Showing papers on "Earnings published in 2003"

Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts

Abstract: This paper examines the career concerns of security analysts. We relate long histories of their earnings forecasts to job separations. We find that relatively accurate past forecasts lead to favorable career outcomes such as remaining at or moving up to a high status (large, prestigious) brokerage house. Controlling for accuracy, optimistic forecasts relative to the consensus increase the chances of favorable job separations. Job separations depend much less on accuracy for analysts who cover stocks that are underwritten by their brokerage houses. Such analysts are also much more likely to be rewarded for optimistic forecasts than other analysts. Furthermore, job separations were much less sensitive to accuracy and somewhat more sensitive to optimism during the stock market mania of the late 1990s. These findings suggest that the well-documented analyst forecast optimism bias is likely due to incentives to promote stocks.

Limited Attention, Information Disclosure, and Financial Reporting

Abstract: This paper models firms' choices between alternative means of presenting information, and the effects of different presentations on market prices when investors have limited attention and processing power. In a market equilibrium with partially attentive investors, we examine the effects of alternative: levels of discretion in pro forma earnings disclosure, methods of accounting for employee option compensation, and degrees of aggregation in reporting. We derive empirical implications relating pro forma adjustments, option compensation, the growth, persistence, and informativeness of earnings, short-run managerial incentives, and other firm characteristics to stock price reactions, misvaluation, long-run abnormal returns, and corporate decisions.

Exploring the Term of the Auditor‐Client Relationship and the Quality of Earnings: A Case for Mandatory Auditor Rotation?

Abstract: In this study, we document evidence on the relation between auditor tenure and earnings quality using the dispersion and sign of both absolute Jones‐model abnormal accruals and absolute current acc...

Disclosure Practices, Enforcement of Accounting Standards, and Analysts' Forecast Accuracy: An International Study

Abstract: Using a sample from 22 countries, I investigate the relations between the accuracy of analysts' earnings forecasts and the level of annual report disclosure, and between forecast accuracy and the degree of enforcement of accounting standards. I document that firm-level disclosures are positively related to forecast accuracy, suggesting that such disclosures provide useful information to analysts. I construct a comprehensive measure of enforcement and find that strong enforcement is associated with higher forecast accuracy. This finding is consistent with the hypothesis that enforcement encourages managers to follow prescribed accounting rules, which, in turn, reduces analysts' uncertainty about future earnings. I also find evidence consistent with disclosures being more important when analyst following is low and with enforcement being more important when more choice among accounting methods is allowed.

Why Are Earnings Kinky? An Examination of the Earnings Management Explanation

Abstract: Prior research has documented a “kink” in the earnings distribution: too few firms report small losses, too many firms report small profits. We investigate whether boosting of discretionary accruals to report a small profit is a reasonable explanation for this “kink.” Overall, we are unable to confirm that boosting of discretionary accruals is the key driver of the kink. We caution the use of the ratio of small profit firms to small loss firms as a measure of earnings management. We investigate and discuss a number of alternative explanations for the kink.

The World Price of Earnings Opacity

Abstract: We analyze financial statements from 34 countries for the period 1984–1998 to construct a panel data set measuring three dimensions of reported accounting earnings for each country: earnings aggressiveness, loss avoidance, and earnings smoothing. We hypothesize that these three dimensions are associated with uninformative or opaque earnings, and so we combine these three measures to obtain an overall earnings opacity time‐series measure per country. We then explore whether our three measures of earnings opacity affect two characteristics of an equity market in a country: the return the shareholders demand and how much they trade. While not all results are consistent for our three individual earnings opacity measures, our panel data tests document that, after controlling for other influences, an increase in overall earnings opacity in a country is linked to an economically significant increase in the cost of equity and an economically significant decrease in trading in the stock market of that country.

