Showing papers on "Earnings published in 1998"

Do Stock Prices Fully Reflect Information in Accruals and Cash Flows About Future Earnings

Abstract: This paper investigates whether stock prices reflect information about future earnings contained in the accrual and cash flow components of current earnings. The extent to which current earnings performance persists into the future is shown to depend on the relative magnitudes of the cash and accrual components of current earnings. However, stock prices are found to act as if investors "fixate" on earnings, failing to fully reflect information in the accrual and cash flow components of current earnings until it impacts future earnings.

The Effect of Audit Quality on Earnings Management

Abstract: This study examines the relation between audit quality and earnings management. Consistent with prior research, we treat audit quality as a dichotomous variable and assume that Big Six auditors are of higher quality than non-Big Six auditors. Earnings management is captured by discretionary accruals that are estimated using a cross-sectional version of the Jones 1991 model. Prior literature suggests that auditors are more likely to object to management's accounting choices that increase earnings (as opposed to decrease earnings) and that auditors are more likely to be sued when they are associated with financial statements that overstate earnings (as compared to understate earnings). Therefore, we hypothesize that clients of non-Big Six auditors report discretionary accruals that increase income relatively more than the discretionary accruals reported by clients of Big Six auditors. This hypothesis is supported by evidence from a sample of 10,379 Big Six and 2,179 non-Big Six firm years. Specifically, clients of non-Big Six auditors report discretionary accruals that are, on average, 1.5-2.1 percent of total assets higher than the discretionary accruals reported by clients of Big Six auditors. Also, consistent with earnings management, we find that the mean and median of the absolute value of discretionary accruals are greater for firms with non-Big Six auditors. This result also indicates that lower audit quality is associated with more “accounting flexibility”.

Corporate Disclosure Policy and Analyst Behavior

Abstract: This paper examines the relation between the disclosure practices of firms, the number of analysts following each firm, and properties of the analysts' earnings forecasts. Using data from the Financial Analysts Federation Corporate Information Committee Report (FAF Report), we provide evidence that firms with more informative disclosure policies have a larger analyst following, more accurate analyst earnings forecasts, less dispersion among individual analyst forecasts and less volatility in forecast revisions. The results enhance our understanding of the role of analysts in capital markets. Further, they suggest that potential benefits to disclosure include increased investor following, reduced estimation risk and reduced information asymmetry, each of which have been shown to reduce a firm's cost of capital in theoretical research.

Earnings Management to Exceed Thresholds

Abstract: Earnings provide important information for investment decisions. Thus executives--who are monitored by investors, directors, customers, and suppliers--acting in self-interest and at times for shareholders, have strong incentives to manage earnings. We introduce behavioral thresholds for earnings management. A model shows how thresholds induce specific types of earnings management. Empirical explorations identify earnings management to exceed each of three thresholds: report of positive profits, sustain recent performance, and meet analysts' expectations. The positive profits threshold proves predominant. The future performance of firms that have possibly boosted earnings just across a threshold appears poorer than that of less suspect control groups.

Earnings Management and the Long‐Run Market Performance of Initial Public Offerings

Abstract: Issuers of initial public offerings ~IPOs! can report earnings in excess of cash f lows by taking positive accruals. This paper provides evidence that issuers with unusually high accruals in the IPO year experience poor stock return performance in the three years thereafter. IPO issuers in the most “aggressive” quartile of earnings managers have a three-year aftermarket stock return of approximately 20 percent less than IPO issuers in the most “conservative” quartile. They also issue about 20 percent fewer seasoned equity offerings. These differences are statistically and economically significant in a variety of specifications.

