Reevaluation of Revaluations: A Cross-Country Examination of the Motives and Effects on Future Performance

Abstract:  This study examines the motives for asset revaluations in a sample drawn from 35 countries that permit asset revaluations. Prior studies that examined this issue concentrated on one or two countries, the UK and Australia, and showed that revaluations are related to financing needs, the capital intensity of the firm as well as issues related to political costs. The previous literature also found that revaluations were indicators of improved future performance and that performance was related to the magnitude of the revaluations. This study shows that although the conclusions drawn from the previous studies are applicable to countries that are similar to the UK and Australia, they do not hold when applied to a much larger set of countries and that the motivations for and effects of revaluation are not uniform across various country classifications.     

Management’s tone change, post earnings announcement drift and accruals

This study explores whether the management discussion and analysis (MD&A) section of Forms 10-Q and 10-K has incremental information content beyond financial measures such as earnings surprises and accruals. It uses a classification scheme of words into positive and negative categories to measure the tone change in the MD&A section relative to prior periodic SEC filings. Our results indicate that short window market reactions around the SEC filing are significantly associated with the tone change of the MD&A section, even after controlling for accruals and earnings surprises. We show that management’s tone change adds significantly to portfolio drift returns in the window of 2 days after the SEC filing date through 1 day after the subsequent quarter’s preliminary earnings announcement, beyond financial information conveyed by accruals and earnings surprises. The drift returns are affected by the ability of the tone change signals to help predict the subsequent quarter’s earnings surprise but cannot be completely attributed to this ability. We also find that the incremental information of management’s tone change depends on the strength of the firm’s information environment.     

The new Form 8-K disclosures

The Securities and Exchange Commission (SEC) has mandated new disclosure requirements in Form 8-K, which became effective on August 23, 2004. The SEC expanded the list of items that have to be reported and accelerated the timeliness of these reports. This study examines the market reactions to 8-Ks filed under the new SEC regime and investigates whether periodic reports (10-K/Qs) became less informative under the new 8-K disclosure rules. We observe that the newly required 8-K items constitute over half of all filings and that most firms disclose the required items within the new shortened period (four business days). We find that all disclosed items (old and new) are associated with abnormal volume and return volatility around both the event and the SEC filing dates, and some items have significant return drifts after the SEC filings. Surprisingly, we find that the information content of periodic reports has not diminished by the more expansive and timely 8-K disclosures under the new guidance, possibly indicating that investors may use periodic filings to interpret the effects of material events that had been disclosed earlier.     

Who,if anyone,reacts to accrual information?

We show that the vast majority of investors ignore value-relevant accruals information when it is first released, but that investors who initiate trades of at least 5,000 shares tend to transact in the proper direction. These investors trade on accruals information only when the previously-announced earnings signal is non-negative. Unconditionally, those investors initiating the smallest trades appear to respond to accruals in the wrong direction, but further investigation suggests this behavior is explained by their attraction to attention-grabbing stocks. Finally, we find that those who trade on accruals information have insufficient market power to mitigate the accruals anomaly.     

ADVANCE PAYMENTS DURING INFLATIONARY PERIODS

During periods of rismg prices, contracts for future delivery of merchandise are usually linked to a price index to protect suppliers from future cost increases, and customers, therefore, advance payments to avoid the price linkage. Suppliers are then faced with two problems: (i) the investment of advance payments and (ii) the presentation of the investment outcome in the fimancial reports. This paper uses a portfolio selection process to analyse the suppliers' investment decisions, and shows that the accounting presentation depends on the particular investment decision, which in turn affects the principalagent relationship. Suggestions are made to eliminate the undesirable effects of this relationap on management's decision making.     

Differential Market Reactions to Revenue and Expense Surprises

This study investigates investors' reactions to revenue and expense surprises around preliminary earnings announcements. Results show that investors value more highly a dollar of revenue surprise than a dollar of expense surprise. Results further show that these differential market reactions to revenue and expense surprises vary systematically for growth versus value firms and depend on (a) the proportion of variable to total costs, (b) the relative persistence of sales and expenses, and (c) the proportion of operating to total expenses. Results highlight the importance of interpreting the earnings surprise in the context of its sources—e.g. surprise in revenues or in total expenses.     

Corporate Reorganizations: Changes in the Intensity of Labor and Capital Expenditures

Using a new measure that indirectly captures a firm's restructuring efforts on the basis of changes in its labor and capital expenditure patterns, this study examines the link between restructuring and financial performance for an international sample of firms during the years 1989–1997. Results show that firms that curbed the growth in labor expense intensity (labor expense relative to sales), regardless of the accompanying changes in sales or in capital expenditure intensity, had significantly higher annual returns (despite having lower profitability) than firms that expanded their labor intensity. Financial market's response to a reduction in labor expense intensity appears to be more favorable if this reduction is accompanied by a reduction in capital expenditure growth when firms face declining sales, and an increase in capital expenditure growth when firm sales are growing.     

The mode of corporate diversification: Internal ventures versus acquisitions

This study investigates empirically the underlying motives for selecting the mode of corporate diversification and attempts to match the form of capital investments with a corresponding theoretical rationale for diversification. The empirical results seem to support both the transaction-costs rationale for diversification and the motive that arises from a firm's prior experience with each form of capital investment. However, the empirical findings are inconsistent with the explanation that is based on the owner-manager conflict of interest.