Individual Investors' Attention to Accounting Information: Evidence from Online Financial Communities*

Online financial communities provide a unique opportunity to directly examine individual investors' attention to accounting information on a large scale and in great detail. I analyze accounting-related content in large samples of Yahoo! message board posts and StockTwits and find investors pay attention to a range of accounting information, fixating particularly on earnings, cash, and revenues. Consistent with the expectation that investors react to relevant information events, I find accounting-related discussion elevated around the filings of earnings releases and 8-K reports, but the reaction to periodic reports is confined to small firms. I also find investors expand their acquisition of accounting information and processing efforts in poor information environments. Greater attention to accounting information at earnings releases does not appear to be meaningfully associated with better information processing.     

Analysts' Interpretation and Investors' Valuation of Tax Carryforwards*

We examine how financial analysts and equity investors incorporate information on deferred taxes from carryforwards into earnings forecasts and share prices. We focus on carryforwards because, in providing this information each period, management must use their private information about the firm's profitability prospects. Thus, accounting measurement of tax carryforwards is another way of providing a management earnings forecast. In analyzing the role of carryforwards in valuation, we distinguish between two conflicting effects. First, deferred taxes from carryforwards represent future tax savings; hence, they should be valued positively as assets. In contrast, the existence of tax carryforwards may signal a higher likelihood of future losses, which would have a negative effect on expected earnings and share prices. We find that analysts consider earnings of firms with carryforwards to be less persistent because of the increased likelihood of future losses. We also find that analysts tend to be less precise and more optimistic (biased) in forecasting earnings of firms with carryforwards. This higher optimism and lower precision are more pronounced just after firms adopt Statement of Financial Accounting Standards (SPAS) 109 and are almost entirely corrected over time. An analysis of investors' valuation indicates a strong positive relation between deferred taxes from carryforwards and share prices, suggesting that these carryforwards are valued as assets. Also, earnings and book values of equity are valued less in firms that have carryforwards than in firms without carryforwards. Finally, the valuation allowance required under SFAS 109 assists equity investors in valuing a firm's earnings and net assets. The combined findings on analysts' interpretation and investors' valuation suggest that analysts fail to fully capture the implication of carryforwards on future earnings within their forecasting horizon.     

重大会计差错临时披露的盈余信息含量分析

文章以2004-2005年期间353家发生重大会计差错更正的A股上市公司为样本,运用Wilson（2005）的一期模型．检验了重大会计差错更正披露前后的季度盈余信息含量。研究发现,重大会计差错更正披露减少了此后季度盈余公告的信息含量,特别是重大会计差错更正披露前后季度盈余的ERC呈现u形;但是这种影响是暂时的。从重大会计差错更正披露后的第二季度到第四季度,盈余公告的信息含量很快恢复到重大会计差错更正披露前盈余公告信息含量;另外,投资者对重大会计差错更正临时披露信息是有反应的,核心盈余差错更正披露减少了此后四个季度的盈余公告信息含量。     

A Simple Approach to Better Distinguish Real Earnings Manipulation from Strategy Changes*

Researchers typically infer real earnings management when a firm's operating and investing activities differ from industry norms. A significant problem with classifying deviations from industry averages as myopic earnings management is that companies can change their operating and investing decisions for strategic business reasons rather than to mislead stakeholders. Using principal components analysis, we systematically evaluate existing measures and develop a comprehensive real activities measure to better capture earnings manipulation. Our measure reflects (i) deviations from industry averages across multiple activities and (ii) other signals of manipulation. This approach is promising because, although there are many sources of abnormal activities, manipulation is more likely the cause when managers engage in multiple income-increasing abnormal activities that coincide with other signals that indicate an elevated risk of manipulation. This simple approach results in a metric that associates negatively with future operating performance and earnings persistence, yields high-power tests, and captures manipulation reasonably well across most life-cycle stages. Importantly, this approach performs better than the standard real earnings management metrics across all dimensions. Specifically, it generates the expected reduction in future earnings and reduced earnings persistence in 82% of the tests compared to 36% and 46% in common alternatives. Also, because this innovation does not require a long time-series or rely on future period realizations for classification, it can be useful in more research settings than other recent innovations in the literature.     

