Earnings Measures Research Articles

Direct Evidence on the Informational Properties of Earnings in Loan Contracts

Using a sample of firms that disclose the realizations of earnings used for determining covenant compliance in loan contracts, we provide direct evidence on the informational properties of earnings used in the performance covenants included in debt contracts. We find that the earnings measure used in performance covenants does not exhibit asymmetric loss timeliness and has significantly greater cash flow predictive ability than GAAP measures of earnings. We suggest that these results reflect the idea that contracting parties design accounting rules for performance covenants to enhance their efficacy as “tripwires.”

An Empirical Examination of the Information Content of Ohlson and Aierrs Modified Cash Flows

Ohlson and Aier (2009) propose a model of modified cash accounting (MCA) for analyzing and evaluating a firm’s cash flows. They suggest that MCA cash earnings provide a better measure of earnings than GAAP’s measure, and that the MCA bottom line is more informative because it identifies earnings due to operations on a cash- and approximate cash-equivalent basis. However, there is no empirical test for the information content of MCA cash earnings proposed by Ohlson and Aier (2009). This study empirically examines the incremental information content of MCA cash earnings compared with cash flow from operations (CFO) and GAAP earnings per share (EPS) using stock returns as the benchmark for firms’ performance during the 2001–2011 period. We find that MCA cash earnings provide incremental information content beyond CFO and EPS.

Labor Reallocation, Employment, and Earnings: Vector Autoregression Evidence

An increasing number of data sources have measured the components of reallocation of jobs across employers and workers across jobs. Whether and how job reallocation across employers and excess worker “churn” affect other measures of the health of the U.S. economy remains an open question. In this paper, we present time series evidence for the U.S. 1993-2013 and consider the relationship between labor reallocation, employment, and earnings using a vector autoregression (VAR) framework. We find that labor market churn Granger-causes higher employment and lower unemployment, while job destruction does the opposite. We also find more limited evidence that churn and job destruction predict increased earnings, although this is not found for all earnings measures.

Did partnership in Ireland deliver for all workers? Unions and earnings

PurposeAfter 20 years of social partnership in Ireland the purpose of this paper is to use a national survey of firms and employees to examine the extent of the wage gap between union and non-union workers in the private sector and compare the degree of wage inequality in union and non-union firms and among union and non-union employees.Design/methodology/approachThe analysis in the paper is based on the National Employment Survey carried out by the Central Statistics Office in October 2008. Approximately 9,000 enterprises were sampled and almost 5,000 enterprises responded – a response rate of over 50 per cent while almost 100,000 employees were sampled and 65,535 completed the questionnaire – a response rate of over 60 per cent. In total 22 per cent (14,619) of respondents worked in the public sector and 78 per cent (50,916) in the private sector.FindingsIt appears that over time the earnings premium enjoyed by unionised workers has declined. This may reflect a long term decline in union bargaining power in the private sector as union density levels have declined. Even so unionised employees enjoy a wage premium over non-union employees and collective coverage appears to reduce levels of income inequality. However, the overall union wage gap is relatively modest – being generally below 10 per cent possibly due to the harmonising effects associated with the period of social partnership supported by government trade unions and employers.Research limitations/implicationsThe cross-sectional nature of the data means that the factors associated with variations in employee earnings over time cannot be identified.Practical implicationsThere is substantial evidence of a considerable spill-over effect as nationally agreed rates of pay percolated from the union to the non-union sector. It may also be the case that social partnership has acted to reduce wage inequality in non-union as well as union establishments. It appears that partnership type arrangements have the capacity to deliver for all workers in the private sector.Originality/valueA unique aspect of the national survey data used here is the availability of employer/employee matched data from a robust national level survey with measures of union membership, earnings, individual and employment characteristics.

What is Economic Income for Corporate Taxation?

ABSTRACT The economic income concept is relevant to numerous corporate tax issues, yet it is not clearly defined. It does not equate to taxable income or financial accounting retained earnings. The concept is required for earnings and profits, accumulated earnings and personal holding company penalty taxes, alternative minimum tax, and adjusted current earnings adjustment. However, it is defined differently under each provision. This complexity is inefficient. This article offers suggestions to improve tax law as it relates to economic income. A uniformly defined measure of economic income, earnings and profits, would be the starting point for all related tax measures, with appropriate adjustments that are consistent with the intent of tax measures. The resulting computation should be codified and provide comprehensive guidance for analysis in one source. Thus, earnings and profits becomes the platform for other provisions that require an economic income proxy, with necessary adjustments to meet specific policy objectives.

