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  • Jennifer M Mueller-Phillips
    Tone Management.
    research summary posted July 16, 2015 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.04 Management Integrity, 06.06 Earnings Management 
    Title:
    Tone Management.
    Practical Implications:

    The evidence indicates that tone manipulation succeeds in misleading investors, and that this effect is incremental to the effect of accruals management. An abnormally positive tone incites an overly optimistic immediate stock price response to the earnings announcement and a subsequent return reversal. The evidence indicates that abnormal positive tone contains negative information about future firm fundamentals, that firms tend to engage in tone management particularly when incentives to manipulate investor perceptions are high, and that investors are misinformed by tone management.

    Citation:

    Huang, X., Teoh, S. H., & Zhang, Y. 2014. Tone Management. Accounting Review 89 (3): 1083-1113.

    Keywords:
    behavior finance, earnings management, market efficiency, qualitative disclosure, tone management, management integrity
    Purpose of the Study:

    The tone of the qualitative text in earnings press releases can be too optimistic or pessimistic relative to concurrent disclosures of quantitative performance. The authors call the choice of the tone level in qualitative text that is incommensurate with the concurrent quantitative information tone management. The authors investigate whether managers engage in tone management for informative or strategic purposes, and whether and to what extent the capital market discounts for strategic motives, if any, when reacting to earnings announcements.

    Earnings press releases, being voluntary, are not subject to explicit rules about the disclosure, so management has wide latitude in the qualitative presentation of the quantitative information. The authors are interested in studying how the tone of the press release affects readers’ response to the communication, and whether and how tone can be used as a tool to affect investors’ perception about the firm. As the old adage goes, “It’s not what you say; it’s how you say it.”

    A key goal for this paper is to test whether tone management in earnings press releases informs or misinforms investors. The authors examine how abnormal positive tone relates to future firm performance, whether abnormal tone is more likely used in situations where managerial strategic incentives to manipulate investor perception are present, and whether and how investors react to tone management at the time of, and subsequent to, the earnings announcements.

    Design/Method/ Approach:

    The authors obtain a sample of 14,475 observations of firm-year abnormal positive tone from the text of annual earnings press releases from PR Newswire and Business Wire, historical financial data from Compustat, stock returns from CRSP, analysts’ earnings forecasts data from I/B/E/S, seasoned equity offering (SEO) and merger and acquisition (M&A) effective dates from SDC, and option grants data for CEOs from ExecuComp. The sample period was 19972007.

    Findings:

    The evidence indicates that abnormal positive tone is associated with a more positive immediate market response to the earnings announcement and a more negative market response in one and two quarters subsequent to the announcement. The return reversal in the post-announcement period is strong evidence of an over-reaction to abnormal positive tone at the earnings announcement. Among firms that use both accruals and tone management in a consistent direction, the authors find that tone management is more likely in older firms and firms facing higher balance sheet bloat, as proxied by lagged assets scaled net operating assets, and so are more constrained in further upward accruals management. Abnormal positive tone is usually higher when firms just meet or beat past earnings or analysts’ consensus forecasts, when earnings are upwardly biased to such an extent as to require a future restatement, and before a new equity issuance or a merger or acquisition activity. When firms award stock options to CEOs, with an associated managerial incentive to reduce the share price, they prefer to manipulate abnormal tone downward. Overall, the evidence suggests that managers use tone management to mislead investors and other financial statement users.

    Category:
    Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management, Management Integrity
  • Jennifer M Mueller-Phillips
    Was Dodd-Frank Justified in Exempting Small Firms from...
    research summary posted November 26, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 07.0 Internal Control, 07.05 Impact of 404 on Fees and Financial Reporting Quality, 08.0 Auditing Procedures – Nature, Timing and Extent, 08.05 Evaluating Accruals/Detection of Abnormal Accruals, 08.06 Earnings Management – Detection and Response, 14.0 Corporate Matters, 14.01 Earnings Management 
    Title:
    Was Dodd-Frank Justified in Exempting Small Firms from Section 404b Compliance?
    Practical Implications:

    Our study evaluates a provision of Dodd-Frank which provided permanent exemption from Section 404b compliance to non-accelerated filers. Our results show that these small firms did not improve their reporting quality to the same extent as large firms implying that the Dodd-Frank exemption will probably serve to keep the reporting quality of the exempted firms at lower than achievable levels.