The Effect of Limited Liability on the Informativeness of Earnings: Evidence from the Stock and Bond Markets*

Previous empirical research on the informativeness of earnings has focused on stockholders, and has not examined differences in earnings' informativeness for stockholders and bondholders. Because stockholders are residual claimants and bondholders are fixed claimants, the informativeness of earnings should differ for these two types of investors. When a firm's default risk is low, changes in its financial condition should be of limited relevance to bondholders, but should be relevant to stockholders. In contrast, as the likelihood of financial distress increases, stockholders' limited liability allows them to abandon the firm to the bondholders (Fischer and Verrecchia 1997). Accordingly, as a firm's default risk increases, changes in its financial condition should be increasingly important to bondholders and less important to shareholders. Because earnings provide information on firm value, the stock return-earnings association should decrease as the firm's financial strength declines, while the bond return-earnings association should increase. We use two measures of a firm's financial strength: the firm's bond rating and its reporting of a loss. Consistent with our hypotheses, we find that the association between stock returns and changes in annual earnings decreases as bond ratings decline, while the association between bond returns and changes in annual earnings increases. These results suggest that as the company's financial condition deteriorates, earnings become less relevant for stock valuation and more relevant for bond valuation. When we partition firms based on their loss status, we find a stronger association between stock returns and annual earnings changes for firms with positive earnings (profit firms) than for firms with losses, consistent with earlier studies. In contrast, we find that the association between bond returns and earnings changes is greater for loss firms than for profit firms. These results suggest that losses reduce the informativeness of earnings for stockholders but increase informativeness for bondholders, suggesting that investors view losses as indicating increased credit risk.     

Earnings Non‐Synchronicity and Voluntary Disclosure

Earnings non‐synchronicity reflects the extent to which firm‐specific factors determine a firm's earnings. Prior research suggests that high earnings non‐synchronicity impedes corporate outsiders' ability to process information. This study examines the impact of earnings non‐synchronicity on managers' decisions to provide earnings forecasts. We propose that high earnings non‐synchronicity motivates managers to issue earnings forecasts to reduce information asymmetry between managers and investors and to preempt costly information acquisition by outsiders. Consistently, we find a positive relation between earnings non‐synchronicity and managers' propensity to issue earnings forecasts, particularly long‐horizon forecasts. This positive relation is weaker when earnings are easier to predict based on the firm's earnings history and is stronger when the firm has higher institutional ownership and greater analyst following. We also find that the market's reaction to management forecasts increases with earnings non‐synchronicity. Overall, the evidence suggests that managers voluntarily provide earnings forecasts to alleviate the adverse consequences of earnings non‐synchronicity. These findings provide a more complete picture about the impact of earnings non‐synchronicity on a firm's information environment, and highlight the effect of the nature of information asymmetry on voluntary disclosures.     

Conditional Conservatism and Debt versus Equity Financing

Extant research suggests that conditional conservatism reduces information asymmetry between a firm and its shareholders as well as its debtholders. However, there is little evidence on whether conditional conservatism reduces information asymmetry differentially for shareholders and debtholders. We use the setting of a firm's choice between equity versus debt when it seeks a significant amount of external financing to examine this research question. We find that when firms raise a significant amount of external financing, the use of equity (versus debt) increases with the level of conservatism. We also find that the reduction in cost of equity associated with conservatism is greater for equity issuers than for debt issuers, but find no such difference when we examine cost of debt. In addition, we find that the positive effect of conservatism on the choice of equity issuance (versus debt issuance) is accentuated when the information asymmetry between the firm and its shareholders is more severe. Overall, our results suggest that conservatism reduces information asymmetry more between firms and shareholders than between firms and debtholders.     