Effect of Private Equity on Performance of IndianCompanies: A Comparative Study of Pre- andPost-Financial Crisis

Private equity investors provide a significant amount of funding, are actively involved in the company, and help earn high returns by taking risks. India has been open to private equity investment since 1998. During the financial crisis era, when many companies shifted their focus toward private equity financing, many investments were made in India during the period 2007–2008. This article studies the earnings quality of private equity-backed firms and non-private equity-backed firms. Measures of earnings are taken as a persistence effect of accruals and cash flows, the dataset has been arranged in a panel data form for a time period of 10 years, and the Heckman [1979] correction procedure has been used to control endogeneity and sample selection bias.

Measurement of Earnings Quality: A comparative study on PE Backed Firms and Non PE backed firms in India.

Private Equity investors provide lot of funding, are actively involved in the company and help earn high returns by taking large amount of risk. India has been open to Private Equity investment since 1998. During the financial crisis era, lots of companies had shifted their focus towards Private Equity Financing and lots of investments where done in India during 2007-2008. The paper studies about the Earnings quality of PE backed firms and non PE backed firms. The measures of earnings have been taken as persistence effect of accruals and cash flows. The dataset has been arranged in a Panel data form for a time period of 10 years and Heckman(1979) correction procedure has been used to control endogenity and sample selection bias. Keywords: Private Equity, Earnings, Endogenity, Heckman

Moving Towards Estimating Sons' Lifetime Intergenerational Economic Mobility in the UK

AbstractEstimates of intergenerational economic mobility that use point in time measures of income and earnings suffer from lifecycle and attenuation bias. They also suffer from sample selection issues and further bias driven by spells out of work. We consider these issues together for UK data, the National Child Development Study and British Cohort Study, for the first time. When all three biases are considered, our best estimate of lifetime intergenerational economic persistence in the UK is 0.43 for children born in 1970. Whilst we argue that this is the best available estimate to date, we discuss why there is good reason to believe that this is still a lower bound, owing to residual attenuation bias.

Employee Stock Options with Performance Conditions: Do Commonly Used Valuation Heuristics Work?

Valuation heuristics are widely used in industry practice, policy documents, and several academic studies to value traditional time vesting option plans. This paper analyzes to what extent such heuristics also qualify for valuing performance vesting plans. To this end, we examine performance conditions tied to the underlying stock, the stock’s performance relative to a stock index and an earnings measure and derive optimal option exercises in a simulation framework. We investigate the valuation differences between the optimal exercise model, the commonly used adjusted maturity approximation, and the approach proposed by Hull and White (2004). For optimal exercise behavior, the changes in option costs due to the performance conditions we investigate are generally low. Only when the options represent a large fraction of the employee’s wealth do the performance conditions prevent value-diminishing early exercises and thus increase the option cost to the firm. The differences between the optimal and approximated option values are overall smaller with the performance conditions than without them. This can be mainly attributed to the fact that the performance conditions restrict the possible option exercise states and thus limit the effect of the misspecified true exercise boundary within the approximations.

Pengaruh Perubahan Dividen Terhadap Profitabilitas Perusahaan Pada Masa Yang Aakan Datang (Future Profitability)

<em>The research investigates the incremental information content of dividend changes about future profitability. We regress three of measurement of earnings (earnings level, earnings changes and abnormal earnings) to dividend changes and a number of control variables. By using 87 samples (420 firm years) of firm at Jakarta Stock Exchange over 1997-2003, We find that dividend changes provide information about the earnings insubsequent years, incremental to market and accounting data. The paper also documents that dividend changes are positively related to earnings changes for merely four year ahead. In detail examining, We find that dividend increase convey must new information about earnings changes and abnormal earnings for three year ahead than dividend decrease.</em>

GLOBAL AND DISAGGREGATED MEASURES OF EARNINGS MOBILITY: EVIDENCE FROM FIVE EUROPEAN COUNTRIES

ABSTRACTThis paper offers the first application of the local approximation method pioneered by Schluter and Trede (2003) for the Shorrocks mobility indices across the earnings distribution for a range of European Countries covering the main European social models: Denmark, Germany, Spain, the UK and Italy in the pre‐accession EU (1994‐2001). This insightful approach allows us to offer a global and disaggregate analysis of mobility as proportionate change in inequality and hence provide the reader with a full set of information to make his/her own judgment about the extent of mobility and country ranking. Specifically, we investigate the degree to which mobility is driven by low or high earners and how this picture changes across three different earnings measures: full‐time full‐year working, adding part‐time working and then part‐year working.Our results draw out some general key facts. First of all the vast bulk of the measured mobility occurs in the tails especially the lower tail with at least half of the index driven by mobility in the bottom earning quintile. Second, in the top 20 percent of the distribution there are few movements of earnings that effect the level of permanent inequality except in Denmark. Third, no country has a clear dominance for mobility across the full earnings distribution but Denmark differs from the other countries with clearly greater mobility in the middle and at the top. Finally, we find that with the exception of Denmark and Italy, mobility does not lead to clear convergence to the mean but rather to points around 0.7‐0.8 and 1.5 to 2 times the mean.

