Showing papers on "Earnings published in 1999"

The causal effect of education on earnings

Abstract: This paper surveys the recent literature on the causal relationship between education and earnings. I focus on four areas of work: theoretical and econometric advances in modelling the causal effect of education in the presence of heterogeneous returns to schooling; recent studies that use institutional aspects of the education system to form instrumental variables estimates of the return to schooling; recent studies of the earnings and schooling of twins; and recent attempts to explicitly model sources of heterogeneity in the returns to education. Consistent with earlier surveys of the literature, I conclude that the average (or average marginal) return to education is not much below the estimate that emerges from a standard human capital earnings function fit by OLS. Evidence from the latest studies of identical twins suggests a small upward "ability" bias -- on the order of 10%. A consistent finding among studies using instrumental variables based on institutional changes in the education system is that the estimated returns to schooling are 20-40% above the corresponding OLS estimates. Part of the explanation for this finding may be that marginal returns to schooling for certain subgroups -- particularly relatively disadvantaged groups with low education outcomes -- are higher than the average marginal returns to education in the population as a whole.

Causal Effects in Nonexperimental Studies: Reevaluating the Evaluation of Training Programs

Abstract: This article uses propensity score methods to estimate the treatment impact of the National Supported Work (NSW) Demonstration, a labor training program, on postintervention earnings. We use data from Lalonde's evaluation of nonexperimental methods that combine the treated units from a randomized evaluation of the NSW with nonexperimental comparison units drawn from survey datasets. We apply propensity score methods to this composite dataset and demonstrate that, relative to the estimators that Lalonde evaluates, propensity score estimates of the treatment impact are much closer to the experimental benchmark estimate. Propensity score methods assume that the variables associated with assignment to treatment are observed (referred to as ignorable treatment assignment, or selection on observables). Even under this assumption, it is difficult to control for differences between the treatment and comparison groups when they are dissimilar and when there are many preintervention variables. The estimate...

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. The authors 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 positive profits, sustain recent performance, and meet analysts' expectations. The positive profits threshold proves predominant. The future performance of firms suspect for boosting earnings just across a threshold is poorer than that of control group firms. Copyright 1999 by University of Chicago Press.

The Boundaries of Financial Reporting and How to Extend Them

Abstract: In this study we investigate the usefulness of financial information to investors in comparison to the total information in the marketplace.1 Our evidence indicates that the usefulness of reported earnings, cash flows, and book (equity) values has been deteriorating over the past 20 years. We document that this deterioration in usefulness, in the face of both increasing investor demand for relevant information and persistent regulator efforts to improve the quality and timeliness of financial information, is due to change. Whether driven by innovation, competition, or deregulation, the impact of change on firms' operations and economic conditions is not adequately reflected by the current reporting system. The large investments that generally drive change, such as restructuring costs and R&D expenditures, are immediately expensed, while the benefits of change are recorded later and are not matched with

Stock Performance and Intermediation Changes Surrounding Sustained Increases in Disclosure

Abstract: This paper investigates whether firms benefit from expanded voluntary disclosure by examining changes in capital market factors associated with increases in analyst disclosure ratings for 97 firms. The disclosure rating increases are accompanied by increases in sample firms' stock returns, institutional ownership, analyst following, and stock liquidity. These findings persist after controlling for contemporaneous earnings performance and other potentially influential variables, such as risk, growth, and firm size. While it is difficult to draw unambiguous causal conclusions, these results are consistent with disclosure model predictions that expanded disclosure leads investors to revise upward valuations of the sample firms' stocks, increases stock liquidity, and creates additional institutional and analyst interest in the stocks.

Intergenerational Mobility in the Labor Market

Abstract: This chapter summarizes what has been learned from recent research on intergenerational transmission of earnings status. The chapter begins by using a simple theoretical model to highlight several key concepts. Then it reviews (and discusses the connections among) three related empirical literatures: on sibling correlations in earnings, on the intergenerational elasticity of offspring’s earnings with respect to parents’ earnings or income, and on neighborhood effects. © 1999 Elsevier Science B.V. All rights reserved.

