Nonlinearity in the Returns-Earnings Relation: Tests of Alternative Specifications and Explanations*

Abstract. Several authors recently challenged the linearity of the returns-earnings relation. In this article, we test the adequacy of alternative nonlinear specifications and examine the validity of various explanations put forth for the returns-earnings nonlinearity. Our main findings are (1) that the nonlinearity persists even when the returns-earnings relation is estimated on annual data (most previous studies used quarterly data) and by a nonparametric procedure that does not impose a specific functional form on the relation; (2) that some nonlinearity exists in the relation between stock returns and earnings levels (previous studies have considered earnings surprises), although it is much less pronounced than the returns-earnings surprise nonlinearity; (3) that the main nonlinear estimation methods used in previous studies and in the current one appear to characterize equally well the underlying returns-earnings relation; predictions of subsequent stock returns based on each of the three specifications the authors examined are largely indistinguishable with respect to their accuracy; (4) that although “special items,” usually identified as transitory by the accountants, appear to contribute to the nonlinearity, there are probably additional contributing factors; the authors find that when all extraordinary items and “special items” are removed from earnings, the returns-earnings relation still exhibits nonlinearity, (5) that the inclusion of cash flow or accrual information also does not eliminate the nonlinearity; and (6) that the returns-cash flow relation is also nonlinear. The authors conclude that nonlinearity of the returns-earnings relation is quite robust across several alternative specifications. However, the candidate explanations they examined do not fully explain the observed nonlinearity. The search for the underlying cause of nonlinearity must therefore continue. Résumé. Plusieurs auteurs remettaient récemment en question la linéarité de la relation rendements-bénéfices. Les auteurs de l'article qui suit vérifient, pour leur part, si les formes non linéaires envisageables sont appropriées et examinent la validité de diverses explications mises de l'avant pour éclairer la non-linéarité de la relation rendements-bénéfices. Leurs principales observations sont les suivantes: (1) la non-linéarité persiste même lorsque la relation rendements-bénéfices est estimée à partir de données annuelles (la plupart des études précédentes s'appuyaient sur des données trimestrielles) et au moyen d'un procédé non paramétrique qui n'impose pas de forme fonctionnelle précise à la relation; (2) une certaine non-linéarité existe dans la relation entre le rendement des actions et les niveaux de bénéfice (les chercheurs avaient, jusque-là, pris en considération les bénéfices inattendus), bien que cette non-linéarité soit beaucoup moins accentuée que la non-linéarité des rendements-bénéfices inattendus; (3) les principales méthodes d'estimation non linéaire utilisées dans les études précédentes et dans la présente étude semblent définir tout aussi bien la relation sous-jacente rendements-bénéfices; les prédictions relatives aux rendements subséquents des actions en fonction de chacune des trois formes que les auteurs ont examinées sont, dans la majorité des cas, impossibles à différencier en ce qui a trait au degré d'exactitude; (4) bien que des éléments ? exceptionnels ?, habituellement définis comme étant provisoires par les comptables, semblent contribuer à la non-linéarité, d'autres facteurs y contribuent probablement aussi; selon les auteurs, lorsque tous les éléments extraordinaires et les ? éléments exceptionnels ? sont exclus des bénéfices, la relation rendements-bénéfices demeure non linéaire; (5) la relation demeure aussi non linéaire si l'on tient compte de l'information relative aux flux de trésorerie ou aux engagements; et (6) la relation rendements-flux de trésorerie est également non linéaire. Les auteurs concluent que la non-linéarité de la relation rendements-bénéfices, envisagée sous plusieurs formes différentes, résiste assez bien à l'analyse. Toutefois, les causes possibles qu'ils ont choisi d'examiner n'expliquent pas entièrement la non-linéarité observée, et les recherches doivent se poursuivre.     

