Operating cash flow opacity and stock price crash risk

We examine the relation between operating cash flow (OCF) opacity and stock price crash risk. We find that OCF opacity is positively associated with future stock price crash risk after controlling for accruals opacity and other determinants known to influence crash risk. This finding suggests that OCF opacity facilitates bad news hoarding and enables managerial resource diversion, which in turn increases crash risk. We also find that the positive relation between OCF opacity and crash risk is more pronounced when external monitoring is weak, information asymmetry is high, OCF importance is low, and cost of accruals management is high. Overall, our evidence highlights the severe consequence of OCF opacity in that it boosts crash risk; our study should alert the researchers, investors, and regulators to pay more attention to OCF management.     

Why and how firms use operating cash flow in compensation**

This study considers the choice of operating cash flow (OCF) in contracts and further examines the sensitivity of the CFO's and CEO's compensation to OCF performance, conditional on our stylized indicator of the importance of working capital management (WCM). The analysis depicts OCF as conveying distinct information about WCM, and predicts that firms for which WCM is an important source of value are more likely to contract on OCF. The importance of WCM is instrumented by firm conditions that create strong demand for WCM, including large working capital, rapid growth in working capital, highly volatile working capital, and large debt relative to total assets. Using a sample of firms whose incentive plans explicitly include OCF measures and a control sample of firms without such plans, we show that all four indicators of the importance of WCM have positive association with the likelihood of contracting upon OCF, individually and collectively. In compensation regressions, we find that WCM importance has a pronounced positive effect on the weight of OCF, but muted effect on the weight of accrual earnings. The results suggest that firms include measures of OCF performance in contracts largely to provide incentives for WCM and internal cash generation.     

Four Things No One Will Tell You About ESG Data

As the ESG finance field and the use of ESG data in investment decision‐making continue to grow, the authors seek to shed light on several important aspects of ESG measurement and data. This article is intended to provide a useful guide for the rapidly rising number of people entering the field. The authors focus on the following:

1. The sheer variety, and inconsistency, of the data and measures, and of how companies report them. Listing more than 20 different ways companies report their employee health and safety data, the authors show how such inconsistencies lead to significantly different results when looking at the same group of companies.
2. ‘Benchmarking,’ or how data providers define companies' peer groups, can be crucial in determining the performance ranking of a company. The lack of transparency among data providers about peer group components and observed ranges for ESG metrics creates market‐wide inconsistencies and undermines their reliability.
3. The differences in the imputation methods used by ESG researchers and analysts to deal with vast ‘data gaps’ that span ranges of companies and time periods for different ESG metrics can cause large ‘disagreements’ among the providers, with different gap‐filling approaches leading to big discrepancies.
4. The disagreements among ESG data providers are not only large, but actually increase with the quantity of publicly available information. Citing a recent study showing that companies that provide more ESG disclosure tend to have more variation in their ESG ratings, the authors interpret this finding as clear evidence of the need for ‘a clearer understanding of what different ESG metrics might tell us and how they might best be institutionalized for assessing corporate performance.’

What can be done to address these problems with ESG data? Companies should ‘take control of the ESG data narrative’ by proactively shaping disclosure instead of being overwhelmed by survey requests. To that end, companies should ‘customize’ their metrics to some extent, while at the same time seeking to self‐regulate by reaching agreement with industry peers on a ‘reasonable baseline’ of standardized ESG metrics designed to achieve comparability. Investors are urged to push for more meaningful ESG disclosure by narrowing the demand for ESG data into somewhat more standardized, but still manageable metrics. Stock exchanges should consider issuing—and perhaps even mandating—guidelines for ESG disclosures designed in collaboration with companies, investors, and regulators. And data providers should come to agreement on best practices and become as transparent as possible about their methodologies and the reliability of their data.     

