Browsing by Author "Schipper, Katherine A"

I develop an empirical model that estimates a firm-specific accrual noise ratio (ANR), an operational and statistically grounded measure of accrual reliability, and test the measure's construct validity. The model allows accrual reliability to vary across firms, which is particularly important because many reliability determinants vary in cross-section. Unlike metrics that measure relative perceived reliability, ANR measures accrual reliability independent of the perceptions of investors, creditors or auditors. I find that ANR relates in expected ways with multiple proxies of accounting reliability, that ANR's relation with the proxies of other accounting constructs is consistent with theory, and that ANR's sensitivity to percentage changes of accrual components is consistent with a subjective ordinal ranking of the components' reliability from prior literature.

I examine the relation between a corporate commitment to increased disclosure and measures of liquidity, information asymmetry, and cost of equity capital. Relative to prior research on voluntary disclosure, I use a composite, ex ante measure of commitment based in social psychology and measure commitment using characteristics of earnings announcement disclosures. Prior to Regulation Fair Disclosure (Reg FD) I find that commitment to increased disclosure is negatively related to bid-ask spreads, probability of informed trade (PIN) scores, and implied cost of capital estimates. Further analysis reveals that the disclosure of balance sheet information in earnings releases is significantly related to spreads and PINs, regardless of firms' conference call behavior, while the combination of consistent open calls and disclosure of balance sheet information in earnings releases yields the most significant results for cost of capital. After the effective date of Reg FD I find that commitment is negatively related to PIN scores and implied cost of capital estimates, but not related to bid-ask spreads. Further analysis reveals that the disclosure of balance sheet information in earnings releases is significantly related to PINs and cost of capital, regardless of firms' conference call behavior.

I examine the decision usefulness of the equity method of accounting from two perspectives. First, I examine the value relevance of information provided under the equity method relative to the value relevance of information resulting from measuring investments in affiliates at fair value. For a sample of 221 U.S. investors with publicly-traded affiliates during 1993-2011, I find that balance sheet measures of investments in publicly-traded affiliates provided under the equity method are associated with investors' stock prices, but income from these affiliates recognized under the equity method is not associated with investors' stock prices. In addition, fair value balance sheet and income measures of investments in publicly-traded affiliates are incrementally associated with investors' stock prices after controlling for information provided under the equity method. The incremental value relevance of fair value measures for investments in publicly-traded affiliates exists for both investments identified as held for sale and those identified as strategic, with no evidence that the incremental value relevance is higher (lower) for investments identified as held for sale (strategic). This result suggests that the 2010 and 2013 proposals by the U.S. Financial Accounting Standards Board to distinguish between investments in affiliates based on management's intended method of value realization are not supported by differences in the relative value relevance of fair value measures for these types of investments. Second, I evaluate whether equity method investors use their significant influence to manage income reported under the equity method. For a sample of 202 U.S. firms from 1993-2011, I find that signed discretionary accruals of affiliates are higher when income from affiliates allows investors to meet earnings targets. This result is consistent with equity method investors influencing the financial reporting of affiliates to achieve earnings targets.

This paper examines the role of earnings management for firms that report at least three consecutive years of annual earnings increases (hereafter earnings string firms). Specifically, I examine how levels of earnings management change as earnings string firms approach the end of their earnings string patterns. My results show that earnings string firms engage in income-increasing earnings management consistent with an attempt to stretch these earnings string patterns. I also examine whether the cumulative effect of income-increasing earnings management activities during the earnings string period reduces the ability of these firms to continue reporting earnings increases. I do not find evidence to suggest that earnings string firms, on average, break their earnings string patterns because they ran out of accounting flexibility. However, there are two instances which the accumulated effect of income-increasing earnings management increases the likelihood of ending the earnings string. The two instances relate to firms which repeatedly engage in income-increasing earnings management throughout the earnings string period, and firms whose pre-managed earnings decline in the last year of the earnings string period. Finally, I show that firms that resume a subsequent series of reporting at least three consecutive years of annual earnings increases, on average, exhibit similar earnings management behavior. That is, these firms also increasingly resort to income-increasing earnings management toward the end of their second (or third) earnings strings.

