Showing papers in "Journal of Business Finance & Accounting in 2005"

Board Monitoring and Earnings Management: Do Outside Directors Influence Abnormal Accruals?

Abstract: This paper examines whether the incidence of earnings management by UK firms depends on board monitoring. We focus on two aspects of board monitoring: the role of outside board members and the audit committee. Results indicate that the likelihood of managers making income-increasing abnormal accruals to avoid reporting losses and earnings reductions is negatively related to the proportion of outsiders on the board. We also find that the chance of abnormal accruals being large enough to turn a loss into a profit or to ensure that profit does not decline is significantly lower for firms with a high proportion of outside board members. In contrast, we find little evidence that outside directors influence income-decreasing abnormal accruals when pre-managed earnings are high. We find no evidence that the presence of an audit committee directly affects the extent of income-increasing manipulations to meet or exceed these thresholds. Neither do audit committees appear to have a direct effect on the degree of downward manipulation, when pre-managed earnings exceed thresholds by a large margin. Our findings suggest that boards contribute towards the integrity of financial statements, as predicted by agency theory.

Evaluating the performance of ethical and non-ethical funds: a matched pair analysis

Abstract: This paper studies the performance of 60 European funds from four countries. The paper extends the UK matched pair approach for fund evaluation developed by Mallin et al. (1995) to a European setting. The findings suggest that there is no difference between ethical and non-ethical funds according to the performance measures employed. Neither type of fund displayed any ability to time the market. Finally, the results indicate that the management fee is a significant explanatory variable for the Jensen measure as Chen et al. (1992) and Grinblatt and Titman (1994) suggested.

The Impact on UK Acquirers of Domestic, Cross-border, Public and Private Acquisitions

Abstract: We examine the announcement and post‐acquisition share returns of UK acquirers in over 4,000 acquisitions of domestic, cross‐border, public and private targets. Domestic public acquisitions result in negative announcement and post‐acquisition returns, whilst cross‐border public acquisitions result in zero announcement returns and negative post‐acquisition returns. In contrast, both domestic and cross‐border private acquisitions result in positive announcement returns and zero post‐acquisition returns. The main differences between private and public acquisitions are that glamour acquirers underperform in public acquisitions but not in private acquisitions, and that acquirers using noncash methods of payment underperform in domestic public acquisitions but not in domestic private acquisitions. Overall, cross‐border acquisitions result in lower announcement and long run returns than domestic acquisitions. In cross‐border acquisitions, those involving high‐tech firms perform relatively well, as do those with low national cultural differences.

Intangible Assets, Information Complexity, and Analysts’ Earnings Forecasts

Abstract: We examine the relation between analysts' earnings forecasts and firms' intangible assets, including technology-based intangibles, brand names, and recognized intangibles. We predict that high information complexity of intangible assets increases the difficulty for analysts to assimilate information and increases analysts' forecast error of intangibles-intensive firms. We find a positive association between analysts' forecast error and the firm's intangible intensity that deviates from the industry norm. We also find that analysts' forecast errors are greater for firms with diverse and innovative technologies. In contrast, analysts' forecast errors are smaller for biotech/pharmaceutical and medical equipment firms that are subject to intangibles-related regulation.

Institutional Traders’ Behavior in an Emerging Stock Market: Empirical Evidence on Polish Pension Fund Investors

Abstract: In this paper, we contribute to the literature on institutional herding and feedback trading by analysing the investment behavior of pension funds on the Polish stock market Pension funds entered into the stock market due to the national pension system reform in 1999, providing a unique opportunity to receive deeper insight into the behavior of institutional investors in an emerging capital market Our results show that Polish pension fund investors are to a greater extent involved in herd-like behavior and pursue feedback trading strategies more often than their counterparts in mature markets This finding is primarily attributed to a stringent investment regulation and high market concentration We do not detect, however, that trading by the pension funds exerts significant influence on the future stock prices

The Effect of Earnings Management on the Asymmetric Timeliness of Earnings

Abstract: Is earnings management affecting (driving) the measures of earn- ings conservatism? Ball et al. (2000) point out that the asymmetry in the recogni- tion of good and bad news in earnings (faster recognition of bad news: earnings conservatism) is more pronounced in common-law than in code-law based accounting regimes. However, comparative studies on earnings conservatism in Europe have failed to identify significant differences between common-law and code-law based countries. We argue that in code-law based countries managers have incentives to reduce earnings consistently. This enhances the association between earnings and returns in bad news periods. We find that after controlling for discretionary accruals, the differential earnings response to bad news in Germany and France decreases significantly.

