[Effective January 1985, SFAS No. 80 requires banks to recognize changes in the market value of futures contracts that qualify (a) as micro hedges as adjustments to the carrying amount of the hedged item ("hedge accounting"), and (b) as macro hedges currently in income ("immediate recognition"). The distinction between micro and macro hedges depends on whether the futures contracts are linked with identifiable hedge transactions (micro hedge) or not (macro hedge). Three factors motivate commercial banks to use macro hedges: (1) it may be difficult to isolate hedge transactions; (2) since 1983, required disclosures provide readily available measures of macro exposure; and (3) it is possible to increase exposure by micro hedging some items but not others. Consequently, commercial banks, as large macro hedge users, are concerned that immediate recognition accounting causes gains and losses on futures contracts and hedged items to be recognized in different periods. This asymmetry, they argue, increases the variability of earnings and discourages effective use of futures contracts to hedge interest rate risk. Brokerage firms have similar concerns about immediate recognition accounting for futures contracts used for investment or speculation. This paper examines commercial banks' and brokerage firms' claim that the current accounting rules for futures contracts increase earnings variability. As such, this analysis departs from prior studies that focus on the security market's reaction to an accounting change. Simulations calibrated with empirical data collected from a sample of 76 commercial banks are used to generate earnings streams computed under immediate recognition and hedge accounting. The variability of the simulated earnings patterns is then compared using parametric and nonparametric tests. These tests show that immediate recognition accounting significantly increases the dispersion of annual earnings vis-�-vis the earnings stream produced under hedge accounting. This finding, which is robust to the size of the hedge and the measure of earnings, suggests at least one motivation for a change in commercial banks' hedging behavior. Empirical tests are used to compare earnings patterns of a sample of 27 brokerage firms. These results indicate no significant difference between the variability of earnings before and after the effective date of SFAS No. 80. Although based on a small number of time series observations, this finding does not support critics' concern over the accounting treatment for futures contracts used for investment or speculation.]

Examines commercial banks' and brokerage firms' claim that existing accounting rules for futures contracts increase earnings variability in the United States. Background on the SFAS No. 80 requiring banks to recognize market changes in futures contracts that qualify as micro and macro hedges; Hedging interest rate exposures; Accounting for futures contracts by commercial banks.

We investigate three explanations for prior studies' finding that the usefulness of earnings announcements, as measured by their absolute market responses, has increased over time. We confirm this increase for a sample of 426 relatively large, stable firms over 1980–1999. We find no evidence that this over-time increase in the magnitude of the market reaction to our sample firms' earnings announcements is attributable to increases in the absolute amount of unexpected earnings conveyed in the announcements or to increases in the intensity of investors' average reaction to unexpected earnings. To test the third explanation—an over-time expansion in the amount of concurrent (with bottom line earnings) information in earnings announcement press releases—we analyze and code the contents of 2,190 earnings announcement press releases made by 30 of our sample firms over 1980–1999. Concurrent disclosures increased significantly over this period and we find that these concurrent disclosures, especially the inclusion of detailed income statements, explain increases in the absolute market reactions to earnings announcements for our sample firms.

We examine the relation between the cost of equity capital and seven attributes of earnings: accrual quality, persistence, predictability, smoothness, value relevance, timeliness, and conservatism. We characterize the first four attributes as accounting-based because they are typically measured using accounting information only. We characterize the last three attributes as market-based because proxies for these constructs are typically based on relations between market data and accounting data. Based on theoretical models predicting a positive association between information quality and cost of equity, we test for and find that firms with the least favorable values of each attribute, considered individually, generally experience larger costs of equity than firms with the most favorable values. The largest cost of equity effects are observed for the accounting-based attributes, in particular, accrual quality. These findings are robust to controls for innate determinants of the earnings attributes (firm size, cash flow and sales volatility, incidence of loss, operating cycle, intangibles use/intensity, and capital intensity), as well as to alternative proxies for the cost of equity capital.

For a broad sample of firms, we use structural equations modeling to construct latent variables for real-action aggressiveness and reporting policy aggressiveness. We estimate the association between the latent variables and the associations of each latent variable with shareholder payoffs (returns) and CEO payoffs (annual compensation to the CEO position). Results show the two types of aggressiveness are positively correlated but have different associations with the payoffs we consider. Greater policy-choice aggressiveness is associated with higher returns and compensation; the opposite is true for greater real-action aggressiveness. We find a positive association between policy-choice aggressiveness and restatement likelihood. Compared with nonrestatement firms, abnormal returns of restatement firms with aggressive policy choices are larger in the pre-restatement period and lower in the post-restatement period. Negative returns at the restatement announcement do not, on average, eliminate long-run (multi-year) positive returns of the pre-restatement period or of the period whose results are restated.

We examine the properties of a returns‐based representation of earnings quality, estimated from firm‐specific asset‐pricing regressions augmented by an earnings quality mimicking factor. The coefficient on the earnings quality factor (the “e‐loading”) captures the sensitivity of the firm's returns to earnings quality in a given year or quarter, analogous to beta as a measure of the sensitivity of returns to market movements. Relative to other proxies for earnings quality, e‐loadings can be calculated for larger samples of firms and can be estimated for shorter intervals at any point in time. Along all dimensions examined, we find that e‐loadings perform well in capturing notions of earnings quality.

We examine the properties of a returns-based representation of earnings quality, estimated from firm-specific asset-pricing regressions augmented by an earnings quality mimicking factor. The coefficient on the earnings quality factor (the “e-loading”) captures the sensitivity of the firm's returns to earnings quality in a given year or quarter, analogous to beta as a measure of the sensitivity of returns to market movements. Relative to other proxies for earnings quality, e-loadings can be calculated for larger samples of firms and can be estimated for shorter intervals at any point in time. Along all dimensions examined, we find that e-loadings perform well in capturing notions of earnings quality.