I examine whether financial statement preparers (managers and auditors) treat recognized versus disclosed fair value of option compensation differently. Recognition refers to items that appear on the face of financial statements and that are included in subtotal figures that appear in the summary accounts; disclosure refers to items that appear in words and amounts in only the financial statement footnotes. I find that fair value recognition of option compensation is likely to have a significant impact on net income. Firms in my sample granted options amounting to a median fair value of 7% of profits in 1996 and 11% of profits in 2004. I compare the terms of option grants and the properties of fair value estimation under a disclosure reporting regime to terms and properties under a recognition regime. Under a fair value recognition regime, I find firms reduce/eliminate option grants across all levels of employees, reduce the statutory length of options, and substitute restricted stock and bonuses for option compensation. The fair value reduction in option grants is on average 9% (0.4%) of absolute net income. In contrast, under a fair value disclosure regime, option compensation was not reduced. I also find that firms increase the bias in three inputs to fair value option estimation: volatility, dividend, and interest. This increase amounts to 4%, 2%, and 0.3% of fair value cost. Mandatory recognition firms also display increased dividend and interest input accuracy. Combined, these results suggest that financial statements reflect differences in behavior between recognition and disclosure reporting regimes, such that both real actions and fair value estimation are used to reduce recognized values.

In Chapter 1, I review the existing literature on the investor and contracting usefulness of other comprehensive income (OCI) components. In Chapter 2, I perform empirical tests focused on one aspect of investor usefulness of accounting information: risk-relevance. I examine whether OCI component volatilities are associated with investors' returns volatility using a sample of bank holding companies from 1998 to 2012. The results indicate that the volatilities of unrealized gains and losses on available-for-sale (AFS) securities and cash-flow hedges, typically deemed beyond managers' control, are negatively associated with risk, while volatilities of OTTI losses, over which managers have relatively more control, are positively associated with risk. The results are consistent with investors perceiving the volatility of non-OTTI AFS unrealized gains and losses as relatively less important, less risky, or less risk-relevant, than the volatility of OTTI losses, and perceiving the volatility of OTTI losses as an informative signal about risk. In Chapter 3, I find that Tier 1 Capital including more components of accumulated other comprehensive income (AOCI), as stipulated by Basel III, is no more volatile than pre-Basel-III Tier 1 Capital, and that the volatilities of the AOCI components new to Tier 1 Capital are not positively associated with risk. In Chapter 4, I discuss future research.

While a considerable body of research examines the determinants of financial reporting decisions, much of the heterogeneity in financial reporting outcomes is not explained by firm and industry factors. Guided by the Upper Echelons perspective of Hambrick and Mason (1984), I examine the relation between the presence of a financial expert, defined as either a CEO or a CFO with an accounting background and earnings quality. I propose that the coupling of decision rights and domain-specific knowledge supports the team's influence discretionary reporting choices, controlling for incentives, corporate governance and firm-specific factors. I find that in the pre Sarbanes Oxley era, executive teams with financial expertise have higher discretionary earnings quality as measured by smaller absolute abnormal accruals; however, this relation is eliminated in the period following Sarbanes Oxley. Building on research that proposes that accruals management and real activities management are substitutes, I examine four proxies for real activities management and do not find evidence of a relation between firms with executive teams with financial expertise and these proxies for real activities management.

