Shareholder‐ Versus Stakeholder‐Focused Japanese Companies: Firm Characteristics and Accounting Valuation*

Recent research has found that the value‐relevance of accounting variables depends not only on whether a country's accounting rules are code‐law oriented or common‐law oriented, but also on the reporting incentives created by the legal and business environment in which a firm operates. Therefore, for example, the earnings of firms in some countries with common‐law oriented rules but with code‐law incentives have more code‐law‐type characteristics. We further this research by examining whether this is true for firms facing the same accounting regime and institutional environment but different stakeholder‐related incentives. We find significant stakeholder‐related incentives across 23 Japanese firms listed in the United States and 23 Japanese firms not listed in the United States that are matched by industry and size. Although these firms face the same institutional environment and the same accounting regime, consistent with the differences in stakeholder‐related incentives, the earnings and book values of the firms listed in the more shareholder‐oriented U.S. markets have significantly more explanatory power for market value than those for firms not cross‐listed in the United States. These findings are unaffected by whether the reports are based on consolidated or parent‐only accounting or whether they are based on U.S. or Japanese GAAP, emphasizing the potential influence of reporting incentives at all levels on the effect of standardization, conversion, or harmonization of accounting methods globally.     

Conservative Accounting and Linear Information Valuation Models*

Prior research using the residual income valuation model and linear information models has generally found that estimates of firm value are negatively biased. We argue that this could result from the way in which accounting conservatism effects are reflected in such models. We build on the conservative accounting model of Feltham and Ohlson 1995 and the Dechow, Hutton, and Sloan 1999 (DHS) methodology to propose a valuation model that includes a conservatism‐correction term, based on the properties of past realizations of residual income and “other information”. “Other information” is measured using analyst‐forecast‐based predictions of residual income. We use data comparable to the DHS sample to compare the bias and inaccuracy of value estimates from our model and from models similar to those used by DHS and Myers 1999. Valuation biases are substantially less negative for our model, but valuation inaccuracy is not markedly reduced.     

Valuation and Clean Surplus Accounting for Operating and Financial Activities*

Abstract. This paper models the relation between a firm's market value and accounting data concerning operating and financial activities. Book value equals market value for financial activities, but they can differ for operating activities. Market value is assumed to equal the net present value of expected future dividends, and is shown, under clean surplus accounting, to also equal book value plus the net present value of expected future abnormal earnings (which equals accounting earnings minus an interest charge on opening book value). A linear model specifies the dynamics of an information set that includes book value and abnormal earnings for operating activities. Model parameters represent persistence of abnormal earnings, growth, and accounting conservatism. The model is sufficiently simple to permit derivation of closed form expressions relating market value to accounting data and other information. Three kinds of analyses develop from the model. The first set deals with value as it relates to anticipated realizations of accounting data. The second set examines in precise terms how value depends on contemporaneous realizations of accounting data. The third set examines asymptotic relations comparing market value to earnings and book values, and how earnings relate to beginning of period book values. The paper demonstrates that in all three sets of analyses the conclusions hinge on the extent to which the accounting is conservative as opposed to unbiased. Further, the absence/presence of growth in operating activities is relevant if, and only if, the accounting is conservative. Résumé. Les auteurs présentent sous forme de modèle la relation entre la valeur marchande d'une entreprise et les données comptables relatives à ses activités d'exploitation et ses activités financières. La valeur comptable est égale à la valeur marchande lorsqu'il s'agit d'activités financières, mais elle peut être différente dans le cas des activités d'exploitation. Les auteurs supposent que la valeur marchande est égale à la valeur actualisée nette des dividendes futurs prévus et démontrent que, lorsqu'on applique la méthode du résultat global, la valeur marchande est aussi égale à la valeur comptable additionnée de la valeur actualisée nette des bénéfices extraordinaires futurs prévus (qui sont égaux aux bénéfices comptables diminués de frais d'intérêt implicites sur la valeur comptable nette). Un modèle linéaire précise la dynamique d'un ensemble de données, incluant la valeur comptable et les bénéfices extraordinaires, relatives aux activités d'exploitation. Les paramètres du modèle traduisent la persistance des bénéfices extraordinaires, la croissance et le principe de prudence. Le modèle est suffisamment simple pour permettre de dériver des expressions fermées qui mettent en relation la valeur marchande et les données comptables et autres. Du modèle se dégagent trois formes d'analyses. La première porte sur la valeur, dans sa relation avec la matérialisation anticipée des données comptables. La deuxième porte sur l'examen précis du lien entre la valeur et la matérialisation actuelle des données comptables. Enfin, la troisième porte sur l'examen des relations asymptotiques à travers lesquelles se comparent la valeur marchande, d'une part, et les bénéfices et la valeur comptable, d'autre part, ainsi que sur la façon dont les bénéfices se rattachent aux valeurs comptables du début de l'exercice. Les auteurs établissent que dans les trois formes d'analyses, les conclusions s'orientent vers la mesure dans laquelle, dans le domaine comptable, l'accent est mis sur la prudence par opposition à l'impartialité. En outre, l'absence ou la présence de croissance dans les activités d'exploitation n'est pertinente que si et seulement si le principe de prudence est appliqué à la comptabilité.     

