Examines earnings management in the health maintenance organization (HMO) sector of the prepaid health-care industry. HMO industry evolution and regulation; HMO management strategy in the accrual of incurred but not reported expenses (IBNRs); Discretionary and nondiscretionary components of IBNR to total expenses ratio.
Companies that use commodities as inputs (e.g., crude oil and coffee) often face inventory decisions in an environment of widely fluctuating prices. Under LIFO, the end-of-period decision to replace liquidated LIFO layers (or not) may dramatically affect cost of goods sold for both tax and financial reporting. In this paper, we first model the factors involved in the end-of-period decision to acquire inventory. We then apply this model in the context of the difficult situation faced by the management of the Farmer Brothers (coffee) Company in fiscal year 1977. The events reflected in Farmers Brothers' fiscal year 1977 financial statements reveal many of the economic factors involved in managing inventories recorded on a LIFO basis. The actual end-of-period decision reached by Company management is compared to plausible alternative actions. The analysis focuses on estimates of the effects of these alternative actions on cash flows and reported income as well as other factors that might have influenced management to increase the level of ending inventory in the face of declining prices.
Managers must understand relations among costs in order to make decisions. Prior literature assumes managers' use of cost accounting system output is affected by the information coming from the system, but not by the design of the cost system itself. This study examines how the classification of costs into cost pools affects the accuracy of individuals' understanding of relations among costs. I hypothesize that individuals will estimate relations between costs in the same cost pool first and thus more accurately than relations across different pools, because cost pools provide strong cues that meaningful relations are likely to exist within, but not across, pools. I also hypothesize that cost location (within- versus across-pool) has a greater effect on individuals' judgment accuracy when relations among costs are negative than when they are positive. Experimental results are generally consistent with these hypotheses. This experiment shows that cost pool classification choices not only affect the information managers receive, but also their interpretation and use of that information. Data Availability: Contact the author.
Regulatory officials and market analysts have speculated that the loss of credibility in subsequently reported financial information is a long-lasting consequence of earnings restatements. I measure the information content of earnings using a standard earnings-returns framework over several years surrounding restatements to examine characteristics of the decline in the information content of earnings. Results indicate that although the information content of earnings declines following restatements, the loss is temporary. In particular, the earnings response coefficients for earnings announcements surrounding restatements exhibit a U-shaped pattern in which they are no longer significantly lower in the post-restatement period over an average of four quarters. The extent to which the earnings of restatement firms suffer a loss of information content varies across several dimensions. First, the duration of the loss is greater for firms that restate earnings to correct revenue recognition errors and for restatements that result in a large decline in the stock price at the announcement date. Second, there is not a loss in the information content of earnings for firms that make changes to their financial reporting governance structures following restatements. Overall, the evidence in this paper is consistent with a short-term decline in investor confidence regarding financial reporting following restatements, but shows that suspicion regarding the information loss of post-restatement earnings in the long-term is unwarranted.