Firm Earnings Research Articles

Does accounting for uncertain tax benefits provide information about the relation between book-tax differences and earnings persistence?

Purpose – This study aims to use research setting provided by the implementation of Financial Accounting Standards Board Interpretation 48 (FIN48) to help develop a further understanding of large positive book–tax differences (LPBTD) and their relationship with earnings persistence. Extant literature indicates that the tax information provided in financial statements, such as large book–tax differences, is useful for detecting earnings management and signals less persistent future earnings. However, more information is needed about the causes of large book–tax differences and their abilities to signal the differences in earnings persistence (Blaylock et al., 2012). Design/methodology/approach – In the first step, temporary book–tax differences are ranked by quintiles based on the approach in Hanlon’s (2005) study and the highest quintile in the sample observations are designated as large positive temporary book–tax differences (LPBTD). In the second step, differences in the persistence of earnings for high tax-planning firms as measured by UTB_NonETR are searched for. In further testing, an ordered logistic model and the Vuong (1989) test are applied to compare both the incremental and the relative ability of UTB_NonETR and Cash-ETR to explain the ranking order of temporary book–tax differences. Findings – The negative relation between temporary differences and earnings persistence is moderated by the level of tax planning as measured by UTB_NonETRs. More specifically, the persistence of earnings appears to be higher for firm-years with large UTB_NonETRs. When comparing the relative power of UTB_NonETR with Cash-ETR, the results indicate that UTB_NonETR is incrementally useful for explaining the ranking orders of temporary book–tax differences. However, it appears that neither UTB_NonETR nor Cash-ETR is relatively more useful over another under the Vuong (1989) test. Originality/value – First, the part of UTB, if recognized, that would not affect earnings (UTB_NonETR) is used as an empirical proxy and its usefulness is tested in the context of book–tax differences and the persistence of earnings. Second, new evidence is provided supporting the predictions, as in Ayers’ et al. (2010) and Blaylock et al.’s (2012) studies, that the level of tax planning will attenuate the negative association between large book–tax differences and earnings quality. Third, the findings can contribute to the post-implementation review of FIN48 (Financial Accounting Foundation, 2012) supporting the argument that FIN48 can provide decision-useful information for financial statement users.

Analystss Earnings Surprise Components and Future Earnings Performance

Our paper examines the association between components of analysts’ earnings surprises and future earnings. We decompose the analysts’ earnings surprise into its revenue, pretax margin, pretax income, and tax components. After controlling for current period earnings and discretionary accruals, we find that each component is positively associated with future earnings. When we form portfolios based on the sign of the earnings surprise and its components, we find that the future earnings of firms that meet revenue, pretax income, and net income expectations is significantly greater than firms that only meet net income expectations. Supplemental analysis shows that the significant association between future earnings and the revenue and pretax income components of the earnings surprise persists for at least three years. However, the association between the tax surprise and future earnings dissipates after one year. Overall, our evidence shows that decomposing earnings surprises into its components can assist investors in identifying firms that are associated with better future performance.

How do analysts react to shareholder class action lawsuits?

This paper examines security analyst's earnings estimates and recommendations during the period around shareholder class action lawsuits. We find that analysts respond rapidly to the class action lawsuits. The magnitude of the forecast revisions is greater for smaller firms and for firms with large unexpected earnings surprises (SUE), high beta, and more negative three-day cumulative abnormal returns around the filing date. The speed of analyst response is directly related to firm size, SUE, beta, and share turnover, and is inversely related to the magnitude of the cumulative abnormal return for the three days around filing date. Finally, our results show that analysts utilize an industry spillover effect when estimating earnings for other related firms in the same industry.

On the Association between Strategic Institutional Ownership and Earnings Quality: Does Investor Protection Strength Matter?

The aim of this study is to examine: (i) whether strategic institutional ownership is associated with better earnings quality at the international level, and (ii) whether this relationship varies with the strength of investor protection. Using firm level data from 41 different countries, we document a positive association between strategic institutional ownership and firm earnings quality. More importantly, we find that the documented association is economically more significant in countries with stronger investor protection. Our results are robust to a battery of robustness tests. We interpret our findings as evidence that the monitoring role played by institutional investors is shaped by the degree of investor protection at the country level.