Boards of Directors, Market Discipline and Firm Performance

Abstract: The board of directors is generally seen as an important internal governance structure. However, the empirical evidence on the board-performance relationship is not conclusive. On the other hand, a growing literature suggests that different control mechanisms, either internal or external to the firm, can interact with each other and affect performance. One such important factor is product market competition. The objective of the study is to investigate further the board-performance relationship taking into consideration the potential effect of market competition. More precisely, the study analyzes the combined effect of boards of directors’ characteristics, and market discipline on firm performance. Overall, the results suggest that competition has a positive and significant impact on firm profitability and productivity. Moreover, this determinant factor creates the conditions for which the board-performance relationship is supported. In other words, for boards to be effective, firms should be exposed to a competitive environment.

Cost of Capital, Strategic Disclosures and Accounting Choice

Abstract: Research by Botosan and Plumlee (2002) finds that firms’ cost of capital increases the more timely are disclosures B&P propose this can occur because more frequent disclosure can lead to increased volatility, which in turn increases cost of capital While not disputing that increased frequency can lead to increased volatility we consider an alternative explanation for the B&P results We suggest that the results may be driven by too restrictive a view having been taken concerning what constitutes corporate communication In particular, implicit in the B&P analysis is an assumption that the whole communication strategy space is identified when testing the linkage between voluntary disclosures and the cost of capital We suggest that such an assumption may be highly unrealistic in practice Firms use a mix of message spaces to communicate with capital markets In this research we consider empirically how to reinterpret and test B&P like hypotheses when firms are assumed to communicate along two strategic dimensions: via disclosures concerning strategic ventures, and in addition via choice of accounting policy Contrary to B&P, we find a negative relationship between our measure of timely disclosure and cost of equity capital Second, we find that firms making aggressive accounting choices have higher costs of capital than firms making conservative accounting choices Finally, we find that firms that choose aggressive accounting policies can lower their cost of capital via increased disclosure whereas no such relationship is observed for ‘conservative’ firms This is consistent with theory, that conservative firms benefit from lower cost of capital regardless of disclosure policy, therefore their disclosure policy may be driven by the fact that they perceive that benefits from increased disclosure are dominated by the costs

Corporate Dividend Policy: The Views of British Financial Managers

Abstract: Using a survey approach, this paper examines the importance and relevance of the various theories of dividend policy for UK companies. Further, it evaluates the extent to which corporate characteristics such as size and industry influence managerial responses to the survey. In general, the results support dividend hypotheses relating to signalling and ownership structure, in preference to those about capital structure and investment decisions and agency issues. At a more detailed level, the cross sectional analysis reveals important differences between managers’ responses, based on company size, industry sector, growth opportunities, ownership structure and information asymmetry.

Are Unsolicited Credit Ratings Lower? International Evidence From Bank Ratings

Abstract: In recent years credit rating agencies have started rating firms who have not asked for a rating. Recipients of unsolicited ratings argue that the assigned ratings are too low and reflect a lack of comprehensive knowledge of the rated firms. We set out to examine these claims using a comprehensive and international sample of 1,060 bank ratings. Our results show that there is a significant difference in the distributions of ratings, and the shadow group has lower ratings. The results also indicate that banks that received shadow ratings are smaller and have weaker financial profiles than banks that have other ratings. This explains, in part, the lower ratings. In addition, we develop a model to explain bank ratings. The two-step treatment effects model shows that bank size, profitability, asset quality, liquidity, and sovereign credit risk are important factors in determining bank ratings.

Trade Credit Terms: Asymmetric information and price discrimination evidence from three continents

Abstract: Trade credit terms offer firms contractual solutions to informational asymmetries between buyers and sellers. The credit period permits buyers to reduce uncertainty concerning product quality prior to payment, while the seller can reduce uncertainty concerning buyer payment intentions by prescribing payment before/on delivery or through two-part payment terms and other mechanisms. Variation in trade credit terms also offers firms price discriminating opportunities. This study, drawing on the responses of 700 large firms in the US, UK and Australia, explores trade credit terms through the twin objectives of reducing information asymmetries and discriminatory pricing. Support is found for both theories.