Auditor Industry Specialization and Earnings Quality

Abstract: This study examines the association between measures of earnings quality and auditor industry specialization. Prior work has examined the association between auditor brand name and earnings quality, using auditor brand name to proxy for audit quality. Recent work has hypothesized that auditor industry specialization also contributes to audit quality. Extending this literature, we compare the absolute level of discretionary accruals (DAC) and earnings response coefficients (ERC) of firms audited by industry specialists with those of firms not audited by industry specialists. We restrict our study to clients of Big 6 (and later Big 5) auditors to control for brand name. Because industry specialization is unobservable, we use multiple proxies for it. After controlling for variables established in prior work to be related to DAC and the ERC, we find clients of industry specialist auditors have lower DAC and higher ERC than clients of nonspecialist auditors. This finding is consistent with clients of industry ...

Analyst Forecast Revisions and Market Price Discovery

Abstract: We document several factors that help explain cross‐sectional variations in the post‐revision price drift associated with analyst forecast revisions. First, the market does not make a sufficient distinction between revisions that provide new information (“high‐innovation” revisions) and revisions that merely move toward the consensus (“low‐innovation” revisions). Second, the price adjustment process is faster and more complete for “celebrity” analysts (Institutional Investor All‐Stars) than for more obscure yet highly accurate analysts (Wall Street Journal Earnings‐Estimators). Third, controlling for other factors, the price adjustment process is faster and more complete for firms with greater analyst coverage. Finally, a substantial portion of the delayed price adjustment occurs around subsequent earnings‐announcement and forecast‐revision dates. Collectively, these findings show that more subtle aspects of an earnings revision signal can hinder the efficacy of market price discovery, particularly in fir...

Does Big 6 Auditor Industry Expertise Constrain Earnings Management

Abstract: Earnings management remains a popular topic of debate and discussion among investors, regulators, analysts, and the public. One mechanism that might mitigate earnings management is auditors' industry expertise. Using a large sample of clients of Big 6 auditors, this research examines the association between auditor industry expertise, measured in terms of both auditor market share in an industry and an industry's share in the auditor's portfolio of client industries and a client's level of absolute discretionary accruals, a common proxy for earnings management. Clients of non-specialist auditors report absolute discretionary accruals that are, on average, 1.2 percent of total assets higher than the discretionary accruals reported by clients of specialist auditors. This finding is consistent with the notion that specialist auditors mitigate accruals-based earnings management more than non-specialist auditors and therefore, influence the quality of earnings.

Accounting for the U.S. Earnings and Wealth Inequality

Abstract: We show that a theory of earnings and wealth inequality, based on the optimal choices of ex ante identical households that face uninsured idiosyncratic shocks to their endowments of efficiency labor units, accounts for the U.S. earnings and wealth inequality almost exactly.

Does Greater Firm-Specific Return Variation Mean More or Less Informed Stock Pricing?

Abstract: Roll [1988] observes low R 2 statistics for common asset pricing models due to vigorous firm-specific return variation not associated with public information. He concludes that this implies “either private information or else occasional frenzy unrelated to concrete information” [p. 56]. We show that firms and industries with lower market model R 2 statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Roll’s first interpretation: higher firm-specific return variation as a fraction of total variation signals more information-laden stock prices and, therefore, more efficient stock markets.

