Earnings Management and Investor Protection: An International Comparison

We review and evaluate the methods commonly used in the accounting literature to correct for cross-sectional and time-series dependence. While much of the accounting literature studies settings where variables are cross-sectionally and serially correlated, we find that the extant methods are not robust to both forms of dependence. Contrary to claims in the literature, we find that the Z2-statistic and Newey-West corrected Fama-MacBeth do not correct for both cross-sectional and time-series dependence. We show that extant methods produce misspecified test statistics in common accounting research settings, and that correcting for both forms of dependence substantially alters inferences reported in the literature. Specifically, several findings in the cost of equity capital literature, the cost of debt literature, and the conservatism literature appear not to be robust to the use of well-specified test statistics.

Correcting for Cross-Sectional and Time-Series Dependence in Accounting Research

Our paper examines whether audit quality is higher for industry audit specialists at the national and city-office levels using the framework developed in Ferguson et al. [2003] and Francis et al. [2005]. We find that auditors who are both national and city-specific industry specialists have clients with the lowest abnormal accruals, suggesting that joint national and city-specific industry specialists have the highest audit quality. In addition, we find some evidence that abnormal accruals of firms audited by city-industry specialists alone (without also being national specific industry specialists) are lower than those audited by non-industry specialists. Using alternative measures of audit quality, we find that when the auditor is both a national and a city-specific industry specialist, its clients are less likely to meet or beat analysts’ earnings forecasts by one penny per share and more likely to be issued a going-concern audit opinion. Together these results provide consistent evidence that audit quality is higher when the auditor is both a national and city-specific industry specialist, suggesting that auditors’ national positive network synergies and the individual auditors’ deep industry knowledge at the office level are jointly important factors in delivering higher audit quality.

National and Office-Specific Measures of Auditor Industry Expertise and Effects on Audit Quality

Our paper examines whether audit quality is higher for industry audit specialists at the national and city-office levels using the framework developed in Ferguson et al. [2003] and Francis et al. [2005]. We find that auditors who are both national and city-specific industry specialists have clients with the lowest abnormal accruals, suggesting that joint national and city-specific industry specialists have the highest audit quality. In addition, we find some evidence that abnormal accruals of firms audited by city-industry specialists alone (without also being national specific industry specialists) are lower than those audited by nonindustry specialists. Using alternative measures of audit quality, we find that when the auditor is both a national and a city-specific industry specialist, its clients are less likely to meet or beat analysts' earnings forecasts by one penny per share and more likely to be issued a going-concern audit opinion. Together these results provide consistent evidence that audit quality is higher when the auditor is both a national and city-specific industry specialist, suggesting that auditors' national positive network synergies and the individual auditors' deep industry knowledge at the office level are jointly important factors in delivering higher audit quality.

National and Office-Specific Measures of Auditor Industry Expertise and Effects on Audit Quality*

We review accounting and finance research on corporate governance (CG). In the course of our review, we focus on a particularly vexing issue, namely endogeneity in the relationships between CG and other matters of concern to accounting and finance scholars, and suggest ways to deal with it. Given the advent of large commercial CG databases, we also stress the importance of how CG is measured and in particular, the construction of CG indices, which should be sensitive to local institutional arrangements, and the need to capture both internal and external aspects of governance. The ‘stickiness’ of CG characteristics provides an additional challenge to CG scholars. Better theory is required, for example, to explain whether various CG practices substitute for each other or are complements. While a multidisciplinary approach to developing better theory is never without its difficulties, it could enrich the current body of knowledge in CG. Despite the vastness of the existing CG literature, these issues do suggest a number of avenues for future research.

Corporate governance, accounting and finance: A review

This study investigates the effect of firms' adoption of SFAS No. 131 segment disclosure rules on the stock market's ability to predict the firms' earnings, as captured by the forward earnings response coefficient (FERC). The FERC is the association between current‐year returns and next‐year earnings. SFAS No. 131, effective for fiscal years beginning after December 15, 1997, arguably increased both the quantity and quality of segment disclosure. Consistent with the standard's intended qualitative effects, pre‐131 multi‐segment firms experienced a significant increase in FERC after adopting SFAS No. 131. Consistent with the standard's intended quantitative effects, many pre‐131 single‐segment firms began disclosing multiple segments, and those that did experienced an increase in FERC. However, pre‐131 single‐segment firms that remained single segment (i.e., were unaffected by SFAS No. 131) had no change in FERC, indicating that the increase in FERC for 131‐affected firms is not due to some other event con...

https://www.jstor.org/stable/pdfplus/4093176.pdf

The Impact of SFAS No. 131 Business Segment Data on the Market's Ability to Anticipate Future Earnings

This paper extends prior studies in auditor industry specialization to an international setting and examines if the impact of industry specialist auditors on earnings quality is dependent on the legal environments Using data for 28 countries over 20 industries from 1993 to 2003, we find that clients of industry specialist auditors have lower discretionary current accruals and higher earnings response coefficients than clients of nonspecialist auditors In addition, we find that the impact of auditor industry specialization on earnings quality increases as the legal environment weakens Collectively, the results suggest that the benefits from engaging the services of industry specialist auditors increase as a country's legal environment shifts from a strong to a weak environment Our results are robust to the inclusion of additional control variables

Legal Systems and Earnings Quality: The Role of Auditor Industry Specialization

Ownership structure and earnings informativeness: Evidence from Korea

Our study assesses whether SFAS No. 131 improved disclosure about the diversity of multiple segment firms' operations. We find a post-SFAS No. 131 increase in cross-segment variability of segment profits, an increase in the association between reported and inherent cross-segment variability, and an increase in association between reported variability and capital market incentives to disclose. We interpret the results as evidence that SFAS No. 131 increased the transparency of segment profitability disclosures, and as indicating SFAS No. 131 allowed firms depending more on external financing to disclose more about differences in segment profitability.

The Effect of SFAS No. 131 on the Cross-Segment Variability of Profits Reported by Multiple Segment Firms

Our study assesses whether SFAS No. 131 improved disclosure about the diversity of multiple segment firms’ operations. We find a post-SFAS No. 131 increase in cross-segment variability of segment profits, an increase in the association between reported and inherent cross-segment variability, and an increase in association between reported variability and capital market incentives to disclose. We interpret the results as evidence that SFAS No. 131 increased the transparency of segment profitability disclosures, and as indicating SFAS No. 131 allowed firms depending more on external financing to disclose more about differences in segment profitability.

/pdf/the-effect-of-sfas-no-131-on-the-cross-segment-variability-1tae2layw8.pdf

Soo Young Kwon

Papers

The Impact of SFAS No. 131 Business Segment Data on the Market's Ability to Anticipate Future Earnings

Legal Systems and Earnings Quality: The Role of Auditor Industry Specialization

Ownership structure and earnings informativeness: Evidence from Korea

The Effect of SFAS No. 131 on the Cross-Segment Variability of Profits Reported by Multiple Segment Firms

The Effect of SFAS No. 131 on the Cross-Segment Variability of Profits Reported by Multiple Segment Firms