Does external finance pressure affect corporate disclosure of Chinese non-state-owned enterprises?

We examine whether external finance pressure influences information disclosure of Chinese non-state-owned enterprises (NSOEs), which are often entrepreneurial firms. Existing Chinese stock exchange regulations stipulate that firms need to meet certain earnings performance criteria to qualify for rights issue or avoid delisting. These regulatory criteria create pressures for firms in need for external equity financing to manipulate earnings in order to meet and beat the performance targets. To examine this, we exploit an exogenous event of Chinese accounting standards change in 2007, when firms are given greater accounting disclosure discretion. Following this change, we find evidence consistent with increased earnings manipulation among NSOEs that barely meet these performance targets. This effect is also more pronounced among such NSOEs with weaker political connections, which increases their dependence on the capital market for external financing. Our findings have policy implications for the financing of NSOEs and entrepreneurial firms in emerging economies.     

Earnings management and firm financial motives: A financial investigation of UK listed firms

This study focuses on the investigation of motives for and characteristics of UK firms that engage in earnings management activities. It concentrates particularly on the provision of voluntary accounting disclosures, the violation of debt covenants, management compensation, and on the equity and debt capital needs of firms and their relation with the use of earnings management. The study examines also the earnings management inclination of firms that seek to meet or exceed financial analysts' forecasts. The findings generally indicate that firms with low profitability and high leverage measures are likely to use earnings management. Also, firms that are in equity and debt capital need and are close to debt covenant violation also appear to be inclined to employ earnings management practices. Likewise, firms tend to use earnings management to improve their financial numbers and subsequently reinforce their compensation and meet and/or exceed financial analysts' earnings forecasts. In contrast, the study shows that firms that provide voluntary accounting disclosures appear to be less inclined to make use of earnings management.     

Managing Earnings with Intercorporate Investments

Abstract:  We explore to what extent firms deliberately manage their financial reports by exploiting the flexibility of generally accepted accounting principles. Using a sample of Oslo Stock Exchange-listed firms with 20–50% equity holdings in other firms, we find that firms with high financial leverage tend to maximize reported earnings from these investments through their choice between the cost method and the equity method, possibly in an attempt to reduce debt renegotiation costs or to avoid regulatory attention. In contrast, managers do not systematically bias reported earnings to extract private benefits or to signal revised expectations about future cash flows. Firms use different earnings management tools in a consistent way, as the earnings effect of the cost/equity choice is not offset by discretionary accruals.     

What Triggers Top Management Turnovers in China?

Studies on management turnover in Chinese companies typically find that turnover decisions are associated with companies' accounting performance. Using a sample of Chinese company turnovers during 2000–2003, we disaggregate their net-earnings into core, recurring non-core, and other non-recurring components. Analyzing these earnings components, we show that turnover decisions for government firms are related negatively only to recurring earnings which consist of operating, administrative and financial expenses. Leverage also plays a significant role suggesting the concern that high debt levels may reduce the impacts of the Chinese SOE reforms. However, turnovers in private firms are associated with poor core earnings, a result similar with profit-maximizing firms in developed economies.     

Can media deter management from manipulating earnings? Evidence from China

This study examines the influence of media exposure on managers’ earnings management behavior using China’s publicly traded firms during 2001–2009. We find that firms with more media exposure (both negative and non-negative) manage their earnings less than firms with less media exposure. We also find that “suspect firms” (being specially treated or with refinancing plans like seasoned equity offerings or right offerings) with more media exposure engage in more accrual-based earnings management relative to other firms. These results suggest that Chinese media serve as an external monitor to the majority of firms and place excessive pressure on suspect firms. This paper contributes incrementally to the literature by emphasizing the conflicting role media exposure plays in managerial decisions in earnings management. The findings of this study have practical implications for regulators, auditors, financial analysts, as well as other information intermediaries.     

