Product market pricing power, industry concentration and analysts’ earnings forecasts

This is the first study to establish a link between product market power and analysts’ earnings forecast accuracy and bias. Relating two different dimensions of market power to earnings forecastability, we document that (a) a firm’s relative pricing power and (b) its industry concentration are strong positive determinants of analysts’ earnings forecast accuracy. We find that forecasting earnings of higher market power firms is less complex due to their ability to withstand cost shocks as well as greater informational-efficiency enjoyed by such firms. Further, forecast optimism increases with weakening product market pricing power and with lower industry concentration. The knowledge derived from this study will hopefully improve the accuracy of equity valuation, and thereby engender better buy-side (stock selections) and sell-side recommendations by analysts. Our analysis also suggests that brokerage firms compensating analysts based on forecast accuracy need to adjust for the differential in the information complexity of different industries.     

Internal corporate governance,CEO turnover,and earnings management

The likelihood and speed of forced CEO turnover – but not voluntary turnover – are positively related to a firm's earnings management. These patterns persist in tests that consider the effects of earnings restatements, regulatory enforcement actions, and the possible endogeneity of CEO turnover and earnings management. The relation between earnings management and forced turnover occurs both in firms with good and bad performance, and when the accruals work to inflate or deflate reported earnings. These results indicate that boards tend to act proactively to discipline managers who manage earnings aggressively, before the manipulations lead to costly external consequences.     

Corporate governance and pay-for-performance: The impact of earnings management

We ask whether the apparent impact of governance structure and incentive-based compensation on firm performance stands up when measured performance is adjusted for the effects of earnings management. Institutional ownership of shares, institutional investor representation on the board of directors, and the presence of independent outside directors on the board all reduce the use of discretionary accruals. These factors largely offset the impact of option compensation, which strongly encourages earnings management. Adjusting for the impact of earnings management substantially increases the measured importance of governance variables and dramatically decreases the impact of incentive-based compensation on corporate performance.     

Regulations,earnings management,and post-IPO performance: The Chinese evidence

In this study, we examine whether government regulatory initiatives in China involving IPO by SOEs may have contributed to opportunistic behaviors by the issuer. We focus on two sets of IPO regulations issued between January 1, 1996 and February 11, 1999: pricing regulations, which stipulate that IPO prices be a function of accounting performance, and penalty regulations, which penalize IPO firms for overly optimistic forecasts. We find that IPO firms that report better pricing-period accounting performance have larger declines in post-IPO profitability, lower first-day stock returns and worse long-run post-IPO stock performance. Furthermore, IPO firms that make overoptimistic forecasts also have lower first-day returns and worse post-IPO stock performance. Using non-core earnings as the proxy for earnings management, we document some evidence that IPO firms that report higher pricing-period accounting performance have engaged in more income-increasing earnings management. Hence, pricing regulations may have induced IPO firms to inflate pricing-period earnings and affect the post-IPO performance negatively. On the other hand, penalty regulations have deterred IPO firms from making overoptimistic earnings forecast and therefore have a positive impact on the behavior of IPO firms.     

Auditor reputation and earnings management: International evidence from the banking industry

We examine the relation between auditor reputation and earnings management in banks using a sample of banks from 29 countries. In particular, we examine the implications of two aspects of auditor reputation, auditor type and auditor industry specialization, for earnings management in banks. We find that both auditor type and auditor industry specialization moderate benchmark-beating (loss-avoidance and just-meeting-or-beating prior year’s earnings) behavior in banks. In addition, we find that once auditor type and auditor industry specialization are included in the same tests, only auditor industry specialization has a significant impact on constraining benchmark-beating behavior. In separate tests related to income-increasing abnormal loan loss provisions, we find that both auditor type and auditor expertise constrain income-increasing earnings management. Again, in joint tests, only auditor industry expertise has a significant impact on constraining income-increasing earnings management.     

Overvaluation and earnings management

Consistent with Jensen’s [Jensen, M., 2005. Agency costs of overvalued equity. Financial Management 34, 5–19] agency-costs-of-overvalued-equity prediction, we find that overvaluation is statistically and economically related to subsequent income-increasing earnings management. This relation is robust to a series of tests that address potential endogeneity concerns, including omitted variable bias and reverse causality. The agency costs of overvalued equity are substantial. Overvaluation-induced income-increasing earnings management is negatively related to future abnormal stock returns and operating performance, and this negative relation becomes more pronounced as prior overvaluation intensifies. Among the most overvalued firms, those with high discretionary accruals underperform those with low discretionary accruals during the following year by 11.88% as measured by the three-factor alphas, and by 12.87% points as measured by industry-adjusted unmanaged EBITDA-to-assets ratio.     