The Incremental Informativeness of Stock Prices for Future Accounting Earnings*

This study extends previous research that documents a stock price reaction leading accounting earnings. The primary issue is that prior studies use a naive earnings expectation model (random walk) as the benchmark for the information content of lagged returns and do not adequately address the “incremental” information content of lagged returns. This study identifies and estimates firm-specific models of earnings to control directly for the autocorrelation in earnings. The explanatory power of lagged prices with respect to this earnings residual is investigated using both a multiple regression model of lagged returns and a multiple time-series vector autoregressive model. In-sample estimation of the models provides clear evidence that stock prices impound information about future earnings incremental to the information contained in historical earnings data. Holdout period analysis of the earnings forecasts from these lagged return models finds that both models outperform the naive seasonal random walk expectation, but neither model outperforms the more sophisticated Box-Jenkins forecasts. On an individual firm basis, earnings forecasts supplemented with the lagged return data tend to be less precise than the Box-Jenkins forecasts, but the price-based models demonstrate an ability to rank the earnings forecast errors from the time-series models. The analysis helps to characterize the limitations of lagged returns as a means of predicting future earnings innovations.     

The North American Industry Classification System and Its Implications for Accounting Research*

Industry classification is an important component of the methodological infrastructure of accounting research. Researchers have generally used the Standard Industrial Classification (SIC) system for assigning firms to industries. In 1999, the major statistical agencies of Canada, Mexico, and the United States began implementing the North American Industry Classification System (NAICS). The new scheme changes industry classification by introducing production as the basis for grouping firms, creating 358 new industries, extensively rearranging SIC categories, and establishing uniformity across all NAFTA nations. We examine the implications of the change for accounting research. We first assess NAICS's effectiveness in forming industry groups. Following Guenther and Rosman 1994, we use financial ratio variances to measure intra‐industry homogeneity and find that NAICS offers some improvement over the SIC system in defining manufacturing, transportation, and service industries. We also evaluate whether NAICS might have an impact on empirical research by reproducing part of Lang and Lundholm's 1996 study of information‐transfer and industry effects. Using SIC delineations, they focus on whether industry conditions or the level of competition is the main source of uncertainty resolved by earnings announcements. Across all levels of aggregation, we find inferences are similar using either SIC or NAICS. How‐ever, we also observe that the regression coefficients in Lang and Lundholm's model show smaller intra‐industry dispersion for NAICS, relative to SIC, definitions. Overall, the results suggest that NAICS definitions lead to more cohesive industries. Because of this, researchers may encounter some differences in using NAICS‐industry definitions, rather than SIC, but these will depend on research design and industry composition of the sample.     

An Experimental Investigation of the Effect of Cost Information and Feedback on Product Cost Decisions*

Abstract. In this paper we report the results of an experiment designed to investigate the potential benefits of more accurate costing systems. Subjects in our experiment participated in one of four single-person decision making settings, which varied in terms of the accuracy of costing systems (less accurate versus more accurate cost reports) and in the complexity of the economic environment (less heterogeneous versus more heterogeneous products). The costing systems provided imperfect reports that subjects could use to select forecasts of future product costs. Forecast accuracy determined the resulting payoffs for subjects. In addition to having the cost reports when making forecasts, subjects also observed the association between forecasts and actual profits for previous periods and the rank ordering of the products' relative usage of resources at each of the production processes. The results from our experiment indicate that subjects did not select forecasts based only on reported costs. Rather they updated forecasts using profit feedback and the supplemental rank information about the products' relative usage of resources. We found that profits decreased as the complexity of economic environment increased but increased with the accuracy of cost reports. The profits associated with less accurate costing systems, however, were not as low as we would have predicted had the subjects used the cost reports as their forecasts. In fact, using profit feedback, subjects were able to converge toward optimal profits even with imperfect cost information.     

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.     