Are Accruals during Initial Public Offerings Opportunistic

Abstract: We find evidence that initial public offering (IPO) firms, on average, have high positive issue-year earnings and abnormal accruals, followed by poor long-run earnings and negative abnormal accruals The IPO-year abnormal, and not expected, accruals explain the cross-sectional variation in post-issue earnings and stock returns The results are robust with respect to alternative abnormal accruals and earnings performance measures IPO firms adopt more income-increasing depreciation policies when they deviate from similar prior performance same industry non-issuers, and they provide significantly less for uncollectible accounts receivable than their matched non-issuers The results taken together suggest opportunistic earnings management partially explains the new issues anomaly

An Analysis of Sample Attrition in Panel Data: The Michigan Panel Study of Income Dynamics

Abstract: By 1989 the Michigan Panel Study on Income Dynamics (PSID) had experienced approximately 50 percent sample loss from cumulative attrition from its initial 1968 membership. We study the effect of this attrition on the unconditional distributions of several socioeconomic variables and on the estimates of several sets of regression coefficients. We provide a statistical framework for conducting tests for attrition bias that draws a sharp distinction between selection on unobservables and on observables and that shows that weighted least squares can generate consistent parameter estimates when selection is based on observables, even when they are endogenous. Our empirical analysis shows that attrition is highly selective and is concentrated among lower socioeconomic status individuals. We also show that attrition is concentrated among those with more unstable earnings, marriage, and migration histories. Nevertheless, we find that these variables explain very little of the attrition in the sample, and that the selection that occurs is moderated by regression-to-the-mean effects from selection on transitory components that fade over time. Consequently, despite the large amount of attrition, we find no strong evidence that attrition has seriously distorted the representativeness of the PSID through 1989, and considerable evidence that its cross-sectional representativeness has remained roughly intact.

Multifactor Explanations of Asset Pricing Anomalies

Abstract: Previous work shows that average returns on common stocks are related to firm characteristics like size, earnings/price, cashflow/price, book-to-market equity, past sales growth, long-term past return, and short term past return. Because these patterns in average returns apparently are not explained by the CAPM, they are called anomalies. We find that, except for the continuation of short-term returns, the anomalies largely disappear in a three-factor model. Our results are consistent with rational ICAPM or APT asset pricing, but we also consider irrational pricing and data problems as possible explanations.

The Conservatism Principle and the Asymmetric Timeliness of Earnings

Abstract: Conservatism is interpreted to mean that accountants more frequently report current "bad news" about future cash flows in contemporaneous earnings than current "good news." Thus, earnings reported under GAAP should be more timely in reporting "bad news" about future cash flows than "good news." This paper, using the firm's stock return as a measure of news, shows that the contemporaneous association between earnings and negative returns is two to five times as large as the contemporaneous association between earnings and positive returns. It is also shown that the greater timeliness of earnings relative to cash flow measures is largely due to a greater sensitivity to concurrent negative returns. This result is consistent with accountants recording accruals conservatively. Another implication of conservatism is that negative earnings surprises are likely to be less persistent than positive earnings surprises, because earnings reports more bad news concurrently than good news, with the latter being spread over several periods. This is shown to be true empirically. It is predicted and found that earnings response coefficients are higher for positive earnings changes than for negative earnings changes, which is consistent with the market correcting for the difference in persistence in conservatively determined earnings. It is also found that the sensitivity of earnings to negative returns has more than quadrupled since 1980, while the sensitivity of earnings to negative returns has declined by two-thirds, suggesting that earnings measurement has become more conservative. Increases in accounting conservatism are found to be correlated with increases in auditor liability, but no causal inferences are drawn.

Discretionary Management Earnings Forecast Disclosures: Antecedents and Outcomes Associated with Forecast Venue and Forecast Specificity Choices

Abstract: In this paper we investigate the effects of disclosure-related costs on managers' decisions about how (in terms of specificity) and where (in terms of venue-such as special press releases or analyst meetings) to disclose earnings forecasts. We also examine consequences of alternative venue and specificity choices. Our investigation focuses on managers' forecasts of annual earnings identified from the Dow Jones News

The Association between Competition and Managers' Business Segment Reporting Decisions

