Earnings management,corporate governance and expense stickiness

Cost and expense stickiness is an important issue in accounting and economics research, and the literature has shown that cost stickiness cannot be separated fr...     

Earnings quality and corporate cash holdings

Poor earnings quality exacerbates information asymmetry between internal and external stakeholders of a firm. Agency considerations then persuade investors to discount the value of corporate cash holdings out of concern about the inappropriate use of funds. In this study, we show that poor earnings quality has a negative impact on the value of corporate cash holdings and a positive impact on the level of cash reserves. We find that the negative effect of poor earnings quality either neutralizes or more than offsets the positive effect of excess cash on firm value. Our results are robust to several measures of earnings quality and model specifications.     

Earnings management and corporate governance: the role of the board and the audit committee

We examine the role of the board of directors, the audit committee, and the executive committee in preventing earnings management. Supporting an SEC Panel Report's conclusion that audit committee members need financial sophistication, we show that the composition of a board in general and of an audit committee more specifically, is related to the likelihood that a firm will engage in earnings management. Board and audit committee members with corporate or financial backgrounds are associated with firms that have smaller discretionary current accruals. Board and audit committee meeting frequency is also associated with reduced levels of discretionary current accruals. We conclude that board and audit committee activity and their members' financial sophistication may be important factors in constraining the propensity of managers to engage in earnings management.     

Earnings expectations and interactive discussions with corporate insiders

This study aims to empirically clarify the informational role of interactive discussions with corporate insiders by analyzing how participants’ expectations are affected by their participant comments during analyst and investor days. The results indicate that the tone of management presentations and responses to participants’ comments exhibit no impact on analysts’ expectations of company performance. By contrast, analysts’ earnings forecasts react significantly to comments from their peers (especially star analysts). Furthermore, peer comments contain additional information on analysts’ forecast errors. Finally, analysts whose earnings forecasts diverge positively (negatively) from the consensus are influenced by their peers' negative (positive) opinions. The results suggest that interactive meetings contribute in acquiring information and opinions from other participants (especially informed participants) rather than from corporate insiders.     

Earnings management,audit adjustments,and the financing of corporate acquisitions: Evidence from China

Acquirers are motivated to overstate earnings prior to stock-financed acquisitions. We hypothesize that audits help to detect and correct such overstatements. We test this using a difference-in-differences design, which compares audit adjustments to earnings for stock-financed and cash-financed acquirers before versus after the acquisitions. Consistent with our hypothesis, we find larger downward adjustments in the audits immediately before stock-financed acquisitions. Further analysis of regulatory sanctions suggests the downward adjustments are in fact warranted, rather than auditors being overly conservative. Moreover, modifications in audit reports suggest that downward adjustments do not correct all of the reporting irregularities in audited financial statements.     

Earnings management and deferred tax

This study analyses the deferred tax provisions of firms during a period in which the firms' incentive to manage earnings may have been be particularly strong and in which firms made disclosures in relation to partial deferred tax provisions which revealed readily their under- or over-provision of deferred tax. Using a sample of 58 firms for the two years 1991 and 1992, the magnitude of the under- or over-provisions found is economically significant, amounting, on average, to around 20% of the maximum potential deferred tax liability and, more important, 9% of profit or loss before tax. This paper takes such under- and over-provision of deferred tax and investigates its relationship with a number of posited explanatory variables - as derived and developed from the earnings management literature. In a multivariate setting it is found that the level of under-/over-provision is related to the following characteristics: whether the firm is reporting a pre-tax loss or a pre-tax profit; the extent of adjustment to prior year tax; and the level of surplus advance corporation tax (ACT). These findings support a general profit- smoothing hypothesis, and the finding in relation to ACT suggests that firms take an overall view in determining the required level of provision in order to manage earnings, rather than concentrating upon particular line items. There is also weaker evidence of a relationship between the level of under-/over-provision and firms' levels of gearing and effective tax rates.     

Earnings management and market liquidity

The main purpose of this paper is to argue the extent that earnings management lowers disclosure quality. It should increase information asymmetry and impair trading liquidity. Using a large sample of NYSE firms from 1996 to 2001, we find evidence to suggest that firms which exhibit greater earnings management are associated with lower market liquidity. Our results are robust to both real and accounting based measures of earnings management and two well established measures of market liquidity. However, they are not consistent with the Easley et al. probability of informed trade measure.     

Earnings management and earnings quality

Viewing the detection of earnings management from the perspective of a crime scene investigator sheds new light on prior research on earnings management and its close relative, earnings quality. The works of Ball and Shivakumar [2008. Earnings quality at initial public offerings. Journal of Accounting and Economics, in press.] and Teoh et al. [1998. Earnings management and the subsequent market performance of initial public offerings. Journal of Finance 53, 1935–1974.] are used to illustrate the application of seven components of a crime scene investigation to earnings management research.     

Earnings management and accounting income aggregation

Quarterly earnings allow aggregation into annual earnings in four different ways. Fiscal year earnings is one measure of annual earnings, the others being earnings for annual periods ending at interim quarter-ends. We investigate earnings management in fiscal year earnings relative to these alternative measures of firms’ annual earnings. We confirm prior findings in Burgstahler and Dichev (1997. Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics 24, 99–126) of discontinuities around zero and prior year earnings in histograms of earnings. Subsequent research questions whether these discontinuities are evidence of earnings management. Using histograms of our alternative annual earnings measures, we offer evidence suggesting earnings management is responsible for the discontinuities.     