Do Institutional Investors Prefer Near-Term Earnings over Long-Run Value?

Abstract: Critics often argue that institutional investors have an excessive focus on short-term firm performance that leads corporate managers to make decisions to boost short-term earnings at the expense of long-run value. This paper examines whether institutional investors exhibit preferences for near-term earnings over long-run value and whether such preferences have implications for firms' stock prices. Using the Ohlson [1995] model, I separate firm value into three components-book value, expected near-term earnings, and expected long-term (terminal) value-and test whether institutions prefer firms for which more of firm value is expected to be realized as near-term earnings rather than as long-term earnings. The results indicate that the level of ownership by institutions with short investment horizons (transient institutions) and by institutions held to stringent fiduciary standards (banks) is positively (negatively) associated with the amount of value in near-term (long-term) earnings. This evidence indicates that institutions with the strongest incentives to favor firms with a high proportion of value in near-term earnings exhibit such preferences. This evidence that banks and transient institutions prefer near-term earnings over long-run value raises the question of whether such institutions myopically price firms, overweighting short-term earnings potential and underweighting long-term earnings potential. Evidence of such myopic pricing would establish a link through which institutional investors could pressure managers into a short-term focus. The results provide no evidence that high levels of ownership by banks translate into myopic mispricing. However, high levels of transient ownership are associated with an over- (under-) weighting of near-term (long-term) expected earnings and a trading strategy based on this finding generates significant abnormal returns. This finding supports the concerns that many corporate managers have about the adverse effects of an ownership base dominated by short-term-focused institutional investors.

Market rewards associated with patterns of increasing earnings

Abstract: *Stanford University; tCornell University; +Northwestern University. We appreciate comments from workshop participants at Baruch College, Cornell University, Harvard Business School, the University of Iowa, the University of North Carolina, the University of Notre Dame, Ohio State University, Pennsylvania State University, the University of Rochester, Temple University, the University of Waterloo, the Financial Economics Conference at SUNY Buffalo, the American Accounting Association Annual Meeting, and the Financial Decisions and Control Seminar at Harvard Business School, and from four anonymous reviewers, Dan Collins, Sanjay Kallapur, Wayne Landsman, Charles Lee, Barbara Lougee, and Krishna Palepu. We also appreciate the research assistance of Don Cram, Philip Joos, and Peter Joos. Funding from the Financial Research Initiative, Stanford University Graduate School of Business, the Stanford Business School Class of 1969 Faculty Fellowship, Cornell's Accounting Institute, the Institute of Professional Accounting at the University of Chicago, Northwestern's Accounting Research Center, and Division of Research, Harvard Business School is gratefully acknowledged. We thank IIBIEIS for use of analyst forecast data. 1 The term "earnings multiple" refers to either the coefficient on earnings in price regressions or the coefficient on earnings changes in returns regressions. We refer to firms with nondecreasing patterns of earnings as firms with increasing patterns. Fewer than 1% of the firm-year observations have a zero year-to-year change as part of an increasing earnings pattern.

On the Association between Voluntary Disclosure and Earnings Management

Abstract: This study investigates whether managers who issue annual earnings forecasts manage reported earnings toward their forecasts, fearing legal actions by investors and loss of reputation for accuracy. I hypothesize that managers make income-increasing (decreasing) accounting decisions when earnings would otherwise be below (above) management forecasts, and that the earnings management activity is increasing in expected forecast error costs.1 These costs are likely higher for overestimates than for underestimates and are increasing in the magnitude of the forecast

Accounting Conservatism, the Quality of Earnings, and Stock Returns

Abstract: Quality of earnings questions arise when firms that practice conservative accounting change the level of their investment in net operating assets: increases in net operating assets create "hidden reserves," depressing earnings, and decreases in investment release hidden reserves into earnings. This paper develops diagnostics that capture this joint effect of investment and conservative accounting and finds that the diagnostics forecast differences in future return on net operating assets from the current return on net operating assets. Moreover, the diagnostics forecast stock returns, indicating that the stock market does not appreciate how conservatism and investment combine to raise quality questions about reported earnings.

