Showing papers in "The Accounting Review in 2008"
TL;DR: In this article, the authors found that firms that just achieved important earnings benchmarks used less accruals and more real earnings management after the passage of the Sarbanes-Oxley Act (SOX) when compared to similar firms before SOX.
Abstract: We document that accrual‐based earnings management increased steadily from 1987 until the passage of the Sarbanes‐Oxley Act (SOX) in 2002, followed by a significant decline after the passage of SOX. Conversely, the level of real earnings management activities declined prior to SOX and increased significantly after the passage of SOX, suggesting that firms switched from accrual‐based to real earnings management methods after the passage of SOX. We also document that the accrual‐based earnings management activities were particularly high in the period immediately preceding SOX. Consistent with these results, we find that firms that just achieved important earnings benchmarks used less accruals and more real earnings management after SOX when compared to similar firms before SOX. In addition, our analysis provides evidence that the increases in accrual‐based earnings management in the period preceding SOX were concurrent with increases in equity‐based compensation. Our results suggest that stock‐option compo...
1,863 citations
TL;DR: In this article, a new measure of long-run corporate tax avoidance is proposed based on the ability to pay a low amount of cash taxes per dollar of pre-tax earnings over long time periods.
Abstract: We develop and describe a new measure of long‐run corporate tax avoidance that is based on the ability to pay a low amount of cash taxes per dollar of pre‐tax earnings over long time periods. We label this measure the “long‐run cash effective tax rate.” We use the long‐run cash effective tax rate to examine (1) the extent to which some firms are able to avoid taxes over periods as long as ten years, and (2) how predictive one‐year tax rates are for long‐run tax avoidance. In our sample of 2,077 firms, we find there is considerable cross‐sectional variation in tax avoidance. For example, approximately one‐fourth of our sample firms are able to maintain long‐run cash effective tax rates below 20 percent, compared to a sample mean tax rate of approximately 30 percent. We also find that annual cash effective tax rates are not very good predictors of long‐run cash effective tax rates and, thus, are not accurate proxies for long‐run tax avoidance. While there is some evidence of persistence in annual cash effec...
1,005 citations
TL;DR: In this article, a straightforward procedure for classifying restatements as either errors or irregularities is proposed, based on prior research, the reading of numerous restatement announcements, and guidance that boards receive from lawyers, auditors, and the SEC on how to respond to suspicions of deliberate misreporting.
Abstract: Research on restatements has grown significantly in recent years. Many of these studies test hypotheses about the causes and consequences of intentional managerial misreporting but rely on restatement data (such as the GAO database) that contains both irregularities (intentional misstatements) and errors (unintentional misstatements). We argue that researchers can significantly enhance the power of tests related to restatements by distinguishing between errors and irregularities, particularly in recent periods when the relative frequency of error-related restatements is increasing. Based on prior research, the reading of numerous restatement announcements, and the guidance that boards receive from lawyers, auditors, and the SEC on how to respond to suspicions of deliberate misreporting, we propose a straightforward procedure for classifying restatements as either errors or irregularities. We show that most of the restatements we classify as irregularities are followed by fraud-related class acti...
957 citations
TL;DR: In this paper, the authors examined the role of borrower accounting quality in debt contracting and found that poorer borrowers preferred bank loans over private debt. But they did not consider the impact of accounting quality on the choice of the market, with poorer borrowers preferring bank loans.
Abstract: We study the role of borrower accounting quality in debt contracting. Specifically, we examine how accounting quality affects the borrower's choice of private versus public debt market and how the design of debt contracts vary with accounting quality in the two markets. We find that accounting quality affects the choice of the market, with poorer accounting quality borrowers preferring private debt, i.e., bank loans. This is consistent with banks possessing superior information access and processing abilities that reduce adverse selection costs for borrowers. We also find that accounting quality has an economically significant but differential impact on contract design in the two markets consistent with differences in recontracting flexibility across the two markets. In the case of private debt, since there is greater recontracting flexibility, both the price (i.e., interest) and non‐price (i.e., maturity and collateral) terms are significantly more stringent for poorer accounting quality borrowers, unlik...