Investor Overreaction to Earnings Surprises and Post‐Earnings‐Announcement Reversals

Prior literature suggests that the market underreacts to the positive correlation in a typical firm's seasonal earnings changes, which leads to a post‐earnings‐announcement drift (PEAD) in prices. We examine the market reaction for a distinct set of firms whose seasonal earnings changes are uncorrelated and show that the market incorrectly assumes that the earnings changes of these firms are positively correlated. We also document that positive (negative) seasonal earnings changes in the current quarter are associated with negative (positive) abnormal returns in the next quarter. Thus, we observe a reversal of abnormal returns, consistent with a systematic overreaction to earnings, rather than the previously documented PEAD. Additional analysis indicates that financial analysts similarly overestimate the autocorrelation of these firms, although to a lesser extent. We also find that the magnitude of overestimation and the subsequent price reversal are inversely related to the richness of the information environment. Our results challenge the notion that investors recognize but consistently underestimate earnings correlation and provide a new perspective on the inability of prices to fully reflect the implications of current earnings for future earnings. That is, we show that investors predictably overestimate correlation when it is lacking, but underestimate it when it is present.     

The Fair Value of Cash Flow Hedges,Future Profitability,and Stock Returns

The SEC and FASB recently expressed concerns that investors do not fully assimilate all of the information provided by complex and incomplete derivatives and other comprehensive income (OCI) disclosures. My evidence supports these concerns. Specifically, I examine the information content of unrealized cash flow hedge gains/losses for future profitability and stock returns. An unrealized gain on a cash flow hedge suggests that the price of the underlying hedged item (i.e., commodity price, foreign currency exchange rate, or interest rate) moved in a direction that will impair the firm's profits after the hedge expires. Consequently, I find that unrealized cash flow hedge gains/losses are negatively associated with future gross profit after the firm's existing hedges have expired. This association only holds after the firm has reclassified its hedges into earnings, and is weaker for firms that can pass input price changes on to their customers. Finally, investors do not immediately price the cash flow hedge information. Instead, investors appear surprised by future realizations of gross margin, consistent with the view that complex and incomplete disclosures delay pricing. These results are relevant to policymakers involved in the current FASB and IASB project designed to simplify the accounting and disclosure for derivatives and, in particular, cash flow hedges.     

Do Shareholders Assess Managers' Use of Accruals to Manage Earnings as a Negative Signal of Trustworthiness Even When Its Outcome Serves Shareholders' Interests?*

We examine how shareholders' trust in managers is affected by (i) the outcome of earnings management (inconsistent vs. consistent with shareholders' interests) and (ii) the method of earnings management (accruals vs. real methods). Using a controlled experiment, we predict and find that trust is impaired when the outcome of earnings management suggests that managers have put their interests above shareholders' interests and/or when the method of earnings management suggests that managers misreported the firm's economic performance. We argue that shareholders assess managers putting their interests above shareholders' interests as a signal of untrustworthiness because it involves a transfer of the firm's resources away from shareholders to managers. We argue that shareholders also assess managers' use of accruals to manage earnings as a signal of untrustworthiness because, in this instance, managers misreport the firm's economic performance. Finally, we show that trust mediates the combined effects of the outcome of earnings management and the method of earnings management on investment decisions. Our study incrementally contributes to the literature by highlighting the adverse implications of managers' use of accruals to manage earnings even when its outcome serves shareholders' interests.     

The Effect of Changes in Income Shifting on Affiliate Managers' Internal Reporting Decisions*†

This study examines the interplay between tax and internal reporting incentives among affiliates of multinational corporations (MNCs). MNCs face limited information flows that may prevent affiliates' performance metrics to be responsive immediately to changes in the firm's tax planning. Using granular data of affiliates belonging to MNCs from 21 European countries, our study provides new empirical evidence of affiliate internal reporting responses induced by changing tax plans. When high-tax-rate countries tighten income shifting rules, we first document that income shifting is reduced and low-tax-rate affiliates have less income. Second, we predict and document that managers of these low-tax-rate affiliates offset this decrease in profits by managing upwards a key performance metric: affiliate earnings. Our results are consistent with firms not quickly adjusting the affiliate managers' incentives in the face of changing tax planning strategies, and affiliates managing reported earnings to offset the effect of changes in the tax planning of the firm. Cross-sectional analyses provide further evidence consistent with the theory underlying the main tests. The results support the policy of tightening income shifting rules when the objective is to reduce income shifting, and firms' central management would benefit from considering the implications of changing tax plans on the assessment of local managers.     

