New evidence on the incremental information content of earnings reported using the LIFO inventory method

This study extends prior research by comparing the relative information quality of LIFO earnings and non-LIFO earnings using updated data and methodology. Results suggest LIFO earnings are incrementally informative independent of tax reporting implications. In addition to shedding light on why the results of prior studies present conflicting evidence about the relative information content of LIFO, these findings are important in light of international accounting standards convergence efforts, under which LIFO is currently prohibited.     

Quality of reported earnings by Chinese firms: The influence of ownership structure

This paper examines the influence of ownership structure on earnings quality of firms listed on the Chinese Stock Exchanges. We empirically test four contemporary earnings quality measures, including volatility of earnings, variability of earnings over cash flows, correlations between accruals and cash flows, and level of discretionary accruals, for 1438 firms listed on Shenzhen Stock Exchange and Shanghai Stock Exchange. We find that although state-owned firms are bigger in size and appear more profitable based on reported earnings; privately-owned firms, foreign-owned firms and society-owned firms outperform the state-controlled firms in earnings quality; and foreign-owned firms have the highest earnings quality among all types of ownership groups. We find that there is not much difference in earnings quality between collectively-owned firms and state-owned firms and employee-owned firms exercise least discretion in earnings management. The findings in particular will have direct policy implications for the China Securities Regulatory Committee (CSRC).     

The effect of earnings surprises on information asymmetry

We examine the effect of earnings surprises on changes in information asymmetry. We hypothesize and find that asymmetry is lower (higher) in the quarter following positive (negative) earnings surprises compared to firms that meet the consensus analyst earnings forecast. The relations between earnings surprises and information asymmetry are stronger when the surprises are more likely to capture investors’ attention. Examining the source of these changes, we show that decreased information search activities is the most important factor for asymmetry declining after positive surprises; for negative surprises, decreased uninformed trading plays a dominant role increasing asymmetry.     

Evaluating the information content of earnings forecasts

This study develops a framework to compare the ability of alternative earnings forecast approaches to capture the market expectation of future earnings. Given prior evidence of analysts’ systematic optimistic bias, we decompose earnings surprises into analysts’ earnings surprises and adjustments based on alternative forecasting models. An equal market response to these two components indicates that the associated earnings forecast is a sufficient estimate of the market expectation of future earnings. To apply our framework, we examine four recent regression-based earnings forecasting models, alongside a simple earnings-based random walk model and analysts’ forecasts. Using the earnings forecasts of the model that satisfies our sufficiency condition, we identify a set of stocks for which the market is unduly pessimistic about future earnings. The investment strategy of buying and holding these stocks generates statistically signi?cant abnormal returns. We offer an explanation as to why this and similar strategies might be successful.     

The effect of target managerial ownership on the choice of acquisition financing and CEO job retention

In this paper we report on our investigation into whether the level of target managerial ownership has an effect on acquisition financing choice and target CEO job retention. We find that cash is more likely used to finance acquisitions when target management ownership levels are high. This result is consistent with a reduced monitoring hypothesis, where bidding firm managers seek to avoid the formation of a large block holder that may become an active monitor. We also find evidence specific only to stock deals that the probability of target CEO job retention increases with the level of target managerial ownership. In these cases, it appears the potential benefits associated with retaining certain target managers outweighs any negative consequence associated with creating a new monitoring block.     

Intertemporal variation in the information content of aggregate earnings and its effect on the aggregate earnings-return relation

Review of Accounting Studies - We develop and test explanations for sources of intertemporal variation in the information content of aggregate earnings and how that variation explains variation in...     

The real-time information content of macroeconomic news: implications for firm-level earnings expectations

This paper investigates the usefulness of the real-time macroeconomic news-flow as a leading indicator of firm-level end-of-quarter realized earnings. Using recent advances in macroeconomics, I develop a nowcasting model for quarterly earnings and provide two main findings. First, I show that my model provides out-of-sample expectations that are as accurate as analysts’ forecasts. Second, macroeconomic news embedded in my nowcasts is not fully incorporated into investors’ earnings expectations and predicts future abnormal returns around earnings announcements. These findings have three main implications for capital markets research. First, real-time macroeconomic news can be used to update earnings expectations in real-time. Second, there are economic benefits of doing so, as evidenced by the magnitude of risk-adjusted returns around earnings announcements. Third, after three decades of almost nonexistent research on time-series models for quarterly earnings, the door is open again for fruitful research in this area.     