Earnings conservatism, litigation and contracting: The case of cross-listed firms

Abstract: We compare earnings conservatism of UK companies cross-listed in the US to that of UK companies without a US-listing. We expect that conservatism will be more pronounced for cross-listed firms than for firms with a UK listing only, because the cross-listed firms face a stricter enforcement regime. Furthermore, cross-listed firms may use a listing on a US exchange to signal high-quality reporting to investors. Using a matched-pairs research design, we find that earnings of UK cross-listed firms are significantly more conservative than earnings of UK firms without a US listing. Moreover, cross listed firms display particularly high levels of conservatism during the early years of their cross-listing. This indicates that firms use earnings conservatism to commit to highly demanding reporting requirements and in doing so communicate a perception of investor care.

Performance of private to public MBOs: The role of venture capital

Abstract: Using a unique dataset, we examine financial performance, arid venture capital involvement in 167 MBOs exiting through IPOs (MBO-IPOs) on the London Stock Exchange, during the period 1964 -1997. VC backed MBOs seem to be more underpriced than MBOs without venture capital backing, based on average value-weighted returns. MBOs backed by highly reputable VCs tend to be older companies, and exit earlier than MBOs backed by less reputable VCs. The results contradict 'certification' and 'grandstanding' hypotheses supported by US data (Meggirison arid Weiss, 1991; arid Gompers, 1996, respectively). We found no evidence of either significant underperformance, or that VC backed MBOs perform better than their non-VC backed counterparts in the long run. However, MBOs backed by highly reputable venture capital firms seem to be better long-term investments as compared to those backed by less prestigious venture capitalist firms. The results remain robust after using different methods to measure performance, and after controlling for sample selectivity bias. © Blackwell Publishing Ltd. 2005.

Incentive Effects, Monitoring Mechanisms and the Market for Corporate Control: An Analysis of the Factors Affecting Public to Private Transactions in the UK

Abstract: This paper investigates the factors that influence the decision to change the status of a publicly quoted company to that of a private company. We find that firms that go private are more likely to have higher CEO ownership and higher institutional ownership. In relation to their board structures, firms going private tend to have more duality but there is no statistical difference in the proportion of non-executive directors. They do not show signs of having excess free cash flows but there is some evidence of lower growth opportunities. We do not find that firms going private experience a greater threat of hostile acquisition. The results are therefore consistent with incentive and monitoring explanations of going private. Calculation of the probability of going private shows that incentive effects are stronger than the monitoring effects.

The Impact of Managing Director Changes and Financial Distress on Audit Qualification and Auditor Switching

Abstract: This study examines the interactive effects of change in managing director/chief executive officer (MD) and financial distress together with five control variables (type of audit firm; audit fees; gearing; time; and company size) on first, audit opinion and secondly on auditor switching. Based on a sample of 297 UK listed companies between 1987 and 2001, we find that companies that are financially distressed and change their MD are most likely to receive a qualified audit report, ceteris paribus. In addition, we find evidence of both familiarity and intimidation threats and that the probability of a switch increases with the severity of qualification.

The Pricing of Dividends in Equity Valuation

Abstract: This study uses Ohlson's (1995 and 2001) accounting-based equity valuation model to structure tests of four explanations for the anomalously positive pricing of dividends reported by Rees (1997) and Fama and French (1998). First, we find that dividends are not simply a proxy for publicly available information that helps predict future abnormal earnings. Second, although dividends act as if they signal managers’ private information about future profitability, they remain positively priced for firms with low incentives to signal. Third, dividends do not signal management's willingness to abstain from incurring agency costs. Fourth, however, controlling for one-year-ahead realized forecast errors yields a pricing of dividends that is very close to that of dividend displacement. After showing that dividends are not simply a proxy for analysts’ misforecasting, we conclude that dividends appear to be positively priced because they are a proxy for the mispricing by investors of current earnings or book equity.

Investment opportunity set and voluntary disclosure of prospective information : a simultaneous equations approach.