Determinants of the Choice of Accounting for Investments in Associated Companies*

Abstract. The Australian standard on investments in associated companies first took effect in 1984. It prohibited the use of equity accounting in the primary financial statements but required the provision of supplementary equity accounting disclosures. Prior to this, firms voluntarily adopted either of the alternative cost and equity methods in their primary financial statements. This paper contributes to the positive accounting literature by analyzing the accounting policy choice of listed Australian companies in the first year in which the standard took effect. Noncompliance with the standard took the form of either adopting the equity method in the primary financial statements or using the cost method without supplementary disclosures. We focus on the choice of noncompliance procedures. The results support the contractual efficiency but not the alternative opportunistic behavior perspective on accounting method choice. They indicate that the choice is associated with the proportion of listed associates, the materiality of investments in associates, and the existence of guarantees but not with the degree of ownership nor the number of associates. Résumé. La premiére norme australienne au sujet des participations dans des sociétés apparentées remonte à 1984. Cette norme proscrit le recours à la méthode de la comptabilisation à la valeur de consolidation dans les états financiers de base, tout en exigeant la présentation d'information complémentaire préparée selon cette méthode. Auparavant, la comptabilisation des participations à la valeur d'acquisition ou à la valeur de consolidation était laissée à la discrétion des entreprises dans leurs états financiers de base. Les auteurs ajoutent ici aux écrits portant sur la théorie comptable positive en analysant le choix des méthodes comptables effectué dans les sociétés australiennes dont les valeurs sont cotées, au cours de la première année d'existence de la norme. Le non-respect de la norme se manifeste tantôt par l'adoption de la méthode de la comptabilisation à la valeur de consolidation dans les états financiers de et base tantôt par celle de la méthode de comptabilisation à la valeur d'acquisition sans information complémentaire. Les auteurs s'intéressent particulièrement au choix des avenues de non-conformité. Les résultats obtenus confirment l'efficience du contrat mais non l'autre perspective, celle du comportement opportuniste en ce qui a trait au choix de la méthode comptable. Ils révèlent que le choix de la méthode est lié à la proportion de sociétés apparentées dont les valeurs sont cotées, à l'importance des participations dans les sociétés apparentées et à l'existence de garanties, mais qu'il n'est pas lié aux pourcentages de participation ou au nombre des sociétés apparentées.     

Determinants of the Time Series of Earnings and Implications for Earnings Quality*

This paper examines whether differences in accrual accounting methods across balance sheet accounts influence the time‐series process of earnings. We define earnings quality as the responsiveness of earnings to shifts in permanent earnings and predict that responsiveness will increase in a firm's use of variable rate debt, where accruals move directly with shifts in interest rates. We also predict that responsiveness will decrease in a firm's investment in property plant and equipment because depreciation is largely predetermined and does not respond to shifts in opportunity costs. </P><P>To test these hypotheses, we regress earnings on lagged earnings and a proxy for permanent earnings (that is, the implied dividend annuity in lagged equity value). Within the context of an adjustment cost model, this regression captures the responsiveness of earnings by the coefficient on lagged price and by one minus the coefficient on lagged earnings. Consistent with this framework, we find the unconstrained estimated coefficients on these two variables to be negatively correlated. Furthermore, consistent with our hypotheses, we find that the coefficient on lagged earnings (lagged price) is positively (negatively) associated with the relative magnitude and life of fixed assets on the balance sheet and negatively (positively) associated with the relative magnitude of variable rate debt on the balance sheet.</P>     

An Overview of the Proximate Determinants of Economic Growth in Indonesia Since 1960*

In this paper, we address two questions. First, what determined the growth of GDP per worker in Indonesia from 1960 to 2014? We examine Indonesia’s economic performance, using a growth accounting framework. We show that economic growth during the Soeharto era after 1975 was mainly determined by an increase in capital accumulation. Negative growth in total factor productivity (TFP) during the Asian financial crisis was more noticeable in Indonesia than in comparable ASEAN countries. In Indonesia, the contribution of TFP growth turned persistently positive after 1999. Second, what are the key determinants of the GDP per worker differences between Indonesia and the United States? Using data from the recently updated Penn World Table database and employing a levels accounting method, we find that the gap in physical capital deepening between the two countries is of declining importance in explaining the gap in labour productivity between Indonesia and the United States. We then compare our findings with data from the World Bank’s Changing Wealth of Nations 2018.     