Earnings Surprises, Growth Expectations, and Stock Returns: Don't Let an Earnings Torpedo Sink Your Portfolio

Abstract: It is well-established that the realized returns of ?growth? stocks have been low relative to other stocks. We show that this phenomenon is explained by a large and asymmetric response to negative earnings surprises for growth stocks. After controlling for this effect, there is no longer evidence of a stock return differential between growth stocks and other stocks. Our evidence is more consistent with investors having naively optimistic expectations about the prospects of growth stocks (e.g., Lakonishok, Shleifer, and Vishny, 1994) than with the existence of unidentified risk factors that are lower for growth stocks (e.g., Fama and French, 1992).

Equity valuation and negative earnings: The role of book value of equity

Abstract: This study provides an explanation for the anomalous significantly negative price‐earnings relation using the simple earnings capitalization model for firms that report losses. We hypothesize and find that including book value of equity in the valuation specification eliminates the negative relation. This suggests that the simple earnings capitalization model is misspecified and the negative coefficient on earnings for loss firms is a manifestation of that misspecification. Furthermore, we provide evidence on three competing explanations for the role that book value of equity plays in valuing loss firms. Specifically, we investigate whether the importance of book value in cross‐sectional valuation models stems from its role as (1) a control for scale differences (Barth and Kallapur 1996), (2) a proxy for expected future normal earnings (Ohlson 1995; Penman 1992), or (3) a proxy for loss firms' abandonment option (Berger et al. 1996; Barth et al. 1996; Burgstahler and Dichev 1997). Our results do not suppo...

Product mix and earnings volatility at commercial banks: evidence from a degree of leverage model

Abstract: Commercial banks’ lending and deposit-taking business has declined in recent years. Deregulation and new technology have eroded banks’ comparative advantages and made it easier for nonbank competitors to enter these markets. In response, banks have shifted their sales mix toward noninterest income — by selling ‘nonbank’ fee-based financial services such as mutual funds; by charging explicit fees for services that used to be ‘bundled’ together with deposit or loan products; and by adopting securitized lending practices which generate loan origination and servicing fees and reduce the need for deposit financing by moving loans off the books. The conventional wisdom in the banking industry is that earnings from fee-based products are more stable than loan-based earnings, and that fee-based activities reduce bank risk via diversification. However, there are reasons to doubt this conventional wisdom a priori. Compared to fees from nontraditional banking products (e.g., mutual fund sales, data processing services, mortgage servicing), revenue from traditional relationship lending activities may be relatively stable, because switching costs and information costs reduce the likelihood that either the borrower or the lender will terminate the relationship. Furthermore, traditional lending business may employ relatively low amounts of operating and/or financial leverage, which will dampen the impact of fluctuations in loan-based revenue on bank earnings. We test this conventional wisdom using data from 472 U.S. commercial banks between 1988 and 1995, and a new ‘degree of total leverage’ framework which conceptually links a bank’s earnings volatility to fluctuations in its revenues, to the fixity of its expenses, and to its product mix. Unlike previous studies that compare earnings streams of unrelated financial firms, we observe various mixes of financial services produced and marketed jointly within commercial banks. Thus, the evidence that we present reflects the impact of production synergies (economies of scope) and marketing synergies (cross-selling) not captured in previous studies. To implement this framework, we modify standard degree of leverage estimation methods to conform with the characteristics of commercial banks. Our results do not support the conventional wisdom. As the average bank tilts its product mix toward fee-based activities and away from traditional lending activities, we find that the bank’s revenue volatility; its degree of total leverage, and the level of its earnings all increase. The first two results imply increased earnings volatility (because earnings volatility is the product of revenue volatility and the degree of total leverage) and the third result implies a possible risk premium. These results have implications for bank regulators, who must set capital requirements at levels that balance the volatility of bank earnings against the probability of bank insolvency. These results also suggest another explanation for the shift toward fee-intensive product mixes: a belief by bank managers that increased earnings volatility will enhance shareholder value (or at least will increase the value of the managers’ call options on their banks’ stock). Our results have no direct implications for the expanded bank powers debate we examine only currently permissible fee-based activities, and these activities may have demand and production characteristics different from insurance underwriting, investment banking, or real estate brokerage.

