Browsing by Subject "Accounting"

This paper examines whether deferred tax asset valuation allowance growth, as a measure of expected future performance, aggregated at the macroeconomy level, conveys information about future GDP growth. Using hand-collected tax footnote data from publicly traded firms over the 1993 to 2019 period, I find that quarterly aggregate valuation allowance growth is negatively associated with future GDP growth up to four quarters ahead. This relationship is incremental to existing accounting and macroeconomic GDP growth indicators, especially for forecast horizons longer than one quarter when other indicators are uninformative. Additionally, the findings suggest that aggregate valuation allowance growth provides unique information that cannot be obtained from other sources of management information, such as management forecasts, the allowance for doubtful accounts, banks’ loan loss provision, and goodwill impairment loss. The findings further indicate that the documented association of GDP growth and aggregate valuation allowance growth is driven by the corporate profit growth component of GDP growth. Collectively, the evidence indicates that aggregate valuation allowance growth provides incremental forward-looking information about GDP growth.

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 dissertation examines whether investors’ cognitive limitations can influence market prices and, if so, how this affects corporate decisions. In the first chapter, I investigate whether and how investors’ cognitive limitations influence market prices. I study this issue in the context of an accounting rule that enabled firms to avoid recognition of a compensation expense against reported earnings. I begin by noting that, because of the high cost associated to processing information, it is reasonable for an individual investor to make buy or sell decisions based on a few salient signals, such as front-page earnings. Following this premise, I argue, overstated earnings that lead investors to form over-optimistic views of a firm should result in the overvaluation of the firm’s stock under the presence of conditions that limit arbitrage.

In this chapter, I provide evidence in support that market prices did not incorporate this compensation expense, which did not lead to a reduction in reported earnings but needed to be disclosed in a footnote to the financial statements. Consistent with the argument that this result is driven by investors’ cognitive limitations, I find that firms’ use of employee option grants –the form of compensation in question– and abnormal return performance are associated to the composition of firms’ investor base. Specifically, I find that these two are positively related to the presence of individual investors. Furthermore, I find that these are positively correlated to the presence of institutional investors with a short-term investment horizon, or transient investors, according to the classification developed in Bushee (1998). These results challenge the widespread notion that prices incorporate all publicly available information not only in the absence of well-funded rational investors, or arbitrageurs, but also in their presence.

The results in Chapter 1, however, are subject to potential criticisms. Measuring market efficiency is a treacherous endeavor, being the “bad model problem” the chief challenge. As noted in Fama (1970), market efficiency can only be tested jointly with an equilibrium asset-pricing model characterizing normal returns. Therefore, the presence of abnormal return performance can be interpreted either as evidence against the hypothesis that market prices incorporate all publicly available information, the inappropriateness of the equilibrium pricing model under consideration, or a combination of these two. To mitigate concerns related to this issue, I propose three complementary methods to assess the informational efficiency of market prices: a calendar-time portfolio strategy, a regression analysis of abnormal returns, and an event-study around earnings announcements. Although the results of these analyses are all consistent with the behavioral view, it is not possible to fully reject the alternative that the “bad model problem” can at least partially explain the evidence here documented.

After showing that due to the favorable accounting treatment of option grants firms had a stock-price motivation to use this form of compensation, in Chapter 2, I examine whether this affects firms’ behavior. Specifically, I explore whether it shaped CEO option-based compensation during the period under study and provide evidence that sustains that this is the case.

These findings help explain the sudden shift away from executive option grants observed in 2002, and by doing so they contribute to fill in a void in the literature, which has so far not been able to determine the causes of this phenomenon (Frydman and Jenter, 2010). Existing studies have examined how the change in the accounting for options affected CEO compensation. Differently, in this chapter, I provide evidence that the most significant changes in firms’ CEO option-based compensation took place in 2002 –following the string of accounting and corporate scandals that rocked corporate America– well in advance of the mentioned change in the accounting rule. This finding is particularly important for studies that examine the effect that rules and laws have on corporate policies. As this dissertation demonstrates, in these studies, it is of first order importance to consider the events that lead to the implementation of any rule or law because the actions of lawmakers and rule-setters are rarely exogenous or unanticipated.

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.

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.

Equity crowdfunding (ECF) is a growing market in the U.S., where firms issue unregistered securities to the public over the Internet. This market is characterized as informationally opaque and dominated by unsophisticated retail investors. I provide the first evidence with respect to information intermediation in this market by examining the role of KingsCrowd (KC), the sole ECF information intermediary that provides analyst reports for a selected subset of Regulation Crowdfunding offerings. I find a 136% (298%) increase in average weekly web traffic to the KC report page (platform click-throughs) the week a report is released, consistent with investors acquiring reports and considering an investment on the offering platform. I find a one unit increase in the report recommendation favorableness is associated with a 17-19% increase in average daily investment pledges. Further, this effect is more heavily concentrated in the first three weeks following the release of a report, whereby a one unit increase in report favorableness is associated with a 22-27% increase in average daily investment pledges, and less thereafter. In terms of dollar magnitude, a one unit increase in report favorableness is associated with a $25,076 increase in investment pledges over the nine weeks following the report release. The collective evidence suggests information intermediation by KC in the form of recommendations are utilized by investors when making investment decisions in the opaque ECF market.