Communication in Multiperiod Agencies with Production and Financial Decisions*

Abstract. This paper examines a two-consumption date principal/agent model in which the manager receives private information at the first date. After observing his private information, the manager (agent) selects both the capital and personal effort he will invest in production. Operating cash flows are realized at both dates and any uninvested funds at the initial date are either paid out as a dividend to the equityholders (principal) or invested in zero net present value investments that require no effort. The aggregate cash flow at the second date is paid out as a dividend to the equityholders. The compensation contract specifies the manager's compensation as a function of the information available at the two dates. The key issue is whether it is valuable to have the contract based on the agent's communication of his private information. As in a single-consumption date model, communication may permit the implementation of more efficient incentives with respect to the manager's action choices. In addition, communication can facilitate the smoothing of the manager's consumption over the two dates. Direct communication can have positive value, but the analysis identifies a number of factors that can result in communication having no value. These factors include no direct preference for effort, public reporting of the private information at the second date, access to personal investments, and access to a dividend policy that will costlessly convey the private information through first-date dividends. Although access to personal investments may make communication redundant (since it is an alternative means of smoothing consumption), the analysis identifies conditions under which the equityholders would prefer to use communication and restrict the manager's access to personal investments (since it can have a negative effect on incentives). Résumé. Les auteurs examinent un modèle mandant-mandataire à deux dates de consommation dans lequel le gestionnaire reçoit de l'information privilégiée à la première des deux dates. Après avoir observé l'information privilégiée, le gestionnaire (c'est-à-dire le mandataire) sélectionne le capital et l'effort personnel qu'il investira dans la production. Les flux monétaires provenant de l'exploitation sont réalisés aux deux dates, et tous les fonds qui ne sont pas investis à la date initiale sont soit versés sous forme de dividendes aus. actionnaires (c'est-à-dire les mandants), soit investis dans des placements à valeur actualisée nette nulle et qui n'exigent aucun effort. Les flux monétaires totaux à la seconde date sont versés sous forme de dividendes aux actionnaires. Selon le contrat de rémunération, la rétribution des gestionnaires est fonction de l'information disponible aux deux dates. Le principal problème consiste à déterminer si le fait de baser le contrat sur la communication par le mandataire de l'information privilégiée dont il dispose présente un intérêt. Comme dans un modèle à une seule date de consommation, la communication peut permettre la mise en place de stimulants plus efficients en ce qui a trait au choix du gestionnaire concernant son plan d'action. En outre, la communication peut faciliter le nivellement de la consommation du gestionnaire entre les deux dates. La communication directe peut avoir une valeur positive, mais l'analyse permet de cerner plusieurs facteurs qui peuvent retirer toute valeur à une communication. Au nombre de ces facteurs figurent: l'absence de préférence directe pour l'effort, la communication publique de l'information privilégiée à la seconde date, l'accès aux placements personnels et l'accès à une politique de dividendes qui livrera sans frais l'information privilégiée par le truchement du versement de dividendes de la première date. Bien que l'accès aux placement personnels puisse rendre la communication redondante (puisqu'il s'agit d'un moyen de rechange de niveler la consommation), les auteurs définissent les conditions dans lesquelles les actionnaires préféreraient utiliser la communication et restreindre l'accès du gestionnaire aux placements personnels (puisqu'ils peuvent avoir un effet négatif sur les stimulants).     

Valuation and Clean Surplus Accounting: Some Implications of the Feltham and Ohlson Model for the Relative Information Content of Earnings and Cash Flows*

Abstract. This paper provides an analysis of the implications of the Feltham and Ohlson (1995) model for the relationship between unexpected security returns and unexpected earnings and cash flows. A simplified version of the Feltham and Ohlson linear information model is utilized to provide an intuitive explanation of the coefficients in the unexpected returns equation and to show that incremental information content for unexpected free cash flow beyond accounting earnings in the model depends on the existence of positive net present value (NPV) investment opportunities. The paper concludes by arguing that the model provides useful insights into factors that may influence the empirical relationship between security returns and accounting data. Résumé. L'auteur expose les résultats d'une analyse des répercussions du modèle de Feltham et Ohlson (1995) sur la relation entre les rendements imprévus des titres, d'une part, et les bénéfices et les flux monétaires imprévus, d'autre part. Il a recours à une version simplifiée du modèle d'information linéaire de Feltham et Ohlson pour expliquer intuitivement les coefficients de l'équation des rendements imprévus et pour montrer que, dans le modèle, le contenu marginal en information supérieur des flux monétaires disponibles imprévus par rapport aux bénéfices comptables dépend des possibilités d'investissement existantes offrant une valeur actualisée nette (VAN) positive. L'auteur conclut en affirmant que le modèle livre des renseignements utiles quant aux facteurs susceptibles d'influencer la relation empirique entre les rendements des titres et les données comptables.     