Does Big 6 Auditor Industry Expertise Constrain Earnings Management

Abstract: SYNOPSIS: Earnings management remains a popular topic of debate and discussion among investors, regulators, analysts, and the public. One mechanism that might mitigate earnings management is auditors' industry expertise. Using a large sample of clients of Big 6 auditors, this research examines the association between auditor industry expertise, measured in terms of both auditor market share in an industry and an industry's share in the auditor's portfolio of client industries, and a client's level of absolute discretionary accruals, a common proxy for earnings management. Clients of nonspecialist auditors report absolute discretionary accruals that are, on average, 1.2 percent of total assets higher than the discretionary accruals reported by clients of specialist auditors. This finding is consistent with the notion that specialist auditors mitigate accruals-based earnings management more than nonspecialist auditors and, therefore, influence the quality of earnings. Keywords: industry specialization; Big 6; specialist firms; earnings management; discretionary accruals; audit quality. Data Availability: The data used in this study are publicly available from the sources indicated in the text. INTRODUCTION Earnings management is a concern for investors, regulators, analysts, and the public. In a review of the earnings management literature, Healy and Wahlen (1999) call for research on factors that limit earnings management. This study is a response that provides empirical evidence on one mitigating factor: auditors' industry expertise. Specifically, I examine the association between Big 6 auditor industry expertise and the level of firms' absolute discretionary accruals--a common proxy for earnings management. Bonner and Lewis (1990) find that, on average, more experienced auditors outperform less experienced auditors. Similarly, Bedard and Biggs (1991) observe that auditors with more manufacturing experience are better able to identify errors in a manufacturing client's data than auditors with less manufacturing experience. This is consistent with the findings of Johnson et al. (1991) that industry experience is associated with enhanced ability to detect fraud. Wright and Wright (1997) conclude that significant experience in the retailing industry enhances hypothesis generation in identifying material errors. Specialist auditors are likely to invest more in staff recruitment and training, information technology, and state-of-the art audit technologies than nonspecialist auditors (Dopuch and Simunic 1982). Solomon et al. (1999) find that specialist auditors have more accurate nonerror frequency knowledge than nonspecialists. This finding is important because it is not unusual that client firms suggest nonerror explanations for ratio fluctuations. Audit effectiveness thus depends on the accuracy of auditors' nonerror frequency knowledge. All these findings support the conclusion that auditors' industry-specific knowledge is associated with audit effectiveness. How does an auditor's specialized industry knowledge help in detecting earnings management? Maletta and Wright (1996) observe fundamental differences in error characteristics and methods of detection across industries. This suggests that auditors who have a more comprehensive understanding of an industry's characteristics and trends will be more effective in auditing than auditors without such industry knowledge. Auditors who specialize in the banking industry can assess the adequacy of loan loss provisions better than nonspecialist auditors and, therefore, can improve the credibility of reported earnings. Auditors with expertise in manufacturing can evaluate whether the client's provision for warranty obligations is in line with industry standards better than an auditor without this expertise. Specialist auditors are also likely to develop databases detailing industry-specific best practices, industry-specific risks and errors, and unusual transactions, all of which serve to enhance overall audit effectiveness. …

Fifty Years of Mincer Earnings Regressions

Abstract: The Mincer earnings function is the cornerstone of a large literature in empirical economics. This paper discusses the theoretical foundations of the Mincer model and examines the empirical support for it using data from Decennial Censuses and Current Population Surveys. While data from 1940 and 1950 Censuses provide some support for Mincer's model, data from later decades are inconsistent with it. We examine the importance of relaxing functional form assumptions in estimating internal rates of return to schooling and of accounting for taxes, tuition, nonlinearity in schooling, and nonseparability between schooling and work experience. Inferences about trends in rates of return to high school and college obtained from our more general model differ substantially from inferences drawn from estimates based on a Mincer earnings regression. Important differences also arise between cohort-based and cross-sectional estimates of the rate of return to schooling. In the recent period of rapid technological progress, widely used cross-sectional applications of the Mincer model produce dramatically biased estimates of cohort returns to schooling. We also examine the implications of accounting for uncertainty and agent expectation formation. Even when the static framework of Mincer is maintained, accounting for uncertainty substantially affects the return estimates. Considering the sequential resolution of uncertainty over time in a dynamic setting gives rise to option values, which fundamentally changes the analysis of schooling decisions. In the presence of sequential resolution of uncertainty and option values, the internal rate of return - a cornerstone of classical human capital theory - is not a useful guide to policy analysis.

Auditor Tenure and Perceptions of Audit Quality

Abstract: We analyze how investors and information intermediaries perceive auditor tenure. Using earnings response coefficients from returns-earnings regressions as a proxy for investor perceptions of earnings quality, we document a positive association between investor perceptions of earnings quality and tenure. Further, we find that the influence of reported earnings on stock rankings becomes larger with extended tenure, although the association between debt ratings and reported earnings does not vary with tenure. Finally, we find that the influence of past earnings on one-year-ahead earnings forecasts becomes larger as tenure increases. In general, our results are consistent with the hypothesis that investors and information intermediaries perceive auditor tenure as improving audit quality. One implication of our study is that imposing mandatory limits on the duration of the auditor-client relationship might impose unintended costs on capital market participants.