Determinants of Funding Strategies and Actuarial Choices for Defined-Benefit Pension Plans*

This paper examines the effects of firms' financial and pension profiles on their funding strategies and actuarial choices. The paper uses reports filed by individual pension plans with the Department of Labor under the requirements of the Employee Retirement Income Security Act of 1974 for the analysis. Evidence reported in the paper shows that as firms become overfunded, they make conservative actuarial choices to avoid visibility costs, and that as firms become underfunded, they make liberal actuarial choices to avoid visibility costs. As the annual contributions increase relative to the permissible contribution ranges, firms make conservative actuarial choices to minimize penalties and maximize tax benefits. As the annual contributions decrease relative to the permissible contribution ranges, firms make liberal actuarial choices to minimize penalties and maximize tax benefits. The larger the profitability, cash flow from operations, and tax liability, and the smaller the debt of a firm, the higher the likelihood that the firm's managers will make conservative actuarial choices to maximize contributions. Conversely, the smaller the profitability, cash flow from operations, and tax liability, and the larger the debt of a firm, the higher the likelihood that the firm's managers will make liberal actuarial choices to minimize contributions. This evidence, which is consistent with the hypothesis of funding management, can aid the Internal Revenue Service (IRS) in regulating the defined-benefit pension plans more effectively and help plan beneficiaries to manage their retirement portfolios more efficiently. The debiasing method developed in the paper can provide investors and creditors with the tools to identify the discretionary components of pension liabilities and thereby value firms more efficiently.     

Vulnerability of Vietnamese Elderly to Poverty: Determinants and Policy Implications*

We identify determinants of elderly poverty in Vietnam using household survey data from 2004. The elderly living in urban and rural areas face significantly different conditions. Some factors impact poverty in both urban and rural areas (e.g. age, marital status, region and remittance receipts), some factors are insignificant in both areas (e.g. living arrangements and household head characteristics) and some factors have a differing impact in the two areas (e.g. gender, ethnicity, and household composition and size). With these findings, we formulate policy priorities, including reducing regional disparities, promoting the rural economy and reforming social security.     

Study of the Measurement and Determinants of Intra‐industry Trade in East Asia*

The present paper investigates the development of intra‐industry trade (IIT) among the East Asian economies over the 1970–1996 period. A dynamic index is used to capture the changes in the structure of trade flows. Based on this approach, IIT is decomposed into horizontal (HIIT) and vertical components (VIIT) and the determinants of each are investigated. The results show that both HIIT and VIIT have exhibited increased importance over the sample period in manufacturing. Using pooled panel data the two‐way trade in all measures of IIT is found to be positively related to the country‐specific variables, such as the market size, exhange rate depreciation, the levels of development and income, and negatively to the geographic proximity of the partners. Economies of scale are seen to have a positive influence on IIT and HIIT, but a negative relationship with VIIT. Although the relative openness of a country's trade regime shows no significant relationship with any form of IIT, a trade imbalance does affect IIT and HIIT flows. The findings have implications for assessing the structural adjustment costs associated with the trade liberalization process as HIIT is associated with demand for variety and relates to two‐way trade in goods of similar quality, while VIIT is driven by international specialization and differences in relative factor endowments.     