The Causal Effect of Education on Earnings

Abstract: This paper surveys the recent literature on the causal relationship between education and earnings. I focus on four areas of work: theoretical and econometric advances in modelling the causal effect of education in the presence of heterogeneous returns to schooling; recent studies that use institutional aspects of the education system to form instrumental variables estimates of the return to schooling; recent studies of the earnings and schooling of twins; and recent attempts to explicitly model sources of heterogeneity in the returns to education. Consistent with earlier surveys of the literature, I conclude that the average (or average marginal) return to education is not much below the estimate that emerges from a standard human capital earnings function fit by OLS. Evidence from the latest studies of identical twins suggests a small upward “ability” bias – on the order of 10%. A consistent finding among studies using instrumental variables based on institutional changes in the education system is that the estimated returns to schooling are 20–40% above the corresponding OLS estimates. Part of the explanation for this finding may be that marginal returns to schooling for certain subgroups – particularly relatively disadvantaged groups with low education outcomes – are higher than the average marginal returns to education in the population as a whole. © 1999 Elsevier Science B.V. All rights reserved. JEL codes: I20; J30

The Value-Relevance of Intangibles: The Case of Software Capitalization

Abstract: We examine in this study the relevance to investors of information on the capitalization of software development costs, as promulgated in 1985 by the Financial Accounting Standards Board in its Statement No. 86 (SFAS 86). We find that software capitalization is value-relevant to investors: The annually capitalized development costs are positively and significantly associated with stock returns and the cumulative software asset reported on the balance sheet is associated with stock prices. Furthermore, software capitalization figures are associated with subsequent reported earnings, indicating another dimension of relevance to investors. We also find that investors undervalue firms that expense all their software development costs. Finally, we find no support for the frequent argument that the judgment and subjectivity involved in software capitalization adversely affects the quality of reported earnings. We also investigate why the industry petitioned the FASB, in March 1996, to abolish SFAS 86. We document a significant shift in the mid-1990s in the impact of software capitalization on reported earnings and return-on-equity of software companies. Whereas in the early period of SFAS 86 application (mid- to late-1980s) software capitalization enhanced reported earnings considerably more than its detraction by the amortization of the software asset (since that asset was still small), during the early 1990s the gap between capitalization and amortization narrowed, and in 1995, the amortization?s negative impact on reported profitability roughly offset the positive impact of capitalization. This diminished impact of capitalization on reported performance may have been among the reasons underlying the petition to abolish SFAS 86. Finally, we find that analysts? earnings forecast errors are positively and significantly associated with the intensity of software capitalization.

Incentives and Penalties Related to Earnings Overstatements that Violate GAAP

Abstract: This paper investigates the incentives and the penalties related to earnings overstatements primarily in firms that are subject to accounting enforcement actions by the Securities and Exchange Commission (SEC). I find (1) that managers in treatment firms are more likely to sell their holdings and exercise stock appreciation rights in the period when earnings are overstated than are managers in control firms, and (2) that the sales occur at inflated prices. I do not find evidence that earnings overstatement in these firms is motivated by concerns about debt covenant violations or the cost of external financing. The evidence suggests that the monitoring of managers' trading behavior can be informative about the likelihood of earnings overstatement. Many economists believe that insider trading is an efficient method of compensating managers for their efforts. These economists argue that reputation losses would preclude managers from making profitable trades before periods of poor corporate performance. Conse...

The Detection of Earnings Manipulation

Abstract: Presented are a profile of a sample of earnings manipulators, their distinguishing characteristics, and a suggested model for detecting manipulation. The model's variables are designed to capture either the financial statement distortions that can result from manipulation or preconditions that might prompt companies to engage in such activity. The results suggest a systematic relationship between the probability of manipulation and some financial statement variables. This evidence is consistent with the usefulness of accounting data in detecting manipulation and assessing the reliability of reported earnings. The model identifies approximately half of the companies involved in earnings manipulation prior to public discovery. Because companies that are discovered manipulating earnings see their stocks plummet in value, the model can be a useful screening device for investment professionals. The screening results, however, require determination of whether the distortions in the financial statement numbers r...