758 citations
TL;DR: This paper examined fixed asset investments for a large sample of public companies during the 1978-2002 period and found that firms that manipulate their earnings over-invest substantially during the misreporting period.
Abstract: This paper examines whether firms manipulating their reported financial results make suboptimal investment decisions. We examine fixed asset investments for a large sample of public companies during the 1978–2002 period and document that firms that manipulate their earnings—firms investigated by the SEC for accounting irregularities, firms sued by their shareholders for improper accounting, and firms that restated financial statements—over-invest substantially during the misreporting period. Furthermore, following the misreporting period, these firms no longer over-invest, consistent with corrected information leading to more efficient investment levels. We find similar patterns for firms with high discretionary revenues or accruals. Our findings suggest that earnings management, which is largely viewed as targeting parties external to the firm, can also influence internal decisions.
722 citations
TL;DR: In this paper, the authors argue that information asymmetry between insiders and outside equity investors generates conservatism in financial statements, which increases firm and equity values and reduces the deadweight losses generated by information asymmetries.
Abstract: In this paper we argue that information asymmetry between firm insiders and outside equity investors generates conservatism in financial statements. Conservatism reduces the manager's incentives and ability to manipulate accounting numbers and so reduces information asymmetry and the deadweight losses that information asymmetry generates. This increases firm and equity values. Our empirical tests are consistent with our proposition that information asymmetry is significantly positively related to conservatism after controlling for other demands for conservatism. Further, our tests are more consistent with our prediction that changes in information asymmetry between equity investors lead to changes in conservatism than the FASB's proposition that conservatism produces information asymmetry among equity investors. An important implication is that, if the FASB was successful in meeting its stated goal of eliminating conservatism, then it would increase information asymmetry between investors, not reduce it. ...
668 citations
TL;DR: In this paper, the authors investigate the effect of internal control deficiencies and their remediation on accrual quality and find that firms that report internal control deficiency have significantly larger positive and larger negative abnormal accruals relative to control firms.
Abstract: This paper investigates the effect of internal control deficiencies and their remediation on accrual quality. We first document that firms reporting internal control deficiencies have lower quality accruals as measured by accrual noise and absolute abnormal accruals relative to firms not reporting internal control problems. Second, we find that firms that report internal control deficiencies have significantly larger positive and larger negative abnormal accruals relative to control firms. This finding suggests internal control weaknesses are more likely to lead to unintentional errors that add noise to accruals than intentional misstatements that bias earnings upward. Third, we doc- ument that firms whose auditors confirm remediation of previously reported internal control deficiencies exhibit an increase in accrual quality relative to firms that do not remediate their control problems. Finally, we find firms that receive different internal control audit opinions in successive years exhibit changes in accrual quality consistent with changes in internal control quality. Collectively, our cross-sectional and intertem- poral change tests provide strong evidence that the quality of internal control affects the quality of accruals.
638 citations
TL;DR: In this article, the authors investigate whether audit quality is associated with the predictability of accounting earnings by focusing on analyst earnings forecast properties and find that audit quality relates positively to unobservable financial reporting quality.
Abstract: Under the assumption that audit quality relates positively to unobservable financial reporting quality, we investigate whether audit quality is associated with the predictability of accounting earnings by focusing on analyst earnings forecast properties. The evidence shows that analysts' earnings forecast accuracy is higher and the forecast dispersion is smaller for firms audited by a Big 5 auditor. We further find that auditor industry specialization is associated with higher forecast accuracy and less forecast dispersion in the non‐Big 5 auditor sample but not in the Big 5 auditor sample. Overall, our results suggest that high‐quality audit provided by Big 5 auditors and industry specialist non‐Big 5 auditors is associated with better forecasting performance by analysts.
409 citations
TL;DR: In this article, the authors examined the relation between auditor exposure to legal liability and audit quality and audit fees and found that auditors acquiesce to opportunistic earnings management by issuers in an attempt to increase the offering price.
