The role of accounting conservatism in management forecast bias

We investigate whether management earnings forecasts fully incorporate information in historical accounting conservatism. We find that management earnings forecasts are more optimistic for firms with greater accounting conservatism in the previous year. We further examine whether this conservatism-related optimistic bias in management earnings forecasts varies with managers’ difficulty predicting earnings accurately, managers’ opportunistic incentives, and the firms’ litigation risk. We find that the negative association between management forecast errors and conservatism increases, to various extent, with the firms’ operating cycles, earnings volatility, and the width of forecast range but does not change with proxies for opportunistic incentives or litigation risk. These results suggest that forecast difficulty is the primary reason for managers’ failure to incorporate conservatism fully in their earnings forecasts.     

A Wealth-Based Explanation for Earnings Conservatism

This study extends research on earnings conservatism – the degree to which the accounting system recognizes bad news regarding future cash flows in a more timely manner than good news – by arguing that heterogeneous executives' risk attitudes will influence the degree of conservatism. Prior research has demonstrated that differences in earnings conservatism are mainly the result of differences in institutional factors (Basu (1997) and Ball et al. (2000a)). We hypothesize that more risk-averse managers, who demand a risk premium that offsets the effects of the variance in their compensation, will report more conservative earnings. Earnings conservatism will temper expectations among stakeholders about the future cash flows to be distributed thereby diminishing the likelihood of disappointing outcomes and potential litigation or threats for executives of being fired. The more risk-averse manager would be more inclined to reduce such conflicts, since they will have a destabilizing effect on his future compensation. The empirical results for a sample of Dutch companies over the period of 1983 to 1995 confirm our hypothesis: more risk-averse managers report earnings more conservatively than do less risk-averse managers.     

The Effect of Managerial Litigation Risk on Earnings Warnings: Evidence from a Natural Experiment

We examine the causal effect of managerial litigation risk on managers’ disclosure of earnings warnings in the face of large earnings shortfalls. Exploring the staggered adoption of universal demand (UD) laws as an exogenous decrease in litigation risk, we find that the adoption leads to a decrease in managers’ issuance of earnings warnings, especially among firms facing a higher litigation risk prior to the adoption. In contrast, we find no change in managers’ tendency to alert investors of impending large positive earnings surprises. Collectively, our results provide causal evidence that higher litigation risk incentivizes managers to issue more earnings warnings. Our results differ from Bourveau et al.’s finding of an increase in the frequency of management earnings forecasts after the adoption of UD laws. We reconcile our findings with theirs by demonstrating that the effect of adopting UD laws on management earnings forecasts depends critically on forecast horizon: The adoption increases long-horizon forecasts, but decreases short-horizon forecasts.     

会计师事务所组织形式、盈余管理与IPO折价

会计师事务所组织形式由有限责任制变为特殊普通合伙制,增加了审计师的法律责任,提高了审计的鉴证价值和保险价值,有利于审计师在 IPO 审计过程中更好地发挥信息中介作用。以保荐制下 IPO公司为样本,实证考察事务所组织形式对 IPO 盈余管理和 IPO 折价的影响。研究发现,相比有限责任制事务所,特殊普通合伙制事务所审计的发行公司的正向盈余管理水平更低,IPO 折价率也更低。研究结论表明事务所转制后,审计师加强了对发行公司盈余管理行为的约束,提高了 IPO 定价效率,监管部门推动的事务所转制对 IPO 市场具有积极治理效果。     

Managerial myopia and the unintended real consequences of conditional conservatism

We examine whether the demand for conditional conservatism produces unintended real consequences that are exacerbated by managerial incentives to report higher earnings. We document a robust positive association between conditional conservatism and real earnings management (REM), particularly for firms whose CEOs face greater compensation incentives and capital market incentives to report higher earnings. Using mediation analyses, we find that conservatism has a negative indirect relation with future returns via REM over the next 1–3 years. In additional tests, we find that the relation between conservatism and REM is attenuated for firms with higher debt-to-equity, which suggests that debtholders moderate the negative relation between conditional conservative reporting and REM. Our findings suggest that, in contrast to its monitoring benefit, conditional conservatism can exacerbate managerial myopia, resulting in negative consequences for future firm value.     