Language proficiency and labour market performance of immigrants in the UK

Abstract: This paper uses two recent UK surveys to investigate the determinants of language proficiency and the effect of language on earnings and employment probabilities of non-white immigrants. We address the problem of endogenous choice of language acquisition and measurement error in language variables. Our results show that language acquisition, employment probabilities, as well as earnings differ widely across non-white immigrants, according to their ethnic origin. Language proficiency has a positive effect on employment probabilities, and lack of English fluency leads to earning losses.

Regulation FD and the Financial Information Environment: Early Evidence

Abstract: On October 23, 2000, the SEC implemented Regulation FD (Fair Disclosure), which prohibits firms from privately disclosing value‐relevant information to select securities markets professionals without simultaneously disclosing the same information to the public. We examine whether Regulation FD's prohibition of selective disclosure impairs the flow of financial information to the capital markets prior to earnings announcements. After implementation of FD, we find (1) improved informational efficiency of stock prices prior to earnings announcements, as evidenced by smaller deviations between pre‐and post‐announcement stock prices; (2) no reliable evidence of change in analysts' earnings forecast errors or dispersion; and (3) a substantial increase in the volume of firms' voluntary, forward‐looking, earnings‐related disclosures. Overall, we find no evidence Regulation FD impaired the information available to investors prior to earnings announcements, and some of our evidence is consistent with improvement.

Age and individual productivity: A literature survey

Abstract: This article surveys supervisors' ratings, analyses of piece-rates and employer-employee datasets as well as other approaches used to estimate how individual productivity varies with age. The causes of productivity variations over the life cycle are addressed with an emphasis on how cognitive abilities affect labour market performance. Earnings tend to increase until relative late in the working life, while most evidence suggests that individuals' job performance tends to increase in the first few years of one's entry into the labour market, before it stabilises and often decreases towards the end of one's career. Productivity reductions at older ages are particularly strong when problem solving, learning and speed are important, while older individuals maintain a relatively high productivity level in work tasks where experience and verbal abilities matter more.

The Role of Supplementary Statements with Management Earnings Forecasts

Abstract: We investigate managers' decisions to supplement their firms' management earnings forecasts We classify these supplementary disclosures as qualitative “soft talk” disclosures or verifiable forward-looking statements We find that managers provide soft talk disclosures with similar frequency for good and bad news forecasts but are more likely to supplement good news forecasts with verifiable forward-looking statements We examine the market response to these forecasts and find that bad news earnings forecasts are always informative but that good news forecasts are informative only when supplemented by verifiable forward-looking statements, supporting our argument that these statements bolster the credibility of good news forecasts

Earnings Management: New Evidence Based on Deferred Tax Expense

Abstract: We assess the usefulness of deferred tax expense in detecting earnings management. Assuming greater discretion under GAAP than under tax rules, and assuming managers exploit such discretion to manage income upward primarily in ways that do not affect current taxable income, then such earnings management will generate book‐tax differences that increase deferred tax expense. Our results provide evidence consistent with deferred tax expense generally being incrementally useful beyond total accruals and abnormal accruals derived from two Jones‐type models in detecting earnings management to avoid an earnings decline and to avoid a loss. Only total accruals is incrementally useful in detecting earnings management to meet analysts' earnings forecasts. Deferred tax expense is more accurate than the accrual measures in classifying firm‐years as successfully avoiding a loss, whereas no one measure is more accurate in classifying firm‐years as avoiding an earnings decline or meeting analysts' forecasts.