The Economic Incidence of Social Security Contributions: A Discontinuity Approach with Linked Employer-Employee Data

We estimate economic incidence of social security contributions (SSC) on the basis of cross-sectional earnings distributions. The approach exploits discontinuities in earnings distributions at kinks in the budget set which are informative about tax incidence. Contrary to most research on SSC incidence, it does not rely on policy reforms, panel data, or hours information. When the location of kinks does not change significantly, estimates represent equilibrium incidence and are less affected by short-run adjustment frictions than results based on policy reforms. We refine the framework proposed by Alvaredo and Saez (2007), discuss identifying assumptions and related problems in empirical applications. We also suggest parametric and non- parametric estimators. The approach is applied to earnings caps of SSC in Germany where the marginal SSC rate drops to zero. The linked employer-employee data used provide precise measures of gross and net earnings. Utilizing two separate earnings distributions improves identification in the presence of measurement error. We find substantial negative discontinuities at most earnings caps of SSC in the distribution of observed net earnings. Together with smooth gross earnings distributions around the caps this provides consistent empirical evidence that legal and economic incidence of SSC coincide.

Social Security Retirement Income Replacement Rates

One of the main retirement income concerns is adequacy, which is generally measured as the percentage of preretirement income replaced by the retirement benefit. For defined-benefit pension plans the replacement rate or ratio is measured against some measure of final income. For Social Security (more accurately OASDI), however, the Social Security Administration uses a complex measure of career-average earnings. Since Social Security is the main, and often the only, source of retirement income for many millions of Americans, the question of adequacy is paramount. The benefit formula is heavily skewed in favor of lifetime low-income earners. In addition, Supplemental Security Income (SSI) and state augmentations add to the retirement income of low-income claimants. The combination of OASDI and SSI benefits result in retirement income that, while not overly generous, is adequate. This article examines the origins and development of OASDI and SSI with a focus on benefit adequacy.

The Dynamics of Value Comovement Across Global Equity Markets

The ratio between share price and current earnings per share, the Price Earning (PE) ratio, is widely considered to be an effective gauge of under/overvaluation of a corporation’s stock. Arguably, a more reliable indicator, the Cyclically-Adjusted Price Earning ratio or CAPE, can be obtained by replacing current earnings with a measure of permanent earnings i.e. the profits that a corporation is able to earn, on average, over the medium to long run. In this study, we aim to understand the cross-sectional aspects of the dynamics of the valuation metrics across global stock markets including both developed and emerging markets. We use a time varying DCC model to exploit the dynamics in correlations, by introducing the notion of value spread between CAPE and the respective Market Index from 2002 to 2014 for 34 countries. Value spread is statistically significant during the 2008 crisis for asset allocation. The signal can be utilized for better asset allocation as it allows one to interpret the common movements in the stock market for under/overvaluation trends. These estimates clearly indicate periods of misvaluation in our sample. Furthermore, our simulations suggest that the model can provide early warning signs for asset mispricing in real time on a global scale and formation of asset bubbles.

The use of management forecasts to dampen analysts' expectations by Chinese listed firms

This paper studies the use of management earnings forecasts (MEF) to dampen analysts' expectations, i.e. expectation management, by Chinese listed companies. We reveal several important findings: Firstly, information asymmetry is positively associated with the use of MEF to dampen analysts' expectations. State control has been found to moderate this relationship. Secondly, dampening analysts' expectations using MEF leads to negative stock return reactions and downward analysts' forecast revisions. Thirdly, the effectiveness of “pre-empting bad news through MEF” appears mixed and dependent on the information content of MEF and measures of actual earnings surprises. Finally, firms that disclose MEF are found to engage in more earnings management to meet the forecasts than firms that do not.

