Firm Earnings Research Articles

Client Relationships, Analyst Coverage, and Earnings Management

SYNOPSIS Financial analysts have two important roles in the capital market. In addition to their informational role, which has been widely studied, they play an important monitoring role. Similar to their informational role, their monitoring role might be negatively affected when they face conflicts of interest. Using a sample of Chinese firms, we show that if analysts are under pressure (i.e., housed in a brokerage firm where specific mutual funds hold large positions in a company covered by the analyst), their role in lowering the firm earnings management activities is significantly compromised. We find that the closer the business relationship between the mutual fund and the brokerage firm, the greater the firm earnings management. Our findings caution investors and regulators to heed the impact of client pressure on analysts' roles in financial markets.

The Role of Smog in Firm Valuation

ABSTRACT This paper examines the influence of smog on firm earnings and information content using the data of Chinese A share listed firms and the air quality monitoring data released by the China National Environmental Monitoring Center from 2013 to 2017. The empirical results show that smog will not only negatively influence the earnings of local firms, but also result in a decrease in the information content of their earnings for market valuations. This paper further tests the role of firm size in the influence mechanism of smog on earnings and information content. The results reveal the significant moderating effect of firm size in the influence mechanism, which is reflected by large-scale firms being more likely to suffer earnings decrease and less likely to suffer earnings information content decrease due to smog, while small-scale firms tend to experience the opposite.

Foreign- and domestic firm ownership and its impact on wages. Evidence from Poland

This study concentrates on the effect of foreign ownership of companies on worker wage distribution. Using an innovative methodological approach that combines the Oaxaca–Blinder decomposition and the modified DiNardo et al. reweighting approach, we estimate the wage gap between domestic-owned and foreign-owned firms. The study confirms that firm ownership (domestic or foreign) influences the wage distribution of workers, as a worker employed in a foreign-owned firm earns, on average, 5 percent more than a matched worker in a domestic-owned firm with similar characteristics. We link that gap with an origin of foreign capital. This analysis demonstrates that the origin of capital has an impact on wage distribution in the firm and may affect wages in the whole section.

Is Media Really the Great Information Equalizer? The Effects of WSJ Coverage of Firm Earnings Announcements on Peer Information Asymmetry in Information Transfers

Prior research generally finds that the financial media levels the playing field among investors by reducing information acquisition costs for unsophisticated investors. In the setting of information transfers, I demonstrate that when media coverage is likely to reduce the industry information acquisition costs for both sophisticated and unsophisticated investors, their information gap may be widened. Specifically, I find that same-day Wall Street Journal (WSJ) coverage of a focal firm’s earnings announcement (EA) exacerbates information asymmetry of its industry peers around the focal firm’s EA day. However, when the WSJ article is published one day after the EA, there is no change in peer information asymmetry on both the EA day and the day after. Additional analysis shows that the effects of same-day WSJ coverage on peer information asymmetry are stronger when it is more likely to reduce peer investors’ industry information acquisition costs and when inferring the implications of the focal firm EA for the peer entails higher information integration costs. These findings suggest that media coverage may increase information asymmetry among investors despite its importance in information dissemination.

Manager Sentiment Bias and Stock Returns: Evidence from China

ABSTRACT Using textual analysis of Chinese listed firms from 2004 to 2017, we examine the role that managers’ sentiment plays in financial disclosures and its impact on firms’ future stock returns. We distinguish manager sentiment as either signal or noise according to its consistency with firm earnings. We find that good signal sentiment positively impacts stock returns, whereas bad signal sentiment and noisy sentiment that reflects overconfidence negatively impact stock returns. Further analysis shows that external supervision, internal control, and managers’ expertise contribute to improving the information quality of both signal and noisy sentiments, and the enactment of earnings forecast policy helps strengthen the signaling impact of manager sentiment.

All Losses Are Not Alike: Real versus Accounting-Driven Reported Losses

We examine the value relevance of accounting-driven losses that result from the immediate expensing of firms’ internally-generated intangible investments vs. losses occurring irrespective of intangible investments. Contrary to the long-held view that losses are irrelevant for valuation, we find that once the accounting bias of intangibles-expensing is undone, earnings of firms reporting intangibles-related losses are as informative as earnings of profitable firms. Contrary to the view that persistent losses decrease earnings relevance, our evidence shows no decrease in the relevance of earnings for firms reporting persistent intangibles-related losses. We also find that firms reporting intangibles-related losses outperform other loss firms and even profitable firms in value creation from technological innovation and human capital. Our evidence further shows that firms reporting intangibles-related losses have stronger future performance than other firms. Taken together, the results of this study demonstrate the fundamental differences between losses driven by the immediate expensing of internally-generated intangible investments and losses reflecting genuine business performance shortfalls. Standard accounting reports, however, do not properly reflect these differences and their implications.