Market Learning About the Stand-Alone Value of the Acquirer

This paper presents new empirical evidence suggesting that documented losses to the acquirer's stand-alone value are consistent with value maximizing behavior. Firms faced with declining internal investment opportunities can rationally purchase other firms. The acquisition can be the best possible use of their money. Yet, when a growing firm purchases another, market participants will likely learn from the acquisition, that internal investment opportunities facing the acquirer are not as good as previous performance would indicate. The revelation about the slowdown in internal growth of the acquirer prompts market participants to make a negative adjustment to the firm's future earnings growth, hence its stand-alone value. The empirical evidence presented in this paper is strongly consistent with this hypothesis.

R&D and the overseas earnings of Indian firms

This article examines the impact of undertaking R&D, a measure of the enhancement of dynamic capabilities, on firms' overseas earnings patterns, for a panel of several thousand Indian firms, for the period from 1991–92 to 2005–06. The results show that undertaking R&D spending is associated with a significant rise in firms' average overseas earnings levels. These results point to the need for materially enhancing the very low levels of R&D undertaken by firms in India.

Is forward-looking financial disclosure really informative? Evidence from UK narrative statements

Forward-looking financial disclosure (FLFD) is potentially uninformative if it does not change from the previous year, especially after a significant change in firm performance. This study aims to examine whether and to what extent FLFD is changed in response to changes in firm performance. Then, it investigates the effect of such change in FLFD on firm value. The study uses a sample of UK narrative statements over the period from 2005 to 2011. It finds an association between change in FLFD and change in firm earnings performance. However, it finds weak evidence that firms with larger changes in earnings performance are likely to change their FLFD more than those with smaller performance changes. In addition, when we distinguish between well-performing and poorly performing firms, it finds that the change in FLFD is more positively associated with poorly performing firms compared to well-performing firms. Finally, the change in FLFD has no effect on the value of well-performing firms, while, it negatively affects poorly performing firms. The results suggest that forward-looking financial information in UK narratives contains some relevant information about firm performance. However, it neither affects the value of well-performing firms nor enhances investors' valuation of poorly performing firms.

What Do Investors Infer About Future Cash Flows from Foreign Earnings for Firms with Low Average Foreign Tax Rates?

This study examines whether investors discount the foreign earnings of U.S. multinational corporations in anticipation of future repatriation taxes. Investor pricing of repatriation taxes has become increasingly important because of the decline in foreign statutory tax rates relative to the U.S. statutory tax rate over the past twenty years combined with the increasing significance of foreign income for U.S. multinationals. Recent comments by regulators suggest they believe current disclosures related to potential repatriation taxes on foreign earnings are insufficient. Consistent with investors pricing repatriation taxes, we observe a significant difference in the earnings response coefficient on changes in foreign earnings of firms with low versus high average foreign tax rates. We also conduct a series of tests to examine whether investor expectations about the likelihood of future repatriation taxes vary as a function of certain firm characteristics. We find no evidence investors differentiate between low foreign tax rate firms based on the likelihood of repatriation.

Cash holdings, political connections, and earnings quality

Purpose – The purpose of this paper is to investigate the influence of cash holding, political connection and their interaction effect on earnings quality in the Malaysian environment, where political influence plays a vital role in many aspects of business dealings and resources allocation is seriously affected by politics. Design/methodology/approach – This paper uses ordinary least square and seemingly unrelated regressions upon a sample of the Malaysian top 100 listed firms. Findings – This paper finds that earnings of firms with excess cash reserves are of high quality. Consistent with previous research, the study finds that investors perceive earnings numbers of politically connected firms as being of low quality. However, this research fails to support an expectation that the adverse consequences of holding a large amount of cash to earnings quality would be more pronounced when political extraction is high. The findings of this study suggest that policy makers should encourage or mandate firms to disclose information in relation to their connections with government, political party, or politicians so that investors and all interested parties can use the information to better assess the firms’ earnings quality. Originality/value – This research is considered as the first attempt to examine the relationships between cash holdings, political connections, and earnings quality in a developing country such as Malaysia.

The Influence of Insiders and Institutional Owners on the Value, Transparency, and Earnings Quality of Chilean Listed Firms

In 1980, Chile privatized its social security system, and currently there are five private pension funds managing approximately US$83 billion worth of retirement investments. The regulations provide for pension funds to appoint a member to the board of directors, and influence the appointment of auditors. Thus, institutions are playing a major role in Chile's transition a market-based financial system. The study uses data from 70 firms from 1995-2005 to test the impact of these institutional changes on firm value, transparency levels and earnings quality. The study finds that insider ownership levels and institutional ownership positively affects firm value but these factors, and the pension fund representation on firm boards negatively affects the transparency index. Further, institutional ownership levels also encourage the entrenched owners to use positive discretionary accrual to manage earnings. Using agency theory, we suggest that high insider ownership levels are an equilibrium that helps managers co-opt institutions by providing access to information, which bestows private benefits control to stakeholders aligned with entrenched insiders' interests.