Institutional investor type,earnings management and benchmark beaters

This paper classifies institutional investors into transient or long-term by their investment horizons to examine the association between institutional investor type and firms’ discretionary earnings management strategies in two mutually exclusive settings – firms that (do not) use accruals to meet/beat earnings targets. The results support the view that long-term institutional investors constrain accruals management among firms that manage earnings to meet/beat earnings benchmarks. This suggests long-term institutional investors can mitigate aggressive earnings management among these firms. Transient institutional ownership is not systematically associated with aggressive earnings management and is evident only among firms that manage earnings to meet/beat their earnings benchmarks. This indicates transient institution-associated managerial myopia may not be as prevalent as posited by critics. This study highlights the importance of explicitly considering the type of institutional investor and the specific setting when investigating the association between institutional ownership and corporate earnings management.     

Analyst coverage and earnings management

What is the role of information intermediaries in corporate governance? This paper examines equity analysts’ influence on managers’ earnings management decisions. Do analysts serve as external monitors to managers, or do they put excessive pressure on managers? Using multiple measures of earnings management, I find that firms followed by more analysts manage their earnings less. To address the potential endogeneity problem of analyst coverage, I use two instrumental variables based on change in broker size and on firm's inclusion in the Standard & Poor's 500 index, and I find that the results are robust. Finally, given the number of covering analysts, analysts from top brokers and more experienced analysts have stronger effects against earnings management.     

The role of bank monitoring in corporate governance: Evidence from borrowers’ earnings management behavior

In this paper, we examine the corporate governance role of banks by investigating the effect of bank monitoring on the borrowers’ earnings management behavior. Our analyses suggest that a borrowing firm’s earnings management behavior generally decreases as the strength of bank monitoring increases. The strength of bank monitoring is measured as (1) the magnitude of a bank loan, (2) the reputation (rank) of a lead bank, (3) the length of a bank loan, and (4) the number of lenders. These results imply that bank monitoring plays an important role in the corporate governance of bank-dependent firms. We further examine other bank loan characteristics (collateral, refinancing, loan types, and loan purposes) and their effects on borrowers’ earnings management behavior. Our analyses show that collateral and loan types are significantly associated with borrowers’ earnings management behavior while refinancing and loan purposes have no association.     

Disclosure frequency and earnings management

We examine the relation between disclosure frequency and earnings management, and the impact of this relation on post-issue performance, for a sample of seasoned equity offerings (SEOs). We contend that firms with extensive disclosure are less likely to face information problems, leading to less earnings management and better post-issue performance. Our results confirm that disclosure frequency is inversely related to earnings management and positively associated with post-issue performance. We also find that transparency-reducing disclosure is concentrated in firms that substantially, but temporarily, increase disclosure prior to the offering. Such firms exhibit more earnings management and poorer post-SEO stock performance, on average.     

The effect of board composition on the informativeness and quality of annual earnings: Empirical evidence from Greece

This study examines how the informational quality of annual accounting earnings, varies according to the size and composition of the board of directors of publicly listed firms within the Greek capital market. Data analysis over a period of five years (2000-2004) revealed that the informativeness of annual accounting earnings is positively related to the fraction of outside directors serving on the board, but it is not related to board size. Additionally, firms with a higher proportion of outside board members proved to be more conservative when reporting bad news but on the contrary they do not display greater timeliness on the recognition of good news. Finally, firms with a higher proportion of outside directors report earnings of higher quality compared to firms with a low proportion of outside directors. Our results are robust to several sensitivity tests controlling for endogeneity, firm's fixed effects and alternative models for the estimation of discretionary accruals.     

Analyst reputation and management earnings forecasts

Prior studies show that analysts with high reputation are influential in the market. This paper examines whether managers consider analyst reputation in shaping their voluntary disclosure strategy. Using Institutional Investor magazine’s All-American (AA) rankings as a proxy for analyst reputation, we find that the coverage of AA analysts is positively associated with the likelihood of quarterly management earnings forecasts (MEFs). We also find that AA analysts’ forecast optimism is more positively associated with the likelihood of MEFs than non-AA analysts’ forecast optimism when the firm is covered by AA analysts. Analyses based on AA analyst coverage changes and AA status changes confirm the relation between analyst reputation and MEFs. We further find that analyst reputation influences other MEF properties, such as forecast news, bias, and revisions, and that our results are robust to alternative measures of analyst reputation. Further analyses show that market reactions at quarterly earnings announcements are more positive (negative) when firms meet/beat (miss) AA analysts’ forecasts than when firms meet/beat (miss) non-AA analysts’ forecasts. Collectively, our findings suggest that managers strategically provide voluntary forecasts by taking into account the reputation of individual analysts following their firms.     

Ownership structure,corporate governance and analyst following: A study of French listed firms

This study investigates the effects of some characteristics of the French corporate governance model – deemed to foster entrenchment and facilitate private benefits extraction – on the extent of analyst following. The results show that analysts are more likely to follow firms both with high discrepancy level between ownership and control and those controlled through pyramiding. These findings provide empirical support to the argument that minority shareholders value private information on firms with high expropriation likelihood, asking thence for more analyst services. Additional findings show that analysts are reticent to follow firms managed by controlling family members. This is, in part, explained by these firms’ reliance on private communication channels rather than public disclosure, producing a poor informational environment.     