Empirical Evidence on Corporate Governance in Europe. The Effect on Stock Returns, Firm Value and Performance

Abstract: In this paper we analyze whether good corporate governance leads to higher common stock returns and enhances firm value in Europe. Throughout this study we use Deminor Corporate Governance Ratings for companies included in the FTSE Eurotop 300. Following the approach of Gompers, Ishii and Metrick (2003) we build portfolios consisting of well-governed and poorly governed companies and compare their performance. We also examine the impact of corporate governance on firm valuation. Our results show a positive relationship between these variables and corporate governance. This relationship weakens substantially after adjusting for country differences. Finally, we analyze the relationship between corporate governance and firm performance, as approximated by Net-Profit-Margin (NPM) and Return-on-Equity (ROE). Surprisingly, and contrary to Gompers, Ishii and Metrick (2003), we find a negative relationship between governance standards and these earnings based performance ratios for which we discuss possible implications.

The Returns to Education: Microeconomics

Abstract: In this paper we focus on education as a private decision to invest in “human capital” and the estimation of the rate of return to that private investment. While the literature is replete with studies that estimate the rate of return using regression methods where the estimated return is obtained as the coefficient on a years of education variable in a log wage equation that contains controls for work experience and other individual characteristics, the issue is surrounded with difficulties. We outline the theoretical arguments underpinning the empirical developments and show that the evidence on private returns to the individual is compelling. Despite some of these issues surrounding the estimation of the return to schooling, our evidence, based on estimates from a variety of datasets and specifications, is that there is an unambiguously positive effect on the earnings of an individual from participation in education. Moreover, the size of the effect seems large relative to the returns on other investments.

Making Sense of Cents: An Examination of Firms that Marginally Miss or Beat Analysts Forecasts

Abstract: This paper examines the role of earnings quality in the future performance of firms that marginally miss or beat analysts' forecasts. We focus primarily on two groups of firms: those that miss their forecast but appear not to have attempted to exceed it by managing earnings, and those that exceed their forecast but appear to have done so through accruals or reducing discretionary expenditures. We find that while the miss/beat effect is initially stronger, earnings quality manifests itself over a longer horizon. During the first year, markets seem to react more strongly to the miss-beat effect, with firms that beat analyst forecasts despite a low quality of earnings outperforming firms that miss their forecasts despite reporting high quality earnings. During the second and third years, however, the performance of firms that missed their forecasts while maintaining high quality earnings exceeds the firms that beat their forecasts with low quality earnings. This holds for both future returns and future earnings changes. Our results suggest that while beating expectations has short-term benefits, there are negative long-term consequences associated with managing earnings in order to do so.

On the association between institutional ownership and aggressive corporate earnings management in Australia

Abstract: This study examines the association between institutional ownership and Australian firms' aggressive earnings management strategies. In contrast to similar studies, this study does not assume that the two views on how institutional ownership associates with firms' earnings management behaviour are mutually exclusive. The association between institutional ownership and firms' income increasing discretionary accruals is expected to vary as the level of institutional ownership increases. The results support the predicted non-linear association between institutional ownership and income increasing discretionary accruals. In particular, a positive association is found at the lower institutional ownership levels, consistent with the view that transient (short-term oriented) institutional investors create incentives for managers to manage earnings upwards. On the other hand, a negative association is found at the higher institutional ownership levels, consistent with the view that long-term oriented institutional investors' monitoring limits managerial accruals discretion. These findings suggest that institutional investors can act as a complementary corporate governance mechanism in mitigating myopic aggressive earnings management by corporations when they have a sufficiently high ownership level.

Social Capital and the Wages of Mexican Migrants: New Hypotheses and Tests

Abstract: In this article, we develop hypotheses about the ways in which network ties influence wages and the circumstances under which social capital assumes greater or lesser importance in the determination of migrant earnings. We then test these hypotheses using data on male Mexican migrants gathered by the Mexican Migration Project. We find that social capital has both direct and indirect effects on migrant wages. Indirectly, social capital influences how a job is obtained and whether it is in the formal sector. Directly, having friends and relatives with migratory experience improves the efficiency and effectiveness of the job search to yield higher wages. Moreover, the effects of social capital on wages are greater for undocumented than documented migrants, reflecting the more tenuous labor market position of the former. These results confirm and extend social capital theory and underscore the importance of social networks in understanding the determination of migrant earnings.