Mandatory IFRS Adoption and the Role of Accounting Earnings in CEO Turnover

We study whether mandatory adoption of International Financial Reporting Standards (IFRS) is associated with changes in the sensitivity of CEO turnover to accounting earnings and how the impact of IFRS adoption varies with country‐level institutions and firm‐level incentives. We find that CEO turnover responds more to a firm's accounting performance after adoption. This increase in turnover‐to‐earnings sensitivity is concentrated in countries with stronger enforcement of financial reporting and is more prominent for mandatory adopters that have strong firm‐level compliance incentives. In addition, we link the change in turnover‐to‐earnings sensitivity directly to accounting changes due to IFRS adoption and find a stronger adoption effect when firms report large overall accounting changes and large de‐recognition of loss provisions upon adoption. Some of the above findings are sensitive to the exclusion of UK firms, which account for more than half of our sample.     

Accounting Accruals and Auditor Reporting Conservatism*

Accounting accruals are managers' subjective estimates of future outcomes and cannot, by definition, be objectively verified by auditors prior to occurrence. This causes audits of high-accrual firms to pose more uncertainty than audits of low-accrual firms because of potential estimation error and a greater chance that high-accrual firms have undetected asset realization and/or going concern problems that are related to the high level of accruals. One way that auditors can compensate for this risk exposure is to lower their threshold for issuing modified audit reports, an action that will increase modified reports and, therefore, lessen the likelihood of failing to issue a modified report when appropriate. We call this auditor reporting conservatism and test if high-accrual firms in the United States, are more likely to receive modified audit reports for asset realization uncertainties and going concern problems. Empirical results for a large sample of U.S. publicly listed companies support the hypothesis that auditors are more conservative, that is, more likely to issue both types of modified audit reports for high-accrual firms. Further analyses show that income-increasing accruals are somewhat more likely to result in reporting conservatism than income-decreasing accruals, and that only the Big Six group of auditors show evidence of reporting conservatism. These findings add to our understanding of the audit report formation process and the potentially important role played by accounting accruals in that process.     

Earnings Quality and the Equity Risk Premium: A Benchmark Model*

This paper solves a model that links earnings quality to the equity risk premium in an infinite‐horizon consumption capital asset pricing model (CAPM) economy. In the model, risk‐averse traders hold diversified portfolios consisting of risk‐free bonds and shares of many risky firms. When constructing their portfolios, traders rely on noisy reported earnings and dividend payments for information about the risky firms. The main new element of the model is an explicit representation of earnings quality that includes hidden accrual errors that reverse in subsequent periods. The model demonstrates that earnings quality magnifies fundamental risk. Absent fundamental risk, poor earnings quality cannot affect the equity risk premium. Moreover, only the systematic (undiversified) component of earnings‐quality risk contributes to the equity risk premium. In contrast, all components of earnings‐quality risk affect earnings capitalization factors. The model ties together consumption CAPM and accounting‐based valuation research into one price formula linking earnings quality to the equity risk premium and earnings capitalization factors.     

The Walk‐down to Beatable Analyst Forecasts: The Role of Equity Issuance and Insider Trading Incentives*

It has been alleged that firms and analysts engage in an "earnings‐guidance game" where analysts first issue optimistic earnings forecasts and then "walk down" their estimates to a level that firms can beat at the official earnings announcement. We examine whether the walk‐down to beatable targets is associated with managerial incentives to sell stock after earnings announcements on the firm's behalf (through new equity issuance) or from their personal accounts (through option exercises and stock sales). Consistent with these hypotheses, we find that the walk‐down to beatable targets is most pronounced when firms or insiders are net sellers of stock after an earnings announcement. These findings provide new insights on the impact of capital‐market incentives on communications between managers and analysts.     

