Showing papers in "Journal of Accounting, Auditing & Finance in 2011"
TL;DR: In this article, the impact of International Financial Reporting Standards (IFRS) on accounting quality in a regulated market, China, where new substantially IFRS-convergent accounting standards became mandatory for listed firms in 2007, was examined for the period 2005 to 2008 with only firms mandated to follow the new standards.
Abstract: As more countries consider the adoption of International Financial Reporting Standards (IFRS) that are based on practices prevalent in the English-speaking countries with free markets, it’s increasingly important to understand the impact of IFRS on countries of different institutional, economic, and political environments. This article reports a study that examines the impact of IFRS on accounting quality in a regulated market, China, where new substantially IFRS-convergent accounting standards became mandatory for listed firms in 2007. Accounting quality is examined for the period 2005 to 2008 with only firms mandated to follow the new standards. The empirical results generally indicate that accounting quality improved with decreased earnings management and increased value relevance of accounting measures in China since 2007. Firms audited by the Big Four are expected to have higher quality before the standard change evidenced quality improvement to a smaller extent. Further analysis shows that such chan...
237 citations
TL;DR: In this article, the effectiveness of enterprise risk management (ERM) has been investigated and little is known about its effectiveness, except that it is a construct that overcomes limitations of silo-based traditional risk management.
Abstract: Enterprise risk management (ERM) has emerged as a construct that ostensibly overcomes limitations of silo-based traditional risk management (TRM), yet little is known about its effectiveness. The s...
225 citations
TL;DR: The corporate governance literature advances the idea that certain aspects of a board of directors' structure improve the monitoring of managerial decisions as mentioned in this paper. Among these decisions are a manager's decision making.
Abstract: The corporate governance literature advances the idea that certain aspects of a board of directors’ structure improve the monitoring of managerial decisions. Among these decisions are a manager’s p...
175 citations
TL;DR: In this article, a positive relation between research and development (R&D) and the variaverage of the United States economy was found, consistent with the uncertainty of R&D's future benefits.
Abstract: Consistent with the uncertainty of research and development’s future benefits, prior accounting studies hypothesize and find a positive relation between research and development (R&D) and the varia...
165 citations
TL;DR: In this paper, the authors discuss the challenge of balancing relevance and reliability when establishing generally accepted accounting principles and the tension is especially heightened when setting standard setters face a perpetual challenge.
Abstract: Accounting standard setters face a perpetual challenge in balancing relevance and reliability when establishing generally accepted accounting principles. This tension is especially heightened when ...
159 citations
TL;DR: In this article, the authors examine whether higher information risk in the form of poor financial reporting quality offers an explanation for the higher expected returns of sin stocks, and they find that the reporting quality of sin firms is superior relative to a variety of control groups along two dimensions: predictability of earnings for future cash flows and timely loss recognition.
Abstract: Recent empirical evidence suggests that sin stocks—publicly traded stocks in the gaming, tobacco, alcohol, and adult entertainment industries—are neglected by stock market participants because of social norms, regulatory scrutiny, and litigation risk. Consequently, these firms experience low institutional ownership, low analyst following, and higher expected returns. This paper examines whether higher information risk in the form of poor financial reporting quality offers an explanation for the higher expected returns of sin firms. Inconsistent with this explanation, we find that the financial reporting quality of sin firms is superior relative to a variety of control groups along two dimensions: predictability of earnings for future cash flows and timely loss recognition. These results imply that, despite superior returns and higher financial reporting quality, investors are willing to neglect sin stocks and instead bear a financial cost in order to comply with societal norms and reflect non-financial ta...
131 citations
TL;DR: In this article, the authors investigate whether off-balance sheet operating leases have the same risk relevance for explaining ex ante measures of risk as a firm's on-balance-sheet capital leases.
Abstract: This study uses ex ante cost-of-equity capital measures based on accounting valuation models to assess the risk relevance of off-balance sheet operating leases. We investigate whether off-balance sheet operating leases have the same risk-relevance for explaining ex ante measures of risk as a firm’s on-balance sheet capital leases. We also investigate how investors’ risk perception of operating leases has changed in recent years when off-balance sheet transactions in general and operating leases in particular have been facing increased regulatory and investor scrutiny. This study finds that a firm’s ex ante cost-of-equity capital is positively associated with adjustments in its financial leverage (financial risk) and operating leverage (operating risk) resulting from capitalized off-balance sheet operating leases and that the positive association between the ex ante cost of capital and the impact of operating leases on a firm’s financial leverage is weaker for the operating leases compared with the capital...
76 citations
TL;DR: In this article, the effect of Section 404 of the Sarbanes-Oxley Act on two primary characteristics of earnings quality, reliability and relevance in combination was studied using a difference-in-differences method.
