Knowledge that Transforms

This paper examines the Beaver, Lambert, and Morse (1980) valuation model that capitalizes ‘ungarbled’ earnings. The analysis identifies the model's unspecified capitalization factor, and it emphasizes that a complete model of ungarbled earnings must focus on the joint stochastic behavior of earnings and dividends. It is shown that expected ungarbled earnings, scaled for a constant, equal expected dividends. Except for the scale factor, no apparent economic reasons suggest that ungarbled earnings are any different from dividends.

This paper performs a financial statement analysis that combines a large set of financial statement items into one summary measure which indicates the direction of one-year-ahead earnings changes. Positions are taken in stocks on the basis of this measure during the period 1973–1983, which involve canceling long and short positions with zero net investment. The two-year holding-period return to the long and short positions is in the order of 12.5%. After adjustment for ‘size effects’ the return is about 7.0%. These returns cannot be explained by nominated firm risk characteristics.

Financial and pension variables are analyzed to test predictions of a number of explanation for the recent surge in reversions of excess assets from terminations of overfunded pension plans. Terminations are apparently motivated by cash needs, rather than tax, accounting, or wealth transfer considerations. These cash needs arise from large unexpected declines in funds from operations or financial restructuring subsequent to hostile takeover attempts. However, terminations appear to be a costly source of funds, since firms seek funds from numerous other sources (dividend cuts, ‘slow’ withdrawals of pension assets, and investment cuts) before resorting to terminations.

This study examines the economic consequences of Statement of Financial Accounting Standards No. 8 (SFAS No. 8). Compared to a matched control group, both early adopters and late adopters of SFAS No. 8 exhibited significantly negative excess returns in the Exposure Draft release period, even after adjusting for a size effect in January. Weighted least-squares and ordinary least-squares cross-sectional regressions were compared. The late adopter regressions weakly support contracting and political cost theories.

The effect that voluntarily disclosed managers' earnings forecasts have on the security prices of the announcing firms and other firms in the same industry is examined. The results are consistent with information content in managers' forecasts and with information transfer between forecast firms and other firms in the industry. These inferences are drawn from firms' abnormal returns computed from single- and two-index pricing models - where the latter includes market and industry indexes. Interestingly, while a positive information transfer is evident with market model residuals, once industry cross-sectional covariation in firms' returns is removed, no directional relation is apparent.

Studies of the information content of accounting earnings typically assume earnings response coefficients do not vary across firms. Valuation models relating earnings to security prices, however, predict that earnings response coefficients are positively associated with revision coefficients (coefficients relating current earnings to future earnings) and negatively associated with expected rates of return. A random coefficient regression model provides evidence consistent with these predictions. This evidence has implications for interpreting multiple regression models that relate abnormal returns to unexpected earnings and other information variables.

Stock pride change associated with a given unexpected earnings change (the earnings response coefficient) exhibits cross-sectional and temporal variation. We predict and document evidence that the earnings response coefficient is a function of riskless interest rates and the riskiness, growth and/or persistence of earnings. The earnings response coefficient also varies cross-sectionally with the holding period return interval. Collectively, our results explain the previously reported differential earnings response coefficient with respect to size. Moreover, by including the factors noted above, the empirical specification of the earnings/returns relation is significantly improved.

Inventory accounting method, Uncertainty, Inventory accounting method changes, FIFO

Gerald J. Lobo, Amal A. W. Mahmoud, Relationship between Differential Amounts of Prior Information and Security Return Variability, Journal of Accounting Research, Vol. 27, No. 1 (Spring, 1989), pp. 116-134

Performance evaluation, Linear aggregation, Compensation contracts