Long‐Term Evidence on the Effect of Aggregate Earnings on Prices

We examine the time‐series properties and determinants of the relation between aggregate earnings information and stock prices (aggregate earnings response coefficient or AERC) employing return decompositions with data since 1871. We confirm that AERC is negative even though firms respond positively to individual firm earnings information, but we also find that AERC is time varying. Furthermore, we show that AERC components based on expected earnings, cash flows, and discount rates are also time varying and differ in relative importance.

Logarithmic Transformations in Cross Section Regression Models of the Long Run Relation between Market and Accounting Values

Empirical evidence, mostly cross-sectional, is provided in this paper supporting the theory that the market accounting-relation is best understood as a multiplicative relation, when the modeled variables are positive. The theory is shown to work well with large sets of cross section and pooled data as well as in time series analysis with more limited numbers of observations. The distributions of market value and the main accounting aggregates, net book value of firm assets, earnings and dividends are all better approximated by a log-normal form, when the data are positive. The error term in regressions of market value on these variables is also more closely approximated by a log-normal distribution. Together these findings are consistent with the long-run market-accounting relation and the cross-section of market value being better explained by a geometric mean of the fundamental accounting variables, rather than an arithmetic mean of those variables, which is invariably used in the accounting literature. Implications for the interpretation of coefficients in cross-section regressions of market value and for the theories of market valuation are discussed.

Consequences of Scheduled Earnings Announcements: Evidence from Customer-Supplier Relationships

I test whether the anticipation of earnings news stimulates acquisition of customer information and mitigates returns to the customer-supplier anomaly documented by Cohen and Frazzini (2008). I find that attention to a firm’s publicly disclosed customers increases shortly before the firm announces earnings, and that customer stock returns predict supplier stock returns shortly before, but not after, the supplier’s earnings announcement. I further find some evidence that these predictable returns are increasing in the level of customer information acquisition. These results are unique to anticipated disclosure events and suggest that anticipation of supplier earnings announcements resolves investor limited attention to customer information and accelerates price discovery of customer news.

Relationship between Earnings Quality and External Audit Quality

During the recent years, the accounting scandals have multiplied (Enron, World com, Xerox,...). Several factors have contributed to these scandals. Among these factors we find the quality of audit. This paper examines the impact of audit quality on earning quality. Audit quality is measured by financial statements audited by the Big 4 accounting firms. Earning quality is measured by the investors' ability to predict future earnings for profitable and unprofitable firms. We use a sample of around 4,417 firm-year observations in the U.K. market for the period 1996-2002. We document evidence that investors are able to better anticipate future earnings when financial statements are audited by the big four accounting firms. However, the findings are not applicable for unprofitable firms.

Investigation the Relationship between Audit Firm Size and Cash-Based Earnings Management for the Companies Listed on Tehran Stock Exchange (TSE)

There are many researches in relation of earnings management and audit quality. However, there are three ways to earnings management: 1. Accruals earnings management 2. Real activities manipulation and 3. Shifting of core expense; the famous methods to earnings management are accruals earnings management and real activities manipulation. This research investigates the relationship between audit firm size and cash – based earnings management (real earnings management) for the companies listed on Tehran Stock Exchange. Financial managements have more incentives for earnings management by real activities than accruals. The sample consists of 61 companies in the period 2008–2012 and for testing the hypothesis the statistical panel data regression was exerted. For measuring real earnings management have used the model developed by Cohen and Zarowin (2010). The results show that there is not a relationship between audit firm size and real earnings management. This means that, big audit firm are not more capable than small audit firms in finding real earnings management. In addition, the results show that there is a positive relation between firm size and a negative relation between financial leverage and firm growth with real earnings management.

The effect of financial ratios on the firm value and earnings per share

The present study investigates the effect of financial ratios, operating cash flows and firm size on earnings per share and firm value of companies in IT sector. In the present study, the ratios like Net Profit Margin, Current Ratio, Asset Turnover Ratio, Operating cash Flows and Firm Size are used as the independent variables while the earnings per share and Firm Value are used as the dependent variable. Twelve hypotheses were formulated to investigate the research independent variables with earnings per share and Firm Value and were tested using regression model. The results were consistent with the research results of Legziyan et al. (2011), Martani et al.(2009) and Taani and Banykhaled (2011) but inconsistent with the research results of Martani et al. (2009), Zeynali and Mohammadshilan (2011).