A central function of commodity futures markets is to help firms in the real sector insure against commodity price fluctuations. I examine how greater availability of information about commodity fundamentals (henceforth, information transparency) affects the capacity of these markets to accommodate firms’ hedging needs. Theory suggests that while greater availability of information can reduce adverse selection and increase traders’ willingness to absorb risk, it can also accelerate the realization of risk and hinder the transfer of risk via the markets. Using both cross-sectional variation in information transparency across 26 commodity markets over 20 years and information shocks induced by the launch of the Agricultural Market Information System (AMIS) and the SEC’s revision of firms’ 10-K oil and gas reserve disclosures, I document that information transparency (i) makes it costlier to use commodity futures to hedge commodity price risk and (ii) reduces traders’ propensity to trade futures. Evidence suggests that these findings are consistent with theories positing that information disclosure impairs risk-sharing opportunities. This study contributes new evidence on how information influences the efficient allocation of commodity price risk across the real and financial sectors.

In this study, I examine whether managers make self-serving attributions by internally (externally) attributing favorable (unfavorable) performance or demonstrate leadership by accepting blame and deflecting praise when communicating with analysts and investors. After validating the attribution measure I use in this paper, I find that managers tend to attribute favorable performance to internal factors and unfavorable performance to external factors, consistent with self-serving attribution being the dominant force. I also find that investors react negatively to mangers' internal attributions. Further analysis reveals that more internal attributions are associated with lower earnings persistence.

This thesis includes three papers that consider the effects of IFRS adoption on accounting comparability in the European Union (EU). In the first paper, I use actual financial statement data to create a measure of distance (my accounting measure of comparability) from local GAAP to IFRS prior to the adoption of IFRS in 2005. Specifically, I identify 27 accounting items and I examine recognition and disclosure practices of 296 firms listed on Euronext before and after 2005. In contrast to prior work, which conducted such analyses at a de jure level, this de facto level analysis of accounting differences provides evidence about firms' actual reporting choices in their annual reports. This analysis is particularly important when accounting standards (both local GAAPs and IFRS) allow a variety of methods for recognition and disclosure.

My tests suggest that the change in comparability due to the adoption of IFRS is not uniform. In jurisdictions where local GAAP was more distant from IFRS the increase in comparability was larger than the increase in comparability that occurred in jurisdictions where local GAAP was closer to IFRS prior to IFRS adoption. This result is important because it provides a refined measure that can be used to appraise the actual IFRS effect on various outcome variables.

In the second study I predict that, if IFRS adoption has led to positive market effects, there would be larger IFRS adoption effects among firms domiciled in countries where local GAAP was further from IFRS prior to 2005 than among firms domiciled in countries where local GAAP was closer to IFRS prior to 2005. I exploit my measure of distance (developed in the first paper) to examine whether firms domiciled in Euronext countries where the distance between local GAAP and IFRS was greater prior to IFRS adoption exhibited larger improvements in the usefulness of their earnings announcements. I measure usefulness as the short-term price and volume reactions to earnings announcements. My analysis proceeds in two steps. First, I confirm an increase in absolute returns and volume reactions, similar to observations in prior research (e.g., Landsman et al., 2011). Second, and more importantly, I find that these increased reactions are not due to IFRS adoption per se, but rather to the inclusion of concurrent information in firms' press releases, most prominently statement of cash flows information. A potential explanation for this result is the regulators' recommendation to expand disclosures in firms' press releases in 2005. I cannot rule out, however, that IFRS had an effect, because the greater consistency in rules and format for the statement of cash flows may have led to an increase in the disclosure of cash flow information in firms' press releases.

In my third study I expand my sample to all European Union countries and I investigate how cross-border earnings information transfer (my market measure of comparability) changed after IFRS adoption. I explore this effect through two intermediate and complementary effects: accounting uniformity and reporting quality. First, I examine whether an increase in accounting uniformity has led to a greater transfer of market information. Using a sample of firms in the European Union 2001 - 2010, I find support for the presence of a positive change in earnings information transfer after IFRS adoption. Second, I exploit differences across countries in accounting distance and legal enforcement to consider a separate (but related) effect of IFRS on reporting quality. I measure reporting quality as value relevance (the explanatory power of the two summary accounting variables, earnings and book value of equity, in price regressions). I find that IFRS had a positive effect on reporting quality, but only in countries that exhibited strong enforcement and large accounting distance prior to IFRS adoption. In the final test, I partition the countries into groups according to the change in reporting quality after IFRS adoption. I fail to find significant differences in comparability across groupings: the increase in comparability in countries that experienced a positive change in reporting quality is not distinguishable from the change in comparability occurred in countries that did not exhibit an increase in reporting quality around IFRS adoption.

