Showing papers in "Review of Accounting and Finance in 2012"

Does overlapping membership on audit and compensation committees improve a firm's financial reporting quality?

Abstract: Purpose – The purpose of this paper is to examine whether audit committee members of the board prove to be better monitors if they are also on the compensation committee, as they would be more attuned to compensation related earnings management incentives.Design/methodology/approach – The paper uses archival data on a sample of nonfinancial S&P 500 firms representing 1,032 firm years over the period 2003‐2005, and discretionary accruals as a proxy for financial reporting quality.Findings – Firms with overlapping audit and compensation committees have higher financial reporting quality than those without such overlap. In addition, there is an inverted U‐shaped relationship between overlapping magnitude and financial reporting quality, suggesting that there are costs as well as benefits to overlapping committees.Practical implications – The findings on this paper have implications for recent policy deliberations on the composition of board committees in general and audit committees in particular, as they cl...

Do CEO Compensation Incentives Affect Firm Innovation

Abstract: Purpose – The purpose of this paper is to examine if the structure and design of CEO compensation has any effect on firm innovation. It further investigates the effectiveness of each component of portfolio of compensation incentives in encouraging innovation.Design/methodology/approach – This study uses systems of simultaneous equations to model the interdependence between compensation incentives and measures of firm innovation.Findings – Results indicate that the pay‐performance sensitivity of the CEO portfolio of compensation incentives is positively related to investment in R&D expenditures, number of patents and citations. Options in general are more effective than stocks. However, within the options portfolio, recently awarded and unvested options are more effective than previously awarded and vested options. Restricted stock is more effective than unrestricted stock.Research limitations/implications – Measuring innovation output is difficult as innovation could take different forms, including busine...

Analysts' estimates: What they could be telling us about the impact of IFRS on earnings manipulation in Europe

Abstract: Purpose – The purpose of this paper is to examine whether mandatory adoption of International Financial Reporting Standards (IFRS) in the European Union reduced earnings manipulation, as proxied by the difference between a firm's reported earnings and ex post estimate of earnings by financial analysts. Design/methodology/approach – Controlling for firm and institutional factors and drawing upon a sample of 15,034 firm‐year observations from 20 European countries, the research design entailed examining the change in the earnings manipulation proxy during pre‐ and post‐IFRS adoption periods. Findings – The principal finding from this analysis was a decline in the magnitude of the proxy for earnings manipulation coincidental with IFRS adoption, which suggests that a uniform financial reporting regime may have contributed to exposing the use of temporary activities to manipulate earnings. Originality/value – The results of this study make an important contribution to the extant literature on the outcomes of IFRS adoption, and should be of value to investors and standard setters, who want honest and comparable financial reporting but are opposed to regulatory intervention. Of equal significance is the innovative model introduced to proxy for earnings manipulation.

Evidence of voluntary accounting disclosures in the Athens Stock Market

Abstract: Purpose – The purpose of this paper is to explore the motives for providing voluntary accounting disclosures and investigate the financial differences between voluntary and non‐voluntary disclosers. The paper also examines the association between the provision of voluntary disclosures and earnings management.Design/methodology/approach – The study utilises logistic regressions to test the hypothetical relations set up in the study. The categorisation of firms into those that report the minimum required by law and those that provide voluntary accounting information is based on the examination of firms' financial statements. Company categorisation is based on the construction of an index similar to the disclosure index formulated by the Center for International Financial Analysis and Research. Each sample firm obtains a score, with a higher score reflecting a more significant level of disclosure.Findings – The findings show that voluntary disclosers exhibit higher profitability and growth and appear to be g...

Impact of cash holdings and ownership concentration on firm valuation

Abstract: Purpose – The purpose of this paper is to investigate the impact of firms' cash holdings and ownership concentration on the firms' valuation using an unbalanced panel dataset of non‐financial listed firms in Australia.Design/methodology/approach – The author used a generalized method of moments approach suitable for unbalanced panel dataset to examine the impact of firms' cash holdings and ownership concentration on firms' q‐ratios after controlling for the impact of financing, dividend and investment decisions, respectively.Findings – The paper finds a positive relationship between cash holdings and q‐ratio of Australian firms. The ownership structure moderates the effect of cash holdings on q‐ratio in asymmetric fashion, i.e. for widely held firms, there is a positive relationship between cash holdings and q‐ratio; while for closely held firms, there is significant negative relationship between cash holdings and q‐ratio. Furthermore, changes associated with corporate governance reforms, also effect q‐ra...

