Posts

Posts

  • Jennifer M Mueller-Phillips
    Are Seemingly Self-Serving Attributions in Earnings Press...
    research summary posted July 16, 2015 by Jennifer M Mueller-Phillips, tagged 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior, 14.08 Press Release Language and Signaling in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Are Seemingly Self-Serving Attributions in Earnings Press Releases Plausible? Empirical Evidence.
    Practical Implications:

    The finding that investors distinguish the plausibility among seemingly self-serving attributions based on concurrent industry performance and earnings commonality suggests that investors are somewhat sophisticated when interpreting these narrative disclosures. This study should be of interest to policymakers who advocate the importance of narrative disclosures. A potential concern that policymakers face is that managers can use unregulated narrative disclosures to manipulate investor perceptions, particularly if investors accept managers’ self-serving pronouncements uncritically. These findings mitigate this concern because investors appear to be sophisticated enough to use relevant information to distinguish the plausibility of seemingly self-serving attributions. Apparently, providing self-serving attributions purely to mislead investors may not be an effective strategy.

    Citation:

    Kimbrough, M. D., & Wang, I. Y. 2014. Are Seemingly Self-Serving Attributions in Earnings Press Releases Plausible? Empirical Evidence. Accounting Review 89 (2): 635-667.

    Keywords:
    attribution, narrative disclosure, plausibility, earnings announcements
    Purpose of the Study:

    Managers often provide causal explanations for earnings news by linking earnings performance to internal actions or to external causes. These attributions potentially help investors assess the implications of current earnings news, such as earnings persistence. A well-documented pattern from prior research on attributions is that managers are more likely to attribute good news to internal causes (enhancing attributions) and bad news to external causes (defensive attributions). Managers presumably provide such seemingly self-serving attributions to heighten (dampen) investors’ perceptions of the persistence of good (bad) earnings news, thereby increasing (decreasing) the market reward (penalty) for good (bad) earnings news.

    Investors face a challenge when interpreting seemingly self-serving attributions because they may provide unbiased information about future earnings or they may reflect managers’ psychological biases or opportunism. In this study, the authors examine the information that investors appear to rely upon when assessing the plausibility of seemingly self-serving attributions in earnings press releases. Specifically, the authors test whether the market’s reactions to earnings announcements that contain seeming self-serving attributions vary with:
    (1) The concurrent performance of other firms in the same industry, and 
    (2) The commonality of the firm’s earnings with the market and its industry, defined as the historical degree of co-movement between a firm’s earnings and market- and industry-level earnings.

    Design/Method/ Approach:

    Using a sample of earnings press releases from 94 randomly selected firms from 1999 to 2005, the authors document cross-sectional differences in the market’s response to earnings announcements that contain either defensive or enhancing attributions that are consistent with the predictions.

    Findings:

    The authors find that firms that provide defensive attributions to explain earnings disappointments experience less severe market penalties when:
    (1) More of their industry peers also release bad news, and
    (2) Their earnings share higher commonality with industry- and market-level earnings.

    On the other hand, firms that provide enhancing attributions to explain good earnings news reap greater market rewards when:
    (1) More of their industry peers release bad news, and
    (2) Their earnings share lower commonality with industry- and market-level earnings.

    Collectively, the results suggest that investors neither completely ignore seemingly self-serving attributions nor accept them at face value, but use industry- and firm-specific information to assess their plausibility. Further analyses reveal that investors’ use of industry peer performance and earnings commonality information appears justified because investors’ perceptions are consistent with the association between the plausibility measures and the ex post actual persistence of earnings surprises.

    In supplemental analysis, the authors find that the pattern of the effects of the plausibility factors observed for the seemingly self-serving sample does not extend to the non-self-serving sample, indicating that investors use these measures to assess plausibility only when seemingly self-serving attributions exist.