This paper examines how agents’ response to macroeconomic uncertainty affects firms’ revenues, expenses, and profitability. Consistent with consumers reducing purchases and managers cutting costs, I find that increases in macroeconomic uncertainty lead to lower revenues and expenses. The net effect on profitability, however, is positive as the reduction in expenses exceeds the fall in revenues. The results last up to six quarters, vary predictably with countries’ institutional environment, and hold under instrumental variable estimation employing exogenous variation in macroeconomic uncertainty arising from natural disasters, political unrest, revolutions, and terrorist attacks.

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 analyzes a manager's optimal ex-ante reporting system using a Bayesian persuasion approach (Kamenica and Gentzkow (2011)) in a setting where investors affect cash flows through their decision to finance the firm's investment opportunities, possibly assisted by the costly acquisition of additional information (inspection). I examine how the informativeness and the bias of the optimal system are determined by investors' inspection cost, the degree of incentive alignment between the manager and the investor, and the prior belief that the project is profitable. I find that a mis-aligned manager's system is informative

only when the market prior is pessimistic and is always positively biased; this bias decreases as investors' inspection cost decreases. In contrast, a well-aligned manager's system is fully revealing when investors' inspection cost is high, and is counter-cyclical to the market belief when the inspection cost is low: It is positively (negatively) biased when the market belief is pessimistic (optimistic). Furthermore, I explore the extent to which the results generalize to a case with managerial manipulation and discuss the implications for investment efficiency. Overall, the analysis describes the complex interactions among determinants of firm disclosures and governance, and offers explanations for the mixed empirical results in this area.

Earnings management could be motivated by either managerial opportunism or efficient contracting. To discriminate between these motivations, I use a measure of product market competition that analytical research predicts will discipline managers and better align their interests with those of shareholders. Thus, if earnings management reflects managerial opportunism, then an increase in competition will decrease earnings management; and if it reflects efficient contracting, then an increase in competition will increase earnings management. Consistent with earnings management indicating managerial opportunism, I show that an increase in competition decreases real earnings management in the form of overproduction to avoid reporting negative earnings or a negative change in earnings.

Reconciliation language, however well-intentioned, is neither innocent nor innocuous. In this dissertation, I argue that reconciliation is part of a grammar of whiteness. This word, particularly when spoken and enacted by White people, works violence upon Black life. I argue that reconciliation grammar is a performance of whiteness that banks on racial difference properly managed to assuage White anxiety of otherness. This performance is explored in three acts. The first act concerns the theo-economics of reconciliation accounting and its afterlife in Luca Pacioli. The second act concerns the theo-patriarchy of Lethal Weapon fantasies of racial reconciliation that is real if men are really men, and if the explosions of violence upon muscular White male flesh look real enough. The final act concerns the theo-technology of the human found in White feminist theological writings of Letty Russell, revealing a reconciling humanism that renders difference an “ism” to be overcome by Jesus’ singular humanity. Each of these acts works violence upon Black life in different, and yet intersecting ways. Each of these acts performs reconciliation in such a way that inequitable power relationships result. Reckoning with reconciliation entails a reckoning not only with the words White people use, but also with the ways those words have a material effect on relationships, imaginations, and bodies. I show how reconciliation as a grammar of whiteness has been performed on Black life to account for it as fungible and expendable, to profit from a Black Madonna attending a manly White hero Jesus, and to render the Black woman as plastic material from which any manner of White theologies and ontologies might be built. I then point toward the excess and otherwise life that can never fully be consumed by reconciliation grammar; I argue for the liberative possibilities of life unreconciled.

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.

This paper studies firms' optimal qualitative disclosure about hard-to-quantify risk exposure to affect investors' information acquisition under the feedback effect channel. Based on a model with unknown payoff distribution, disclosure softness, and ambiguity aversion, I find that firms with lower risk exposure disclose more precisely. Particularly, low (medium) exposure firms provide perfect (partially informative) risk disclosures, whereas high exposure firms always disclose vaguely. In addition, the softness of risk disclosure enables firms to induce different risk perceptions among informed and uninformed investors with one disclosure, which gives firms the flexibility to separately influence the beliefs of the two groups of investors. Finally, I find that lower cost of information acquisition may improve economic efficiency at the expense of risk disclosure quality.