Abstract: In this article, the authors study the effect of Section 404 of the Sarbanes-Oxley Act on two primary characteristics of earnings quality, reliability and relevance in combination. Using a difference-in-differences method, they find that firms that were required to comply with Section 404 during the first 2 years of its implementation improved the reliability of their reported earnings more than control firms that were not required to comply. The results also suggest that the regulation helped to reduce intentional misstatement, which may contribute to the improvement in earnings reliability. Furthermore, the improvement in reliability did not come at the expense of the relevance of earnings. On the contrary, the authors find a significantly larger improvement in the predictive power of current earnings over future earnings and future cash flows associated with complying firms. As earnings quality improved, investor confidence appears to be restored, in that they reacted more strongly to earnings surprise...
67 citations
TL;DR: In this paper, the authors investigate the association between auditor-provided nonaudit tax services (NATS) and financial reporting quality for public companies in a post-Sarbanes-Oxley environment.
Abstract: In this study, the authors investigate the association between auditor-provided nonaudit tax services (NATS) and financial reporting quality for public companies in a post-Sarbanes-Oxley environment. They measure the quality of financial reporting by means of appropriately screened financial statement restatements. The Sarbanes-Oxley Act of 2002 (SOX) restricts the scope of auditor-provided tax services and simultaneously bans other major nonaudit services by the auditor. The authors argue that the restriction limits the potential financial reporting quality benefits of NATS, while the ban simultaneously makes those services a relatively more important source of revenue to the auditor, exacerbating the potential for impairment of independence. Consequently, pre-Sarbanes-Oxley results may not hold in a post-Sarbanes-Oxley environment. On examination, they find no significant association between auditor-provided NATS and general financial statement restatements. However, they find a significant negative ass...
67 citations
TL;DR: Li et al. as discussed by the authors found that Chinese family firms have higher discretionary accruals compared to non-family firms, which is consistent with the view that family firms engage in more opportunistic reporting behavior.
Abstract: We posit that family firms in China exhibit accounting properties consistent with the prevalence of Type II agency problems. In contrast to the owners of non-family firms, the owners of family firms have more incentives to seek private benefits of control at the expense of minority shareholders and provide lower-quality earnings for self-interested purposes. The empirical evidence presented in this study suggests that the accounting earnings of listed Chinese family firms are less informative, and family firms employ less conservative accounting practices than their non-family counterparts. We also find that Chinese family firms have higher discretionary accruals compared to non-family firms, which is consistent with the view that family firms engage in more opportunistic reporting behavior. Overall, our study suggests that family ownership in China is associated with lower earnings quality, which is in sharp contrast to the findings of prior studies that examine such ownership in the U.S.
64 citations
TL;DR: In this article, the authors compare firms with high and low industry-adjusted R&D intensity and find that the high intensity firms are more likely to engage in basic research activities, whereas the low Indus try-adjusted firms are likely to mimic and extend existing technologies.
Abstract: Research has established that research and development (R&D)-intensive firms are characterized by substantial future risk-adjusted stock returns. The reasons for this phenomenon and its policy implications, however, are widely debated. Some attribute the excess returns to investors' systematic undervaluation of R&D firms and argue for improved disclosure to mitigate the mispricing. whereas others claim that the excess returns are just compensating for an R&D-speciftc risk factorWe aim to provide insights into this controversy by examining R&D firms with substantial R&D outlays, that is, firms with R&D as an important ingredient in their strategy. Among such firms, we compare firms with high and low industry-adjusted R&D intensity. The high industry-adjusted R&D intensity firms are more likely to engage in basic research activities, whereas the low Indus try-adjusted R&D intensity firms are likely to mimic and extend existing technologies. As such, compared with the low industry-adjusted R&D intensity firm...
TL;DR: In this paper, the relationship between equity incentives and earnings management in the banking industry is examined, focusing on this regulated industry and using industry-specific earnings management proxies, and the relationship is examined in the context of the financial services industry.
Abstract: We examine the relationship between equity incentives and earnings management in the banking industry. By focusing on this regulated industry and using industry-specific earnings management proxies...
TL;DR: Backdating stock options, a practice that retroactively adjusts stock option grant dates to lower the exercise price, has raised governance, legal, accounting, tax, and auditing concerns.
Abstract: Backdating stock options, a practice that retroactively adjusts stock option grant dates to lower the exercise price, has raised governance, legal, accounting, tax, and auditing concerns. The pract...
TL;DR: In this article, the authors examined the effect of managerial ownership on the cost of debt as measured by the interest rate spread on corporate bonds for Japanese firms and found that managerial ownership is positively associated with interest rates.