Valuation Implications of Unconditional Accounting Conservatism: Evidence from Analysts' Target Prices

We examine whether financial analysts understand the valuation implications of unconditional accounting conservatism when forecasting target prices. While accounting conservatism affects reported earnings, conservatism per se does not have an effect on the present value of future cash flows. We examine whether analysts adjust for the effect of conservatism included in their earnings forecasts when using these forecasts to estimate target prices. We find that signed target price errors (actual minus forecast) have a significant positive association with the degree of conservatism in forward earnings, suggesting that target prices are biased due to accounting conservatism. Cross‐sectional analysis suggests that more sophisticated analysts and superior long‐term forecasters adjust for conservatism to a greater extent than other analysts. In additional analyses, we explore the mechanism through which conservatism leads to bias in target prices. We first show that analysts' earnings forecasts are negatively associated with the degree of conservatism; that is, analysts include the effect of unconditional conservatism in their earnings forecasts. Based on alternative earnings‐based valuation models that analysts may use, our evidence suggests that analysts fail to appropriately adjust their valuation multiple for the effect of conservatism included in their earnings forecasts when using these forecasts to derive target prices. As a consequence, we find that, for extreme changes in conservatism, the bias in analysts' target prices due to conservatism leads to a distortion of market prices. The evidence highlights the concern that analysts may not appreciate the valuation implications of conservative accounting which could inhibit price discovery.     

Foreign Currency Exposure of Multinational Firms: Accounting Measures and Market Valuation*

Abstract. The accounting method in Statement of Financial Accounting Standards (SFAS) No. 8 for restatement of a foreign operation's financial statements denominated in a foreign currency into the parent's currency equivalents for inclusion in the parent company's financial statements was severely criticized by market participants and managers. Its replacement, SFAS No. 52, represented an attempt to improve on the methods of SFAS No. 8. This study examines two questions: did SFAS No. 8 produce relevant information for valuing US multinational firms, and are the results reported under SFAS No. 52 more valuation relevant than those reported under SFAS No. 8? Valuation relevance is studied because the Financial Accounting Standards Board (FASB) has stated that relevance is an important criterion for choosing among alternative accounting methods. Considered collectively, the results suggest that the rules in SFAS No. 8 produced a poor accounting measure for valuing US multinational firms, and that the introduction of SFAS No. 52 has resulted in a significant improvement in the valuation relevance of the accounting numbers associated with the restatement of a foreign operation's financial statements. However, this improvement applies only to the subset of firms that designated a foreign currency as their functional currency (i.e., switched to the current-rate method) and not to firms that designated the dollar as their functional currency (i.e., as if they still reported under SFAS No. 8).     

Fixed Cost Magnitude,Fixed Cost Reporting Format,and Competitive Pricing Decisions: Some Experimental Evidence*

Although neoclassical economic theory predicts that fixed cost magnitude and fixed cost reporting format will not influence short‐term pricing decisions, these factors systematically affected pricing decisions in a duopoly experiment. Increasing fixed cost magnitude (a pure sunk cost in this study) across experimental conditions caused participants to first lower, then raise, competitive prices. Consistent with the psychological phenomenon of loss aversion, this change in pricing behavior reduced the frequency of reported losses. This study further reveals that the accounting format for reporting fixed costs influenced pricing behavior. Specifically, participants receiving capacity costing feedback reports established increasingly lower selling prices relative to the prices established by participants receiving contribution margin feedback reports. Given that a very simple cosmetic reporting manipulation produced increasingly significant competitive pricing differences in a market setting, this study provides evidence that functional fixation is not necessarily eliminated by market forces.     

Accounting Quality,Stock Price Delay,and Future Stock Returns*

In frictionless capital markets with complete information and rational investors, stock prices adjust to new information instantaneously and completely. However, a substantial body of research studies information imperfections such as asymmetric information and incomplete information. Information imperfections potentially hinder timely price discovery and are likely associated with delayed stock price adjustment to information. Our first research question therefore is whether the quality of accounting information (or “accounting quality”) is one such information imperfection that is associated with cross‐sectional variation in stock price delay. We define accounting quality as the precision with which financial reports convey information to equity investors about the firm’s expected cash flows. Poor accounting quality is likely associated with higher expected returns through uncertainty about stock valuation parameters and incomplete information. Our second research question therefore is whether the accounting quality component of price delay is associated with higher future stock returns. Consistent with our hypotheses, the results show that poor accounting quality is associated with delayed price adjustment and higher future stock returns. Thus, accounting quality plays a role in timely stock price discovery.     

The Effect of Public Infrastructure on Cost Structure and Performance of Chinese Provinces*

This paper estimates a translog cost function for 29 Chinese provinces between 1979 and 2018. The results imply that investment in public infrastructure reduces costs in all provinces. Comparing the estimated rate of return to infrastructure with the rate of return to private capital, our results indicate underinvestment for the initial period after the economic reforms; however, after 2010 our results show overinvestment in infrastructure. Infrastructure capital is a substitute input to labor, private capital and intermediate inputs. Finally, public infrastructure growth contributes positively to labor and total factor productivity growth, but the effect is small. The growth of private capital and intermediate inputs are the most important factors that boost the growth of labor productivity.