The Determinants of Accounting Professors' Publishing Productivity—The Early Career*

Abstract. This study tests the ability of the accumulative advantage and human capital models to explain the vast differences among accounting faculty in publishing productivity and impact (citations) during their early careers. Using data from a survey of accounting faculty in U.S. universities and a variety of secondary sources, we estimate a measurement model for two theoretical constructs and a system of structural equations for each theoretical model using LISREL. Both theoretical models fit the data well. None of the hypotheses that are unique to human capital theory, but a majority of the unique accumulative advantage hypotheses are supported by the empirical results. The results suggest the following: (1) graduate program quality influences productivity indirectly and is positively associated with access to appointments in top academic departments, (2) the quality of the first faculty appointment is positively related to the number of publications in both academic and practitioner journals, and citations by others, (3) ability is positively related to access to top doctoral programs but is not directly related to the number of academic or practitioner journal publications, or their impact, (4) the receipt of external research funding in graduate school is positively related to the number of subsequent publications in academic journals, and (5) the receipt of a faculty research fellowship or grant is positively related to the number of publications in practitioner journals. Résumé. Les auteurs évaluent dans quelle mesure les modèles de l'avantage cumulatif et du capital humain parviennent à expliquer, tant en matière de publications que d'influence de ces publications (c'est-à-dire la mesure dans laquelle elles sont citées), les très grands écarts qui caractérisent la productivité des professeurs de comptabilité qui commencent leur carrière. À l'aide des données provenant d'un sondage mené auprès de professeurs de comptabilité d'universités des États-Unis, et d'information tirée de diverses sources secondaires, les auteurs élaborent un modèle de mesure pour deux appareils conceptuels théoriques et un système d'équations structurelles pour chaque modèle théorique faisant appel au LISREL. Les deux modèles théoriques s'ajustent bien aux données. Les résultats empiriques ne confirment aucune des hypothèses propres à la théorie du capital humain, mais attestent la majorité des hypothèses propres à celle de l'avantage cumulatif. Ils semblent indiquer ce qui suit: (1) la qualité des programmes d'études supérieures influe indirectement sur la productivité en matière de publications et est en relation positive avec l'accès à des postes dans des départements universitaires de niveau supérieur; (2) la qualité du premier poste de professeur est en relation positive avec le nombre des publications dans les revues tant universitaires que professionnelles et avec l'influence de ces publications; (3) la capacité est en relation positive avec l'accès aux programmes de doctorat de haut niveau, mais elle ne l'est pas avec le nombre de publications dans des revues universitaires ou professionnelles ou avec leur influence; (4) l'obtention de financement auprès de sources externes pour la recherche dans les écoles supérieures est en relation positive avec le nombre de publications subséquentes dans des revues universitaires; et (5) l'obtention d'une subvention ou d'une bourse de recherche par les professeurs est en relation positive avec le nombre de leurs publications dans des revues professionnelles.     

Determinants of Remittances: Recent Evidence Using Data on Internal Migrants in Vietnam*

The present paper examines the determinants of remittance behavior for Vietnam using data from the 2004 Vietnam Migration Survey on internal migrants. It considers how, among other things, the vulnerability of a migrant's life at the destination, their link to relatives back home, and the time spent at the destination affect remittances. The paper finds that migrants act as risk‐averse economic agents and send remittances back to the household of origin as part of an insurance exercise in the face of economic uncertainty. Remittances are also found to be driven by a migrant's labor market earnings level. The paper highlights the important role of remittances in providing an effective means of risk‐coping and mutual support within the family.     

Inequality and Determinants of Earnings in Malaysia, 1984–1997*

Using three large nationally‐representative Malaysian Household Income Surveys from 1984, 1989 and 1997, the present paper examines inequality and determinants of earnings. During the period 1984–1997, Malaysia's real per capita GDP increased by approximately 70percent, the participation rates for both men and women went up among all age groups, and the average number of years of schooling increased by 1.2years. There was a significant relative wage improvement among the bottom deciles. The rate of return to an additional year of schooling remained high (at 10percent), despite the huge increase in the supply of the highly educated. The stable overall rate, however, masks an increased rate of return on women's education, and a decreased rate for men. Wage discrimination against women amounts to 16–20percent, and the bias has increased in 1997. The pro‐Chinese earning ethnic bias is estimated at 31percent.     