Abstract: We use the IPO setting to examine the relation between auditor exposure to legal liability and audit quality and audit fees. With regard to audit quality, we report robust evidence that pre-IPO audited accruals are negative and less than post-IPO audited accruals. In contrast to extant literature, our findings provide scant support for the inference that auditors acquiesce to opportunistic earnings management by issuers in an attempt to increase the offering price. With regard to audit fees, we find auditors earn higher fees for IPO engagements than post-IPO engagements. While inherent differences in auditor responsibilities between IPO audits and post-IPO audits should lead to higher fees for IPOs, a substantial portion of IPO audit fees (in levels and changes) is associated with our proxy for the auditor’s 1933 Act exposure. Overall, our results suggest that both audit quality and audit fees are higher in a higher-litigation regime, consistent with the effects an increase in litigation exposur...
400 citations
Abstract: This paper investigates the relation between differences in accounting standards across countries and foreign analyst following and forecast accuracy. We develop two measures of differences in generally accepted accounting principles (GAAP) for 1,176 country‐pairs. We then examine the impact of these measures of accounting differences on foreign analysts. In so doing, we utilize a unique database that identifies the location of financial analysts around the world, creating a sample that covers 6,888 foreign analysts making a total of 43,968 forecasts for 6,169 firms from 49 countries during 1998–2004. We find that the extent to which GAAP differs between two countries is negatively related to both foreign analyst following and forecast accuracy. Our results suggest that GAAP differences are associated with economic costs for financial analysts.
389 citations
TL;DR: In this article, the authors comprehensively explore the DuPont components and contribute to the literature along three dimen- sions, including the stock market's use of accounting information by examining immediate and future equity return responses to these components by investors.
Abstract: DuPont analysis, a common form of financial statement analysis, decom- poses return on net operating assets into two multiplicative components: profit margin and asset turnover. These two accounting ratios measure different constructs and, accordingly, have different properties. Prior research has found that a change in asset turnover is positively related to future changes in earnings. This paper comprehensively explores the DuPont components and contributes to the literature along three dimen- sions. First, the paper contributes to the financial statement analysis literature and finds that the information in this accounting signal is in fact incremental to accounting signals studied in prior research in predicting future earnings. Second, it contributes to the literature on the stock market's use of accounting information by examining immediate and future equity return responses to these components by investors. Finally, it adds to the literature on analysts' processing of accounting information by again testing immediate and delayed response of analysts through contemporaneous forecast revi- sions as well as future forecast errors. Consistent across both groups of market par- ticipants, the results show that the information is useful as evidenced by associations between the DuPont components and stock returns as well as analyst forecast revi- sions. However, I find predictable future forecast errors and future abnormal returns indicating that the information processing does not appear to be complete. Taken to- gether, the analysis indicates that the DuPont components represent an incremental and viable form of information about the operating characteristics of a firm.
TL;DR: In this article, the authors analyze a sample of 330 firms making unaudited disclosures required by Section 302 and 383 firms making audited disclosures requiring by Section 404 of the Sarbanes-Oxley Act and conclude that Section 302 disclosures are informative and point to lower credibility of disclosing firms' financial reporting.
Abstract: We analyze a sample of 330 firms making unaudited disclosures required by Section 302 and 383 firms making audited disclosures required by Section 404 of the Sarbanes‐Oxley Act. We find that Section 302 disclosures are associated with negative announcement abnormal returns of −1.8 percent, and that firms experience an abnormal increase in equity cost of capital of 68 basis points. We conclude that Section 302 disclosures are informative and point to lower credibility of disclosing firms' financial reporting. In contrast, we find that Section 404 disclosures have no noticeable impact on stock prices or firms' cost of capital. Further, we find that auditor quality attenuates the negative response to Section 302 disclosures and that accelerated filers—larger firms required to file under Section 404—have significantly less negative returns (−1.10 percent) than non‐accelerated filers (−4.22 percent). The findings have implications for the debate about whether to implement a scaled securities regulation system ...
TL;DR: In this paper, the authors predict and find that accounting restatements that adversely affect shareholder wealth at the restating firm also induce share price declines among non-restating firms in the same industry and that investors impose a larger penalty on the stock prices of peer firms with high earnings and high accruals when peer and restating firms use the same external auditor.