Earnings Seasons: Analysis of Inferred and Announced News

Earnings announcements are clustered in calendar time and such clusters, referred to as earnings seasons, are characterized by intense arrival of information from firms in an industry. The news arrives not only from earnings announcement by the firm, announced news, but also from pre-emptive inference of news from peer firm announcements, inferred news. We find that announced news appears to be underweighted for firms that announce later in the earnings season and this is not explained by a higher level of inferred news for these firms. This suggests that as the season progresses, investors appear to pay less attention to firm earnings, particularly in the case of good news. Finally, the tone of the season, i.e. nature of news announced on the first day of the season, affects the reaction to announced news of subsequent announcers. Our results highlight the importance of viewing earnings announcements in the context of the earnings season.

Cash-Flow Based Dynamic Inventory Management

Small-to-medium size enterprises (SMEs), including many startup firms, need to manage interrelated flows of cash and inventories of goods. In this paper, we model a firm that can finance its inventory (ordered or manufactured) with loans in order to meet random demand which in general may not be time stationary. The firm earns interest on its cash on hand and pays interest on its debt. The objective is to maximize the expected value of the firm’s capital at the end of a finite planning horizon. Our study shows that the optimal ordering policy is characterized by a pair of threshold variables for each period as function of the initial state of the period. Further, upper and lower bounds for the threshold values are developed using two simple-to-compute ordering policies. Based on these bounds, we provide an efficient algorithm to compute the two threshold values. Since the underlying state space is two-dimensional which leads to high computational complexity of the optimization algorithm, we also derive upper bounds for the optimal value function by reducing the optimization problem to one dimension. Subsequently, it is shown that policies of similar structure are optimal when the loan and deposit interest rates are piecewise linear functions, when there is a maximal loan limit and when unsatisfied demand is backordered. Finally, further managerial insights are provided with numerical studies.

Exporting, Innovation and the Role of Immigrants

This research uses Statistics New Zealand’s Integrated Data Infrastructure and data from the Business Operations Survey to investigate the correlations at the firm level between a) employee characteristics and firm international engagement, and b) firm international engagement and innovation. The main findings on employee characteristics and international engagement are: • Firms that employ a higher fraction of high-ability foreigners (and thus a lower fraction of high-ability natives) are more likely to export. • Firms that employ a higher proportion of people who previously worked for an exporter are more likely to export. • The proportions of foreign employees and employees with export experience are correlated with many other types of international engagement by firms. • Employees from Australia and the Pacific and from Europe are positively correlated with firm exporting. The correlations are absent for foreign employees from Asia. • The probability that a firm earns income in a given country is more correlated with its fraction of employees from that country than with its total fraction of foreign employees. • A firm with a higher fraction of employees from a given country is more likely to earn income in that country only if the country is developed. The main findings on international engagement and innovation are: • Firms that export innovate more, even after controlling for size. • Among exporters, the proportion of firm sales that comes from exports shows little correlation with innovation. • Firms that export to more countries innovate more. • Exports of raw goods have little correlation with innovation; exports of manufactured goods or services have a strong correlation. • Firms that recently entered a new export market report especially high innovation, and firms that began earning overseas income in the previous two years report higher innovation than those that have earned overseas income for a longer period. • Not all export destinations are correlated with higher innovation. Exports to the Americas are positively correlated with innovation, but there is no evidence that firms that export more to Asia are more likely to innovate. • In addition to exporting, most other types of international engagement, such as inward and outward foreign direct investment, are positively correlated with innovation. • Firms' sources of ideas for innovation vary with the types of international engagement in which they are involved. The patterns are consistent with exporters gaining ideas from their international customers, firms gaining ideas from their foreign owners, and importers gaining ideas from their foreign suppliers. Although these relationships are correlations only and should not be interpreted as proof of causality, they do suggest that the experience and specialized knowledge of employees may be relevant to firms’ decisions to engage internationally, and that such engagement may act as a conduit for foreign knowledge to enter the country.

The effect of ownership structure on the price earnings ratio — returns anomaly

It is well known that firms with low price to earnings ratios (value firms) earn higher stock returns in the long term than high price to earnings firms (growth firms). This study investigates how insider ownership affects this relation. We show that when insider ownership is high, returns decline for low P/E firms and improve for high P/E firms. These findings are rationalized in the context of entrenchment and alignment of incentive effects. For low P/E firms, low stock returns reflect the inability of boards of directors and outside shareholders to influence poorly performing entrenched management. For high P/E firms, boards of directors and outside shareholders are less likely to intervene since higher returns reflect increased agency incentives for value-creating managers.