External financing and earnings management: Evidence from international data

Corporate financing conditions in the external capital market are significantly affected by information asymmetry, while internal financing is not. Given that earnings information influences market perceptions regarding firms’ quality, firms relying on external financing should have incentives to manage earnings to improve their financing conditions. This study investigates the effect of corporate external financing behavior on earnings management. Using a sample comprising 75,790 observations of 12,874 firms in 43 countries, we find that accrual-based and real earnings management are positively associated with firms’ reliance on external financing. This positive relationship holds especially true for firms that rely on equity rather than debt financing. We argue that reliance on external financing (especially equity financing), which is subject to problems arising from information asymmetry, generates a motive for earnings management.     

Earnings Predictability, Information Asymmetry, and Market Liquidity

We investigate the relation between earnings predictability, information asymmetry and the behavior of the adverse selection cost component of the bid-ask spread around quarterly earnings announcements for NASDAQ firms. While we find an increase in the adverse selection component of the bid-ask spread on the day of and the day prior to quarterly earnings announcements for firms with less predictable earnings, we find no evidence of such changes for firms with more predictable earnings. During a non-announcement period, we find that firms with relatively less predictable earnings have consistently higher total bid-ask spreads than firms with more predictable earnings. This finding suggests that firms with relatively less predictable earnings have a higher cost of equity capital than comparable firms with more predictable earning streams, ceteris paribus. Hence, earnings predictability may be a legitimate concern of managers who wish to minimize their cost of equity capital at least as it pertains to bid-ask spreads.     

The Effects of International Financial Reporting Standards on the Accounts and Accounting Quality of Australian Firms: A Retrospective Study

We examine the effect of Australian equivalents to International Financial Reporting Standards (IFRS) on the accounts and accounting quality of 1,065 listed firms, relying on retrospective reconciliations between Australian Generally Accepted Accounting Principles (AGAAP) and IFRS. We find that IFRS increases total liabilities, decreases equity and more firms have earnings decreases than increases. IFRS earnings and equity are not more value relevant than AGAAP earnings and equity and while adjustments for changes in accounting for provisions and intangibles other than goodwill are value relevant, they weaken associations with market value. Goodwill adjustments improve associations with market value. We also find that the reconciliation note for the earnings adjustments contained no new information.     

Duration of equity overvaluation and managers’ choice to use aggressive underlying earnings disclosure and accrual-based earnings management: Australian evidence

This paper examines whether equity overvaluation duration influences managers’ choice of different earnings management mechanisms and how corporate governance and the Australian Securities and Investment Commission’s underlying earnings disclosure guidelines influence managers’ choices. The study samples Australian Securities Exchange 200 firms from 2009 to 2016. Findings show that on average, firms more likely engage in accrual-based earnings management in the early overvaluation stage. In later stages, firms more likely disclose underlying earnings aggressively to sustain overvaluation. Additionally, firms with a high proportion of independent directors on the board prefer to disclose underlying earnings aggressively to sustain the equity overvaluation; firms with a low proportion of independent directors prefer both accrual-based earnings management and aggressive underlying earnings disclosure to sustain the overvaluation. Moreover, firms that conform to the Commission’s underlying earnings disclosure guidelines use neither accrual-based earnings management nor aggressive underlying earnings disclosure to sustain overvaluation, but non-conforming firms use both mechanisms.     

Short-selling and cost of equity: evidence from China

In this study, we take advantage of the gradual lifting of the short-selling ban in China and find that firms affected by the lifting of the ban experience a lower cost of equity. In addition, the affected firms also incur less earnings management, higher market liquidity and higher investment efficiency. Further evidence shows that firms’ cost of equity increases after their stocks are no longer eligible for short selling. Our inferences are robust to alternative measures of cost of equity, and to using a propensity score-matched sample. Our study contributes to the literature by providing evidence that short sellers play a monitoring role in the Chinese stock markets and sheds light on the benefits of short selling in emerging markets.     