Earnings management surrounding CEO changes

This paper investigates the extent of earnings management in the periods surrounding CEO changes by Australian firms. Evidence is presented of incoming CEOs undertaking earnings management to reduce income in the year of CEO change, with abnormal and extraordinary items being the primary vehicle through which this is achieved. This result is consistent with the notion of new CEOs engaging in an 'earnings bath', and is strongest for non–routine CEO changes, where the opportunities to manage earnings are greatest. Extending prior work, classification of CEO changes as routine or non–routine is based on an expanded information search, and this provides insights into the CEO change process and identifies problems with simpler mechanistic classification methods. Additionally, detailed information of the operation of the modified Jones model for estimating expected accruals is presented, and this is consistent with such models having low explanatory power in identifying abnormal accruals.     

Earnings management and IPO anomalies in China

This paper empirically examines the impact of earnings management and investor sentiment on IPO anomalies using a sample of 506 Chinese IPOs issued over the 1998–2003 period. We develop a parsimonious pricing model in which both the offer price and the short-term aftermarket price are influenced by the use of earnings management, and show that the offer price can be below the fair price while the short-term equilibrium price in the aftermarket can be overvalued due to investor sentiment. Consistent with the overreaction hypothesis, the empirical results reveal a positive relation between the initial return and managed accruals and a negative relation between the long-term stock performance and the initial return. Earnings management appears to generate a pattern where the initial price following an IPO tends to be inflated by overreaction in the secondary market but adjusts to its fundamental level in the long run. These findings are robust across a variety of test specifications.     

Executive compensation and corporate risk management

We provide the first evidence on the effects of executive compensation on corporate risk management for insurers. Our unique data set allows the construction of a new, more complete measure of corporate risk management behavior. Specifically, we include hedging-driven usage of not only derivatives but also insurance. To address potential endogeneity, we utilize a difference-in-differences approach, based on the implementation of FAS 123R that required firms to expense stock-based compensation at fair value. We find that the decline in the convexity of executive compensation following FAS 123R led firms to significantly increase corporate risk management, primarily through increased demand for insurance.     

Data breaches and corporate liquidity management

This paper investigates the effects of data breach disclosure laws and the subsequent disclosure of data breaches on the cash policies of corporations in the United States. Exploiting a series of natural experiments regarding staggered state-level data breach disclosure laws, we find that the passage of mandatory disclosure laws leads to an increase in cash holdings. Our finding suggests that mandatory data breach disclosure laws increase the risks related to data breaches. Further, we find firms that suffer data breaches adjust their financial policies by holding more cash as well as decreasing external finance and investment.     

Cost management and corporate payout decisions

Review of Quantitative Finance and Accounting - We investigate the relationship between cost management and dividend payout decisions. Prior studies document that firms with consistent earnings or...     

Earnings management and firm valuation under asymmetric information

This paper seeks to provide an explanation for why corporate officers manage the disclosure of accounting information. We show that earnings management affects firm value when value-maximizing managers and investors are asymmetrically informed. In equilibrium, the strategic management of reported earnings influences investors' assessments of the market values of companies' shares.     

Earnings management by classification shifting and IPO survival

The study examines the effect of earnings management by classification shifting on firm success, focusing on the survival of newly listed firms. We argue that shifting income-decreasing expenses from core to special items should negatively associate with future operating performance because of improper signaling of actual repeatable core profitability. We find that classification shifting strongly and negatively affects future Initial Public Offering (IPO) success and survival. We further identify the economic mechanisms that drive this finding and observe that our results are mitigated when the quality of external corporate governance alleviating agency concerns is stronger, also for IPO firms operating within stronger business contexts. Therefore, in an environment that facilitates firm survivability, the existence of weaker than reported sustainable performance may not end up materializing in the form of lower firm survivability as these factors aid firms' continuing operations from a business perspective. Our findings provide evidence of the longer-term implications of a method of earnings management that has long been considered “soft” and without any longer-term reversing consequences.     

High order corporate crisis management

Much research has shown corporation managers generally to be unprepared for such crisis as political upheavals, kidnapping, dramatic changes in foreign exchange transactions, etc. Three related approaches to collecting and structuring information which warns of possible impending crises, or helps in their management once erupted are described: INFER, OPINT and EVAL. They draw on the experience of the US Department of Defence and intelligence agencies.     

Mandatory governance reform and corporate risk management

Using the Sarbanes-Oxley Act of 2002 as a quasi-natural experiment to identify the impact of corporate governance reform on foreign exchange risk hedging, we find that the substantial improvements in governance standards increased derivatives hedging and reduced foreign exchange exposure. The results are robust whether we consider initial reform gap or actual implementation, focus on legally required governance measures or include voluntary concomitant reforms. The economic magnitude of the effect is large. Our findings are corroborated by cross-sectional evidence, showing that firms with larger foreign markets exposure and a larger distortion in CEO incentives react more strongly to the reform. Financial hedges are implemented rapidly whereas exposure measures that encompass operational hedges take more time to adjust.     

Seasoned equity offerings and corporate financial management

We assume executives managing corporate financial policy consider the firm's current and target leverage, investment plans, anticipated cash flows, and consequences of alternative sequences of financing transactions, operating within efficient markets. Our analysis yields time-series and cross-sectional predictions for management of investment spending and leverage; use of maturity, priority, and convertibility covenants; and management of dividends, share repurchases, cash balances, and credit lines. Our evidence from 8608 SEOs covering 1970–2015 is consistent with implications of our theory, helps to resolve an array of issues in corporate finance, and offers a step toward a more unified analysis of rational corporate financial management.