James Jiambalvo

Bio: James Jiambalvo is an academic researcher from University of Washington. The author has contributed to research in topics: Earnings & Audit. The author has an hindex of 18, co-authored 24 publications receiving 7658 citations.

The Effect of Audit Quality on Earnings Management

Abstract: This study examines the relation between audit quality and earnings management. Consistent with prior research, we treat audit quality as a dichotomous variable and assume that Big Six auditors are of higher quality than non-Big Six auditors. Earnings management is captured by discretionary accruals that are estimated using a cross-sectional version of the Jones 1991 model. Prior literature suggests that auditors are more likely to object to management's accounting choices that increase earnings (as opposed to decrease earnings) and that auditors are more likely to be sued when they are associated with financial statements that overstate earnings (as compared to understate earnings). Therefore, we hypothesize that clients of non-Big Six auditors report discretionary accruals that increase income relatively more than the discretionary accruals reported by clients of Big Six auditors. This hypothesis is supported by evidence from a sample of 10,379 Big Six and 2,179 non-Big Six firm years. Specifically, clients of non-Big Six auditors report discretionary accruals that are, on average, 1.5-2.1 percent of total assets higher than the discretionary accruals reported by clients of Big Six auditors. Also, consistent with earnings management, we find that the mean and median of the absolute value of discretionary accruals are greater for firms with non-Big Six auditors. This result also indicates that lower audit quality is associated with more “accounting flexibility”.

Institutional Ownership and the Extent to which Stock Prices Reflect Future Earnings

Abstract: Articles in the financial press suggest that institutional investors are overly focused on current profitability, which suggests that as institutional ownership increases, stock prices reflect less current period information that is predictive of future period earnings. On the other hand, institutional investors are often characterized in academic research as sophisticated investors and sophisticated investors should be better able to use current-period information to predict future earnings compared with other owners. According to this characterization, as institutional ownership increases, stock prices should reflect more current-period information that is predictive of future period earnings. Consistent with this latter view, we find that the extent to which stock prices lead earnings is positively related to the percentage of institutional ownership. This result holds after controlling for various factors that affect the relation between price and earnings. It also holds when we control for endogenous portfolio choices of institutions (e.g., institutional investors may be attracted to firms in richer information environments where stock prices tend to lead earnings). Further, a regression of stock returns on order backlog, conditional on the percentage of institutional ownership, indicates that institutional owners place more weight on order backlog compared with other owners. This result is consistent with institutional owners using non-earnings information to predict future earnings. It also explains, in part, why prices lead earnings to a greater extent when there is a higher concentration of institutional owners.

Factors Related to Auditor-Client Disagreements over Income-Increasing Accounting Methods*

Abstract: . The Securities and Exchange Commission requires disclosure of auditor-client disagreements that precede a change in auditor. Although prior research has documented that disclosure of disagreements is associated with a decline in equity value, no empirical work has examined factors that result in auditor-client disagreements. We hypothesize that managers are motivated by debt and compensation arrangements to propose methods that are objected to by their auditors (resulting in a disagreement). Because of their greater independence, we also hypothesize that reported disagreements will be more likely for Big Eight (now Big Six) auditors, A comparison of 40 firms that changed auditors and reported a disagreement with a control group of 40 firms that simply changed auditors revealed that disagreement firms are more likely to have debt covenant violations. Disagreement firms are also more likely to have higher leverage, a decline in earnings, and Big Eight auditors. For firms that disclosed the magnitude of the disagreement's effect on earnings, the use of the questionable procedure tended to enhance “flat” earnings growth. Resume. La Securities and Exchange Commission exige que soit publiee l'information relative aux desaccords verificateur-client qui precedent un changement de verificateurs. Bien que les recherches anterieures aient demontre que la publication de cette information est accompagnee d'un declin de la valeur des titres, aucun travail empirique n'a examine les facteurs qui sont a l'origine des desaccords verificateur-client. Les auteurs posent l'hypothese selon laquelle ce sont le passif et les regimes de remuneration qui motivent les gestionnaires a proposer des methodes auxquelles s'opposent les verificateurs (et qui donnent lieu a un desaccord). Les auteurs posent egalement l'hypothese selon laquelle il est plus probable que les desaccords declares mettent en cause les huit grands cabinets d'experts-comptables (maintenant les six grands), etant donne leur independance plus grande. La comparaison de 40 entreprises ayant change de verificateurs et fait etat d'un desaccord a un groupe de controle de 40 entreprises ayant simplement change de verificateurs a revele que les entreprises en desaccord sont davantage susceptibles d'avoir deroge a des clauses restrictives. Les entreprises qui declarent etre en desaccord avec leurs verificateurs sont aussi davantage susceptibles d'etre caracterisees par un levier financier eleve, un declin dans les benefices et le recours aux services d'un cabinet d'experts-comptables appartenant aux huit grands. Dans le cas des entreprises qui ont fait etat de l'ampleur des consequences du desaccord sur les benefices, l'utilisation du procede discutable a eu tendance a favoriser une croissance « horizontale » des benefices.