Abstract: We predict and find that accounting restatements that adversely affect shareholder wealth at the restating firm also induce share price declines among non‐restating firms in the same industry. These share price declines are unrelated to changes in analysts' earnings forecasts, but instead seem to reflect investors' accounting quality concerns. Peer firms with high industry‐adjusted accruals experience a more pronounced share price decline than do low‐accrual firms. This accounting contagion effect is concentrated among revenue restatements by relatively large firms in the industry. We also find that investors impose a larger penalty on the stock prices of peer firms with high earnings and high accruals when peer and restating firms use the same external auditor. Our results are consistent with the notion that some accounting restatements cause investors to reassess the financial statement information previously released by non‐restating firms.
TL;DR: In this article, the determinants and consequences of earnings management by firms in the context of their relationships with suppliers and customers are examined, and they find that industry-level proxies for relationship-specific investments by suppliers/customers are positively associated with the magnitude of discretionary accruals.
Abstract: We examine the determinants and consequences of earnings management by firms in the context of their relationships with suppliers and customers. We find that industry-level proxies for relationship-specific investments by suppliers/customers are positively associated with the magnitude of discretionary accruals, volatility of earnings, and the frequency of large earnings increases. We also find that firm-level proxies for the intensity of relationship-specific investments by actual suppliers are positively related to the magnitude of discretionary accruals. In addition, earnings management by the firm in one period is positively related to the magnitude of R&D investments by suppliers and customers in the next period. However, we find that earnings management adversely affects the duration of customer-supplier relationships. Overall, our findings suggest that earnings management is used opportunistically to influence the perception of suppliers/customers about the firm’s prospects.
TL;DR: In this paper, the authors present a theory that poor matching manifests as noise in the economic relation of advancing expenses to earn revenues, and as a result, poor matching decreases the correlation between contemporaneous revenues and expenses, increases earnings volatility, decreases earnings persistence and induces a negative autocorrelation in earnings changes.
Abstract: We present a theory that poor matching manifests as noise in the economic relation of advancing expenses to earn revenues. As a result, poor matching decreases the correlation between contemporaneous revenues and expenses, increases earnings volatility, decreases earnings persistence, and induces a negative autocorrelation in earnings changes. The empirical tests document these effects in a sample of the 1,000 largest U.S. firms over the last 40 years. We find a clear and economically substantial trend of declining contemporaneous correlation between revenues and expenses, increased volatility of earnings, declining persistence of earnings, and increased negative autocorrelation in earnings changes. The combined evidence suggests that accounting matching has become worse over time and that this trend has a pronounced effect on the properties of the resulting earnings. This evidence also suggests that the standard-setters’ stated goal of moving away from matching and toward more fair-value accoun...
TL;DR: In this article, the authors discuss the implications of the subprime crisis for accounting and discuss issues that have arisen regarding sale accounting for subprime mortgage securitizations under FAS No. 140 and consolidation of securitization entities under FIN No. 46(R) associated with mortgage foreclosures and modifications.
Abstract: This essay describes implications of the subprime crisis for accounting. First, I overview the institutional and market aspects of subprime lending with the greatest accounting relevance. Second, I discuss the critical aspects of FAS No. 157’s fair value definition and measurement guidance and explain the practical difficulties that have arisen in applying this definition and guidance to subprime positions during the crisis. I also raise a potential issue regarding the application of FAS No. 159’s fair value option. Third, I discuss issues that have arisen regarding sale accounting for subprime mortgage securitizations under FAS No. 140 and consolidation of securitization entities under FIN No. 46(R) associated with mortgage foreclosures and modifications. Fourth, I indicate ways that accounting academics can address the implications of the subprime crisis in their research and teaching.
TL;DR: In this paper, the authors investigated the effects of relative performance feedback and incentive compensation method on performance, and found that providing relative feedback improves the mean performance of participants under an individual incentive scheme regardless of the precision or specific content of the feedback.