    Category:
    Corporate Matters
    Sub-category:
    Earnings Targets & Management Behavior, Press Release Language & Signaling
  • Jennifer M Mueller-Phillips
    Audit Quality and the Trade-Off between Accretive Stock...
    research summary posted June 21, 2013 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.08 Proxies for Audit Quality, 14.0 Corporate Matters, 14.01 Earnings Management, 14.05 Earnings Targets and Management Behavior in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Audit Quality and the Trade-Off between Accretive Stock Repurchases and Accrual-Based Earnings Management
    Practical Implications:

    This study provides evidence that is important to corporate governance decisions. The results suggest that hiring a high quality auditor to constrain accruals earnings management may result in management’s use of real earnings management as a substitute. Real earnings management involves potentially costly deviations from “business as usual.” Consequently, it may be important to consider other corporate governance measures aimed at constraining real earnings management concurrently with the decision to hire a high quality auditor. 

    Citation:

    Burnett, B., B. Cripe, G. Martin, and B. McAllister. 2012. Audit Quality and the Trade-Off between Accretive Stock Repurchases and Accrual-Based Earnings Management. The Accounting Review 87 (6): 1861-1884.

    Keywords:
    Real earnings management; stock repurchases; audit quality; audit industry specialization
    Purpose of the Study:

    When managers decide to manipulate earnings they must make a choice about how they will achieve their goal. The two broad methods for manipulating earnings are the manipulation of accounting choices and estimates (i.e. accrual earnings management) and the manipulation of real business practices (i.e. real earnings management). The authors of this study argue that either method could be considered questionable because the intent of earnings management is to mislead investors or influence accounting-based contractual arrangements. The choice between the two methods is of interest because governance activities that are taken to constrain one type of earnings management behavior may result in another.

    This study investigates whether audit quality affects management’s choice between accrual earnings management and accretive stock repurchases when firms manage earnings per share (EPS) to meet or beat analysts’ forecasts. The use of accretive stock repurchases to manage EPS is a type of real earnings management that involves the firm repurchasing shares in order to boost EPS figures. The authors believe that, because this form of real earnings management can be done quickly and with little disclosure, it is a good comparison to accrual management in this scenario. The authors make and test the following hypotheses (stated in null form):

    H1: High audit quality is unrelated to the use of accretive stock repurchases to meet or beat consensus analysts’ forecasts.

    H2: High audit quality is unrelated to the trade-off between the use of accretive stock repurchases and accrual-based earnings management to meet or beat consensus analysts’ forecasts.

    Design/Method/ Approach:

    The authors use data on publicly-traded companies that meet or beat analysts’ earnings forecasts but would have missed these forecasts if they had not managed their earnings. Using this subset of firms, the authors compare companies that hired an industry specialist auditor to those that had a non-specialist auditor. The sample period includes data from years 1989-2009.

    Findings:

    The authors document (1) a positive and significant relationship between having a high quality auditor and employing accretive stock repurchases in order to meet or beat EPS estimates, and (2) a negative and significant relationship between having a high quality auditor and employing accrual-based earnings management in order to meet or beat EPS estimates. The authors claim that these results suggest the use of accruals-based earnings management is constrained by high quality auditors and, as a result, when managers are faced with a high quality audit they employ accretive stock repurchases instead of accrual-based earnings management to meet or beat analysts’ EPS forecasts.

    Category:
    Audit Quality & Quality Control, Corporate Matters
    Sub-category:
    Earnings Management, Earnings Targets & Management Behavior
    Home:

    home button

  • Jennifer M Mueller-Phillips
    Corporate Governance Reform and Executive Incentives:...
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior, 14.10 CEO Compensation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Corporate Governance Reform and Executive Incentives: Implications for Investments and Risk Taking.
    Practical Implications:

    The evidence speaks to the debate on how corporate governance regulation interacts with firms' and managers' incentives, and ultimately affects corporate operating and investment strategies. The evidence contributes to the literature on the economic effects of the governance regulations in SOX on CEOs’ compensation contracts and corporate investment strategies. The evidence also contributes to this literature by documenting how the period after SOX is associated with changes in stock- and option-based compensation. The authors find evidence that the changes in investments are related to lower operating performances of firms, suggesting that these changes were costly to investors.