More power to you: properties of a more powerful event study methodology

Abstract: Purpose – The purpose of this paper is to demonstrate with real data the enhanced statistical power of a GLS‐based event study methodology that requires the same input data as the traditional testsDesign/methodology/approach – The paper uses full sample, subsample and simulated modified sample analyses to compare the statistical power of the GLS methodology with traditional methodsFindings – The paper finds that it is often the case that traditional tests will not reject the null when a GLS‐based test may (strongly) reject the null The power of the former is poorPractical implications – There are many published event studies where the null is not rejected This may be because of the phenomenon being tested but it may also be because of the lack of power of traditional estimators Hence, rerunning them with the authors' more powerful test is likely to reject some currently well‐accepted null hypotheses of no event effect, stimulating new research ideas Moreover, as individual stocks have become more v

The effect of the type and number of internal control weaknesses and their remediation on audit fees

Abstract: Purpose – The implementation of compliance procedures associated with the Sarbanes‐Oxley Act of 2002 came at a great cost to most publicly‐traded firms, largely due to the internal control disclosures required by Section 404 of the Act. The purpose of this paper is to contribute to the inquiry on internal control effectiveness by examining the impact of the type (same or different) and number of internal control weaknesses on audit fees. The paper also examines whether firms that remediate continue to incur higher audit fees compared to firms that never disclosed a weakness.Design/methodology/approach – The authors evaluate the impact of internal control weaknesses and their remediation on audit fees using ordinary least squares regression for 9,122 firm year observations (3,096 unique firms) over the time period 2004‐2007.Findings – The authors find: an incremental impact on audit fees of additional material weakness disclosures; firms that report the same material weakness pay higher fees than firms rep...

Combining value and momentum indicators in varying stock market conditions: The Finnish evidence

Abstract: Purpose – The purpose of this paper is to examine the added value of combining a momentum indicator with a value indicator in varying stock market conditions.Design/methodology/approach – A comprehensive sample of Finnish non‐financial stocks is first divided into three‐quantile portfolios based on valuation multiples and composite value measures. The value and glamour portfolios are divided further into two‐sextile portfolios based on the price momentum indicator. The performance of portfolios is evaluated on the basis of their raw and risk‐adjusted returns. Moreover, the impact of the stock market cycle on relative performance of quantile portfolios is examined.Findings – Taking account of price momentum beside relative valuation criteria enhances the performance of most of the value‐only portfolios during the full sample period (1993‐2009). During bullish conditions, the inclusion of a momentum criterion somewhat adds value to an investor, but during bearish conditions this added value is negative.Rese...

CEO compensation and strategic expenses: penalizing, shielding or rewarding?

Abstract: Purpose – The purpose of this paper is to investigate the way in which CEOs are shielded or rewarded for incurring R&D expenses. Strategic expenses such as R&D yield returns over a long period of time even though GAAP requires them to be written off in the period they are incurred. Going beyond the existing shielding paradigm, the paper investigates whether compensation committees actively reward CEOs for incurring strategic expenses.Design/methodology/approach – The paper uses empirical analysis by using regression analysis with CEO compensation (both cash and equity) as the dependent variable and firm size, firm performance, earnings risk, market‐to‐book ratio, R&D expenses, advertising expenses and governance variables as control, independent and test variables.Findings – The paper shows that CEOs are not only shielded but are actively rewarded for incurring R&D expenses. The paper also shows that the shield/reward effects are stronger in manufacturing firms. Finally, the paper shows that independent c...

Interest barrier rules as a response to highly leveraged transactions: Evidence from the 2008 German business tax reform

Abstract: Purpose – The tax advantage of debt is considered an important motivation for highly leveraged transactions. The German government limited the tax deductibility of interest expenses to 30.0 percent of earnings before interest, taxes, depreciation, and amortization (the interest barrier rule) in 2008 to reduce the tax incentives for debt financing. This study aims to evaluate the impact of the introduction of the interest barrier rule.Design/methodology/approach – The paper analyzes the changes in the value of the tax shield for German leveraged buyouts as a result of the promulgation of an interest barrier rule. Tax shields are computed to quantify the wealth transfer from taxpayers to corporations.Findings – Prior to the 2008 tax reform, tax shields contributed 8.4 percent to the transaction price, thereby raising the equity value by 33.0 percent on average. With the introduction of the interest barrier rule, the value of tax shields is reduced by 35.1 percent. Affecting more than 75 percent of buyouts, ...