The ownership structure of UK firms and the informativeness of accounting earnings

This paper provides evidence that in the UK, a firm's ownership structure is related to the informativeness of its accounting earnings for price. Evidence is reported that concentrated outside ownership is negatively related to the contemporaneous price-earnings association. This is interpreted as indicative of more non-accounting information being collected and disseminated for firms whose ownership includes large outside (non-managerial) blocks and a consequential loss of informativeness of contemporaneous accounting earnings. Having controlled for the information environment, we provide evidence that the overall relation between return and earnings is attenuated for firms with diffuse outside ownership. This is interpreted as evidence of the market anticipating opportunistic managerial manipulation of earnings when outside ownership is diffuse.     

The information content of earnings announcements: new insights from intertemporal and cross-sectional behavior

This study examines the information content of quarterly earnings announcements, measured as the magnitude of stock price revision at earnings announcements relative to price revision at other times. We investigate whether quarterly earnings announcements are informative using a nonparametric approach and 1971–2011 sample period. The findings affirm prior evidence on earlier sample periods that significantly more information is conveyed to investors in the three days around earnings announcements than in randomly chosen three-day periods. Next, we examine the behavior of information content over our sample period and document four key findings. First, there is a dramatic increase in information content at earnings dates from 2001 onward. Second, the market reaction to loss firms is substantially less than that for profitable firms. Third, there is a significantly greater reaction to larger firms. Fourth, reaction at earnings dates is significantly increasing in analyst coverage, and once analyst coverage is controlled, the association with size becomes less significant.     

The incremental information content of non-US GAAP earnings disclosures: Evidence from UK firms

This paper examines price and trading volume responses in the US equity market to the preliminary earnings announcements (PEAs) in the UK of UK firms listed on US exchanges (e.g., NYSE and AMEX). The inquiry focuses on whether the return forecast error (absolute and squared values) and volume residual (standardized and unstandardized) for each day were significantly different from the average on the day of the earnings announcements (PEA). The most significantly unexpected return occurred the day prior to the Financial Times (FT) announcement. The results suggest prompt volume and price responses to the UK PEAs in the US security market. Excess trading volume occurred the day prior to and the day of the FT release price response occurred on the day subsequent to the PEAs. This may suggests that investors possess differential prior beliefs or likelihood functions in evaluating public disclosure. Consistent with Frost and Pownall [Frost, C., & Pownall, G. (1996), Interdependencies in the global markets for capital and information: The case of Smithkline Beecham plc. Accounting Horizons, 1, 38-57], US investors seem not to be confused by US/UK generally accepted accounting principles (GAAP) differences, and in fact use information about UK GAAP earnings in their valuations and trading decisions. This implies that traders correctly use UK accounting output to the determination of values in setting security prices and arriving at trading decisions. Broadly, these findings support the assumption that disclosures by UK-listed firms in their domestic market influence share liquidity and trading in the US market.     

Is CEO certification of earnings numbers value-relevant?

On June 27, 2002, the Securities and Exchange Commission of the United States ordered the CEOs and CFOs of 688 large firms to certify the earnings numbers of their companies by 5:30PM EST, Aug 14, 2002. This paper uses this natural experiment to find that certification was not only a non-event for the certifiers around their certification date, but it was also a non-event for the non-certifiers around Aug 15, 2002. Further tests make us conclude that CEO certification of earnings numbers is not value-relevant.     

CEO career concerns and the precision of management earnings forecasts

Review of Quantitative Finance and Accounting - We extend the research on how CEOs address career concerns during their early tenure in firms and we argue that CEOs use a forecast precision...     

The effect of earnings quality and country-level institutions on the value relevance of earnings

This study investigates the relationship between the value relevance of earnings and earnings quality across countries. We find that there is a stronger relationship between earnings quality and the value relevance of earnings in countries with high investor protection than in countries with weak investor protection. We also find that the association between the value relevance of earnings and earnings quality is higher when a country’s information environment is less opaque. Overall, our study documents evidence on international differences in the ability of stock prices to capture useful accounting information, consistent with the notion that the returns-earnings association reflects not only the quality of accounting earnings but also the informativeness of stock prices.     

Does trading volume detect information content in earnings reconciliations of foreign firms?

Currently, foreign firms trading securities on U.S. markets provide periodically a quantitative reconciliation of selected financial data consistent with U.S. GAAP (hereafter referred to as reconciled information) in Form 20-F. The SEC is examining whether users believe that this reconciliation process provides additional information above that provided by the foreign GAAP earning announcement and whether this incremental information enhances usefulness for market participants. We examine whether the reconciliation affects a primary indicator of information usefulness: the trading volume of capital markets participants.We use a regression model to examine the relation between a measure of abnormal trading volume and four firm-specific variables in the firm's information environment: similarities of accounting systems, analyst following, difference between reconciled earnings and foreign GAAP earnings, and dispersion of analysts’ expectations. We find a significant relation between abnormal volume and the reconciled earnings number and between abnormal volume and the dispersion of analysts forecasts. Our findings suggest that market participants may use the 20-F reconciliation in trading decisions.     