    Citation:

    Cohen, D. A., Dey, A., & Lys, T. Z. 2013. Corporate Governance Reform and Executive Incentives: Implications for Investments and Risk Taking. Contemporary Accounting Research 30 (4), 1296-1332.

    Keywords:
    corporate governance, executive compensation, investments, risk-taking, executives
    Purpose of the Study:

    In response to a series of corporate scandals beginning with Enron, the U.S. Congress enacted the Sarbanes-Oxley Act (SOX) in 2002 aimed at regulating the governance of firms. While this has resulted in a large and growing body of research, the overall consequences of regulating firms’ governance structures is not yet well understood. For instance, one of the questions still under assessment is to what extent corporate governance regulation interacts with firms’ and managers’ incentives and ultimately affects corporate operating and investment strategies. The authors objective is to investigate how governance regulations in SOX and the exchanges are associated with chief executive officers’ (CEOs) incentives and risk-taking behavior. While there are no direct mandates in SOX regarding executive compensation, two provisions in SOX motivate the analyses. First, SOX requires that a majority of board members of all publicly traded companies be independent, thus increasing the role of independent directors. Second, SOX increases the liability of corporate officers and directors, including expanding the scope of their legal obligations by requiring CEOs and CFOs to certify financial statement information and increasing the penalties associated with violations of securities acts. The authors discuss how these requirements are likely to affect incentive compensation and risk-taking behaviors of executives.

    Design/Method/ Approach:

    The sample consists of industrial companies from the COMPUSTAT annual industrial and research files and ExecuComp and covers the period 19922006. For the analyses with board independence, the authors merge the above sample with RiskMetrics. This results in a sample of 1,158 firms and 12,486 firm-year observations. The final sample represents only firm-year observations where data for all variables included in the analysis are available.

    Findings:
    • The authors find that there were significant shifts in executive compensation to packages that have less incentive-based compensation.
    • The sample firms significantly reduced investments in risky projects in the period following SOX.
    • While the authors find a decline in incentive-based compensation, they also find that CEOs’ responses to risk-inducing incentives declined significantly in the post-SOX period. Therefore, the reductions in investments are not only the consequence of changes in incentive contracts but also the consequence of increased personal costs perceived by CEOs in the period after SOX.
    • Furthermore, the authors find evidence indicating that these changes in investments were, indeed, associated with reduced operating performance of the sample firms and that these changes are correlated with firm-specific stock price changes at the SOX events.
    • The authors find evidence that the changes in investments are related to lower operating performances of firms, suggesting that these changes were costly to investors.
    • The changes in investments were in part due to changes in executive compensation contracts and in part related to increased executives' personal costs of engaging in risky activities.
    Category:
    Corporate Matters
    Sub-category:
    CEO Compensation, Earnings Targets & Management Behavior
  • Jennifer M Mueller-Phillips
    Discontinuities and Earnings Management: Evidence from...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 14.0 Corporate Matters, 14.01 Earnings Management, 14.05 Earnings Targets and Management Behavior in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation
    Practical Implications:

    The results of this study provide important evidence to the earnings management literature. Recent studies provide several plausible alternative explanations for the discontinuities in earnings distributions near earnings benchmarks. Though the findings of this study cannot readily be extrapolated to a broader sample of firms, the authors found evidence that firms commit less egregious earnings management in order to meet earnings benchmarks. This study is therefore important in considering whether earnings management plays a role in the discontinuities in various earnings distributions documented by prior studies.

    For more information on this study, please contact Dain C. Donelson.
     

    Citation:

    Donelson, D. C., J. M. McInnis, and R. D. Mergenthaler. 2013. Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation. Contemporary Accounting Research 30 (1).

    Keywords:
    earnings management; financial restatements; class action lawsuits; descriptive statistics.
    Purpose of the Study:

    A heated debate exists as to whether discontinuities in earnings distributions are indicative of earnings management. Many executives indicate that they would manage earnings within GAAP principles to achieve earnings benchmarks. This study examines the impact of earnings management on the discontinuity in earnings distributions near important benchmarks for a sample of firms where the amount of earnings is measurable. The authors look to find evidence linking earnings management to discontinuities in earnings distributions of this sample.