Spatial Correlation in Household Choices in Rural Indonesia*

Many household choices in developing economies are correlated with choices of nearby households, because nearby locations have unobserved factors in common and households and their neighbors interact. However, models recognizing these spatial correlations are rarely used because few surveys give exact household locations. In the present paper, we use unusual data from rural Indonesia, where distances between households can be measured, to examine spatial effects in equations for non‐farm enterprises' share of household incomes and food's share of total household budgets. Our results indicate that ignoring spatial correlations in household choices might cause bias and inferential errors and could distort recommended policy interventions aiming to raise living standards in rural Asia.     

Avoiding Accounting Fixation: Determinants of Cognitive Adaptation to Differences in Accounting Method*

Much research over the last 30 years has provided evidence that individuals display accounting fixation; that is, their cognitive process does not appropriately adapt to cross‐sectional or temporal differences in an accounting method. This paper presents the results of a quasi‐experimental test of the hypothesis that cognitive adaptation to a change in accounting method is an ordinal interactive function of three person characteristics: relevant accounting knowledge, general problem‐solving ability, and intrinsic motivation to appropriately engage in the decision task. Based on a product‐pricing decision task in which participants are provided with product costs reported by two generally employed product‐costing methods (activity‐based costing [ABC] and volume‐based costing), the results show that the majority of participants did not change their cognitive behavior when there was a change in the costing method. Further, those participants who did adapt to the change in accounting method, and thus avoided accounting fixation, did so by debiasing costs reported by volume‐based costing but not by ABC. Finally, these adapters generally exhibited high values for all three of the person characteristics compared with those who did not adapt.     

Determinants of Corporate Leverage: A Time-Series Analysis Using U.S. Tax Return Data*

Abstract. The study examines how the risk of exhausting corporate tax liabilities before deducting interest expense affects corporate leverage. It differs from prior studies in three ways: (1) it uses data compiled by the Internal Revenue Service (IRS) from corporate tax returns rather than accounting data; (2) it measures risk of tax exhaustion more accurately; and (3) it adopts a first-difference time-series approach, so that firms act as their own control between adjacent years. These methodological innovations reduce biases caused by measurement error and omitted variables that were present in prior research. The results suggest that, all else being equal, high risk of tax exhaustion reduces firms' use of leverage. As well, the study provides the first evidence that personal taxes significantly affect corporate leverage. The effects on leverage decisions of other variables are also tested and the results are consistent with predictions from prior theoretical work.     

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.     

The Determinants of Labour Supply and Demand in Irrigated Agriculture: A Case Study of the Gezira Scheme in Sudan*

Abstract: The objective of this study was to estimate the determinants of labour supply and demand in irrigated agriculture with reference to the Gezira scheme. Two samples, one comprising the farmers and the other the agricultural workers, were randomly selected through a field survey during the 2003/2004 season. A log‐linear model of multiple regressions was fitted to the data. The results indicated that labour demand and supply depend mostly on variables related to the household characteristics and economic and non‐economic conditions.     

Determinants of the Demise of Terrorist Organizations

This article investigates the determinants of terrorist groups' failure by applying survival analysis in a discrete‐time specification. Our sample consists of a diverse set of 586 terrorist groups, in which just over 63% end operations (demise) during 1970–2007. We use RAND event data and Jones and Libicki terrorist group data. Findings show that the survival of terrorist groups is bolstered by diversifying attacks, having multiple home bases, locating in the Middle East, locating in a democratic country, and limiting reliance on transnational terrorist attacks. Moreover, larger groups have better survival prospects. Religious fundamentalist terrorist groups face better survival prospects than other terrorist groups. Terrorist groups located in a country with larger tropical territory are less likely to end operations; however, groups based in a landlocked country are more likely to fail.