Does Meeting Expectations Matter? Evidence from Analyst Forecast Revisions and Share Prices

Abstract: This paper investigates whether firms achieve greater share value, all else equal, by meeting analysts' expectations. We hypothesize that such firms may be rewarded with higher earnings forecasts that lead to higher share values, or with higher share prices controlling for analysts' forecasts. We find that analysts' forecasts are not higher for firms that meet expectations relative to those that do not, controlling for the level of the current year's earnings information. We also find that one or two years ahead earnings are higher for firms that consistently meet expectations relative to those that do not, controlling for the level of analysts' post-announcement earnings forecasts, although earnings three years ahead are not generally greater for such firms. These findings indicate firms meeting expectations are not "rewarded" by analysts with higher earnings forecasts than are warranted. However, consistent with the hypothesis that the market rewards firms for meeting expectations, we find that share prices are higher for firms that consistently meet expectations than for those that do not. These tests control for an estimate of fundamental value based on the book value of equity and analysts' estimates of the present value of abnormal earnings. For firms meeting expectations in one year, the magnitude of the share price difference can be explained by the higher present value of future abnormal earnings realized by these firms. However, for firms meeting expectations in at least two consequent years, the market reward is greater and the incremental future abnormal earnings realized by these firms are of insufficient magnitude to explain the market reward. Our findings therefore support a market reward for firms that consistently meet expectations. This market reward could reflect a lower cost of capital for these firms or a distinct market premium for firms that meet expectations. In addition to documenting a market reward for meeting expectations, we contribute to the literature on financial analysts' processing of accounting information by developing a methodology to compare how analysts weight information with the ex post predictive ability of that information. This approach can be applied to a broad class of questions related to how analysts process information. We contribute to the literature on accounting-based valuation by developing a methodology for testing whether the value-relevance of a given factor derives from its implications for future abnormal earnings. We show that analysts' forecasts do not fully reflect available information, and that failure to adjust for this in valuation analyses can lead to misleading inferences.

Short-sellers, fundamental analysis and stock returns *

Abstract: Firms with low ratios of fundamentals (such as earnings and book values) to market values are known to have systematically lower future stock returns. We document that short-sellers position themselves in the stock of such firms, and then cover their positions as the ratios revert to normal levels. We also show that short-sellers avoid firms where the transaction costs of short-selling are high and where the low ratios are due to temporarily low fundamentals, rather than temporarily high prices. Our evidence suggest that short-sellers use information in these ratios about either (i) temporary mispricing, or (ii) unknown risk factors, to boost their investment returns.

Artistic labor markets and careers

Abstract: ▪ Abstract Artistic labor markets are puzzling ones. Employment as well as unemployment are increasing simultaneously. Uncertainty acts not only as a substantive condition of innovation and self-achievement, but also as a lure. Learning by doing plays such a decisive role that in many artworlds initial training is an imperfect filtering device. The attractiveness of artistic occupations is high but has to be balanced against the risk of failure and of an unsuccessful professionalization that turns ideally non-routine jobs into ordinary or ephemeral undertakings. Earnings distributions are extremely skewed. Risk has to be managed, mainly through flexibility and cost reducing means at the organizational level and through multiple job holding at the individual level. Job rationing and an excess supply of artists seem to be structural traits associated with the emergence and the expansion of a free market organization of the arts. Reviewing research done not only by sociologists, but also by economists, histo...

Inequality in earnings at the close of the twentieth century

Abstract: ▪ Abstract Median income in the United States has fallen and the distribution of income has grown markedly more unequal over the past three decades, reversing a general pattern of earnings growth and equalization dating back to 1929. Median trends were not the same for all groups—women's earnings generally increased—but the growth in earnings inequality has been experienced by all groups. Even white men employed full-time, year-round—traditionally the most privileged and secure group—could not escape wage stagnation and polarization. These patterns suggest research questions that go beyond conventional sociological interest in racial and gender wage gaps, refocusing attention on more general changes in labor market dynamics. The debates over the origins of the rise in US inequality cover a wide range of issues that can be roughly grouped into four categories: the changing demographics of the labor force, the impact of economic restructuring, the role of political context and institutions, and the dynamics...