Abstract: This study investigates the effects of relative performance feedback and incentive compensation method on performance. We examine whether the presence and the content of relative performance feedback have different effects on performance when participants are compensated via a tournament or an individual incentive scheme. Our experimental results show a disordinal interaction between incentive scheme and feedback. Specifically, providing relative performance feedback improves the mean performance of participants compensated under an individual incentive scheme regardless of the precision or specific content of the feedback. In contrast, providing relative performance feedback deteriorates the mean performance of participants compensated under a tournament incentive scheme, but only if the feedback is sufficiently precise. Supplementary analysis suggests that this deterioration in performance is due to ineffective task strategies rather than reduced effort. We also find that in the absence of rel...
TL;DR: In this article, the authors identify challenges and opportunities created by global financial reporting for the education and research activities of U.S. academics, and identify questions that can motivate research related to topics on the International Accounting Standards Board technical agenda and to the globalization of financial reporting.
Abstract: This paper identifies challenges and opportunities created by global financial reporting for the education and research activities of U.S. academics. Relating to education, after overviewing the relation between global financial reporting and U.S. GAAP, it offers suggestions for topics to be covered in global financial reporting curricula and clarifies common misunderstandings about the concepts underlying financial reporting. Relating to research, it explains how and why research can provide meaningful input into standard-setting, and identifies questions that can motivate research related to topics on the International Accounting Standards Board’s technical agenda and to the globalization of financial reporting.
TL;DR: In this paper, the authors investigated whether and under what conditions beating these three earnings benchmarks reduces a firm's cost of debt and found that firms with high default risk have higher probability of rating upgrades and a smaller initial bond yield spread.
Abstract: Prior research documents that firms tend to beat three earnings benchmarks—zero earnings, last year's earnings, and analyst's forecasted earnings—and that there are both equity market and compensation‐related benefits associated with beating these benchmarks. This study investigates whether and under what conditions beating these three earnings benchmarks reduces a firm's cost of debt. I use two proxies for a firm's cost of debt: credit ratings and initial bond yield spread. Results suggest that firms beating earnings benchmarks have a higher probability of rating upgrades and a smaller initial bond yield spread. Additional analyses indicate that (1) the benefits of beating earnings benchmarks are more pronounced for firms with high default risk; (2) beating the zero earnings benchmark generally provides the biggest reward in terms of a lower cost of debt; and (3) the reduction in the cost of debt is attenuated but does not disappear for firms beating benchmarks through earnings management. In sum, result...
TL;DR: The authors studied the effect of whether budget requests are made in the form of a factual assertion and found that less slack is created when budget communication requires a factual argument in the subordinate authority treatment, but not when the superior has final authority.
Abstract: Research in budgeting suggests that subordinates may exhibit economically significant degrees of honesty, in spite of pecuniary incentives to do otherwise. This study continues the exploration of honesty in budgeting along two dimensions. First, unlike prior experiments, we measure the incremental effect of honesty by manipulating whether budget requests are made in the form of a factual assertion. Second, prior designs may have emphasized the ethical dimension of budgeting by granting the subordinate wide discretion over setting the budget, whereas we manipulate whether the subordinate or the superior has final authority over setting the budget. We find that less slack is created when budget communication requires a factual assertion in the subordinate authority treatment, but not when the superior has final authority. Hence, we find an incremental effect of honesty only when the subordinate has final authority. We conjecture, and provide some evidence, that this is due to subordinates framing ...
TL;DR: This paper measured the information content of earnings using a standard earnings-returns framework over several years surrounding restatements to examine characteristics of the decline in the information contents of earnings and found that the information loss is temporary, and that the extent to which the earnings of restatement firms suffer a loss of information content varies across several dimensions.
Abstract: Regulatory officials and market analysts have speculated that the loss of credibility in subsequently reported financial information is a long‐lasting consequence of earnings restatements. I measure the information content of earnings using a standard earnings‐returns framework over several years surrounding restatements to examine characteristics of the decline in the information content of earnings. Results indicate that although the information content of earnings declines following restatements, the loss is temporary. In particular, the earnings response coefficients for earnings announcements surrounding restatements exhibit a U‐shaped pattern in which they are no longer significantly lower in the post‐restatement period over an average of four quarters. The extent to which the earnings of restatement firms suffer a loss of information content varies across several dimensions. First, the duration of the loss is greater for firms that restate earnings to correct revenue recognition errors and for rest...