Managerial Ownership and Accounting Conservatism

In this paper we examine the effect of managerial ownership on financial reporting conservatism. Separation of ownership and control gives rise to agency problems between managers and shareholders. Financial reporting conservatism is one potential mechanism to address these agency problems. We hypothesize that, as managerial ownership declines, the severity of agency problem increases, increasing the demand for conservatism. Consistent with our hypothesis, we find that conservatism as measured by the asymmetric timeliness of earnings declines with managerial ownership. The negative association between managerial ownership and asymmetric timeliness of earnings is robust to various controls, in particular, for the investment opportunity set. We thus provide evidence of a demand for conservatism from the firm's shareholders.     

Conservatism,SEC investigation,and fraud

We present evidence on the relationship between firms that have engaged in fraudulent financial reporting and accounting conservatism. We empirically investigate the extent to which US firms identified by the SEC in their Enforcement Releases demonstrate higher levels of conditional conservatism in order to mitigate information asymmetry and agency problems. Specifically, by assessing the timing of changes in the litigation risk environment for fraud firms, we document how differences in heightened legal liability guide changes in conservative accounting behavior. Compared to a matched non-fraud control sample, we document that fraud firms have significantly lower levels of accounting conservatism in the pre-fraud period. Consistent with changes in potential legal liability, we find an increase in accounting conservatism for fraud firms during the SEC investigation period. Subsequently, during the public discovery of fraud, any increases in accounting conservatism are marginal and appear to converge back to lower levels compared to the SEC investigation period. Overall, our findings suggest more temporary changes in conservative reporting in the short-term for fraud firms. We also document that increased levels of accounting conservatism for fraud firms are not due solely to the passage of the SOX Act. Our findings aid in explaining fraud firms’ incentives and opportunities for accounting conservatism and lend support for why standard setters, regulators and auditors should continue to monitor and re-evaluate conservatism’s short-term effects that are conditioned on changes in a firm’s risk environment.     

Unexpected Accruals and Conditional Accounting Conservatism

Abstract:  This paper examines the impact of management discretion over accruals on conditional accounting conservatism, defined as the tendency of accountants to recognize bad news on a timelier basis than good news. Prior research suggests that conditional accounting conservatism reflected in earnings is mainly due to the accrual component of earnings, not the cash flow component of earnings. After decomposing total accruals into expected and unexpected accruals, I find that (1) conditional accounting conservatism reflected in accruals is mainly due to unexpected accruals; (2) the negative association between unconditional and conditional accounting conservatism is mainly attributable to unexpected accruals; and (3) firms with higher leverage exhibit conditionally more conservative accounting primarily through unexpected accruals. These results are robust to accrual models that take into account the systematic association between accruals and cash flows and their non-linearity and to the asymmetric persistence of earnings changes specification of conditional accounting conservatism. Taken together, these results suggest that managers exercise their discretion over accruals to expedite the recognition of bad news rather than good news.     

Controlling-minority shareholder incentive conflicts and directors’ and officers’ liability insurance: Evidence from China

This paper examines the demand for directors’ and officers’ liability insurance (D&O insurance) by Chinese listed companies where controlling-minority shareholder incentive conflicts are acute due to the concentrated and split ownership structure. We hypothesize and find evidence that the incidence of seeking D&O insurance is positively related to the extent of controlling-minority shareholder incentive conflicts – a finding not previously documented in the literature. Using an event study, we find that the announcements of D&O insurance decisions in firms that engage in earnings management, and/or are controlled by a local government (such firms tend to have stronger incentives to tunnel), seem to have a negative wealth effect. In addition, the incidence of the D&O insurance decision is positively related to the proportion of independent directors and several litigation risk proxies. Therefore, the breakthrough in corporate governance and judicial reforms has created non-negligible perceived securities litigation risks in China.     

Narcissistic managers and IPO underpricing

Using hand-collected data on the signature size of managers in Chinese initial public offerings (IPOs) from 2007 to 2019 as a proxy for managerial narcissism, we examine how IPOs with narcissistic managers (narcissistic IPOs) affect IPO underpricing. The findings suggest that narcissistic IPOs have higher underpricing than non-narcissistic IPOs. Specifically, we find that on average, a narcissistic IPO exhibits approximately 11.3% higher underpricing than a median IPO firm. Our results are robust to alternative metrics of narcissism and underpricing after controlling for endogeneity. Additional analyses suggest that narcissistic IPOs are more likely to engage in earnings management than non-narcissistic IPOs. The former exhibits excessive risk-taking behavior, gauged by earnings volatility pre-IPO and a higher beta post-IPO. In the cross-sectional analyses, we document that the impact of managerial narcissism on IPO underpricing is more salient for IPOs facing unsophisticated investors, high market sentiment, or poor corporate governance.     