News-driven return reversals: Liquidity provision ahead of earnings announcements

This study documents a six-fold increase in short-term return reversals during earnings announcements relative to non-announcement periods. Following prior research, we use reversals as a proxy for expected returns market makers demand for providing liquidity. Our findings highlight significant time-series variation in the magnitude of short-term return reversals and suggest that market makers demand higher expected returns prior to earnings announcements because of increased inventory risks that stem from holding net positions through the release of anticipated earnings news. Collectively, our findings suggest that uncertainty regarding anticipated information events elicits predictable increases in the compensation demanded for providing liquidity and that these increases significantly affect the dynamics and information content of market prices.     

Government assisted earnings management in China

As the socialist system in China embraces the market economy, it has created many conflicts of interests and collusion between firms and different layers of governments. The central government in China sets regulations to ensure the quality of firms listed in the capital market, while local governments engage in inter-jurisdictional competition for more capital, and their interests are aligned with listed firms through the stringent IPO quota system. This paper examines how local governments in China help listed firms in earnings management to circumvent the central government’s regulation. We find that local governments provide subsidies to help firms boost their earnings above the regulatory threshold of rights offering and delisting. Moreover, this collusion between government and listed firms in earnings management exists mainly in firms controlled by local governments.     

Investor sentiment,executive compensation,and corporate investment

We develop a model that predicts corporate investment level increases with investors’ optimism and that the relationship between investment level and executive compensation depends on investor sentiment and other parameters. The empirical test shows that optimism is significantly and positively related to the level of investment and that executive compensation is insignificantly related to the level of investment. The managerial share ownership is positively related to the level of investment, conditional on the degree of optimism. The empirical results suggest that executives make investment decisions that not only cater to investor sentiment but also reflect their own interest in the company.     

Tunneling as an incentive for earnings management during the IPO process in China

Using a sample of 185 Chinese IPO firms listed on the Shanghai Stock Exchange during the period 1999–2001, we show that related-party (RP) sales of goods and services could be used opportunistically to manage earnings upwards in the pre-IPO period. We also provide evidence that such behavior may be motivated by the prospect of tunneling opportunities in the post-IPO period, i.e., exploiting economic resources from minority shareholders for the benefit of the parent company. We provide evidence of one such opportunistic tunneling tool: non-repayment by Chinese parent companies of net outstanding corporate loans made to them by their newly listed subsidiaries. Furthermore, we provide evidence in support of our assertion of an association between such tunneling behavior in the post-IPO period and earnings management via abnormal RP sales in the pre-IPO period. Finally, we demonstrate the apparent failure of investors in Chinese IPOs to perceive the link between the two phenomena. The results enhance understanding of the motives for and consequences of earnings manipulation during the IPO process. They highlight a potential additional investment risk facing foreign investors in China’s capital markets as well as in Chinese firms cross-listed in non-Chinese stock exchanges, and have policy implications for China and other emerging markets which need to improve the protection of minority shareholders’ rights.     

Product differentiation and efficiencies in the retail banking industry

We empirically quantify the welfare implications of bank entry in the United States between 2000 and 2008. We use a fully structural framework that combines a differentiated demand model with an endogenous product model to investigate the market outcomes. We find no evidence for under- or over-entry. Compared with the socially efficient outcome, there is a mild welfare loss resulting from banks entering wrong locations in product space. Compared with the observed outcome, consumer surplus drops by 20–38% and bank profits decline by 48–59% when banks are homogeneous. Therefore product differentiation significantly improves welfare under free entry.     

External social networks and earnings management

Using a sample of U.S. listed firms for the 2000–2017 period, we examine how external social networks of top executives and directors affect earnings management in their firms. We find that well-connected firms are more aggressive in managing earnings through both accruals and real activities and that the results are robust after controlling for internal executive social ties. Using a difference-in-differences approach, we find that earnings management decreases after a socially connected executive or director dies. Additional analysis shows that connections forged by past professional working experiences have a greater impact on earnings management than connections forged by education and other social activities. Moreover, CFO social networks have a greater influence on earnings management than CEO social networks. Finally, we explore the underlying mechanisms, finding that 1) firms that are socially connected to each other show more similarities in their earnings management than firms that do not share a connection, and 2) more connected firms are less likely to incur accounting restatements. Collectively, our findings indicate that the external social networks of top executives and directors are important determinants of both their accrual- and real activity-based earnings management.     

Belief diversity and price informativeness around earnings announcements

The consequences of price informativeness have been extensively studied in the past. In contrast, this study goes a step backward to explore its determinants by examining whether belief diversity facilitates a complete and timely reflection of earnings news into prices. Using a global dataset, we find a higher abnormal return variance ratio (lower post-earnings announcement drift) in the presence of more diversely-informed beliefs among traders. This inference holds despite several robustness checks. Moreover, the cross-country analysis reveals that the documented impact of belief diversity intensifies in countries with higher market development, greater corporate transparency, and stronger investor protection.