Management earnings forecast disclosure policy and the cost of equity capital

We examine the relation between management earnings forecast disclosure policy and the cost of equity capital in a cross-section of 1,355 firms over a 4-year post-Regulation Fair Disclosure period (2001 through 2004). We find evidence of a negative association between the quality of management earnings forecasting policy and cost of equity capital, and we document that the strength of the association is greater for firms with higher disclosure costs and for firms with more relevant quarterly management earnings forecasts. Our results are robust to the use of multiple methods to address both endogeneity and the measurement error in firm-specific estimates of implied cost of equity capital.     

Book-tax conformity and capital structure

We examine the effect of increased book-tax conformity on corporate capital structure. Prior studies document a decrease in the informativeness of accounting earnings for equity markets resulting from higher book-tax conformity. We argue that the decrease in earnings informativeness impacts equity holders more than debt holders because of the differences in payoff structures between debt and equity investments such that increases in book-tax conformity lead to increases in firms’ reliance on debt capital. We exploit a natural experiment in the U.S. and find that firms facing an increase in required book-tax conformity increase leverage relative to other firms. We also provide evidence of an increase in the cost of equity (but not of debt) capital for firms facing an increase in required book-tax conformity, relative to control firms, and show that these increases in cost of equity capital are positively associated with an increase in leverage. Our findings are consistent with firms substituting away from equity and toward more debt in the presence of higher book-tax conformity.     

An empirical analysis of the effects of monitoring intensity on the relation between equity incentives and earnings management

Prior studies suggest that equity incentives inherently have both an interest alignment effect and an opportunistic financial reporting effect. Using three distinct proxies for earnings management we find evidence consistent with the incentive alignment (opportunistic financial reporting) effect of equity incentives increasing as monitoring intensity increases (decreases). Furthermore, using the accrual-based earnings management and meet/beat analyst forecast models we find that the opportunistic financial reporting effect of equity incentives dominates the incentive alignments effect for firms with low monitoring intensity. Using proxies for real earnings management, we find that the incentive alignment effect dominates the opportunistic financial reporting effect for high and moderate monitoring intensity firms. However, for low monitoring intensity firms the opportunistic reporting effect mitigates, but does not completely offset, the benefits of the incentive alignment effect. Overall, these findings are consistent with the level of monitoring affecting the relation between equity incentives and earnings management.     

Earnings Management Surrounding New Debt Issues

We examine whether firms manage earnings before issuing bonds to achieve a lower cost of borrowing. We find significant income‐increasing earnings management prior to bond offerings. We also find that firms that manage earnings upward issue debt at a lower cost, after controlling for various bond issuer and issue characteristics. Our results are consistent with studies that report earnings management around equity issuance. The results indicate that, like equity holders, bondholders fail to see through the inflated earnings numbers in pricing new debt.     

Asymmetric valuation of sustained growth by bond- and equity-holders

Viewing equity as a call option on the firm’s assets with a strike price equal to contractual debt obligations yields an asymmetric prediction on how debt and equity markets view sustained growth. Debt holders are expected to benefit from sustained growth when the default risk is high, while equity holders value such growth when risk is low. Using Altman’s z-score and debt ratings as alternative proxies for the default risk, we document a negative association between bond yield spreads and sustained growth in earnings for firms with high risk only. In sharp contrast, using earnings multiples from returns-earnings regressions as a proxy for equity market rewards, we find that earnings multiples are larger when earnings growth is sustained for the low risk sample only. Decomposing earnings growth into revenue and nonrevenue growth, we find that the debt market rewards for firms with revenue growth are confined to the high risk sample only, while nonrevenue growth firms are not rewarded for either sample. Equity investors value revenue-led earnings growth for low and high risk samples while nonrevenue growth is rewarded for the low risk sample only. Our study adds to our understanding of how changes in firm value from sustained earnings and revenue growth are divided between key providers of capital and how default risk plays an instrumental role in this valuation process.     