The effects of operating cash flow disclosure on earnings comparability,analysts' forecasts,and firms’ investment decisions during the Pre-IFRS era

We examine the effects of the availability of operating cash flow (OCF) information disclosed by firms operating in 15 international countries during the pre-IFRS era on: (1) the comparability of these firms' disaggregated earnings to those of U.S. firms for equity valuation purposes, (2) the properties of analysts' earnings forecasts, and (3) the efficiency of firms' investment decisions. We find that the comparability of disaggregated earnings improves after company-disclosed OCF information is available. We also find decreases in analysts' forecast errors and dispersion and a decrease in firms’ tendency to over- or under-invest when they are predisposed to do so.     

Flexibility in cash-flow classification under IFRS: determinants and consequences

International Financial Reporting Standards (IFRS) allow managers flexibility in classifying interest paid, interest received, and dividends received within operating, investing, or financing activities within the statement of cash flows. In contrast, U.S. Generally Accepted Accounting Principles (GAAP) requires these items to be classified as operating cash flows (OCF). Studying IFRS-reporting firms in 13 European countries, we document firms’ cash-flow classification choices vary, with about 76, 60, and 57% of our sample classifying interest paid, interest received, and dividends received, respectively, in OCF. Reported OCF under IFRS tends to exceed what would be reported under U.S. GAAP. We find the main determinants of OCF-enhancing classification choices are capital market incentives and other firm characteristics, including greater likelihood of financial distress, higher leverage, and accessing equity markets more frequently. In analyzing the consequences of reporting flexibility, we find some evidence that the market’s assessment of the persistence of operating cash flows and accruals varies with the firm’s classification choices and the results of certain OCF prediction models are sensitive to classification choices.     

Why Capital Efficiency Measures Are Rarely Used in Incentive Plans, and How to Change That

Despite the wide acceptance of DCF valuation and its corollary that value is created only by earning more than the cost of capital, very few companies use performance measures that focus on corporate efficiency in using capital—measures such as return on capital (ROC) or economic value added (EVA)—as the main basis for their top management incentive programs. In this article, the authors begin by documenting the surprisingly limited use of such measures in management incentive plans. Next they analyze three often cited problems—difficulty in retaining managers, discouragement of growth investment, and complexity—that could account for the limited use of such measures. Third and last, they suggest a number of adjustments to standard capital efficiency measures that are designed to address these problems and, in so doing, to give corporate directors more confidence in using measures like EVA to reward and hold managers accountable for value-adding performance.
In illustrating the problems encountered when using such performance measures, the article uses case studies of three long-time "EVA companies"—Briggs & Stratton, Herman Miller, and Manitowoc—to highlight the difficulty of using a "bonus bank" (or "clawback") system to hold managers fully accountable for earning a minimum return on capital. After presenting empirical data that shows "delayed productivity" of invested capital, the authors suggest that conventional capital efficiency measures can discourage value-increasing growth.
The article concludes by recommending that although measures like EVA used in combination with negative bonus banks provide the right incentives, EVA capital charges should be phased in gradually to reflect the delayed productivity of capital. At the same time, corporate boards should consider providing bonus bank "relief" when market and industry factors have excessively large negative effects on the performance measures and bonus awards.     

An Analysis of Applicability using Quality Metrics for Ontologies on Ontology Design Patterns

Ontology design patterns (ODPs) provide best-practice solutions for common or recurring ontology design problems. This work focuses on content ODPs, which form small ontologies themselves and thus can be subject to ontology quality metrics in general. We investigate the use of such metrics for content ODP evaluation in terms of metrics applicability and validity. The quality metrics used for this investigation are taken from existing work in the area of ontology quality evaluation. We discuss the general applicability to content ODP of each metric considering its definition, ODP characteristics, and the defined goals of ODPs. The research process presented in this paper has two phases. In the first phase, we conducted a literature research in the area of metrics for assessing ontology quality. The second phase consisted of a two-step evaluation of the ontology metrics identified in the literature analysis. During the first step, we investigated whether the metrics are appropriate to differentiate between content ODPs of different quality. Metrics that proved to be applicable were calculated for a random set of 14 content ODPs. In the second step, a controlled experiment, the quality indicated by the metric value was contrasted with the perception of ontology engineers; that is, do ‘measured quality’ and ‘perceived quality’ match?. Copyright © 2015 John Wiley & Sons, Ltd.     