    Design/Method/ Approach:

    To determine the appropriate sample, this study utilizes the Securities Class Action Services (SCAS) database of historical class action data from RiskMetrics Group. From this database, the authors selected lawsuits that (1) settle and allege fraudulent GAAP violations and (2) involve restatements by firms for periods during which the alleged accounting fraud occurred. To identify and measure earnings management, the study utilizes the COMPUSTAT Point-in-Time database and uses descriptive statistics to compile evidence.

    Findings:
    • Earnings management drives the discontinuities in distribution of analyst forecast errors and earnings changes for sample firms.
    • Discontinuity is linked to earnings management.
    • The sensitivity to the scaling variable could indicate that factors other than earnings management contribute to the discontinuity in the sample.
    • Actual instances of earnings management do create sizable discontinuities in firms’ earnings distribution.
       
    Category:
    Corporate Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management, Earnings Management, Earnings Targets & Management Behavior
  • Jennifer M Mueller-Phillips
    Does Earnings Quality Affect Information Asymmetry? Evidence...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.05 Evaluating Accruals/Detection of Abnormal Accruals, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs
    Practical Implications:

    The quality of reported in earnings is influenced by a firm’s fundamentals. To the extent investors differ in their ability to process this information, poor earnings quality can lead to information asymmetry, which can be costly. For these reasons, standard-setters and regulators are concerned about the quality of accounting information and its consequences for capital markets. This study provides empirical support for the concerns articulated by regulators that an important adverse consequence of poor earnings quality is increased information asymmetry and reduced liquidity.

    For more information on this study, please contact Nilabhra Bhattacharya.
     

    Citation:

    Bhattacharya, N., H. Desai, and K. Venkataraman. 2013. Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs. Contemporary Accounting Research 30 (2).

    Keywords:
    financial reporting; earnings quality; information asymmetry
    Purpose of the Study:

    An important attribute of the quality of accounting information is the extent to which earnings (accruals) map into cash flows. Poor mapping of accruals into cash flows reduces the information content of reported earnings and results in lower-quality earnings. If investors differ in their ability to process earnings related information, then poor earnings quality can result in differently informed investors and thereby exacerbate the information asymmetry in financial markets. Regulators and standard-setters view a reduction in information asymmetry to be an important benefit of improved earnings quality. This study examines whether poor earnings quality is associated with higher information asymmetry in capital markets.

    Design/Method/ Approach:

    The authors examined the association between earnings quality and information asymmetry during non-earnings announcement periods. Additionally, they tested whether earnings quality is associated with the increase in adverse selection risk around earnings release. The initial sample of firms tested included all NSYE and NASDAQ firms with available data on the CRSP, COMPUSTAT, and Trades and Quotes (TAQ) databases. The firm data was measured for the years 1997 through 2006. Information asymmetry was measured as reflected in the adverse selection component of the trading cost.  Descriptive statistics were used to gather empirical results.

    Findings:
    • The inverse relation between earnings quality and the increase in information asymmetry around earnings releases is observed for all measures of earnings quality.
    • The association between earnings quality and the increase in information asymmetry is more pronounced for smaller firms.
    • Managerial choices that cause accruals volatility to be too high or too low relative to industry norms increase information asymmetry.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Corporate Matters
    Sub-category:
    Earnings Targets & Management Behavior, Evaluating Accruals/Detection of Abnormal Accruals
  • Jennifer M Mueller-Phillips
    Earnings Smoothing Activities of Firms to Manage Credit...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Earnings Smoothing Activities of Firms to Manage Credit Ratings
    Practical Implications:

    This paper provides fresh empirical evidence on long-term financial reporting strategies that managers use to impact perceptions of credit risk. It is among the first to examine reporting strategies in a setting where companies with stronger incentives to manage earnings to affect debt ratings can be identified. The authors find evidence that earnings smoothing activities appear to be affectively employed by managers to improve firm credit ratings.