Prediction of Greek takeover targets via bootstrapping on mixed logit model

Abstract: Purpose – The main purpose of this study is to examine the possibility of prediction of Greek takeover targets that belong to the industrial sector, emphasizing the econometric methodology and the prediction testDesign/methodology/approach – The study uses a sample of 51 targets and 290 non‐targets exclusively from Greek industry over the period 1997‐2005 In order to achieve a better predictive accuracy the paper uses a new econometric methodology, the bootstrap mixed logit and different (more advanced) techniques of prediction test and choice of cutoff valuesFindings – The results exhibit that bootstrap mixed logit has significant and valuable predictive ability with respect to the classical conditional logit model Furthermore, the predictive accuracy is higher than the results of other studies (eg Palepu and Espahbodi and Espahbodi)Originality/value – The main contribution of this study is the application of the bootstrap mixed logit in analyzing Greek takeovers The results change the prediction

Bloated balance sheet, earnings management, and forecast guidance

Abstract: Purpose – Barton and Simko argue that the balance sheet information would serve as a constraint on accrual‐based earnings management. This paper aims to extend their argument by examining whether the balance sheet constraint increases managers' propensity to use either downward forecast guidance or real earnings management as a substitute mechanism to avoid earnings surprises.Design/methodology/approach – Following Barton and Simko, the paper uses the beginning balance of net operating assets relative to sales as a proxy for the balance sheet constraint. The argument is that because of the articulation between the income statement and the balance sheet, previous accounting choices that increase earnings will also increase net assets and therefore the level of net assets reflects the extent of previous accrual management. Models from Matsumoto and Bartov et al. are used to measure forecast guidance. Following Rochowdhury and Cohen et al., a firm's abnormal level of production costs and discretionary expend...

A note on US institutional equity flows to Brazil

Abstract: Purpose – The purpose of this research is to understand the long‐run dynamics between returns, commodity prices, volatility, and US equity investment into Brazil. This research is prompted by the rapid increase in foreign equity investment into Brazil.Design/methodology/approach – To address long‐run dynamic nature of the variables, multivariate autoregressive model is fitted for the period of January 1998 to May 2008. To achieve identification of this model, restrictions are imposed based on underlying financial theory and the nature of the data.Findings – The paper finds consistent with a long literature, that US institutional equity investment is forecasted by past returns on the Brazilian stock index (BOVESPA). The paper also documents the important role of commodity prices in forecasting US equity flows to Brazil, a variable that has not been considered in much of existing literature. Finally, the paper uncovers a strong relationship between US equity flows to Brazil and measures of risk. The paper d...

Individual differences and analyst forecast accuracy

Abstract: Purpose – The purpose of this study is to examine the impact of unidentifiable individual differences among financial analysts on the cross section of their earnings forecast accuracy.Design/methodology/approach – The paper employs the concept of analyst fixed effects to control for unidentifiable individual differences. Various psychological factors, such as decision style and personality traits, are documented to impact individuals' decision making. However, analysts' individual differences in such psychological factors are not captured by identifiable personal attributes employed in finance literature, such as years of experience. The methodology used addresses this issue and presents a more comprehensive study of analyst forecast accuracy.Findings – The paper documents that unidentifiable analyst‐specific effects are significant, and that controlling for them improves model fitting and changes the explanatory power of some of the traditionally used independent variables in the literature. The paper co...

The effects of Section 404 of Sarbanes‐Oxley Act of 2002 on the audit fees of foreign firms listed on US exchanges

Abstract: Purpose – The purpose of this study is to examine the change in audit fees for US‐listed foreign firms in their first year of providing Section 404 auditor attestation reports for fiscal years ending between July 15, 2006 and July 14, 2007.Design/methodology/approach – During the sampling time period, foreign large accelerated filers had to provide both auditor and management Section 404 reports while the foreign accelerated filers only had to provide management Section 404 reports without the auditor attestation reports. Foreign non‐accelerated filers did not have to provide any Section 404 report. This research design and sample allows the authors to control for the general market‐wide increases in audit fees. The paper examines the annual change in audit fees from the preceding year to the first year of Section 404 compliance.Findings – It is found that foreign large accelerated filers have an average increase of 74 percent in audit fees in this first year of Section 404 compliance, while the foreign a...