It is about beating the competitors - the usefulness of accounting information in reflecting competitive advantages

This paper examines how a firm's long-term earnings rankings within the industry convey valuable information about its competitive advantages. Earnings rankings are isolated from industry and market-wide factors, therefore, contain firm-specific information that reflects the rareness of the firm's resources and strategies. A higher ranking also indicates more effective value creation and difficulty in imitation, which translates into more sustainable future performance. Since a firm's competitive advantages are defined by rareness, imitability, value, and sustainability, earnings rankings provide a numeric summary of competitive advantages. We decile rank a firm's earnings within the industry and conduct a principal component analysis to measure competitive advantages. The findings confirm a significant positive association between earnings rankings and competitive advantages. In particular, long-term earnings rankings, measured by the 5-year moving averages, should be the most informative. Our results shed light on the usefulness of accounting numbers in implementing strategic management based on competitive advantages.

Does industry expertise at engagement partner and audit firm level matter in emerging market? Evidence from Indonesia

This study investigates the association of industry specialization at the engagement partner level and audit firm level with aggressive earnings management and modified audit opinion. The study employs a sample of 570 firm-year observations of manufacturing industries on the Indonesia Stock Exchange from 2014 to 2018 using a binary logistic regression model. First, this study finds no evidence of a relationship between industry specialization at the engagement partner level and audit firm level with aggressive discretionary accruals. Furthermore, the author finds evidence of a positive association between industry specialization at the audit firm level and aggressive real earnings management due to high audit quality. Finally, the study finds evidence that industry specialization at audit firm level is likely to issue modified audit opinion. This study contributes to the study of industry specialization at the engagement partner level and audit firm level, which is rarely performed in Indonesia. Policy makers and capital market players might learn some lessons from the audit quality of external auditors with industry specialists as the gatekeeper of the capital market. Moreover, this study has provided a valuable perspective to practitioners, researchers, and policy makers in other emerging markets regarding the quality of industry specialization at the partner and audit firm level.

Impact of Capital Structure Decision on Firm Performance and Stock Return Pre during and Post Crisis: An Evidence from Developed and Developing Country

The aim of this investigation is to determine how the financial crisis in 2008 influenced Capital Structure (CS) and firm performance relationship in developed (United State of America) and developing (Pakistan) countries, further how the company’s CS affects stock return and EPS. The study sample consists of 130 firms listed on Pakistan Stock Exchange and 26 leading USA non-financial firms listed on New York Stock exchange (NYSE). To find answers to the questions of this investigation this research employed generalized method of moments (GMM) regression analysis. We split our sample period into two phases i.e. pre-crises (2004-2008) and post-crises (2009-2013). The sample of this study comprise of top US nonfinancial firms listed on the NYSE and Pakistani firms listed on a Pakistan stock exchange. The results indicate that CS has significant association with firm performance and earnings per share. However, the CS relationship with stock return is not significant in Pakistan after the crises. Specifically, an increase of one unit in debts to equity ratio lead to an increase of 0.42 in ROA before crises and the result is highly significant at level 1%, however after crises the increase is 0.026 but insignificant. In addition, the relation of ROA with earning per share and stock return is also highly significant and positively post crises. On the other side, the relationship of EPS and stock return is positive but not significant after crises. Moreover, SR and EPS are related negatively with each other however the result is insignificant before crises, while after crises the result is positive and significant. For US firms, an increase of one unit in debts to equity ratio is linked with a rise of 0.019 in ROA before crises, and .0087 after crises. The results show significant level of 5% in both period of time in USA. If firms increase one percentage point of their leverage, their EPS and SR will increase 0.23 and 0.22 respectively before crisis. Whereas, after crisis EPS and SR increase is .008 and .009 with positive significant level 10% and 5% respectively. Furthermore, the relationship between CS and EPS as well as SR is also positive and significant pre-crises however post crises in case of SR the result is insignificant. The increase in EPS and SR is 0.42 and 0.41 before crises, and after crises the increase is 0.04 and 0.001 respectively. After crises EPS is significant at the 5% level; however SR have insignificant relation after crises in Pakistan. Moreover, EPS is positively and insignificantly related with ROA and SR before crises, but the results after crises is highly significant and positive. A one unit change in SR will increase the value of ROA by 0.096 before crises. Whereas, after crisis the value of ROA rises by 0.113. Results more over shows that EPS value increases by 10% if SR changes by one percent before crisis period. Whereas, after crises the increase is 8%. Keywords: Capital Structure, Financial Crisis, Firm’s Performance, Debt to Equity Ratio DOI: 10.7176/RJFA/12-2-06 Publication date: January 31 st 2021