Instrumental Variables Estimates Of The Effect Of Subsidized Training On The Quantiles Of Trainee Earnings

Abstract: The effect of government programs on the distribution of participants? earnings is important for program evaluation and welfare comparisons. This paper reports estimates of the effects of JTPA training programs on the distribution of earnings. The estimation uses a new instrumental variable (IV) method that measures program impacts on the quantiles of outcome variables. This quantile treatment effects (QTE) estimator accommodates exogenous covariates and reduces to quantile regression when selection for treatment is exogenously determined. The QTE estimator can be computed as the solution to a convex linear programming problem, although this requires first-step estimation of a nuisance function. We develop distribution theory for the case where the first step is estimated nonparametrically. For women, the empirical results show that the JTPA program had the largest proportional impact at low quantiles. Perhaps surprisingly, however, JTPA training raised the quantiles of earnings for men only in the upper half of the trainee earnings distribution.

Does It Pay to Attend an Elite Private College?: Cross-Cohort Evidence on the Effects of College Type on Earnings

Abstract: Although a substantial and rising labor market premium is associated with college attendance in general, little is known about how this premium varies across institutions of different types and across time. In this paper we explicitly model high school students' choice of college type (characterized by selectivity and control) based on individual and family characteristics (including ability and parental economic status) and an estimate of the net costs of attendance. We estimate selectivity-corrected outcome equations using data from both the National Longitudinal Study of the High School Class of 1972 and High School and Beyond, which permit us to determine the effects of college quality on wages and earnings and how this effect varies across time. Even after controlling for selection effects, strong evidence emerges of a significant economic return to attending an elite private institution, and some evidence suggests this premium has increased over time.

International Differences in the Timeliness, Conservatism and Classification of Earnings

Abstract: In this study we compare the timeliness and conservatism of reported earnings across the U.S. and U.K. GAAP regimes. We present a theoretical model of the differential speeds of recognition of good news and bad news. This suggests informative and relatively robust ways of measuring dimensions of conservatism in income recognition. The analysis shows the importance of distinguishing between delays in reporting good news and early recognition of bad news, when comparing conservatism across GAAP regimes. Empirical results suggest that the treatment of extraordinary items is important in assessing relative conservatism. The degree of conservatism of the U.S. GAAP regime appears significantly greater than for the U.K. GAAP regime, when estimated using ordinary earnings. However, when conservatism is estimated using earnings after extraordinary items we find that the gap is far less pronounced, and may even disappear. Our results further indicate that the main feature distinguishing the timeliness of earnings between the U.S. and U.K. is not the relative speed of recognition of bad news, but the much slower recognition of good news under U.S. GAAP.

Labor Migration and Earnings Differences: The Case of Rural China

Abstract: This article presents empirical evidence supporting the hypothesis that the decision of Chinese rural people to migrate is affected by noneconomic forces. Using the 1820 rural household survey from Sichuan province migration behavior and earnings are analyzed. Logistic probability models show that the decision to migrate is driven largely by the availability of rural non-farm employment opportunities. However if jobs are available in the province even at lower wages rural people will choose to stay rather than to migrate. The major deterrent to migration is the lack of safety during transportation and in destination cities as well as forced separation from families. Moreover rural migrants are denied the legal right to reside permanently in cities. Furthermore findings reveal that although labor productivity in migrant activities is higher than it is in local non-farm sectors the economic cost of migration in China is so high as to significantly limit reallocation. One implication of this study is that without artificial barriers to labor migration the number of migratory workers would be higher. Since the important objective of the Chinese government is to control rural-to-urban migration it is likely that restrictive migration policies will continue. However putting aside the issue of social justice the economic efficiency loss under the Chinese system should not be ignored.