Abstract: This paper investigates the relation between levels of industry competition and managers' choices of which operations to report as business segments. One reason managers have objected to segment disclosures is that these disclosures allegedly provide commercially valuable information to competitors that is not available elsewhere. This objection might seem to imply that managers are most reluctant to provide segment disclosures for operations in highly competitive industries; however, if abnormally high earnings tend to occur in less competitive industries, managers' segment reporting discretion may be exercised to avoid reporting these operations as business segments. Using a sample of 929 firms reporting business segments in their annual reports during 1987 to 1991, I estimate a logit model of management's decision to report operations in a given industry as a segment as a function of two measures of industry competition: the four-firm concentration ratio and a measure of the speed of profit adjustment. The

Does Eva Beat Earnings? Evidence on Associations with Stock Returns and Firm Values

Abstract: This study tests assertions that Economic Value Added (EVA) is more highly associated with stock returns and firm values than accrual earnings, and evaluates which components of EVA, if any, contribute to these associations. Relative information content tests reveal earnings to be more highly associated with returns and firm values than EVA, residual income, or cash flow from operations. Incremental tests suggest that EVA components add only marginally to information content beyond earnings. Considered together, these results do not support claims that EVA dominates earnings in relative information content, and suggest rather that earnings generally outperforms EVA.

Earnings and Expected Returns

Abstract: The aggregate dividend payout ratio forecasts excess returns on both stocks and corporate bonds in postwar U.S. data. High dividends forecast high returns. High earnings forecast low returns. The correlation of earnings with business conditions gives them predictive power for returns; they contain information about future returns that is not captured by other variables. Dividends and earnings contribute substantial explanatory power at short horizons. For forecasting long-horizon returns, however, only (scaled) stock prices matter. Forecasts of low long-horizon stock returns in the mid-1990s are caused not by earnings or dividends, but by high stock prices.

Education, Personal Control, Lifestyle and Health: A Human Capital Hypothesis

Abstract: The concept of human capital implies that education improves health because it increases effective agency. We propose that education's positive effects extend beyond jobs and earnings. Through educ...

Mobility and Stability: The Dynamics of Job Change in Labor Markets

Abstract: Three central facts describe inter-firm worker mobility in modern labor markets: 1) long-term employment relationships are common, 2) most new jobs end early, and 3) the probability of a job ending declines with tenure. Models based on firm-specific capital provide a parsimonious explanation for these facts, but it also appears that worker heterogeneity in mobility rates can account for much of what we observe in these data. I investigate tests of the specific capital model and consider whether these tests are successful in distinguishing the specific capital model from a model based on heterogeneity. One approach uses longitudinal data with detailed mobility histories of workers. These analyses suggest that both heterogeneity and specific capital (implying true duration dependence in the hazard of job ending) appear to be significant factors in accounting for mobility patterns. A second approach is through estimation of the return to tenure in earnings functions. This is found to have several weaknesses including endogeneity of tenure and the lack of tight theoretical links between tenure and accumulated specific capital and between productivity and wages. A third approach is to use of data on the earnings experience of displaced workers. Several tests are derived based on these data, but there is generally an alternative heterogeneity-based explanation that makes interpretation difficult. Nonetheless, firms appear willing to pay to encourage long-term employment relationships, and they may do so because it is efficient to invest in their workforce. On this basis, I conclude that, while deriving convincing direct evidence for the specific capital model of mobility is difficult, it appears that specific capital is a useful construct for understanding worker mobility and wage dynamics.

Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the Sec

Abstract: This study investigates firms subject to accounting enforcement actions by the Securities and Exchange Commission (SEC) for alleged violations of GAAP We investigate: (i) the extent to which the alleged earnings manipulations can be explained by extant earnings management hypotheses; (ii) the relation between the earnings manipulations and weaknesses in the firms' internal governance structures; and (iii) the capital market consequences experienced by the firms when the alleged earnings manipulations are made public We find that an important motivation for earnings manipulation is the desire to attract external financing at low cost We show that this motivation remains significant after controlling for contracting motives proposed in the academic literature We also find that firms manipulating earnings are: (i) more likely to have boards of directors dominated by management; (ii) more likely to have a CEO who simultaneously serves as Chairman of the Board; (iii) more likely to have a CEO who is also the firm's founder; (iv) less likely to have an audit committee; and (v) less likely to have an outside blockholder Finally, we document that firms manipulating earnings experience significant increases in their costs of capital when the manipulations are made public

Pessimism Perpetuated: Real Wages and the Standard of Living in Britain during and after the Industrial Revolution

Abstract: New estimates of nominal earnings and the cost of living are presented and used to make a fresh assessment of changes in the real earnings of male and female manual workers in Britain from 1770 to 1870. Workers' average real earnings are then adjusted for factors such as unemployment, the number of their dependants, and the costs of urbanization. The main finding is that the standard of living of the average working-class family improved by less than 15 percent between the 1780s and 1850s. This long plateau is shown to be consistent with other economic, political, and demographic indicators.

Parental Priorities and Economic Inequality

Abstract: Arguing that parental actions are important sources of wealth inequality, this book investigates the transmission of economic status from one generation to the next by constructing a model of parental preferences. It offers evidence on the intergenerational transmission of consumption, earnings and wealth. In the model, parents determine the degree of their altruistic concern for their children and spend time and resources on them accordingly, just as they might make choices about how they spend money. Mulligan tests his model against both old and new evidence, including models which emphasize "financial constraints". One major prediction of Mulligan's model confirmed by the evidence is that children of wealthy parents typically spend more than they earn. Other important behaviour can also be explained using this approach, such as charitable giving and "corporate loyalty". The study should appeal to a wide range of quantitatively-oriented social scientists and sociobiologists.

Estimating the labor market impact of voluntary military service using social security data on military applicants

Abstract: The volunteer armed forces play a major role in the American youth labor market, but little is known about the effects of voluntary militaiy service on earnings. The effects of military service are difficult to measure because veterans are both self-selected and screened by the military. This study uses two strategies to reduce selection bias in estimates of the effects of militaiy service on the earnings of veterans. Both approaches involve the analysis of a special match of Social Security earning records to administrative data on applicants to the armed forces. The first strategy compares applicants who enlisted with applicants who did not enlist, while controlling for most of the characteristics used by the military to select soldiers from the applicant pool. This is implemented using matching methods and regression. The second strategy uses instrumental variables that were generated by an error in the scoring of the exams that screen military applicants. Estimates from both strategies are interpreted using models with heterogeneous potential outcomes. The empirical results suggest that soldiers who served in the early 1980s were paid considerably more than comparable civilians while in the military, and that military service is associated with higher employment rates for veterans after service. In spite of this employment gain, however, military service led to only a modest long-run increase in the civilian earnings of nonwhite veterans while actually reducing the civilian earnings of white veterans.

The Impact of Trading Commission Incentives on Analysts' Stock Coverage Decisions and Earnings Forecasts

Abstract: In this paper, I consider how security analysts' incentives to generate trading commissions affect the accuracy and availability of their reports. I model the interaction between an analyst and an investor who holds an initial endowment of a risky asset and must pay a commission to a brokerage firm in order to buy or sell shares of the asset. The investor bases his decision on information provided by the analyst, who is in turn employed by the brokerage. The analyst's decision about how much information to gather about the asset is driven by his expectations of the commissions to be generated from that information. I find that the analyst's incentives to gather information are strongest for stocks that are expected to perform well; consequently, reports (i.e., forecasts) for these stocks are likely to be more accurate than forecasts

The Impact of Securities Litigation Reform on the Disclosure of Forward-Looking Information by High Technology Firms

Abstract: This study evaluates corporate voluntary disclosure of forward-looking information under the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Using data on earnings and sales forecasts issued by 547 computer, software, and drug firms, we find that there was a significant increase in both the frequency of firms issuing forecasts and the number of forecasts issued following enactment of the Reform Act. The increased level of disclosure is primarily attributable to managers issuing more long horizon forecasts of good news and short horizon forecasts of bad news. Moreover, there is some evidence that the forecasts issued after the safe harbor took effect specified a more precise estimate of expected future earnings performance. We also find that the increase in disclosure was not at the expense of forecast quality in that forecasts issued after passage of the Reform Act are no less accurate than those issued previously. In particular, there is no evidence to support critics' concern that the protection of the safe harbor would prompt managers to issue more overly optimistic statements to investors.