Uncovering the Hidden Effort Problem

We use machine learning to analyze minute-by-minute Bloomberg online status data and study how the effort provision of top executives in public corporations affects firm value. While executives likely spend most of their time doing other activities, Bloomberg usage data allows us to characterize their work habits. We document a positive effect of effort on unexpected earnings, cumulative abnormal returns following firm earnings announcements, and credit default swap spreads. We form long-short, calendar-time, effort portfolios and show that they earn significant average daily returns. Finally, we revisit several agency issues that have received attention in the prior academic literature on executive compensation. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Natural disasters and analysts' earnings forecasts

The effects of natural disasters on capital markets have been investigated by limited evidence even though these calamities bring considerable damages or loss of life. To fill this gap, we investigate the impacts of natural disasters, particularly earthquakes, on security analysts' earnings forecasts for affected firms in China. We obtain three key findings. First, analysts' optimism significantly decreases for firms located in neighborhood areas. Second, earthquakes do not significantly affect firm earnings and stock returns, thereby indicating that post-earthquake analyst pessimism is not based on rational judgment. Third, media attention promotes irrational pessimism among analysts, and post-earthquake pessimism is a result of heuristics bias attributable to psychological shocks. However, analysts correct the bias after initial irrational forecasts. Taken together, our findings contribute to the broader psychology and economics literature on the effects of natural disasters on analyst forecasts.

The effect of Earnings Co-movement on Quarterly Earnings Response Coefficient

The effect of Earnings Co-movement on Quarterly Earnings Response Coefficient

Moderating effect of managerial ownership on accounting conservatism and quality of earnings of listed industrial firms in Nigeria

This study adopts a positivist view to the examined moderating effect of managerial ownership, accounting conservatism, and quality of earnings of listed industrial firms in Nigeria from 2009 to 2018. The study employed ex-post facto research design and panel multiple regression for the analysis. The population of the study comprised of 13 listed industrial firms in Nigeria as at 31st December 2018. Accounting conservatism was measured using Beaver and Ryan's (2000) model while the quality of earnings as measured by the modified Jones model. Managerial ownership was measured by the proportion of managerial ownership in the firm. It was discovered that an increase in accounting conservatism of industrial firms will lead to a decrease in quality of earnings, but moderated accounting conservatism has no statistically significant effect on the quality of earnings of industrial firms in Nigeria. The study recommends that shareholders of industrial firms in Nigeria should encourage accounting conservatism because it will reduce earnings quality practice by the management thereby bringing out the true picture of the financial activities of the organization. This will encourage more investment in the firm by potential and existing shareholders. Keywords: Accounting conservatism, Corporate governance, Financial reporting, Managerial ownership, Quality of earnings

Accounting information in innovative small cap firms: evidence from London’s Alternative Investment Market

We posit that investors and social media users place more weight on cash flows than on earnings for innovative small cap firms and that, in turn, innovative small cap firms (i) manage cash flows more than earnings, and (ii) disclose more cash flow than earnings information on social media. Using a matched sample of innovative and non-innovative small cap firms listed on the London’s Alternative Investment Market (AIM), we document that the value relevance of cash flows (earnings) is higher (lower) for innovative compared to non-innovative small cap firms. Using Twitter to examine the demand of accounting performance measures, we find that Twitter users more frequently retweet and include as ‘Favorite’ information about cash flows, than information about earnings for innovative small cap firms. We then show that innovative small cap firms engage less intensively in earnings management and exhibit higher abnormal cash flows compared to non-innovative small cap firms. Innovative small cap firms emphasise more information in their tweets about cash flows and less about earnings compared to non-innovative small cap firms. Cross-sectional tests demonstrate that seasoned equity offerings provide additional incentives to engage in increasing abnormal cash flow management activities.

Currency fluctuations and the post-earnings announcement drift

This study examines whether currency fluctuations can partially explain the post-earnings announcement drift (PEAD). First, after sorting firms based on standardized unexpected earnings (SUE), we document that firms in high (low) SUE-sorted portfolios respond more (less) favorably to contemporaneous currency fluctuations than the market average. Second, prior studies have found that investors underreact to the impact of currency fluctuations on firm earnings. This underreaction and the differential responsiveness to currency fluctuations across SUE-sorted deciles together offer an explanation why firms in high (low) SUE-sorted deciles continue to have higher (lower) returns than the market average in subsequent months. Empirically, we show that currency fluctuations can predict future earnings surprises and abnormal returns of the PEAD portfolios, which take a long position on firms in the highest SUE-sorted deciles and a short position on firms in the lowest SUE-sorted deciles. These findings provide evidence that currency fluctuations can partially explain PEAD.