    For more information on this study, please contact Boochun Jung.
     

    Citation:

    Jung, B., N. Soderstrom, and Y. S. Yang. 2013. Earnings Smoothing Activities of Firms to Manage Credit Ratings. Contemporary Accounting Research 30 (2).

    Keywords:
    credit ratings; risk assessment; rating agencies; financial disclosure
    Purpose of the Study:

    This study focuses on earnings smoothing, a long-term strategy that is available to a broad range of credit rated firms, as one way in which bond issuers affect credit ratings. Credit rating agencies such as Standard & Poor’s (S&P) and Moody’s evaluate credit risk and assign credit ratings to issues, issuers, or both. These ratings can have significant implications for companies by impacting the cost of future borrowing and affecting stock and bond valuation. Rating agencies often examine the earnings volatility of firms to identify credit risk. Firms can often improve or maintain their credit ratings by reducing the volatility of their earnings. This study attempts to identify mangers’ efforts to alter the rating agencies’ perception of credit risk through these earnings smoothing activities.

    Design/Method/ Approach:

    To test the hypotheses developed, the authors examine discretionary earnings smoothing activity by firms relative to their notch ratings (e.g. AA+, AA-, etc.). The primary measure of earnings smoothing activity is based on earnings smoothness associated with discretionary accruals. Earnings smoothness is measured as the standard deviation of earnings scaled by the standard deviation of cash flows from operating activities. The earnings smoothing activity is measured by subtracting smoothness based on earnings adjusted for performance-matched discretionary accruals from smoothness based on reported earnings. To test additional hypotheses, similar techniques are used in conjunction with descriptive statistics.

    Findings:
    • Earnings smoothing via earnings management is more concentrated in firms with a plus notch rating, particularly in investment grade firms.
    • Earnings smoothing activity increases the likelihood of a subsequent rating upgrade for firms with a plus notch rating.
    • Earnings smoothing activities appears to be an effective tool in managing credit ratings.
       
    Category:
    Corporate Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management, Earnings Targets & Management Behavior
  • Jennifer M Mueller-Phillips
    Equity Incentives and Internal Control Weaknesses.
    research summary posted July 28, 2015 by Jennifer M Mueller-Phillips, tagged 07.0 Internal Control, 07.03 Reporting Material Weaknesses, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior, 14.07 Executive Compensation, 14.10 CEO Compensation in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Equity Incentives and Internal Control Weaknesses.
    Practical Implications:

    The analysis shows that (1) equity incentives are more effective in reducing company-level control problems; (2) restricted equity provides greater incentives than unrestricted equity; and (3) CFO incentives have a more significant impact on the quality of internal control than CEO incentives. These insights have important implications for compensation committees who make compensation recommendations and the full board of directors who ratifies those recommendations. They suggest that both the level and type of equity incentives should be considered in compensation design to motivate managers to invest in strong internal controls.

    Citation:

    Balsam, S., Jiang, W., Lu, B. 2014. Equity Incentives and Internal Control Weaknesses. Contemporary Accounting Research 31 (1):178-201. 

    Keywords:
    Internal auditing, equity incentives, stock options, internal controls, material weakness (auditing), CEO compensation, CFO compensation, executive compensation
    Purpose of the Study:

    The authors address the empirical question of whether incentives associated with equity ownership induce managers to maintain strong internal controls. If managers believe adverse internal control opinions negatively affect the value of their equity holdings, equity incentives may provide the motivation for them to strengthen internal controls. The negative wealth consequences associated with the disclosure of internal control weaknesses suggest that equity-based incentives should motivate managers to develop and maintain effective internal controls over financial reporting, though some prior work has shown that equity incentives can lead to opportunistic actions by management. To the extent that lax internal controls provide the opportunity for earnings management, the link between accounting earning and share prices, along with the motivation provided by equity incentive to increase share prices, may provide an incentive for managers to want weaker internal controls. The study adds to the literature on equity incentives by focusing on specific aspect of managerial performance- the effectiveness of internal controls and the literature examining the determinants of internal control deficiencies. The results of the study provide insight into the role equity incentives play in improving the quality of internal control.