Sources of earnings variability and their effect on earnings forecasts

Previous research shows that analysts’ forecasts of earnings do not fully incorporate information contained in reported earnings variability. This study investigates whether the inefficient forecast is because of a failure to incorporate observable information on two components of earnings variability: variability in operating performance and income smoothing. Our results show that analysts’ forecasts fully incorporate information contained in earnings variability for firms with high income smoothing and for firms with low operating variability. A smaller serial correlation of forecast errors is observed for firms with low operating variability, which suggests that analysts recognize the permanence in earnings for such firms.     

The effect of alternative goals on earnings management studies: An earnings benchmark examination

Firms’ management manages earnings because they have incentives or goals to do so. Earnings management studies have to account for these different goals as tests of earnings management can be compromised by the effect of conflicting goals. I illustrate this in the setting of Dechow et al. (2003). Their study examines whether firms with small profits and firms with small losses (loss-avoidance benchmark) have differing levels of discretionary accruals. Dechow et al. (2003) find that firms just above the loss-avoidance benchmark do not have discretionary accruals that are significantly different than firms just below the benchmark. However, they do not consider firms just below the loss-avoidance benchmark that might be using discretionary accruals to avoid missing an alternative benchmark. I find that after I consider these alternate earnings benchmark goals, firms just above the benchmark have significantly higher discretionary accruals. This provides direct evidence that the ‘kink’ in the distribution of earnings arises from earnings management. I find similar results for the earnings changes benchmark. These findings highlight the need to consider alternative earnings benchmark goals when examining firms immediately around benchmarks.     

Insider sales based on short-term earnings information

I find strong evidence of insiders selling shares prior to imminent bad earnings news through their Rule 10b5-1 trading plans. While Rule 10b5-1 selling plans may conjure images of regular selling over a sustained period of time, I find that insiders’ sales under these plans often consist of a small number of sales (the median plan consists of four sales) and commonly occur over a short period of time (the median plan lasts less than 150 days). Abnormal stock returns, earnings surprises, and abnormal earnings announcement returns are all significantly negative following plans that are short-term in nature, but not following plans that are long-term in nature. Although Rule 10b5-1 does not specify a minimum length for selling plans, finding that sales within short plans significantly outperform sales within longer plans suggests that restrictions on plan length would reduce the incidence and appearance of informed selling through Rule 10b5-1 plans.     

The effects of harmonization and convergence with IFRS on the timeliness of earnings reported under Chinese GAAP

This study examines the effects of a series of harmonization and convergence with IFRS on the timeliness of recognition of earnings in emerging Chinese markets. We find that earnings reported under Chinese GAAP have a lower earnings response coefficient, but a higher future earnings response coefficient, than earnings reported under IFRS before Chinese GAAP converged with IFRS in 2007. This indicates that earnings reported under Chinese GAAP are generally less timely than earnings reported under IFRS before convergence. We also find that the future earnings response coefficient of earnings reported under Chinese GAAP continues to increase, indicating that the timeliness of recognition of earnings reported under Chinese GAAP worsened after a series of harmonization and convergence with IFRS in China. Taken together, this study provides evidence indicating that harmonizing and converging national accounting standards with IFRS in emerging capital markets may not necessarily increase accounting quality.     

Timing of earnings restatements: CEO equity compensation and market reaction

This study investigates the impact of chief executive officers’ (CEO) compensation on their choices regarding the timing of earnings restatements. The results indicate a negative relationship between options exercised and lags in disclosing the restated earnings, suggesting that managers who exercise options in a given year tend to release information quickly. This effect is more pronounced if the options are exercised after the dark period. We also find that the market penalises longer lags in the restatement disclosure. It seems that the CEO would try to optimise the timing of information release so as to balance the costs and benefits.     

The effect of Regulation FD on the properties of management earnings forecasts

We investigate Regulation FD’s (FD) effect on management earnings forecast properties. We posit FD’s prohibition on private manager-analyst communication reduces (increases) optimism (pessimism) in management earnings forecasts. Prior to FD, managers could avoid publicly retracting prior optimistic forecasts by privately communicating with analysts, who could lower investor expectations with a new analyst forecast. After FD, managers with optimistic forecasts must either publicly admit their optimism by issuing a new management forecast or they must negatively surprise investors at the earnings announcement. Further, FD forces managers to use public forecasts instead of private communications to establish beatable expectations. Our evidence suggests FD reduced optimism in management forecasts. This reduction in optimistic bias is not offset by an increase in pessimistic bias. Consistent with this, we further find post-FD improvements in forecast accuracy and informativeness. We find no such changes around several potentially confounding events or for foreign firms surrounding FD. Overall, our evidence suggests FD improved firms’ forecast properties (less bias, greater accuracy, and greater informativeness).