Abstract: This paper examines empirically the relationship between the level of disclosure of prospective information and the investment opportunity set for firms in New Zealand. Using a systems (two-stage least squares) approach that explicitly controls for potential endogeneity between disclosure and IOS, we find that the level of prospective information disclosure is significantly and positively related to IOS in both specifications in our simultaneous analysis. Further, we document that prospective information disclosure is positively related to firm size and new security offerings, and is not related to inside ownership and firm profitability. IOS is positively impacted by a firm's investments in fixed assets and its profitability. Finally, we find that forward looking disclosure levels are positively related to the proportion of outside directors on the board and negatively related to barriers to entry, but these findings are not robust across alternative model specifications.

Futures Trading Activity and Commodity Cash Price Volatility

Abstract: This paper examines the lead-lag relationship between futures trad- ing activity (volume and open interest) and cash price volatility for major agricultural commodities. Granger causality tests and generalized forecast error variance decompositions show that an unexpected increase in futures trading volume unidirectionally causes an increase in cash price volatility for most commodities. Likewise, there is a weak causal feedback between open interest and cash price volatility. These findings are generally consistent with the destabilizing effect of futures trading on agricultural commodity markets.

Accounting, Valuation and Duration of Football Player Contracts

Abstract: FRS 10 requires investments in player contracts by football compa- nies to be capitalized and amortized. Given the high degree of uncertainty associated with such contracts, it is not clear that this treatment is consistent with asset capitalization criteria. The evidence provided in this paper does not support inconclusively this capitalization requirement in that it indicates weak association of investment in player contracts with three measures of future benefits. In particular, the duration of this association is at most two years, which is shorter than the duration implied by the amortization period reported by sample companies. Nonetheless, other findings suggest that market partici- pants seem to agree with the treatment prescribed by FRS 10. These results should be of interest to practitioner and standard setters who (axiomatically) regard intangibles acquired in an arm's length transaction as assets.

Tests of Weak‐Form Efficiency of the Dhaka Stock Exchange

Abstract: Conflicting evidence on weak form efficiency of the Dhaka Stock Market appears to stem from the use of monthly versus daily data, structural changes after the 1996 market crash, and the use of tests with or without heteroscedasticity adjustment. Heteroscedasticity-robust tests indicate short-term predictability of share prices prior to the crash, but not afterwards. Although a heteroscedasticity-robust Box-Pierce test was used by Lo and MacKinlay (1989) in their simulations, our study appears to be the first to apply this test to stock prices. Typical rejection of weak-form market efficiency by the usual autocorrelation tests may be reversed by a heteroscedasticity-robust test.

Derivatives Use, Corporate Governance, and Legislative Change: An Empirical Analysis of New Zealand Listed Companies

Abstract: This paper examines if board composition has any systematic bearing on derivatives usage by New Zealand listed companies. We also test if derivative usage changed following the introduction of the new 1993 Companies Act. The Act raised expectations of directors’ fiduciary responsibilities and the perceived risk of liability on outside directors for poor investment decisions. Using a dataset of listed New Zealand companies in 1994 and 1997, we find companies with higher growth opportunities and a greater proportion of outside directors were less likely to use financial derivatives following the introduction of the new Act. Our results supplement the US-based literature on derivatives usage by illustrating that internal governance mechanisms can play a role in corporate derivatives policy, and that the legislative and regulatory environment may affect this role.

US, UK and European Stock Market Integration

Abstract: This paper examines long-run convergence between US, UK and seven European stock markets. We report evidence to suggest that while real short-run diversification gains may occur, in general they tend to be short-lived. However we also find that US and UK markets are relatively less bound to a common trend, which would imply that increased stock market merger activity, and any transition to the European common currency by the UK, may lead to relatively large stock market adjustments as markets adapt to these institutional changes.

International Publishing Patterns: An Investigation of Leading UK and US Accounting and Finance Journals

Abstract: Research quality is often measured by the quality of the journals in which articles are published. This article looks at 1,867 articles published in six highly-rated UK and six highly-rated US academic journals from 1996 to 2000. The authors publishing in the UK journals come mainly from UK and US institutions, but just over a third come from other countries. However, almost ninety per cent of authors publishing in top US journals come from US institutions. Contributions from authors from institutions in non-English speaking countries in these top journals are rare. The implications of this research are that although accounting is growing increasingly international, academic research, especially in the top US journals remains stubbornly nationally-orientated.