    Design/Method/ Approach:

    The study was conducted using a sample comprised of firms filing SOX Section 404 reports during 2004 and 2005. The authors obtained the data on internal control opinions from Audit Analytics, the financial data from COMPUSTAT, and the compensation and governance variables from Equilar Inc, yielding a sample of 569 firms. The control sample contained 3,798 observations. They used firm size, loss proportion and firm age to capture the level of investment in the internal control systems.

    Findings:
    • Equity incentives motivate managers to implement effective controls.
    • Evidence suggests that firms where the CEO and CFO have higher levels of equity incentives are less likely to have internal control problems.
    • The equity incentives of the CFO play a more significant role in determining internal control quality than those of the CEO.
    • The bonus is significantly lower, and salary significantly higher, as a percentage of total compensation, for firms with material internal control weaknesses.
    • Firms with material internal control weaknesses are smaller, younger, more likely to have had a loss, have more segments and are more likely to have experienced a restructuring, than firms without weaknesses.
    • Material weakness firms had fewer independent directors, smaller audit committees and boards, are less likely to engage a Big 4 auditor, had shorter auditor tenures, and were more likely to have experienced a recent auditor change.
    • Lax internal controls provide the opportunity for earnings management, which may allow managers to meet targets to maintain a higher share price than otherwise warranted. When the authors partition based upon type of opinion, they find that equity incentives are more effective in mitigating company-level internal control risk.
    Category:
    Corporate Matters, Internal Control
    Sub-category:
    CEO Compensation, Earnings Targets & Management Behavior, Executive Compensation, Reporting Material Weaknesses
  • The Auditing Section
    Revenue Manipulation and Restatements by Loss Firms
    research summary posted April 16, 2012 by The Auditing Section, tagged 06.06 Earnings Management, 14.0 Corporate Matters, 14.01 Earnings Management, 14.05 Earnings Targets and Management Behavior in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    Revenue Manipulation and Restatements by Loss Firms
    Practical Implications:

    This study’s results provide auditors and regulators with another potential indicator of managerial incentives to manipulate reported revenues (i.e., continued losses or negative cash flows) and how managers might achieve this result.  The authors demonstrate that this manipulation incentive applies across the general spectrum of firms and is not limited to young or internet-based businesses.

    Citation:

    Callen, J., S.W.G. Robb, D. Segal 2008. Revenue Manipulation and Restatements by Loss Firms. Auditing: A Journal of Practice & Theory 27 (2): 1-29.

    Keywords:
    revenue manipulation; earnings management; auditing; restatements
    Purpose of the Study:

    Regulating entities (such as the SEC and FASB) and auditors recognize managers have incentives to manipulate revenue accounts to achieve certain financial statement-related goals and perceptions with analysts and investors.  Although management can also manipulate earnings and financial data using expense-related accounts, accounting violation investigations by the SEC, FBI, and U.S. Attorney General’s office suggest that management is more likely to manipulate results using revenue-related items.  Survey evidence indicates management’s use of revenue items to increase earnings is more common, and studies show that firms have capital market incentives to provide positive revenue surprises.  Academic studies examining SEC enforcement actions support this perception.  Studies also indicate that individual firm characteristics could lead to a greater tendency to manipulate revenue-related line items.  For instance, studies suggest that young firms and internet-related businesses are more likely to manipulate earnings using revenue accounts.

    One reason why firms are more likely to manipulate revenue-related accounts is that firms with repeated losses or negative cash flows cannot be valued accurately using traditional valuation models such as the discounted cash flow and discounted residual earnings models.  In these cases, analysts use other models and ratios, such as the price-to-sales ratio, to value the firm.  Manipulating revenues in these situations help management project positive expectations concerning future growth and induce higher market capitalization.

