time of disclosure, investigations of cross sectional relationships between security returns and historical cost earnings, and studies of multiple signals. The basic finding is that pre-holding gain net income provides no incremental explanatory powerm given knowledge of historical cost earnings. However, the converse does not hold. Taken together, the findings are consistent with the contention that pre-holding gain net income is a garbled version of historical cost earnings. The basic finding is robust under several extensions of the initial research design. The research design incorporates a two-stage approach which permits a determination of the incremental explanatory power of collinear variables. The findings are in contrast to those of a previous study by Easman et al. (1979). The nature of the difference in research design inducing the difference is identified. Potential reasons for the difference in findings are provided.

This paper is designed to provide additional evidence on the positive theory of accounting policy choice by combining individual accounting principles into firm income strategies. These strategies were the dependent variable in a probit analysis where the independent variables were size, management compensation, industry concentration ratio, systematic risk, capital intensity and the total debt to total asset ratio. The results indicate that four of these factors (size, management compensation, concentration ratio, and the total debt to total asset ratio) have a significant association with the choice of a firm's income strategy. This test provides strong evidence consistent with the positive theory of accounting standard setting/choice. We also present evidence that smaller firms and/or firms in less concentrated industries do not appear to make accounting policy choice decisions that are consistent with this theory.

Portfolios are formed directly and exclusively upon residual return behavior in the months prior to portfolio formation. The empirical behavior of residual return in the post-formation period is then examined. Based upon the overall time period studied (1932 through 1977), the average residual return is essentially zero in the months subsequent to the portfolio formation. However, systematic (i.e., non-zero) residual behavior is observed in particular years. Moreover, the results suggest the possibility that ‘abnormal’ returns observed after certain events (e.g., earnings announcements) may at least in part reflect more general phenomena associated with being ‘winners’ and ‘losers’ in terms of residual returns in the months previous to the event.