Highly Valued Equity and Discretionary Accruals

Abstract:  Overvalued equity provides a strong incentive for managers to report earnings that do not disappoint the market (  Jensen, 2005 ). We find that this can be extended to highly valued equity more generally. In the year following the classification as highly valued and compared to firms with less extreme valuations, highly valued firms have significantly higher discretionary accruals and exhibit a more pronounced positive association between discretionary accruals and proxies for the likelihood of failing to meet earnings targets. These findings are consistent with the use of discretionary accruals to manage earnings in support of extreme valuation. Because highly valued equity will likely result in CEOs with valuable stock and stock option portfolios, we test whether and show that the overvalued equity incentive is incremental to a CEO's equity portfolio incentive. One implication is that directors and audit committees should be especially on guard for possible earnings management when a firm has extremely high valuation multiples and when the CEO has a lot of equity at risk.     

The Valuation Accuracy of the Price-Earnings and Price-Book Benchmark Valuation Methods

This paper evaluates the valuation accuracy of the price-earnings (P/E), the price-book (P/B) and a combined price-earnings and price-book (P/E-P/B) benchmark valuation methods. Performance of the benchmark valuation methods relies on the definition of comparable firms. In this paper, comparable firms are selected based on industry membership, size and return on equity as well as combinations of industry membership with size and with return on equity. We find that within the P/E and P/B benchmark valuation methods, the best definition of the comparable firms are based on industry membership combined with return on equity. However, only the industry membership is necessary to define the comparable firms for the combined P/E-P/B method. In sum, the results suggest that, when firm's value is unknown, the combined P/E-P/B valuation approach selecting comparable firms based on industry membership performs the best among all the approaches evaluated in this paper.We also find that the P/E benchmark valuation method performs better than the P/B benchmark valuation method and the combined method outperforms either the P/E or the P/B method. These results imply that earnings are more important than book value as a single-number firm valuator over our sample years (from 1973 to 1992) and that both earnings and book values are value relevant, one does not substitute perfectly for the other.     

Earnings management,market discounts and the performance of private equity placements

Private equity placement data allow us to determine whether sophisticated investors can uncover the true value of firms. This can be done by defining sophisticated investors as those who meet the stringent participation requirements of the private equity market. Our results show private equity issuing firms overstate their earnings in the quarter preceding private equity placement announcements and that sophisticated investors do not ask for a fair discount when purchasing the shares of the private issuing firms. We also find evidence showing that the reversal of the effects of pre-issue earnings management is a significant determinant of the long-term performance of private issues. Results further show that post-issue stock performance and operating performance of firms using “aggressive” earnings management significantly underperform those using more “conservative” earnings management.     

Excess Control, Corporate Governance and Implied Cost of Equity: International Evidence

We investigate whether the separation between ownership and control rights can be costly to controlling shareholders and firms in terms of capital-raising costs. Using estimates of the cost of equity capital implied by analyst earnings forecasts and growth rate for a sample of 1,207 firms from nine Asian and 13 Western European countries, we find strong, robust evidence that the cost of equity is increasing in excess control, while controlling for other firm-level characteristics. This core finding persists after controlling for legal institutions variables.     

Policy uncertainty and seasoned equity offerings methods

Based on a sample of U.S. seasoned equity offering (SEO) during the period 2002–2017, we examine how the choice of equity issuance method changes in response to policy uncertainty. We find that firms subject to high policy uncertainty are less likely to use accelerated offerings rather than other types of traditional seasoned equity offerings. Our results are robust to alternative variable specifications, propensity score matching method, IV approach, and the inclusion of additional controls. Also, the effect of policy uncertainty on accelerated offering decision is weaker for firms with better information environment, earnings quality, and governance structures. Further, policy uncertainty increases the cost of funds and lowers long-run abnormal returns after SEOs for firms subject to high levels of policy uncertainty.