    Although prior studies and enforcement actions suggest that firms, in particular young and/or internet-based firms, are more likely to manipulate revenues, the purpose of this study is to examine a broad spectrum of firms to determine whether repeated losses and anticipated future losses are an indicator of firms’ likelihood to manipulate revenues in violation of GAAP.

    Design/Method/ Approach:

    The authors use restatement data on U.S. publicly-traded firms for the years 1992-2005 to examine the relationship between revenue misstatements and past and expected future loss or negative operating cash flows.

    Findings:
    • Consistent with prior research, revenues appear relevant to the market valuation of loss and negative cash flow firms, but earnings and operating cash flows do not.
    • The authors find a positive association between the number of anticipated loss years and a firm’s accounts receivables, even after controlling for the firm’s credit policy.
    • The authors find a positive association between the number of actual and anticipated loss years and the probability of a firm manipulating revenue.
    • The authors find that the probability of revenue manipulation is positively related to the level of a firm’s accounts receivable balance.
    Category:
    Corporate Matters
    Sub-category:
    Earnings Management, Earnings Management, Earnings Targets & Management Behavior
    Home:
    home button
  • Jennifer M Mueller-Phillips
    The Disclosure of Non-GAAP Earnings Information in the...
    research summary posted July 16, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment, 09.06 Adequacy of Disclosure, 09.07 GAAP Departures, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Disclosure of Non-GAAP Earnings Information in the Presence of Transitory Gains.
    Practical Implications:

    The authors find that the informative disclosure of non-GAAP earnings information enables investors to better understand firms’ future operating performance relative to opaque disclosures. Further, the results suggest that the most pervasive motive behind the disclosure of non-GAAP earnings information is to inform, although an economically significant proportion of firms appear to be opportunistic in that they only disclose non-GAAP earnings information when it increases investors’ perceptions of core operating earnings. The study should be useful to investors, financial analysts, regulators, and researchers for assessing the non-GAAP disclosure motives of management and the effect of these motives on market participants.

    Citation:

    Curtis, A. B., McVay, S. E., & Whipple, B. C. 2014. The Disclosure of Non-GAAP Earnings Information in the Presence of Transitory Gains. Accounting Review 89 (3): 933-958.

    Keywords:
    disclosure incentives, non-GAAP earnings, transitory gains, transitory items, voluntary disclosure
    Purpose of the Study:

    Managers regularly highlight the transitory components of GAAP earnings in their earnings announcements, and frequently disclose non-GAAP earnings excluding these transitory components. The motivation for managers to disclose non-GAAP earnings, however, is heavily debated. On one hand, managers claim that they disclose non-GAAP earnings to aid investors in assessing the firm’s core operating performance. On the other hand, regulators express concerns that some managers may be motivated to inflate perceptions of core operating performance, which could mislead investors. Essentially, this ongoing debate centers on whether managers disclose non-GAAP earnings to inform or mislead. Non-GAAP earnings are generally more predictive of future operating earnings, but they can also be overstated to meet strategic earnings benchmarks on a non-GAAP basis. Because most transitory items are income-decreasing, both motives predict the same disclosure choice. Because both motives impact managers’ non-GAAP disclosure, it is difficult to determine which motivation is more pervasive or to provide evidence that a particular disclosure is unambiguously informative or opportunistic.

    The authors examine the disclosure of non-GAAP earnings information in quarters containing transitory gains to investigate whether the primary motivation for these managers to disclose non-GAAP earnings is to inform or mislead.

    Design/Method/ Approach:

    The authors examine a sample of 1,920 firm-quarters with transitory gains in the form of net income-increasing special items of at least one penny per share from 2004 to 2009. They require sample firms to have (1) CRSP coverage, (2) a non-missing earnings announcement date on Compustat, (3) a non-missing 10-Q/K filing date on EDGAR, (4) at least two days between the earnings announcement and filing dates, and (5) data available for each of the variables, including one-year-ahead earnings.