TL;DR: This article found that staggered boards are associated with lower likelihoods of committing financial reporting fraud and smaller magnitudes of absolute unexpected accruals, and that they are negatively associated with firm value.
Abstract: The literature suggests that staggered boards may have two opposite effects on earnings management: the expropriation view emphasizes the exacerbating effect, whereas the quiet life view advocates the mitigating effect We use two approaches to examine this issue: a small-sample test based on whether firms are accused of committing financial reporting fraud, and a large-sample test based on the absolute value of unexpected accruals We find that staggered boards are associated with lower likelihoods of committing fraud and smaller magnitudes of absolute unexpected accruals Consistent with prior studies, we also find that staggered boards are negatively associated with firm value The results suggest that staggered boards may enable managers to enjoy the quiet life and lessen their motivation to increase firm value; as a consequence, managers are not motivated to manage earnings
TL;DR: The authors empirically examined the effects of intensified scrutiny over non-GAAP reporting on the quality of nonGAAP earnings exclusions and found that, on average, exclusions are of higher quality (i.e., more transitory) following intervention by the Securities and Exchange Commission (SEC) into non GAAP reporting.
Abstract: We empirically examine the effects of intensified scrutiny over non‐GAAP reporting on the quality of non‐GAAP earnings exclusions. We find that, on average, exclusions are of higher quality (i.e., more transitory) following intervention by the Securities and Exchange Commission (SEC) into non‐GAAP reporting. We further find that firms that stopped releasing non‐GAAP earnings numbers after the SEC intervention had lower quality exclusions in the pre‐intervention period. These results are consistent with the SEC's objectives of improving the quality of non‐GAAP earnings figures. However, when we decompose total exclusions into special items and other exclusions, we find evidence that the quality of special items has decreased in the post‐intervention period, which suggests that managers adapted to the new disclosure environment by shifting more recurring expenses into special items. This suggests that there may be unintended consequences arising from the heightened scrutiny over non‐GAAP reporting.
TL;DR: In this paper, the authors examine the extent to which IT budgets are affected by environmental, organizational, and technological circumstances and find that IT budget levels are positively associated with subsequent firm performance and shareholder returns.
Abstract: For most firms, the information technology (IT) budget represents a major element in the overall firm budget, and IT budget decisions often have significant operational and strategic impacts on the business processes in the firm’s value chain. In this paper we use a large unique data set to examine the extent to which IT budgets are affected by environmental, organizational, and technological circumstances. We find that our cross-sectional model explains substantial variance in IT budgets, which indicates that contingent environmental, organizational, and technological factors affect managers’ budget decisions. We then examine the extent to which these IT budget levels are related to future firm performance, measured using both broad financial accounting measures, such as operating profit margins and return on assets, and market returns. We find that IT budget levels are positively associated with subsequent firm performance and shareholder returns. We further suggest that IT’s aggregate effect ...
TL;DR: In this paper, the authors examine how two factors, the agents' perceptions regarding the fairness of the principal and inter-agent communication, affect agents' behaviors under a peer reporting system.
Abstract: This study examines how two factors, the agents’ perceptions regarding the fairness of the principal and inter-agent communication, affect agents’ behaviors under a peer reporting system. Analytical models show that when agents can observe each other’s actions and local signals, a peer reporting system with a verification mechanism (using one agent’s information to verify the other’s) and a reward for truthful whistleblowing can induce agents to report honestly and thereby help the principal achieve the first-best outcome. However, behavioral research suggests that the agents’ perception regarding the fairness of the principal, as well as communication among agents, may affect how honestly agents report. The results of my experiment show that, under a peer reporting system with a high reward for whistleblowing, the agents’ perception regarding the fairness of the principal positively affects the agents’ reporting honesty and negatively affects their explicit attempts at collusion. Communication ...
TL;DR: In this paper, the authors find that the relation between credit risk changes and equity returns is significantly less negative for firms with more debt than those with less debt, and that credit risk increases are associated with equity value increases (decreases).