Security Analysts' Career Concerns and Herding of Earnings Forecasts

Abstract: Several theories of reputation and herding (see, e.g., Scharfstein and Stein (1990)) suggest that herding among agents should vary with career concerns. Our goal in this paper is to document whether such a link exists in the labor market for security analysts. Specifically, we look at the relationship between an analyst's job tenure (a proxy for career concerns) and various measures of stock earnings forecast performance. We establish the following key results. (1) Older analysts are more likely to produce earnings forecasts of firms before younger ones. (2) Their forecasts also deviate more from the consensus forecast than their younger counterparts. We argue that these results are consistent with some reputational models of herding. We also establish a number of auxiliary findings regarding the relationship between forecast accuracy and frequency of forecast revisions with job tenure.

Earnings Management and the Revelation Principle

Abstract: When the Revelation Principle (RP) holds, managing earnings confers no advantage over revelation. We construct an explanation for earnings management that is based on limitations on owners' ability to make commitments (a violation of the RP's assumptions). Traditionally, earnings management is seen as sneaky managers pulling the wool over the eyes of gullible owners by manipulating accruals; our limited commitment story suggests that the owners, too, can benefit from earnings management. We categorize a variety of extant explanations of earnings management, along with our own, according to which of the assumptions of the RP each explanation violates. Plausibility of multiple simultaneous violations of the assumptions, and strategic use of various accounting and real instruments of earnings management, complicate the task of detecting such management in field data. When managers choose accounting accruals, neutral communication of the firm's under- lying economic reality to the readers of financial reports is not necessarily their only goal. This goal can become enmeshed with managers' desire to use financial reports, especially earnings, opportunistically to serve their own personal ends. The existence of such mixed motives in managers has given rise to hypotheses about management (or manipulation) of earnings, theoretical analyses of the interaction between the two motives for such manage- ment, and an empirical literature that attempts to identify and document this phenomenon. The purpose of the paper is twofold. First, we suggest earnings management is more than just sneaky managers pulling the wool over the eyes of gullible owners. Manipulation can be in the best interests of owners. 1 In particular, we study a setting in which the ability of owners to make binding commitments is constrained. Earnings management is useful because it reduces owner intervention. Although such management is not in the best interest of owners ex post (when the earnings report is submitted), it is in their best interest ex ante (when they are trying to induce the manager to join the firm and exert effort to benefit the firm). Economic explanations for earnings management require one or more of the assumptions of the Revelation Principle (RP) to be violated (Dye, 1988). The RP states that any equi- librium outcome of any mechanism, however complex, can be replicated by a truth-telling equilibrium outcome of a mechanism under which the agents are asked to report their pri- vate information to the principal (see, for example, Myerson (1979)). Hence, when the RP holds, the performance of any mechanism under which managers manipulate earnings can be replicated by a mechanism under which managers report earnings truthfully. 2 As Dye

Beauty, productivity, and discrimination: Lawyers' looks and lucre

Abstract: We propose models with an ascriptive characteristic generating earnings differentials and causing sectoral sorting, allowing us to distinguish among sources producing such differentials. We use longitudinal data on a large sample of graduates from one law school and measure beauty by rating matriculation photographs. (1) Betterlooking attorneys who graduated in the 1970s earned more than others after 5 years of practice, an effect that grew with experience. (2) Attorneys in the private sector are better‐looking than those in the public sector, differences that rise with age. These results support theories of dynamic sorting and customer behavior.