Do Stock Prices Fully Reflect the Implications of Special Items for Future Earnings

Abstract: Previous research (Rendleman, Jones, and Latane [1987]; Freeman and Tse [1989]; Bernard and Thomas [1990]; and Ball and Bartov [1996]) indicates that security prices do not fully reflect predictable elements of the relation between current and future quarterly earnings. We investigate whether this finding also holds for the special items component of earnings. Given that special items are prominent in financial analysis and are assumed to have relatively straightforward implications for future earnings (special items are assumed to be largely transitory), one might expect that prices would fully impound the implications of special items for future earnings. Based on the “two-equation” approach used in Ball and Bartov [1996] and other studies (e.g., Abarbanell and Bernard [1992]; Sloan [1996]; Rangan and Sloan [1998]; and Soffer and Lys [1999]), we find that while prices reflect relatively more of the effects of special items compared to other earnings components, we still reject the null hypothesis that prices fully impound the implications of special items for future earnings. The “two-equation” approach assesses the consistency of coefficients in a pair of prediction and pricing equations, and thus depends on an assumed functional form. However, a less structured abnormal returns methodology like that used in Bernard and Thomas [1990] also supports the conclusion that the implications of special items are not fully impounded in prices. Specifically, a trading strategy based only on the sign of special items earns small but statistically significant abnormal returns during a 3-day window four quarters subsequent to the original announcement of special items.

Detecting Earnings Management

Abstract: This paper evaluates alternative models for detecting earnings management. The paper restricts itself to models that assume the construct being managed is discretionary accruals, since such models are commonly used in the extant accounting literature. Existing models range from simple models in which discretionary accruals are measured as total accruals, to more sophisticated models that separate total accruals into a discretionary and a non-discretionary component. Prior to this paper, there had been no systematic evidence bearing on the relative performance of these alternative models at detecting earnings management. This paper evaluates the relative performance of the competing models by comparing the specification and power of commonly used test statistics across the measures of discretionary accruals generated by each model. The specification of the test statistics is evaluated by examining the frequency with which they generate type I errors for a random sample of firm-years and for samples of firm-years with extreme financial performance. We focus on samples with extreme financial performance because the stimuli investigated in previous research are frequently correlated with financial performance. The first sample of firms are targeted by the Securities and Exchange Commission for allegedly overstating annual earnings and the second sample is created by artificially introducing earnings management into a random sample of firms.

Regression Diagnostics: Identifying Influential Data and Sources of Collinearity

Abstract: 1. Introduction and Overview. 2. Detecting Influential Observations and Outliers. 3. Detecting and Assessing Collinearity. 4. Applications and Remedies. 5. Research Issues and Directions for Extensions. Bibliography. Author Index. Subject Index.

Detecting earnings management

Abstract: This paper evaluates alternative accrual-based models for detecting earnings management. The evaluation compares the specification and power of commonly used test statistics across the measures of discretionary accruals generated by the models and provides the following major insights. First, all of the models appear well specified when applied to a random sample of firm-years. Second, the models all generate tests of low power for earnings management of economically plausible magnitudes (e.g., one to five percent of total assets). Third, all models reject the null hypothesis of no earnings management at rates exceeding the specified test-levels when applied to samples of firms with extreme financial performance. This result highlights the importance of controlling for financial performance when investigating earnings management stimuli that are correlated with financial performance. Finally, a modified version of the model developed by Jones (1991) exhibits the most power in detecting earnings management.

Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC*

Abstract: . This study investigates firms subject to accounting enforcement actions by the Securities and Exchange Commission for alleged violations of Generally Accepted Accounting Principles. We investigate: (i) the extent to which the alleged earnings manipulations can be explained by extant earnings management hypotheses; (ii) the relation between earnings manipulations and weaknesses in firms' internal governance structures; and (iii) the capital market consequences experienced by firms when the alleged earnings manipulations are made public. We find that an important motivation for earnings manipulation is the desire to attract external financing at low cost. We show that this motivation remains significant after controlling for contracting motives proposed in the academic literature. We also find that firms manipulating earnings are: (i) more likely to have boards of directors dominated by management; (ii) more likely to have a Chief Executive Officer who simultaneously serves as Chairman of the Board; (iii) more likely to have a Chief Executive Officer who is also the firm's founder, (iv) less likely to have an audit committee; and (v) less likely to have an outside blockholder. Finally, we document that firms manipulating earnings experience significant increases in their costs of capital when the manipulations are made public. Resume. Les auteurs analysent les entreprises assujetties aux mesures d'execution prises par la Securities and Exchange Commission dans les cas de presomption de transgression des principes comptables generalement reconnus. Ils s'interessent aux aspects suivants de la question: i) la mesure dans laquelle les presomptions de manipulations des benefices peuvent etre expliquees par les hypotheses existantes de gestion des benefices; ii) la relation entre les manipulations de benefices et les faiblesses des structures de regie interne des entreprises; et iii) la reaction du marche financier a l'endroit des entreprises au sujet desquelles les presomptions de manipulation des benefices sont rendues publiques. Les auteurs constatent qu'un incitatif majeur a la manipulation des benefices est le desir d'obtenir du financement externe a moindre cout. Ils demontrent que cet incitatif demeure important meme apres le controle des motifs contractuels que mettent de l'avant les travaux theoriques. Ils constatent egalement que les entreprises qui manipulent les benefices sont: i) davantage susceptibles d'avoir des conseils d'administration domines par la direction; ii) davantage susceptibles d'avoir un chef de la direction qui joue simultanement le role de president du conseil; iii) davantage susceptibles d'avoir un chef de la direction qui est egalement le fondateur de l'entreprise; iv) moins susceptibles d'avoir un comite de verification; et v) moins susceptibles d'avoir un bloc de titres detenus par un actionnaire exterieur. Enfin, les auteurs etablissent le fait que le cout du capital, pour les entreprises qui manipulent les benefices, enregistre des hausses appreciables lorsque ces manipulations sont rendues publiques.