I investigate whether changes in derivative and hedging footnote disclosures required by SFAS 161 affect investor and analyst uncertainty. My study is motivated by accounting standard setters' and researchers' interest in disclosure effectiveness, and by prior research linking investors' interpretations of public information to measures of uncertainty. For a broad sample of firms, I use textual analysis to measure changes in the amount and salience of derivative and hedging information caused by SFAS 161. Using a difference-in-differences design to study the effects of these changes, I find that investor uncertainty is reduced for firms adopting SFAS 161. In addition, I find that for some uncertainty proxies this reduction is greater for firms whose disclosures were more affected by SFAS 161, consistent with the new disclosures improving investor understanding. I also find evidence of a decreased association between bid-ask spread and movements in risk factors, indicating that SFAS 161 reduced uncertainty stemming from these movements.

In this study, I explore whether archival evidence is consistent with auditors conforming to auditing standards when discovering and responding to internal control weaknesses, and whether conforming has adverse consequences for financial misstatement risk. My study is motivated by two sources: The first is Public Company Accounting Oversight Board member Jeanette Franzel, who in 2015 tasked academics with exploring whether all material weaknesses in internal controls over financial reporting are being properly discovered and disclosed by auditors, as trends in financial misstatement and internal control opinion data suggested otherwise. The second is prior research which suggests that auditors fail to discover most material weaknesses in internal controls; and when auditors do discover a material weakness in internal controls, they often fail to sufficiently adjust their audit procedures over financial statement assertions to negate the misstatement risk resulting from the discovered weakness. An inference from this research is that auditors do not behave in accordance with auditing standards with respect to the discovery of and response to material control weaknesses.

I propose and infer from my findings that the combined effect of auditor time constraints, auditor resource constraints, and auditing standards that require the auditor to exercise professional judgment regarding whether and how to perform unplanned control testing procedures leads to a temporal lag in auditors’ discovery of material weaknesses in internal controls, and that the discovery lag results in increased financial misstatement risk. While my results are consistent with auditors failing to discover most material weaknesses in the first year of existence, they also suggest that the discovery failure may be a joint result of auditors following auditing standards while also being constrained by the environment in which they operate.

I use the monthly release of the Employment Situation (ES) by the Bureau of Labor Statistics to examine the impact of macroeconomic uncertainty on the pricing of firm-level earnings news. I use this setting because uncertainty about employment conditions is high the day before the employment report is released and is resolved just after the release of the report. I find a muted initial response to earnings announcements made the day before the employment report. This effect is stronger when ex-ante uncertainty about the contents of the employment report is high. The muted initial response is followed by a stronger-than-usual earning-return relation measured two days after the earnings announcement, or the day after the release of the employment report. These results are consistent with investors applying less weight to earnings signals when there is high uncertainty about macroeconomic conditions, and increasing the weight applied to these signals after the resolution of macroeconomic uncertainty. I consider earnings announcements made on employment-report Fridays and find a muted initial market response followed by greater-than-usual post-earnings-announcement drift. Finally, I find the proportion of bad news earnings announcements (negative unexpected earnings) is significantly higher on employment-report Fridays than on other days, including other Fridays.

In 2010, the Municipal Securities Rulemaking Board proposed a rule change requiring the display of current credit ratings on the EMMA website, a centralized repository of municipal bond information. Prior to the rule change, current credit ratings were freely available on individual rating agencies’ websites or on EMMA if municipalities provided relevant continuing disclosures, making it unclear whether the rule change would benefit investors. A difference-in-difference analysis reveals the rule change is associated with an 8 basis-point decrease in investor transaction costs. This effect is concentrated among the intended beneficiaries (retail investors) when credit risk information demand is high (long-maturity bonds) and current credit rating information on EMMA is low (no continuing disclosure of rating changes was provided on EMMA). The rule change appears to have helped retail investors become aware of current credit ratings by filling a disclosure gap on EMMA for municipalities without continuing disclosures of rating changes.