The monitoring role of the media: Evidence from earnings management

AbstractIn response to the recent debate on the media, this paper examines the effect of media coverage on firm earnings management. Even if prior studies (Dyck et al., 2010; Miller, 2006) have documented the media's role in detecting and deterring accounting fraud (or extreme earnings management), it is unclear ex ante whether the media amplifies or curbs less egregious earnings management. Our results show that media coverage is negatively associated with both accrual‐based and real earnings management, suggesting that the media serves as an external monitor that curbs managers’ opportunistic earnings management behaviors. Further analyses show that the effect of media coverage on earnings management is more pronounced when monitoring from auditors is weak and when the other information intermediaries are active. Overall, the findings suggest a monitoring role of the media in firm financial reporting practices.

Board capital and earnings quality with different controlling shareholders

Purpose The purpose of this study is to examine the relationship between board capital and firm earnings quality with different controlling shareholders for a sample of 252 listed firms in Indonesia over the period 2011–2017. Design/methodology/approach This study uses a two-step dynamic generalized method of moments panel regression to estimate the board capital effect on earnings quality. The board capital measure is constructed from educational capital, networking capital and experience capital. Meanwhile, discretionary accrual is used as the proxy for earnings quality. All financial data is from the annual report. Board capital data is a combination of an annual report, RelSci data, Linkedin searching and Bloomberg data. Findings The findings of this study report that board capital has a significant effect on earnings quality. Higher board capital may result in better earnings quality. In further investigation, this study finds that firms with higher education backgrounds tend to have better earnings quality. Meanwhile, firms with higher experienced board members tend to have bad earnings quality. Additionally, networking capital does not have any impact on earnings quality. The findings of this study also document a strong size effect of controlling shareholders in moderating the relationship between board capital and earnings quality. Research limitations/implications This study contributes to upper-echelon, institutional, positive accounting and agency theory. It implies that agency cost plays an important role in that relationship. In a more deep analysis, this study records different board capital effects on earnings quality across controlling shareholders. Practical implications Shareholders should elect board directors following their competencies and should note that not all competencies will give a quality earning report. The educational background of board members will enhance earnings quality, but the experience of a board member will reduce the earnings quality. Further, the relationship between board capital and earnings quality is significantly moderated by controlling shareholders, implying that different controlling shareholders need different board capital. Originality/value This study examines board capital effects on earnings quality with different controlling shareholders using four major theories. The board capital measure is tedious and detailed allowing to capture the comprehensive human capital.

기업수명주기가 비용의 자의적 분류에 미치는 영향：쇠퇴기를 중심으로

기업수명주기가 비용의 자의적 분류에 미치는 영향：쇠퇴기를 중심으로

The Impact of World Religions on Conservatism

ABSTRACTThis study examines the association between world religions and the earnings attribute of conservatism. I group the major world religions into two sub-groups, Western and Eastern. Prior literature documents that followers of Western religions have a lower preference for risk relative to followers of Eastern religions. Prior literature also finds a lower preference for risk is associated with more conservative reporting. Using a large sample of firms listed on exchanges around the world, I find earnings of firms domiciled in countries with larger Western religious presence are more conservative. The results hold after using an indicator for whether the predominant religion in the country is a Western religion, controlling for religiosity, and using a sample of U.S. foreign registrants that file a 20-F reconciliation with the SEC. My study contributes to our understanding of how social norms affect financial reporting.JEL Classifications: G14; G15; M41.

Hedge Accounting and its Consequences on Portfolio Earnings – A Simulation Study

In this paper, I analyze the consequences of cash flow hedge accounting on portfolio earnings of firms focusing on main changes between IFRS 9 and IAS 39. For this purpose, I develop a simulation study which illustrates the quantitative effects on the accounting entries according to the currently applicable hedge accounting methods. It is especially addressed what accounting differences arise and how these distinctions may affect a firm’s earnings. Furthermore, I examine to which firms early switching becomes especially desirable or burdensome. This information is particularly useful to managers and investors. The paper shows that portfolio earnings are affected differently. In the model, IAS 39 may lead to higher or lower earnings for increasing deviations between foreign and domestic interest rates. Additionally, sensitivity to volatility changes varies among the methods. Moreover, a partly ineffective hedging relationship does not necessarily decrease earnings compared to its fully effective counterpart.