Intertemporal Variation in the News Components of Aggregate Earnings and How it Affects the Aggregate Earnings-Return Relation

Prior research documents a negative contemporaneous relation between earnings changes and stock returns at the aggregate level. We find that the aggregate earnings-returns relation turns significantly positive in recent years (1992-2013). As explanations for that shift, we test over-time shifts in the properties of firm-level earnings and the magnitude of inflation rates. To do so, we use the Bureau of Economic Analysis’ (BEA) corporate profits series as an alternative measure of aggregate earnings, because it is unaffected by changes in GAAP measurement rules and is adjusted for changes in price levels. While changes in both aggregate GAAP earnings and the BEA’s corporate profits series exhibit a significant negative (positive) relation with aggregate returns in the 1970-1991 (1992-2013) period, changes in aggregate GAAP earnings have incremental explanatory power for aggregate returns beyond the BEA’s corporate profits measure in the 1992-2013 period. Additional analysis reveals that such incremental explanatory power stems from GAAP earnings’ inclusion of non-operating items. We also find that a shift over time in inflation, as well as in the proportion of loss-making firms, contribute to inter-temporal variation in the aggregate earnings-returns relation. The effect of changes in the properties of GAAP earnings and inflation rates over time on the aggregate earnings-returns relation is new to the literature.

Earnings management and performance in family-controlled firms

Purpose The purpose of this paper is to introduce an earnings management dimension to compute pre-manipulated accounting performance (free of discretionary accruals) to determine whether family-controlled firms perform better than non-family-controlled firms. Design/methodology/approach The authors used Jones’ model (1991) to obtain a pre-manipulated performance measure for a sample of Chilean firms. The authors then regressed the pre-manipulated measures of accounting performance as dependent variables against the family nature of the largest shareholder using the Blundell and Bond generalized method of moments estimator. Findings The authors found that the pre-manipulated performance of family-controlled firms is superior to that of non-family-controlled firms. The authors also show that the presence of institutional investors in the firm’s ownership structure has a positive influence on the performance of family companies. The results suggest that earnings management behavior is not sufficient to explain the better performance of family-controlled firms that has been reported in the literature. Originality/value The authors provide new evidence regarding the real superior performance of family business. These results provide some degree of confidence to investors since family firms provide good quality earnings measures of financial performance.

Earnings news, expected earnings, and aggregate stock returns

In contrast to firm-level relations, researchers have found that aggregate earnings changes and aggregate stock returns are negatively related. In this paper, we construct new measures of aggregate earnings news based on revisions in analyst forecasts. The findings suggest aggregate earnings news is positively related to contemporaneous stock returns. The results also show that aggregate stock returns are positively related to unexpected aggregate forecast errors, and negatively associated with expected aggregate earnings growth. Taken together, these findings suggest the negative relation between aggregate earnings changes and aggregate contemporaneous stock returns results from the expected component of aggregate earnings, rather than aggregate earnings surprises.

Tattoos, Employment, and Labor Market Earnings: Is There a Link in the Ink?

The popularity of tattooing has increased substantially in recent years, particularly among adolescents and young adults. Moreover, tattooed images are permanent unless the individual opts for expensive, time consuming, and painful removal procedures. Given the increasing popularity of tattooing, and the permanent nature of this action, it is of interest to know whether tattooed workers are more or less likely to be employed and, conditional on employment, if they receive wages that are different from the wages of their non-tattooed peers. To investigate these questions, we analyze two large data sets—from the United States and Australia—with measures of tattoo status, employment, earnings, and other pertinent variables. Regardless of country, gender, specific measures, or estimation technique, the results consistently show that having a tattoo is negatively and significantly related to employment and earnings in bivariate analyses, but the estimates become smaller and nonsignificant after controlling for human capital, occupation, behavioral choices, lifestyle factors, and other individual characteristics related to labor market outcomes. Various robustness checks confirm the stability of the core findings. These results suggest that, once differences in personal characteristics are taken into account, tattooed and non-tattooed workers are treated similarly in the labor market. We offer suggestions for improving future surveys to enable a better understanding of the relationships between tattooed workers and their labor market outcomes.

A Comparative Analysis of Accounting-Based Valuation Models

We empirically compare the reliability of the dividend (DIV) model, the residual income valuation (CT, GLS) model, and the abnormal earnings growth (OJ) model. We find that valuation estimates from the OJ model are generally more reliable than those from the other three models, because the residual income valuation model anchored by book value gets off to a poor start when compared with the OJ model led by capitalized next-year earnings. We adopt a 34-year sample covering from 1985 to 2013 to compare the reliability of valuation estimates via their means of absolute pricing errors ( MAPE) and corresponding t statistics. We further use the switching regression of Barrios and Blanco to show that the average probability of OJ valuation estimates is greater in explaining stock prices than the DIV, CT, and GLS models. In addition, our finding that the OJ model yields more reliable estimates is robust to analysts-based and model-based earnings measures.