Abstract: This article examines the effect of managerial ownership (MO) on the cost of debt as measured by the interest rate spread on corporate bonds for Japanese firms. First, the authors find that the MO is positively associated with interest rate spread after controlling for the other Japanese ownership structure, cross-shareholdings, and the stable shareholdings by financial institutions. Second, by employing factor analysis to measure the agency cost of debt (ACD) based on financial variables, the authors also find that MO has higher correlation with interest rate spread when the ACD at the time of bond issue is already larger. The results are robust to additional analyses, including the possibility of nonlinear relationship, bond rating, endogeneity problem, and Fama and MacBeth approach. The results suggest that prospective bondholders use MO information to anticipate a firm’s future ACD and estimate it higher when the current ACD at issuing bond is already larger. The results also suggest that accounting i...
TL;DR: This article used a large sample of critical accounting policies (CAPs) from SEC filers and found limited support for disclosure decisions following a portfolio rather than an account-by-account approach.
Abstract: To increase investor awareness of the sensitivity of financial statements to the methods, assumptions, and estimates underlying their preparation, the Securities and Exchange Commission (SEC) proposed that firms include disclosures about critical accounting policies (CAPs) in their 10-Ks. Using a large sample of CAP disclosures from SEC filers, we provide evidence on the extent to which CAP disclosures correlate with existing financial statement information, provide new information, and corroborate theories of voluntary disclosure. We also consider the interaction among disclosures, finding limited support for disclosure decisions following a portfolio rather than an account by account approach.
TL;DR: In this paper, the authors systematically studied analysts' notes, an important form of analyst disclosure not previously studied in the literature, and found that analyst notes are written disclosures that represent a product o...
Abstract: This paper systematically studies analysts’ notes, an important form of analyst disclosure not previously studied in the literature. Analyst notes are written disclosures that represent a product o...
TL;DR: In this paper, the authors examined the extent to which analyst recommendations were useful in identifying earnings surprises during the pre- and post-Regulation Fair Disclosure (FD) periods and found that the average abnormal return earned by investors following analysts' advice to exploit earnings surprises is approximately 70% lower in the post-regulation FD period.
Abstract: This study examines the extent to which analyst recommendations were useful in identifying earnings surprises during the pre- and post-Regulation Fair Disclosure (FD) periods. A comparative analysis of the association between recommendation revisions and subsequent earnings surprises suggests a significant decline in the predictive value of analysts’ recommendations after Regulation FD took effect. Recommendation revisions are roughly 55% less useful in predicting earnings surprises in the post-Regulation FD period. Furthermore, the average abnormal return earned by investors following analysts’ advice to exploit earnings surprises is approximately 70% lower in the post-Regulation FD period. Overall, this article’s findings are consistent with Regulation FD having considerably reduced analysts’ comparative advantage in identifying earnings surprises.
TL;DR: This article examined investors' reactions to dividend reductions or omissions conditional on past earnings and dividend patterns for a sample of eighty-two U.S. firms that incurred an annual loss.
Abstract: This paper examines investors' reactions to dividend reductions or omissions conditional on past earnings and dividend patterns for a sample of eighty-two U.S. firms that incurred an annual loss. We document that the market reaction for firms with long patterns of past earnings and dividend payouts is significantly more negative than for firms with lessestablished past earnings and dividends records. Our results can be explained by the following line of reasoning. First, consistent with DeAngelo, DeAngelo, and Skinner (1992), a loss following a long stream of earnings and dividend payments represents an unreliable indicator of future earnings. Thus, established firms have higher loss reliability than less-established firms. Second, because current earnings and dividend policy are a substitute source of means of forecasting future earnings, lower loss reliability increases the information content of dividend reductions. Therefore, given the presence of a loss, the longer the stream of prior earnings and dividend payments, (1) the lower the loss reliability and (2) the more reliably dividend cuts are perceived as an indication that earnings difficulties will persist in the future.
TL;DR: In this paper, the authors study the economic importance of accounting information as defined by the value that a sophisticated investor can extract from publicly available financial statements when optimizing a portfolio of U.S. equities.
Abstract: We study the economic importance of accounting information as defined by the value that a sophisticated investor can extract from publicly available financial statements when optimizing a portfolio of U.S. equities. Our approach applies the elegant new parametric portfolio policy method of Brandt, Santa-Clara, and Valkanov (2009) to three simple and firm-specific annual accounting characteristics-accruals, change in earnings, and asset growth. We find that the set of optimal portfolio weights generated by accounting characteristics yield an out-of-sample, pre-transact ions-costs annual information ratio of 1.9 as compared to 1.5 for the standard price-based characteristics of firm size, book-to-market, and momentum. We also find that the delevered hedge portion of the accounting-based optimal portfolio was especially valuable during the severe bear market of 2008 because unlike many hedge finds it delivered a hedged return in 2008 of 12 percent versus only 3 percent for price-based strategies and −38 perc...