Assessing earnings management flexibility

Abstract: Purpose – The purpose of this paper is to propose a new measure of earnings management flexibility based on the limits of the allowable set of accruals, prior discretionary accruals used, and the reversal rate of these accruals.Design/methodology/approach – Quarterly financial data from Compustat for the period 1990‐2009 were used to construct the flexibility measure. Then the author examined how well this measure captures flexibility by investigating its effect on a firm's probability of meeting analysts' forecasts.Findings – The results show that this flexibility measure better captures the firm‐specific flexibility than that of Barton and Simko which captures mainly the difference in flexibility across industries. Further, the positive effect of their measure on a firm's probability of meeting/beating analysts' forecasts is not observed in the extended sample period.Practical implications – The flexibility measure proposed here can assist investors, analysts, or researchers to compare earnings manageme...

On the interdependence structure of market sector indices: the case of Qatar Exchange

Abstract: Purpose – The purpose of this paper is to investigate the interrelationships amongst the sector‐specific indices of the Qatar Exchange (QE) (i.e. Banking and Financial Institutions (BFI), Industrial (IND), Insurance (INS), and Services (SER)). More specifically, three key issues are explored in this study. First, the long‐run relationships amongst the sectors. Second, the short‐run causal relationships amongst them; and third, the relative degree of endogeneity/exogeneity of each sector.Design/methodology/approach – To address the issues of interest, the author employs the econometric analyses of Johansen's multivariate cointegration, Granger's causality, and generalized forecast error variance decomposition. This battery of techniques gives the opportunity to examine the nature of both long‐ and short‐run intersectoral relationships in the QE. To augment the robustness of the empirical analysis, daily as well as weekly closing stock price indices for the four sectors of the Qatar Exchange are used, spann...

Option grants and investor reaction to restatement‐induced litigation

Abstract: Purpose – The purpose of this paper is to examine the relation between CEO option grants at the beginning of the class period (BCP) and investor reaction to announcement of restatement‐induced securities litigation.Design/methodology/approach – Using a restatement‐induced lawsuit sample over the period 1997‐2005, this study performs cross‐sectional linear regressions of three‐day litigation announcement cumulative abnormal returns (CARs) on CEO option grants, cash compensation, corporate governance and control variables. CARs are calculated over the three‐day (−1,1) interval relative to the lawsuit announcement date using a single‐factor market model, the CRSP equally‐weighted market index, and a 255‐day estimation period ending 45 days prior to the announcement.Findings – A negative association is reported between CEO option grants and investor reaction around restatement‐induced lawsuit announcement.Research limitations/implications – It is possible that some restatements may have triggered a securities...

Does other information improve the usefulness of management earnings forecasts for analysts

Abstract: Purpose – The purpose of this paper is to investigate whether other information included with management earnings forecasts can help analysts to formulate better earnings predictions.Design/methodology/approach – This study uses ordinary least squares regression analysis of 373 management earnings forecasts and compares changes in analyst forecast characteristics surrounding the release of a management forecast of earnings from the same firms which sometimes include other information with their forecasts and sometimes do not.Findings – Analysts make larger forecast revisions when other information is included with a surprising management earnings forecast, especially if the forecast contains good news. This information reduces subsequent analyst forecast error for firms with negative earnings.Research limitations/implications – Results of this study may not extend to smaller firms or to firms that have disclosure policies of always including other information with their forecasts.Originality/value – Prior...

Ripple effects: Sarbanes Oxley's impact upon investor risk in a global economy

Abstract: Purpose – This study seeks to evaluate, in a global context, the impact of Sarbanes Oxley Act on a particular risk measure of importance to investors (risk‐adjusted returns), and two measures of risk due to asymmetry (upside and downside risk). A unique dataset permits a dual evaluation of the law's impact on such measures in leading non‐US economies as well (i.e. “ripple effects”).Design/methodology/approach – Hypotheses are empirically evaluated on a sample (n=712) of the largest US and European firms (control) using daily return data from 1993 through 2009 – one of the most extensive data sets employed in the literature on this topic to date. The reliability of the risk measures is carefully evaluated using multiple approaches, including Fama‐MacBeth regressions. A series of difference‐in‐difference analyses is then employed to empirically assess Sarbanes Oxley's impact on equity risk.Findings – The findings suggest Sarbanes Oxley decreased both risk‐adjusted returns and upside risk, whereas downside r...