The Long Run Abnormal Performance of UK Acquirers and the Free Cash Flow Hypothesis

Abstract: Evidence from recent US and UK studies reveals a pattern of poor long run post acquisition performance by acquiring firms. One explanation, due to Jensen (1986) is that acquirers with an excess of free cash flow (FCF) will have a propensity to squander this on wasteful investments, including take-overs. In this paper, using a dataset of UK take-overs and proxies for free cash flow similar to those used by Lang, Stulz and Walking (1991), we find no support for the FCF hypothesis and show that this conclusion is robust to the model of long run returns employed. Contrary to the free cash flow hypothesis there is evidence that acquirers with high free cash flow perform better than acquirers with low free cash flow. Although not consistent with the Jensen hypothesis, this evidence is compatible with the emerging UK evidence that shows cash flow-to-price measures are associated with market returns.

Signalling and the Long-run Performance of Spanish Initial Public Offerings(IPOs)

Abstract: This paper explores the impact of investor sentiment on IPO pricing Using a model in which the aftermarket price of IPO shares depends on the information about the intrinsic value of the company and investor sentiment, I show that IPOs can be overpriced and still exhibit positive initial return A sample of recent French offerings with a fraction of the shares reserved for individual investors supports the predictions of the model Individual investors' demand is positively related to market conditions Moreover, large individual investors' demand leads to high IPO prices, large initial returns, and poor long-run performance

Directors¿ Recommendations in Takeovers: An Agency and Governance Analysis

Abstract: This paper evaluates whether directors of target companies make response recommendations in takeovers which are consistent with the interests of shareholders, by examining the relationship between target director recommendations and associated takeover characteristics and ownership and corporate governance characteristics of target companies. The findings suggest that response recommendations appear to be more closely associated with the self-interest of directors rather than shareholders' concerns, and that common governance initiatives aimed at aligning the interests of shareholders and managers are ineffective in resolving this agency problem. The results suggest the need for legislative or judicial reforms in Australia to encourage takeover activity and reduce takeover hostility.

Voluntary Disclosure of Bad News

Abstract: This paper shows that in a voluntary disclosure environment entailing both a fixed disclosure cost and a variable proprietary cost, partial disclosure equilibria may arise in which firms voluntarily disclose bad private information to the public. Furthermore, it is shown that such equilibria may arise more frequently as the threat of incuring proprietary cost increases and/or the proprietary cost itself increases.

A New Application of Sustainable Growth: A Multi-Dimensional Framework for Evaluating the Long Run Performance of Bank Mergers

Abstract: We study the mergers of US publicly traded bank holding companies during 1987–2000 and find that the acquiring firm's sustainable growth rate is an important determinant of the cross-sectional variation in the merged entity's long-term operating and stock performance The most economically significant determinants of the merged bank's abnormal stock return performance are the acquiring bank's estimated sustainable growth rate prior to the acquisition, as well as post-acquisition changes in this growth rate, and the bank's dividend payout ratio Our findings are robust even after controlling for several potentially confounding factors

Top Director Shake‐up: The Link between Chairman and CEO Dismissal in the UK

Abstract: Most UK companies separate the roles of CEO and Chairman. The former runs the company and the latter runs the board. Using turnover data on 2,180 separate Chairmanships of the top 460 UK firms over the 1990–1998 period, I find that the Chairman is more likely to be replaced when the CEO is dismissed. Detailed data on the dismissal events suggests that Chairman replacement is associated with board restructuring. This may be necessary to bring in different skills and experience which, in turn, might facilitate changes in future corporate decisions. Moreover, I find that the Chairman's previous position, or the type of Chairmanship, does not affect the association between Chairman removal and CEO dismissal. But, the increase in the dismissal likelihood of the Chairman at the time of forced CEO departure is higher when she is involved in the appointment of the failing CEO. This, in turn, can be interpreted as an indication of effective governance.

Information asymmetry and the bid-ask spread: evidence from the UK

Abstract: The generally accepted factors that determine the bid-ask spread are volatility, trading volume and market value (Atkins and Dyl, 1997; Glosten and Harris, 1988; and Menyah and Paudyal, 2000). Following Kim and Verrecchia (1994) we include a measure of the disagreement in analysts’ earnings forecasts in our model of the bid ask spread. This measure serves as a proxy for the informational disadvantage of market makers with respect to informed traders. Market makers respond to the additional risk by increasing the bid-ask spread. We find that the disagreement amongst analysts is significant for horizons up to and including six months (and with the hypothesised sign) in explaining FTSE 100 company spreads, rendering strong empirical support for our model.