Abstract: We find that equity returns associated with credit risk changes are attenuated by the debt value effect of the credit risk changes, as Merton (1974) predicts. We find that the relation between credit risk changes and equity returns is significantly less negative for firms with more debt—controlling for asset value changes, credit risk increases (decreases) are associated with equity value increases (decreases). This result obtains across credit risk levels. The relation is associated with changes in both expected cash flows and systematic risk, as reflected in analyst earnings forecasts and equity cost of capital. By inverting the Merton (1974) model, we provide descriptive evidence that if unrecognized debt value changes were recognized in income, but not unrecognized asset value changes, most credit upgrade (downgrade) firms would recognize lower (higher) income. These potentially counterintuitive income effects primarily are attributable to incomplete recognition of contemporaneous asset value changes....
TL;DR: In this paper, the authors investigate whether firms that experience earnings restatements recontract with their CEOs to reduce their option-based compensation and if so, whether this leads to improved firm performance.
Abstract: Prior research finds that earnings restatements are linked to CEOs’ excessive option-based compensation and equity holdings. In this paper, we investigate whether firms that experience earnings restatements recontract with their CEOs to reduce their option-based compensation and if so, whether this leads to improved firm performance. Based on 289 restatement firms over the period 1997–2001, we find that the proportion of CEOs’ compensation in the form of options declines significantly in the two years following the restatement. Furthermore, we document that this reduction is accompanied by a decrease in the riskiness of investments, as reflected in lower stock return volatility and subsequent improvements in operating performance. Our results suggest that a decrease in option-based compensation reduces CEOs’ incentives to take excessively risky investments, resulting in improved profitability. Overall, our findings provide insights into the design and efficacy of CEO compensation contracts.
TL;DR: In this paper, the authors test whether trading by individual investors or some class of individual investors, causes post-earnings announcement drift (PEAD), and they find no indication that trading by individuals explains the concentration of drift at subsequent earnings announcement dates.
Abstract: This study tests whether nai¨ve trading by individual investors, or some class of individual investors, causes post-earnings announcement drift (PEAD). Inconsistent with the individual trading hypothesis, individual investor trading fails to subsume any of the power of extreme earnings surprises to predict future abnormal returns. Moreover, individuals are significant net buyers after both negative and positive extreme earnings surprises, consistent with an attention effect, but not with their trades causing PEAD. Finally, we find no indication that trading by individuals explains the concentration of drift at subsequent earnings announcement dates.
TL;DR: In this article, the authors examined whether stock option grants explain missed earnings targets, including reported losses, earnings declines, and missed analysts' forecasts, and found that firms that miss earnings targe...
Abstract: This paper examines whether stock‐option grants explain missed earnings targets, including reported losses, earnings declines, and missed analysts' forecasts. Anecdotal evidence and surveys suggest that managers believe that missing an earnings target can cause stock‐price drops (Graham et al. 2006). Empirical studies corroborate this notion (Skinner and Sloan 2002; Lopez and Rees 2002). Thus, a missed target could benefit an executive via lower strike price on subsequent option grants. Prior option grant studies explore only general downward earnings management (Balsam et al. 2003; Baker et al. 2003), but our study is the first to explore whether option grants encourage missed earnings targets. Indeed, if missed targets drive the prior results, then the literature has failed to document an important negative outcome of stock‐option incentives. We use quarterly and annual data for fixed‐date options granted after firms announce they have missed earnings targets. We find that firms that miss earnings targe...
TL;DR: In this paper, the authors examine the frequency, determinants, and implications of misreported fundraising activities and find that 74 percent of the regulatory filings from nonprofit organizations fail to properly report telemarketing expenses.
Abstract: The purpose of this study is to examine the frequency, determinants, and implications of misreported fundraising activities. We compare state telemarketing campaign reports with the associated information from nonprofits' annual Form 990 filings to directly test nonprofits' revenue and expense recognition policies. Using a conservative approach that understates the extent to which nonprofit organizations violate the reporting rules, our study indicates that 74 percent of the regulatory filings from nonprofit organizations fail to properly report telemarketing expenses. Smaller nonprofits, less monitored firms, and those with less accounting sophistication are more likely to inappropriately report telemarketing costs as a component of net revenues rather than as expenses. Nonprofits that use external accounting services are more likely to properly classify the cost of their telemarketing campaigns as professional fundraising fees.