Does Going Public Affect Innovation?

This paper investigates the effects of going public on innovation by comparing the innovation activity of firms that go public with firms that withdraw their initial public offering (IPO) filing and remain private. NASDAQ fluctuations during the book‐building phase are used as an instrument for IPO completion. Using patent‐based metrics, I find that the quality of internal innovation declines following the IPO, and firms experience both an exodus of skilled inventors and a decline in the productivity of the remaining inventors. However, public firms attract new human capital and acquire external innovation. The analysis reveals that going public changes firms' strategies in pursuing innovation.     

Two-dimensional Hazard Estimation for Longevity Analysis

We investigate developments in Danish mortality based on data from 1974–1998 working in a two-dimensional model with chronological time and age as the two dimensions. The analyses are done with non-parametric kernel hazard estimation techniques. The only assumption is that the mortality surface is smooth. Cross-validation is applied for optimal bandwidth selection to ensure the proper amount of smoothing to help distinguishing between random and systematic variation in data. A bootstrap technique is used for construction of pointwise confidence bounds. We study the mortality profiles by slicing up the two-dimensional mortality surface. Furthermore we look at aggregated synthetic population metrics as ‘population life expectancy’ and ‘population survival probability’. For Danish women these metrics indicate decreasing mortality with respect to chronological time. The metrics can not directly be used for prediction purposes. However, we suggest that life insurance companies use the estimation technique and the cross-validation for bandwidth selection when analyzing their portfolio mortality. The non-parametric approach may give valuable information prior to developing more sophisticated prediction models for analysis of economic implications arising from mortality changes.     

Castries Merchandising Inc.

This two‐part case focuses on red flags of attempted earnings management for a St. Lucian company that is moving from 100 percent family‐owned to selling 50 percent of the family's shares to an equity fund. In order to increase the earnings growth rate in the three years leading up to the proposed sale to an equity fund in 2021, the earnings for the most recent three years (2016–2018) have been artificially depressed. The resulting byproduct of the earnings management is the underprovision of income taxes for the past three years, which is detected by the tax authorities in St. Lucia. The student assumes the role of a tax auditor for the tax authority in St. Lucia assigned to audit Castries Merchandising Inc. (CMI), a merchandiser of building products, hardware, and automobile parts. In Part 1 the student is provided excerpts of the financial statements of CMI with some anomalies that have been detected by a software program. In Part 2 the student is provided with further information of excerpts from the trial balance and an interview with the CFO, who is a member of the family ownership group of CMI and also a Canadian CPA registered in Ontario. Drawing on the student's knowledge of auditing, accounting principles, and financial statement analysis, the student's task is to both reassess the income taxes for the years 2016 to 2018 and contemplate how management may be manipulating the financial statements in order to benefit from the planned future sale of CMI's shares to an equity fund.     

The surprising economics of a "people business"

When people are your most important asset, some standard performance measures and management practices become misleading or irrelevant. This is a danger for any business whose people costs are greater than its capital costs-that is, businesses in most industries. But it is particularly true for what the authors call "people businesses": operations with high employee costs, low capital investment, and limited spending on activities, such as R&D, that are aimed at generating future revenue. If you run a people business-or a company that includes one or more of them how do you measure its true performance? Avoid the trap of relying on capital-oriented metrics, such as return on assets and return on equity. They won't help much, as they'll tend to mask weak performance or indicate volatility where it doesn't exist. Replace them with financially rigorous people-oriented metrics-for example, a reformulation of a conventional calculation of economic profit, such as EVA, so that you gauge people, rather than capital, productivity. Once you have assessed the business's true performance, you need to enhance it operationally (be aware that relatively small changes in productivity can have a major impact on shareholder returns); reward it appropriately (push performance-related variable compensation schemes down into the organization); and price it advantageously (because economies of scale and experience tend to be less significant in people businesses, price products or services in ways that capture a share of the additional value created for customers).     