Why Do Large Firms' Prices Anticipate Earnings Earlier than Small Firms' Prices?*

This paper presents evidence that the positive association between firm size and price leads of earnings is not solely a function of private search incentives for firm‐specific information. Specifically, we find that small‐firm prices also lag large‐firm prices with respect to industry‐wide information. Our empirical analysis extends Collins, Kothari, and Rayburn 1987 and Freeman 1987, who document that security‐price leads of earnings are positively associated with market capitalization. In particular, we examine the association between firm size and the timing of security returns for two components of annual earnings changes: the average change for a firm's industry and the firm's idiosyncratic change. We find that large firms' prices have a longer lead than small firms' prices with respect to both components. Large firms' early lead on industry‐wide earnings suggests that returns of large firms predict returns of same‐industry small firms. To test this implication, we construct a portfolio of long (short) positions in small firms when the prior month's returns of large firms in their industry are above (below) average for large firms in other industries. This zero investment portfolio earns 4.5 percent over 12 months.     

Private Information Production,Public Disclosure,and the Cost of Capital: Theory and Implications*

Both private information production by market traders and public disclosure by firms contribute to dissemination of financial information in the capital market. However, the motives and economic consequences of the two are quite different. In general, private information production is intended by investors to increase their trading profit, which has the effect of widening the information gap between informed and uninformed investors and increasing the firm's cost of capital. On the other hand, public disclosure can be used to narrow this information gap and to lower the cost of capital. This paper provides a theoretical model to examine the economic incentives behind these two forms of information dissemination and their consequences on the cost of capital. By simultaneously considering the firm's and the information traders' decisions, the paper derives an equilibrium in which the amount of private information production, the level of public disclosure, and the cost of capital are all linked to specific characteristics of the firm, of information traders, and of the market. In contrast to conventional beliefs, the paper predicts that, across firms, the cost of capital can be either positively or negatively related to the firm's disclosure level, depending on the specific factors that cause the variation within a particular sample. Similarly, the extent to which investors follow a firm and the firm's disclosure level can be either positively or negatively related to each other. Implications for empirical research are discussed.     

Earnings Forecasts and Price Efficiency after Earnings Realizations: Reduction in Information Asymmetry through Learning from Price*

When information asymmetry is a major market friction, earnings forecasts can lead to higher price efficiency even after the information in forecasts completely dissipates upon earnings realizations. We show this in an experimental market that features information asymmetry (i.e., some traders possess differential private information). Earnings forecasts reduce information asymmetry and lead to prices that reflect a greater amount of private information. Traders can learn more about others' information from prices. This information learned from past prices continues to reduce information asymmetry and improve price efficiency even after earnings realizations. We contribute to the disclosure literature by showing the evidence that the learning‐from‐price effect amplifies the impact of public disclosure on price efficiency.     

Determinants of Managerial Earnings Guidance Prior to Regulation Fair Disclosure and Bias in Analysts' Earnings Forecasts*

Prior to Regulation Fair Disclosure (“Reg FD”), some management privately guided analyst earnings estimates, often through detailed reviews of analysts' earnings models. In this paper I use proprietary survey data from the National Investor Relations Institute to identify firms that reviewed analysts' earnings models prior to Reg FD and those that did not. Under the maintained assumption that firms conducting reviews guided analysts' earnings forecasts, I document firm characteristics associated with the decision to provide private earnings guidance. Then I document the characteristics of “guided” versus “unguided” analyst earnings forecasts. Findings demonstrate an association between several firm characteristics and guidance practices: managers are more likely to review analyst earnings models when the firm's stock is highly followed by analysts and largely held by institutions, when the firm's market‐to‐book ratio is high, and its earnings are important to valuation but hard to predict because its business is complex. A comparison of guided and unguided quarterly forecasts indicates that guided analyst estimates are more accurate, but also more frequently pessimistic. An examination of analysts' annual earnings forecasts over the fiscal year does not distinguish between guidance and no‐guidance firms; both experience a “walk‐down” in annual estimates. To distinguish between guidance and no‐guidance firms, one must examine quarterly earnings news: unguided analysts walk down their annual estimates when the majority of the quarterly earnings news is negative; guided analysts walk down their annual estimates even though the majority of the quarterly earnings news is positive.