ABSTRACT Accounting conservatism allows me to identify a previously undocumented source of predictable cross‐sectional variation in Standardized Unexpected Earnings' autocorrelations viz. the sign of the most recent earnings realization and present evidence that the market ignores this variation (“loss effect”). It is possible to earn returns higher than from the Bernard and Thomas (1990) strategy by incorporating this feature. Additionally, the paper shows that the “loss effect” is different from the “cross quarter” effect shown by Rangan and Sloan (1998) and it is possible to combine the two effects to earn returns higher than either strategy alone. Thus, the paper corroborates the Bernard and Thomas finding that stock prices fail to reflect the extent to which quarterly earnings series differ from a seasonal random walk and extends it by showing that the market systematically underestimates time‐series properties resulting from accounting conservatism.

We document that earnings acceleration, defined as the quarter-over-quarter change in earnings growth, has significant explanatory power for future excess returns. These excess returns are robust to a wide range of previously documented anomalies and a battery of risk controls. The future return predictability appears to be consistent with investors assuming a seasonal random walk model for quarterly earnings and missing predictable implications of earnings acceleration for future earnings growth. Finally, the excess returns from the basic earnings acceleration strategy can be enhanced further by focusing on profit firms, low earnings volatility firms and on specific patterns of earnings acceleration.

During the late 1990s, the SEC alleged that banks were overstating loan loss allowances to establish cookie jar reserves. Their intervention in bank accounting culminated in 2001 with new guidance (SAB 102) designed to improve financial reporting quality. We show that banks' allowance estimation changed in response to the SEC's intervention. While allowance informativeness (as proxied by the ability to explain future losses) improved for Strong Banks, informativeness declined for Weak Banks whose incentives are to understate allowances. Our results help to explain why some (Weak) banks delayed loss recognition during the recent financial crisis.

Abstract Discretionary income smoothing has been argued to increase bank opacity and degrade financial system stability by making banks more difficult to monitor. However, no direct empirical association between discretionary smoothing and opacity has been established to date. We argue that smoothing could reflect either the opportunistic exercise of discretion that disconnects loan loss provisions (LLPs) from changes in underlying credit quality, consistent with smoothing increasing opacity, or an informative exercise of discretion to communicate forward‐looking information about loan losses. We examine the association between discretionary smoothing and the informativeness of LLPs for a sample of banks from 1994 to 2019 and find that discretionary smoothing is, on average, associated with more informative LLPs. However, this association is nuanced, with cross‐sectional differences and changes over time. We find evidence that an intervention by the SEC into bank LLP practices in the late 1990s curbed opportunistic smoothing via provisioning for homogeneous loans. Subsequently, smoothing is associated with more informative provisions, including for banks with both more homogeneous and more heterogeneous loan portfolios. Our findings are inconsistent with the notion that smoothing may be associated with greater opacity.

We examine the effect of litigation risk on managers' decision to issue earnings forecasts. We use a new ex ante measure of litigation risk, namely, the Directors and Officers liability insurance premium. This choice bypasses significant problems associated with the estimation of ex ante litigation risk in prior studies. By using this measure of litigation risk, our results are more intuitively appealing. We find that when faced with ex ante litigation risk, managers with bad news are more likely to issue an earnings warning. For good news firms, we do not see this effect. We also examine three forecast characteristics: forecast horizon, extent of news revealed and forecast precision. Firms with higher litigation risk tend to issue earnings forecasts earlier if they have bad news but not so when they have good news. They also reveal less news in the forecasts if they have good news. As litigation risk increases, bad news earnings forecasts become more precise. Good news earnings forecasts, however, tend to become less precise relative to bad news forecasts. This differential effect of litigation risk on management earnings forecasts, based on the direction of news, has not been documented by previous studies.

Abstract We develop hypotheses regarding the association between two types of creditor rights and bank loan losses. Contrary to prior research conclusions, bank lending risk is negatively associated with both restrictions on reorganization and the secured creditor being paid first. Using accounting disclosures, we develop novel empirical measures of the probability of default (PD) and loss given default (LGD) at the loan-portfolio level. Different types of creditor rights have differential effects pertaining to PD and LGD and exhibit significant intertemporal variation. We corroborate our cross-country findings using the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) shock to creditor rights.

ABSTRACT We find that lower ex ante earnings volatility leads to higher Post–Earnings Announcement Drift (PEAD). PEAD is a function of both the magnitude of an earnings surprise and its persistence. While prior research has largely investigated market reactions to the magnitude of the earnings surprise, in this study we show that the persistence of the earnings surprise is equally important. A unique feature of the anomalous PEAD returns documented here concerns the association between abnormal returns and trading frictions. Besides demonstrating that firms with lower earnings volatility have higher abnormal returns, we also find that lower earnings volatility firms have lower trading frictions. Taken together, these findings imply that higher abnormal returns are associated with lower trading frictions. We exploit this implication to empirically demonstrate that PEAD returns due to earnings volatility are not concentrated in the firms with the largest trading frictions, which is in contrast to the findings in prior anomaly studies.