Cutting hospital costs without cutting staff

A hospital that is seeking ways to cut costs without compromising care should resist the temptation to lay off staff and instead make it a priority to improve efficiencies. This approach requires a formal program to identify and analyze all of the hospital's processes. The focus of the analysis should be to determine which activities are being performed efficiently, which are being performed inefficiently, and which are unnecessary. This effort will achieve the greatest success if it is customer-centric.     

Banks as information specialists: The case of hospital lending

This study analyzes data from the US hospital industry for evidence that banks enjoy informational advantages over direct lenders. In a multivariate analysis, we find a strong positive relationship between bank loans (as a share of total borrowing) and profitability among hospitals widely perceived as financially weak. Thus, among such hospitals, reliance on bank loans suggests the presence of hidden factors that enhance the hospital's financial standing. This supports the view that financial intermediaries are information specialists.     

Focus group methods: Using interactive and nominal groups to explore emerging technology-driven phenomena in accounting and information systems

This paper puts forth arguments for why focus group methods should be used more frequently in accounting and information technology research in order to address emerging technology-driven phenomena in accounting. In this overview of focus group methods and their application to studying accounting and information technology phenomena, we focus on what alternative types of focus group methods may be applied, when such methods are applicable, and what methodological challenges the researcher must address. In examining the methodological challenges that face researchers when using these methods, we demonstrate how these challenges have been addressed in our own research as a way of exemplifying the challenges researchers may face and what compensating strategies researchers might use. Our objective is to highlight when focus groups may be the best method for accounting information systems researchers and demonstrate how they can be used when they are applicable.     

An Information-Based Model of Foreign Direct Investment: The Gains from Trade Revisited

Foreign direct investment (FDI) is observed to be a predominant form of capital flows to emerging economies, especially when they are liquidity-constrained internationally during a global financial crisis. The financial aspects of FDI are the focus of this paper. We analyze the problem of channelling domestic savings into productive investment in the presence of asymmetric information between the managing owners of firms and other portfolio stakeholders. We explore the role played by FDI in reviving equity-financed capital investment for economies plagued by such information problems. In the presence of information asymmetry, the paper identifies, however, how FDI gives rise to foreign overinvestment as well as domestic undersaving. The gains from trade argument (applied to intertemporal trade) is re-examined in this case of informational-asymmetry-driven FDI. We show that the gains could be sizable when the domestic credit market is either under-developed or failing as a result of a financial crisis. But with a well-functioning domestic credit market, the gains turn into losses. Surprisingly, capital may flow into the country even when the autarkic marginal productivity of capital in the domestic economy falls short of the world rate of interest. In such a situation, capital should have efficiently flown out rather than in, and FDI is a social loss-generating phenomenon.     

Is Land Titling in Sub-Saharan Africa Cost-Effective? Evidence from Madagascar

Formalizing land rights has been promoted as a way to encourageagricultural investment and stimulate land markets, yet littleis known about the benefits of such policies in Sub-SaharanAfrica, where the preconditions for success are less favorable.The analysis uses a large sample of plots from an intensivelytitled rice-growing area of Madagascar and compares land-specificinvestments, land productivity, and land values for titled anduntitled plots cultivated by the same household. Having a titlehas no significant effect on plot-specific investment and correspondinglylittle effect on land productivity and land values. These resultsare broadly consistent with a simulation of a theoretical modelof investment under expropriation risk calibrated to the samedata. A cost–benefit analysis suggests that the currentsystem of formal titling should not be extended in rural Madagascarand that any new system of land registration would have to bequite inexpensive to be worthwhile.     

