SFAS No. 2, R&D, Market reaction, R&D expensing

Examines whether firms exhibiting improved inventory utilization subsequent to just-in-time (JIT) adoption achieve a corresponding increase in their Return on Assets (ROA). Effects of JIT adoption; Effects of customer concentration; Effects of cost structure.

This research examines the information content of the bank earnings components entitled "Securities Transactions Gains and Losses" (STGL). STGL reflect the accounting gain or loss that arises when a bank sells an investment security at a price different from the book value. Institutional as well as anecdotal evidence suggests that investors may price STGL differently from the operating earnings come ponent entitled "Income before Securities Transactions" (IBST). For example, prior to 1983, bank regulators viewed the IBST and STGL components as reflecting unique aspects of bank activities and, therefore, required that total bank earnings be disaggregated into IBST and STGL components (SEC 1983). In addition, because of investment market volatility and the discretionary nature of investment securities sales, STGL may convey limited information about current changes in bank value (Linden 1990). Indeed, with banks, security analysts often focus on IBST (Barth et al. 1990), and managers have been accused of selectively selling appreciated investment securities to increase reported levels of accounting earnings (Berton 1991; Wyatt 1991). Research by Barth et al. (1990) has assessed the relative ability of the IBST and STGL income components to explain cross-sectional variation in annual common stock prices. They predicted, for many of the reasons cited above, that the STGL earnings/security price multiple should be less than the multiple assigned to the IBST component. Their results confirm this prediction: IBST played an important role in explaining bank stock prices, but the earnings/security price multiple assigned to STGL did not differ significantly from zero. There are several reasons why STGL might not have exhibited information content in this research. First, as Barth et al. suggest, the incremental information content of the STGL component may have been diminished because STGL appear to be realized to smooth income. In this situation, STGL are likely to provide little incremental information about changes in bank equity values. Second, Barth et al. measure stock returns over a 12-month interval corresponding to the bank's fiscal year. When returns are measured over such a long period, the likelihood increases that information unrelated to earnings will also be reflected in equity prices, thereby (potentially) reducing the ability of earnings to explain security returns. Third, significant tax-related, cross-sectional differences may exist in the STGL earnings component/security price relationship, and these are "averaged away" when one overall earnings/security price coefficient is estimated. For example, Scholes et al. (1990) suggest that STGL may be realized to minimize taxes. Based on this tax-planning scenario (described in section I), security transaction losses (gains) for tax-paying (non-taxpaying) banks are predicted to be negatively (positively) related to bank equity values. The objective of this study is to assess whether the STGL earnings component is priced by investors in a manner consistent with this tax-planning rationale. Empirical tests measure the market reaction to IBST and STGL earnings information over the two-day interval consisting of the day before and day of the preliminary quarterly earnings release, and the results provide evidence that STGL are priced by investors in a manner consistent with the tax-planning hypothesis. However, these results appear to hold only in the first three quarters of the fiscal year. In the fourth quarter, there is no evidence that the STGL component is priced by bank investors. These fourth-quarter results are consistent with an increase in earnings-management activity related to STGL near the fiscal year-end.

The AICPA Special Committee on Financial Reporting has urged disclosure of relevant forward‐looking information on risks and opportunities to supplement conventional financial statements. We conduct a laboratory market experiment to assess the effects of such disclosures on capital allocation decisions. We develop two sets of competing hypotheses regarding how capital markets react to supplemental disclosures. One set is based on the assumption of semi‐strong market efficiency, while the other posits that the bounded rationality of individual traders leads to inefficient market prices. We find that explicit disclosure of management’s best estimate of an uncertain quantity improves market efficiency, even though this disclosure is redundant with information in financial statements. Second, we find disclosure of an upper bound of management’s estimate has the potential to bias security prices upward, while informationally equivalent disclosure of both upper and lower bounds removes this bias. These results suggest that experimental market reactions to these supplemental disclosures are inconsistent with market efficiency. Supplemental analyses of individuals’ price predictions and trading behavior support our conclusion that inefficiencies are at least partially attributable to individual information processing biases.

Many have argued that financial statements created under an accounting model that measures financial instruments at fair value would not fairly represent a bank's business model. In this study we examine whether financial statements using fair values for financial instruments better describe banks' credit risk than less fair-value-based financial statements. Specifically, we assess the extent to which various leverage ratios, which are calculated using financial instruments measured along a fair value continuum, are associated with various measures of credit risk. Our leverage ratios include financial instruments measured at (1) fair value; (2) U.S. GAAP mixed-attribute values; and (3) Tier 1 regulatory capital values. The credit risk measures we consider are bond yield spreads and future bank failure. We find that leverage measured using the fair values of financial instruments explains significantly more variation in bond yield spreads and bank failure than the other less fair-value-based leverage ratios in both univariate and multivariate analyses. We also find that the fair value of loans and deposits appear to be the primary sources of incremental explanatory power. Data Availability: All data are publicly available from the sources indicated in the paper.

To meet the objectives of financial reporting in the IASB's Conceptual Framework, the “balance‐sheet approach” embraced by the Framework is necessary but not sufficient. Critical, but largely overlooked, is the role of uncertainty, which we argue defines the role of accrual accounting as a distinctive source of information for investors when investment outcomes are uncertain. This role is in some sense paradoxical: on the one hand, uncertainty undermines both the balance sheet (because uncertain assets are unrecognized) and the income statement (because mismatching is unavoidable). However, these inevitable accounting effects can be exploited to provide information about uncertainty, though not by a balance‐sheet approach alone. Rather, balance sheet recognition and measurement criteria are established by consideration of the impact of uncertainty on matching and mismatching in the income statement. This combination of balance‐sheet and income‐statement approaches enhances the communication of information to investors under conditions of uncertainty, thereby giving greater clarity and purpose in satisfying the objective of the Framework to provide information about “the amount, timing, and uncertainty of future cash flows.”

This research evaluates whether reporting incentives and consequences change under the new lease accounting standard. Under prior guidance (SFAS 13), we predict and find firms with high financing cost sensitivities to leverage have greater incentive to finance investments with operating leases. Under the new lease accounting standard (ASU 2016-02), we predict and find this leverage incentive remains but is reduced, consistent with the FASB’s objective to limit opportunities to structure lease contracts for balance sheet purposes. Under ASU 2016-02, we also predict and find that the leverage incentive encourages firms to reduce operating lease liabilities by decreasing the duration of minimum lease payments. Lastly, we predict and find that firms use fewer operating leases under both SFAS 13 and ASU 2016-02 when managers’ income objectives exclude depreciation and/or interest expense. These findings suggest reporting incentives remain post ASU 2016-02 that encourage firms to structure leases to achieve accounting outcomes. Data Availability: This study uses licensed data from a variety of sources (see Appendix A for a detailed list of providers).

We hypothesize that firms' 10-K market risk disclosures, recently mandated by SEC Financial Reporting Release No. 48 (FRR No. 48), reduce investors' uncertainty and diversity of opinion about the implications, for firm value, of changes in interest rates, foreign currency exchange rates, and commodity prices. We argue that this reduced uncertainty and diversity of opinion should dampen trading volume sensitivity to changes in these underlying market rates or prices. Consistent with this hypothesis, we find that after firms disclose FRR No. 48-mandated information about their exposures to interest rates, foreign currency exchange rates, and energy prices, trading volume sensitivity to changes in these underlying market rates and prices declines, even after controlling for other factors associated with trading volume. The observed declines in trading volume sensitivity are consistent with FRR No. 48 market risk disclosures providing useful information to investors.