The relationship between R&D intensity,conservatism, and management earnings forecast issuance

R&D-intensive firms suffer from high information asymmetry and high proprietary costs and are prone to exhibit bottom-line losses given the unconditional conservative accounting treatment of R&D expenses. We examine how R&D intensity influences the issuance of management earnings forecasts (MEFs) across levels of accounting conservatism, controlling for proprietary costs and other earnings guidance determinants. We provide insights into how managers view the tradeoffs of using MEF disclosures to lower information asymmetry versus the costs of releasing proprietary information to competitors and the loss of reputational capital that could arise from providing inaccurate forecasts. We find that although R&D intensity and conditional conservatism are negatively related to the issuance of MEFs, as shown in prior research, at high levels of research intensity and the accompanying uncertainty about future payoffs, the negative association between conditional conservatism and MEF issuance is mitigated. These findings point to a role for conditional conservatism as a credibility enhancer for managers of R&D intense firms.     

Analyst forecast,accounting conservatism and the related valuation implications

This study investigates whether financial analysts incorporate accounting conservatism into their earnings forecasts and whether it is more difficult for them to forecast earnings for less conservative firms, and then examines the impact of the findings on the return predictability of the value‐to‐price (V/P) ratio. After controlling for the other factors affecting forecast accuracy, such as earnings predictability and information uncertainty, I find that analysts incorporate accounting conservatism into their earnings forecasts and that forecasting earnings is more difficult for less conservative firms. Consequently, the return predictability of the V/P ratio is stronger for more conservative firms, and previously reported return predictability of the V/P ratio is an average across firms with differing levels of conservatism.     

Do more able managers provide better non-GAAP earnings?

This paper investigates whether managerial ability is associated with non-GAAP earnings quality. I find that the quality of non-GAAP earnings is greater for high-ability managers than low-ability managers. I also find that investors consider non-GAAP earnings released by high-ability management to be informative. Additional tests show that the positive association between managerial ability and the quality of non-GAAP earnings is stronger when return volatility or managerial stock ownership is greater. The results are robust to alternative measures of managerial ability and non-GAAP earnings quality and to controlling for endogeneity bias. Overall, this paper provides evidence that managers of high ability use non-GAAP reporting as a signalling tool to reduce information asymmetry.     

Federal Judge Ideology: A New Measure of Ex Ante Litigation Risk

Drawing on the political theory of judicial decision making, our paper proposes a new and parsimonious ex ante litigation risk measure: federal judge ideology. We find that judge ideology complements existing measures of litigation risk based on industry membership and firm characteristics. Firms in liberal circuits (the third quartile in ideology) are 33.5% more likely to be sued in securities class action lawsuits than those in conservative circuits (the first quartile in ideology). This result is stronger after the U.S. Supreme Court's ruling in the Tellabs case. We next show that the effect of judge ideology on litigation risk is greater for firms with more sophisticated shareholders and with higher expected litigation costs. Furthermore, judicial appointments affect litigation risk and the value of firms in the circuit, highlighting the economic consequences of political appointments of judges. Finally, using our new measure, we document that litigation risk deters managers from providing long‐term earnings guidance, a result that existing measures of litigation risk cannot show.     

Securities class actions and conditional conservatism: Evidence from two legal events

We use two US court rulings as exogenous shocks to firms' litigation environment and examine the changes in conservative financial reporting following these court decisions. The Silicon Graphics ruling in 1999 imposed a heightened pleading standard and discouraged the filing of shareholder lawsuits against firms with headquarters in the Ninth Circuit. The Tellabs ruling in 2007, however, effectively reversed the Silicon Graphics ruling and made it easier to file securities litigation against Ninth Circuit firms. We predict and find that the reduced litigation risk following the Silicon Graphics ruling discourages conservative reporting for Ninth Circuit firms. By contrast, the elevated threat of shareholder lawsuits following the Tellabs ruling encourages conservative reporting for Ninth Circuit firms relative to non-Ninth Circuit firms. The disciplining effect of the threat of shareholder lawsuits on conservatism is stronger for firms facing higher ex ante litigation risk. The litigation-risk-induced increase (decrease) in reporting conservatism leads to higher (lower) firm valuations.     