This paper reconsiders the information content of losses, specifically, the extent to which losses contain distinct and offsetting information about future cash flows and about risk. Based on theory that suggests exit value is the lower bound of firm value, I posit that shareholders who decide to abandon the firm (or some portion thereof) will receive the exit value of disposed resources, thereby resolving uncertainty about payoffs (that is, cash flow uncertainty). Under this view, a higher likelihood of abandonment, proxied by losses, should be associated with both lower payoffs (the exit value of the disposed net assets) and lower risk (because uncertainty about the payoff is partially resolved). Using Vuolteenaho's (2002) method to decompose realized returns into expected returns, cash flow news and discount rate (risk) news, I predict and find that losses provide adverse news about cash flows (the valuation numerator) and favorable news about the discount rate (the valuation denominator). Because the effects of the two types of news are mutually offsetting, the relation between earnings and returns appears weaker for loss firms than for firms reporting profits. These results suggest that losses are valuation relevant, in the sense of providing information that is correlated with the information in returns.

I examine a tax-related friction that limits U.S. multinational corporations’ ability to use foreign assets as collateral in obtaining U.S. debt financing. I find that tax-based collateral limitations are associated with reduced debt capacity and higher borrowing costs. Additionally, I show that collateral limitations are associated with a decrease in the use of capital covenants and an increase in the use of performance covenants in private debt agreements. While the U.S. House and Senate passed versions of the Tax Cuts and Jobs Act of 2017 that included provisions to eliminate tax-based collateral limitations, the final version surprisingly retained these limitations. I find a negative relation between the extent to which a firm is affected by tax-based collateral limitations and market reactions around the passage of the final version of the Act, suggesting tax-based collateral limitations constrain borrowing arrangements and thereby reduce firm value. The costs associated with these collateral limitations offer one explanation for the under-sheltering puzzle, which suggests firms fail to take advantage of the supposed benefits of tax avoidance strategies.

The SEC mandates disclosure of Article 11 pro forma financial statements (pro formas) for acquisitions that exceed one of three bright-line materiality thresholds. Motivated by two theories of mandated disclosure, I test whether pro formas improve analyst forecasts or mitigate incentive alignment problems. Using a fuzzy regression discontinuity design, I provide evidence that pro formas reduce post-acquisition forecast errors and improve target selection. The improvement in forecast accuracy (target selection) is concentrated in acquirers with low analyst following (acquisitions involving third-party advisors), suggesting that benefits to mandated pro forma disclosure depend on the pre-existing information environment.

Disclosure complexity may increase the information asymmetry between sophisticated and retail investors, due to unsophisticated investors’ more limited capacity to process complex disclosures. I explore whether a 2004 Securities and Exchange Commission (SEC) rule that changed the timing of material contract disclosures helps mitigate this problem, by allowing investors more time to process periodic filings. Using data from quarterly financial statements and material contracts filed between 2001 and 2007, I find that the 2004 requirement significantly lowers the information asymmetry among investors immediately following quarterly financial statement disclosures. Moreover, the effect is more pronounced for firms that file more complex contracts, attract more retail investors, and experience greater change in the timeliness of their material contract filings. The effect is also larger for firms whose financial statements are disclosed during periods when investors are more time constrained. This evidence should be of interest to the SEC and other regulators who strive to level the information playing field among investors and to maintain fair and efficient markets.

Using aggregate-level difference-in-differences analysis across 34 countries, I find that the extent to which aggregate accruals predict change in Gross Domestic Product (GDP) is greater for countries that adopted International Financial Reporting Standards (IFRS) than for countries that did not. I do not find a similar change in the predictive ability of aggregate cash flows following IFRS adoption. IFRS adoption also enables aggregate accruals to better predict a component of GDP (corporate profits) and factors related to GDP change (change in corporate investment and unemployment rate). The results are more pronounced for adopting countries with greater differences between local accounting standards and IFRS and for adopting countries with stronger enforcement. These findings support the view that IFRS adoption improves the measurement and recognition of firms’ fundamentals, and suggest that a change in accounting standards can reduce imperfections in accounting measurements of real output from business activities. These inferences have implications for accounting standard setters, users of financial statements, and policy-makers interested in understanding and predicting macroeconomic activity.