Disability insurance and optimal income taxation

This paper studies the design of disability insurance scheme when agents differ in their privately known productivity. We extend the Diamond and Mirrlees (1978) two period model to allow for agents differing ex-ante in their productivity and characterize the optimal nonlinear tax transfer that maximizes a utilitarian welfare function when per-period earnings and age are observable while individuals’ productivity and health status are not observable. We show that the induced tax/benefit scheme should exhibit a marginal income tax that decreases with age for some agents. A marginal subsidy on the young high productive income may be desirable. While the disability scheme always involves the old low productive agents to be indifferent between working and claiming disability benefits, this result is not always true for the old high productive agents. JEL Classification H55 · H23 · E62     

Regulatory incentives and financial reporting quality in public healthcare organisations

English National Health Service Foundation Trusts are subject to a regulatory regime in which the level of monitoring and intervention is determined by performance against two key performance metrics: a ‘financial risk rating’, based on a number of performance metrics, such as the reported surplus margin and return on assets, and a ‘prudential borrowing limit’. In this paper, we investigate the variation in financial reporting quality, proxied by discretionary accruals, with the incentives introduced by this regime. We find: first, that discretionary accruals are managed to report small surpluses; second, that, consistent with the avoidance of regulatory intervention in both the short and medium term, discretionary accruals are more positive when pre-managed performance is below intervention triggering thresholds and more negative when well above threshold; third, that, despite a move away from financial breakeven as the primary performance objective, there remains an aversion to small loss reporting. We further find that the level of discretionary accruals is driven by two metrics of strategic significance: the surplus margin (a measure of retained earnings) and the prudential borrowing limit (a measure of borrowing capacity).     

An eye tracking experiment investigating synonymy in conceptual model validation

A key advantage of conceptual models is that their quality can be evaluated and validated before beginning the costlier stages of information system development. Few research studies investigate the validation process for such models, particularly regarding multiplicities, even though multiplicity mistakes can be very costly. We investigated the validation of conceptual model multiplicities, varying how closely natural language statements of business rules match the models that purport to represent those rules. Participants in an eye tracking experiment completed validation tasks in which they viewed a statement and an accompanying UML class diagram in which a specified multiplicity was consistent with the statement (valid) or inconsistent with the statement (invalid). We varied whether the focal multiplicity was a minimum or a maximum and varied the class diagram’s semantics and order compared to that of the statement. Logistic regression was used to analyze the relationship between accuracy and the experimental manipulations and controls. The results show that the odds of accuracy in validating class diagrams that used synonyms instead of the exact statement terminology were only 0.46 times the odds of accuracy when the class diagram and statement words matched, showing a costly effect of synonymy. Interestingly, independent of the three levels of relative semantics, the odds of accuracy were 0.48 times when class diagrams were consistent with business rules as they were when class diagrams were inconsistent with business rules. To gain insight into cognition under correct task performance, we conducted additional linear regression analysis on various eye tracking metrics for only the accurate responses. Again, synonymy was observed to be costly, with a cognitive burden of increased integrative transitions between statement and model in the range of 39 to 66%.     

Managerial ownership and firm performance: A re-examination using productivity measurement

The role of productivity in firm performance is of fundamental importance to the US economy. Consistent with the corporate finance approach, this paper uses the ownership stake of a firm's managers as an argument in estimating the firm's production function. Accordingly, this paper brings together the corporate finance and productivity literature. Using a large sample of randomly selected manufacturing firms that does not suffer from any survivorship or large firm size biases, we find that managerial ownership changes are positively related to changes in productivity. We also find a higher sensitivity of changes in managerial ownership to changes in productivity for firms who experience greater than the median change in managerial ownership. These results are robust to including lagged estimates of production inputs, year dummies and separate dummies for each firm to control for unobservable firm characteristics. In addition, we find that the stock market rewards firms with increases in firm value when these firms increase their level of productivity.