公司治理水平、董事高管责任保险与盈余管理

董事高管责任保险在董事和高管遭受民事诉讼时具有“兜底”效应,降低了董事高管的执业风险.选取2002-2014年中国A股上市公司为样本,实证检验董事高管责任保险对公司盈余管理的影响,进一步分析在不同公司治理水平下,董事高管责任保险与公司盈余管理的关系是否存在差异.研究结果表明:董事高管责任保险的引入会加剧公司盈余管理行为;随着公司治理水平提高,董事高管责任保险与公司盈余管理的正相关关系减弱.     

The effect of auditor litigation risk on clients' access to bank debt: Evidence from a quasi-experiment

We exploit staggered state-level shocks to third-party auditor legal liability in the U.S. to test whether auditor litigation risk affects client companies' access to private debt markets. We find that an exogenous increase in auditor litigation risk leads to an increase in both clients' likelihood of receiving bank loans and the average amount of the bank loans that clients receive. In support of our proposed mechanism that auditor litigation risk leads to improvements in clients' audit and financial reporting quality, we find that these same shocks lead to a reduction in accruals, an increase in going-concern opinions, a decrease in restatements, and an improvement in accruals' ability to predict future cash flows. We also find that increased auditor litigation risk leads to an increase in the contractibility of clients’ accounting numbers, as proxied by the use of debt covenants, and a decrease in the cost of borrowing.     

Does accounting conservatism pay?

We investigate whether or not there is a link between conservative accounting practices and the sensitivity of executive pay to accounting performance. Using several accrual‐based measures of accounting conservatism as well as alternative measures of accounting performance, we estimate an econometric model of CEO compensation that incorporates the interaction of accounting conservatism and accounting performance. Consistent with optimal contracting theory, we find that the sensitivity of executive pay to accounting performance is higher for firms that report conservative accounting earnings. These results support the hypothesis that accounting conservatism, by limiting earnings management opportunities and improving the reliability of accounting performance measures, allows firms to formulate contracts that tie executive compensation more closely to accounting performance.     

How Do Investors Interpret Announcements of Earnings Delays?

Unlike in the case of delays of 10‐K or 10‐Q filings, the SEC does not require managers to disclose delays of earnings announcements to the public. Thus, for companies that are unable to report earnings by their expected date, managers face a decision: remain silent or announce the delay. Prior research has investigated all earnings delays, whether or not they are accompanied by announcements of the delay announcement, and found that the market reaction is slightly negative, on average, for companies that allow their expected earnings dates to pass without disclosing results. It's not clear, however, whether this negative reaction was due to the absence of news or to the information contained in the announcements of the earnings delays. The authors' recent study documents that earnings delay announcements are associated with an average one‐day abnormal stock return of a negative 6%. This statistically as well as economically significant reduction in value is consistent with anecdotal evidence in the popular business press as well as predictions of disclosure theories, in particular the explanation that concerns about legal liability and managerial reputation motivate managers to disclose bad news. The study also shows that almost all managers who announce earnings delays attempt to influence the market reaction by disclosing the underlying cause. Finally, the study shows that the market reaction to earnings delay announcements is positively related to future earnings changes, consistent with the role of these disclosures in providing a signal of deteriorating financial performance.     

The Allowance for Uncollectible Accounts,Conservatism, and Earnings Management

We study the interrelation between conservatism and earnings management by examining the allowance for uncollectible accounts and its income statement counterpart, bad debt expense. We find that the allowance is conservative and that it has become more conservative over time. Conservatism may, however, facilitate earnings management. We find that firms manage bad debt expense downward (and even record income‐increasing bad debt expense) to meet or beat analysts’ earnings forecasts and that conservatism accentuates the extent to which firms manage bad debt expense. Further, we find that firms manage bad debt expense downward by drawing down previously recorded over‐accruals of bad debt expense that have accumulated on the balance sheet. An implication of our study is that tighter limits on the amount by which firms are permitted to understate net assets may reduce their ability to manage earnings.