    We also note that as part of the Dodd-Frank legislation, the SEC was given a mandate to investigate raising the Section 404b exemption requirements from $75 million to $250 million in market capitalization (Dodd Frank 2010). While the SEC eventually decided to leave the exemption criterion at $75 million, this matter is still considered to be an open topic (SEC 2011). Our study informs this ongoing debate.

    For more information on this study, please contact

    Anthony D. Holder, PhD, CPA

    Assistant Professor, Department of Accounting - MS 103

    University of Toledo

    Toledo, OH 43606-3390

    Email: Anthony.Holder@utoledo.edu

    Web:    http://homepages.utoledo.edu/aholder4/

    Phone: 1.419.530.2560

    Fax: 1.419.530.2873 

    Citation:

    Holder, A., K. Karim, and A. Robin. 2013. Was Dodd-Frank Justified in Exempting Small Firms from Section 404b Compliance? Accounting Horizons 27 (1): 1-22.

    Keywords:
    Sarbanes-Oxley; Dodd-Frank; earnings management; exempt filers
    Purpose of the Study:

    A major component of the Sarbanes-Oxley Act of 2002 (SOX) is Section 404b, which requires auditor certification of internal controls. However, not all firms were required to comply with this section. Fearing that compliance costs may be prohibitive, SOX allowed a temporary exemption to small firms called non-accelerated filers (typically those firms with market capitalizations under $75 million). Later, the Dodd-Frank Act of 2010 made this exemption permanent.

    Needless to say, both 404b itself and the small-firm exemption, remain controversial. At the heart of the issue, as with any regulation, is the cost-benefit tradeoff. In this particular instance, what are the potential benefits small firms would have obtained had they been subject to SOX Section 404b? By focusing just on the costs of compliance, we may be overlooking these benefits. We consider these foregone benefits an opportunity cost.

    The purpose of our study is to estimate this opportunity cost. We estimate the benefits lost by small firms, because they were not subject to SOX Section 404b.

    Design/Method/ Approach:

    Our sample contains listed firms (subject to SOX), divided into the large (accelerated) and small (non-accelerated) categories. Our data span the SOX period and are from 1995-2009. We measure reporting gains using two standard approaches, one measuring the extent of earnings management and the other measuring accrual quality.

    The reporting benefits foregone by small-firms can be understood by comparing the following two quantities:

    • Post-SOX reporting gains achieved by large firms (accelerated filers).
    • Post-SOX reporting gains achieved by small firms (non-accelerated filers). If these gains (or losses) are smaller than those achieved by large firms, we know there is an opportunity cost.
    Findings:

    We detect a significant deterioration in reporting quality for non-accelerated filers but not for accelerated filers. The result is invariant to whether we compare non-accelerated filers with all accelerated filers or only with small accelerated filers.  Our findings suggest a significant opportunity cost for the exemption. Although the consideration of the cost of Section 404b compliance is outside the scope of our study, our result concerning the opportunity cost suggests that it may have been premature to grant permanent exemption to the non-accelerated filers. This result is especially important, considering contemporaneous discussions to grant Section 404b exemption to even larger firms (up to a market capitalization of $500 million).

    Category:
    Auditing Procedures - Nature - Timing and Extent, Corporate Matters, Independence & Ethics, Internal Control, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management – Detection and Response, Earnings Management, Evaluating Accruals/Detection of Abnormal Accruals, Impact of 404 on Fees and Financial Reporting Quality, Impact of SEC Rules Changes/SarBox

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