TL;DR: In this article, the authors examine one market-based motivation suggested for managers to manage earnings upward to meet the earnings threshold: they perceive the market penalty for barely missing an earnings threshold to be disproportionately high (i.e., a torpedo effect).
Abstract: General evidence indicates that managers manage earnings at three common earnings thresholds: analyst forecasts, prior period earnings, and zero earnings. We examine one market-based motivation suggested for this behavior. If managers perceive the market penalty for barely missing an earnings threshold to be disproportionately high (i.e., a torpedo effect), they may use discretion to manage earnings upward to meet the earnings threshold. This market-based incentive would explain the evidence in favor of earnings management at earnings thresholds. To test the existence of a torpedo effect, we employ a comprehensive model that measures the market’s reaction to reported earnings that barely miss earnings thresholds. This model controls for the level of unexpected earnings and several other firm characteristics known to affect the relation between returns and earnings. Overall, we conclude that there is little evidence of a torpedo effect. This conclusion holds for both low-growth and high-growth firms and is...
TL;DR: The authors found that the likelihood of misreporting is positively related to bank borrowing and that bank debt may even provide incentives for managers to misreport, consistent with the debt covenant hypothesis.
Abstract: Two different bodies of literature suggest contradictory relations between the likelihood that a firm misreports its financial statement and the use of debt in its capital structure. We test these relations using three different measures of misreporting and find that the results differ depending upon the materiality of misreporting. For relatively less (more) material misreporting, we find the likelihood of misreporting is positively related (unrelated) to bank borrowing. These results suggest that bank monitoring is insufficient to deter or detect misreporting and that bank debt may even provide incentives for managers to misreport, consistent with the “debt covenant hypothesis.”
TL;DR: This paper examined the cross-sectional association between earnings announcement timing and analyst following that precede the post-Regulation Fair Disclosure (Reg FD) era, using a large sample of firms in the post -Reg FD era.
Abstract: Using a large sample of firms in the post–Regulation Fair Disclosure (Reg FD) era, we examine the cross-sectional association between earnings announcement timing and analyst following that precede...
TL;DR: In this article, the authors examined whether the relationship between firm-level innovation and operating performance is conditional on the success of a firm's R&D efforts and found that some results are consistent with expectations and some other results are not.
Abstract: Pandit, Wasley, and Zach (2011) examine whether both research and development (R&D) input (R&D expenditures) and output measures (patent counts and citations) and their interaction associate with the level and variability of future earnings and operating cash flows. The associations examined contribute to the literature because they help determine whether the relationship between firm-level innovation and operating performance is conditional on the success of a firm’s R&D efforts. The conditioning is important because it can sort out more successful from less successful R&D firms. In my discussion, I focus on the models employed and on the empirical results. Some results are consistent with expectations and some other results are not. I think that the mixed results are due to the models employed and I make some suggestions for model improvements.
TL;DR: In this article, the authors investigated whether financial analysts' characteristics are associated with their asymmetric response of stock recommendations between positive and negative information shocks, and they found that the asymmetric reaction is less for analysts with characteristics that are indicative of higher quality.
Abstract: This article investigates whether financial analysts’ characteristics are associated with their asymmetric response of stock recommendations between positive and negative information shocks. The authors hypothesize that incentives exist such that quality attributes that differentiate analysts are positively associated with the timely revelation of negative news about a firm. As a result, the authors expect the asymmetric response to be reduced for superior analysts. Using the stock return/recommendation changes relationship, they find that the asymmetric reaction is less for analysts with characteristics that are indicative of higher quality. Furthermore, the reduction is more pronounced for analysts in the top decile and is only present when analysts have negative private information. This article therefore contributes to the research on differing analyst characteristics and report quality, and provides additional insights on analyst bias.
TL;DR: In this paper, the authors examine firms' critical accounting policy (CAP) disclosures and find evidence consistent with CAP disclosure influencing investors' valuation decisions, and raise some questions about what we can and cannot learn from their findings.
Abstract: Carolyn B. Levine and Michael J. Smith (2011) examine firms’ critical accounting policy (CAP) disclosures. With respect to motivation for disclosure, Levine and Smith (2011) document an increased likelihood of CAP disclosure for firms facing high ex ante litigation risk. Focusing on the informational value of disclosure, they find evidence consistent with CAP disclosure influencing investors’ valuation decisions. Although the paper provides a large sample analysis of a relatively new accounting disclosure practice, I raise some questions about what we can (and cannot) learn from their findings. In so doing, I highlight potential topics for future research.
TL;DR: Ciftci, Baruch Lev, and Suresh Radhakrishnan as discussed by the authors provide an interesting and innovative look at the question of mispricing and compensation for bearing risk related to research and develo...
Abstract: Mustafa Ciftci, Baruch Lev, and Suresh Radhakrishnan (2011) provide an interesting and innovative look at the question of mispricing and compensation for bearing risk related to research and develo...