    Findings:

    Managers motivated to inform stakeholders about sustainable earnings will disclose non-GAAP earnings information excluding the gain, whereas managers motivated to report higher earnings will obscure the transitory nature of the gain by focusing on GAAP earnings.

    • The most pervasive motivation for non-GAAP reporting in the presence of transitory gains is to inform.
    • Nearly half of the sample discloses non-GAAP earnings information that allows investors to quickly and easily assess operating performance excluding the gain. Investors of these firms appear to efficiently price the transitory nature of these gains.
    • The remaining earnings announcements contain more opaque disclosures. Among these firms, investors price the gain positively at the time of the earnings announcement, but this partially reverses at the time of the subsequent 10-Q/K filing. The evidence is consistent with investors not fully incorporating the transitory nature of the gain at the time of the earnings announcement.
    • Among opaque disclosers, the authors find that approximately half appear to follow a consistent policy of non-disclosure across both transitory gain and transitory loss quarters. The other half, however, appear opportunistic because they disclose non-GAAP earnings information in transitory loss quarters, but not transitory gain quarters.
    • The authors also find some evidence of egregious opportunism. In 101 firm-quarters, which is 5.3 percent of the sample, managers explicitly disclose non-GAAP earnings, excluding expenses but including transitory gains; this is more prevalent when it allows them to meet earnings benchmarks.
    Category:
    Auditor Judgment, Corporate Matters
    Sub-category:
    Adequacy of Disclosure, Earnings Targets & Management Behavior, GAAP Departures
  • Jennifer M Mueller-Phillips
    The Effect of CEO Social Influence Pressure and CFO...
    research summary posted April 19, 2017 by Jennifer M Mueller-Phillips, tagged 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior, 14.06 CFO Tenure and Experience in Auditing Section Research Summary Database > Auditing Section Research Summaries Space public
    Title:
    The Effect of CEO Social Influence Pressure and CFO Accounting Experience on CFO Financial Reporting Decisions
    Practical Implications:

    This study provides direct testing of the effects of two forms of CEO social influence pressure on actual CFO’s reporting decisions. Examining such pressures improves the overall understanding of an individual’s decision to engage in dysfunctional behavior, which can inform auditors and audit committee members who provide oversight of the financial reporting process and have responsibility for mitigating the risk of financial misreporting. 

    Citation:

    Bishop, C. C., F. T. DeZoort and D. R. Hermanson. 2017. The Effect of CEO Social Influence Pressure and CFO Accounting Experience on CFO Financial Reporting Decisions. Auditing: A Journal of Practice and Theory 36 (1): 21 – 41.

    Keywords:
    accounting manipulation, chief financial officer, chief executive officer, compliance pressure, obedience pressure, social influence pressure, and accounting experience.
    Purpose of the Study:

    CFOs play critical stewardship roles related to financial reporting quality and a prominent and increasing role in accounting manipulations, particularly in conjunction with their CEO. This study examines how CEO pressure on the CFO and CFO accounting experience influence public company CFOs’ financial reporting judgments and decisions. 

    Design/Method/ Approach:

    The authors conducted an experiment involving a hypothetical CFO’s earnings manipulation decision. Using a between-subjects manipulation, they utilize three levels of CEO pressure (a control group where the CEO does not pressure the CFO, a compliance pressure group where the CEO asks the CFO to revise an estimate, and an obedience pressure group where the CEO tells the CFO to revise an estimate). 

    Findings:
    • The authors find that two different forms of CEO social influence pressure (obedience pressure and compliance pressure) are both effective in motivating some CFOs to misreport, with no significant difference between the two.
    • The authors find that the CFOs do not abdicate the financial reporting responsibility under pressure, despite predictions from the obedience theory; instead, the CFOs acknowledge that they still have ultimate responsibility.
    • The authors find an inverse relation between CFO accounting experience and revision of the initial adjustment, consistent with accounting experience empowering CFO resistance to pressure. 
    Category:
    Corporate Matters
    Sub-category:
    CFO Tenure & Experience, Earnings Targets & Management Behavior