[We report on an experiment in which experienced auditors (1) determine whether to allow a client to adopt an aggressive reporting method when the auditors have an incentive to do so, and (2), justify aggressive reporting by their interpretations of financial accounting standards. In the experiment, the appropriate reporting method depends upon whether an amount can be "reasonably estimated" as that term is used in an applicable accounting standard. The accounting standard relevant to determining the appropriate reporting method was manipulated between subjects (thus varying whether judging that an amount can be reasonably estimated would justify an aggressive or conservative method), as was engagement risk. The results indicate that the auditors responded to moderate engagement risk by permitting the aggressive reporting method and justified their choice with aggressive interpretations of accounting standards. When faced with high engagement risk, the auditors responded by requiring conservative reporting and justified their choice with conservative interpretations of accounting standards.]
[Prior studies of stock dividends and stock splits have failed to provide valid tests of earnings signaling because they incorrectly assume that "stock splits" do not restrict future cash dividends. Unlike previous studies, which also incorrectly assume that cash dividends are limited only to the amount of retained earnings, we present a study based on actual accounting treatment and appropriate statutory definitions of distributable equity. We find that more positive information is signaled if the stock distribution accounting choice reduces distributable equity.]
[Economic and political events have led to utility regulation decisions which, in turn, provide an impetus for significant changes in industry accounting and reporting practices. The prospect of continuing change in the operating environment for utilities suggests that some deferred assets created by regulatory actions are subject to uncertain recovery. Accounting regulators have responded by imposing additional constraints on the firm's ability to record these so-called "regulatory assets." Our results indicate that investors' valuation of regulatory assets depends on the regulatory environment in which the utility is operating. That is, there are cross-sectional valuation differences arising from the market's assessment of the probability that regulators will ultimately allow for the full recovery of the deferred costs.]
[This study investigates the association between going concern opinions and the market's reaction to bankruptcy filings. The results of prior studies indicate that going concern opinions are useful in predicting bankruptcy and provide some explanatory power in predicting bankruptcy resolution. As such, going concern opinions may reduce the surprise associated with bankruptcy. Our results are consistent with this assertion. Firms receiving going concern opinions experience less negative excess returns in the period surrounding bankruptcy filings than those receiving unqualified opinions. These results hold after controlling for the probability of bankruptcy, the market's reaction to news announcements occurring prior to bankruptcy, and changes in stock price prior to the issuance of the auditor's report. Overall, our results are consistent with going concern opinions having information value.]
[The accounting profession requires that firms disaggregate net income into specific components. Despite the widespread assumption that earnings disaggregation is important for assessing firm profitability, there is little empirical evidence that the classification scheme actually improves profitability forecasts. We analyze accuracy improvements in out-of-sample forecasts of one-year ahead return-on-equity (ROE) to examine the predictive content of earnings disaggregations. The results demonstrate that the classification scheme prescribed by the accounting profession does increase the predictive content of reported earnings. We find forecasting improvements from earnings disaggregation. These improvements go beyond separating extraordinary items and discontinued operations from the other components of earnings. Further disaggregation of earnings (into operating earnings, non-operating earnings and taxes, and special items) improves forecasts of ROE one year ahead.]
[This study uses experiments to examine whether individuals' earnings forecasts correctly reflect the time series properties of quarterly earnings, in particular, the positive autocorrelation in seasonal quarterly changes and the negative fourth-order moving average term documented by Brown and Rozeff (1979). We find that individuals' forecasts are sensitive to the magnitude of these time series components; however, individuals typically underweight the moving average term and under- (over-)weight the most recent seasonal quarterly change when it has a strong (weak) effect on future earnings. Individuals also place slightly more weight on quarterly changes when earnings are reported relative to those four quarters prior. These results suggest that the documented stock market under-reaction to quarterly earnings may not hold universally; rather, it may be composed of under-reactions to firms with strong autocorrelation in seasonal changes and over-reactions to firms with weak autocorrelation in seasonal changes.]
[This paper investigates the role of components of earnings in CEO compensation contracts. It argues that shareholders will use components of earnings as additional performance measures whenever the components provide information, over and above earnings, about managerial decisions. Results indicate that earnings and cash flow measures together have a better association with cash compensation paid to CEOs of U.S. companies than aggregate earnings alone. The evidence also suggests that current accruals and cash flows from operations are aggregated for performance evaluation. Stewardship value measures are able to explain some of the cross-sectional variation in the weights attached to earnings and working capital from operations. Significant variation in the use of cash flow measures and contract efficiency is detected between the early (1970 to 1979) and late (1980-1988) halves of the sample period.]
[This study uses laboratory markets to examine how the level of market efficiency influences managers' use of reporting discretion, and how allowing reporting discretion alters market efficiency. The results show managers that incur costs make favorable information available to more investors in less efficient markets but not in more efficient markets. Although reporting discretion does not change market price levels, it causes the markets to under-react to public information, apparently because investors overestimate the degree to which a favorable (unfavorable) public signal indicates that the public signal was inflated (deflated). Managerial reporting discretion may be related to under-reactions to earnings reports, which are also public disclosures subject to manipulation by managers.]
[This study provides evidence that fair value estimates of loans, securities and long-term debt disclosed under SFAS No. 107 provide significant explanatory power for bank share prices beyond that provided by related book values. In contrast to Eccher et al. (1996) and Nelson (1996), we consistently find incremental explanatory power for loans' fair values. Relatively stronger findings are obtained using a set of significant conditioning variables, including nonperforming loans, and interest-sensitive assets and liabilities. The joint significance of these loan-related variables and loans' fair values indicates that loans' fair values do not reflect completely loan default and interest rate risk. The loans' coefficient is significantly larger for banks with higher regulatory capital, which is consistent with market participants discounting unrealized gains on loans disclosed by less healthy banks. The findings are robust with respect to the inclusion of additional explanatory variables and to a first differences formulation.]
[This paper investigates whether the accuracy of a prior earnings forecast by management serves as an indicator to analysts of the believability of a current management forecast. Regression analysis is used to examine the relationship between the usefulness of a prior forecast by management and analyst response to a current forecast, after controlling for other determinants of believability. The results suggest that management establishes a forecasting "reputation" based on prior earnings forecasts.]