Earnings Measures Research Articles

Risk disclosure, earnings smoothing and firm perceived risk

Purpose This paper aims to examine the association between perceived firm risk and two reporting mechanisms: risk disclosure and earnings smoothing in the UK context. Design/methodology/approach This study juxtaposes three competing views, the “null”, the “divergence” and the “convergence” hypotheses, and empirically investigates whether risk disclosure and earnings smoothing affect firm perceived risk for a sample of large UK firms with rich and poor information environments. This study also uses the global financial crisis as an external shock on overall risk in the economy to investigate when and how managers use these two reporting mechanisms to shape the firm perceived risk. Findings This paper documents that risk disclosures have no significant effect on investors’ risk perceptions, consistent with risk disclosures containing boilerplate and generic statements about firm risk. This paper also finds that earnings smoothing reduces investors’ risk perceptions, reflecting investors’ interpretations about future firm performance. Additional tests reveal that earnings smoothing is not associated with perceived firm risk for firms with rich information environments and expanded risk disclosures. Furthermore, reporting smooth earnings decreases perceived firm risk following the global financial crisis. These findings are robust to alternative specifications and measures of earnings smoothing as well as post-filing perceived firm risk. Research limitations/implications This study does not distinguish between the garbling role and the informational role of earnings smoothing. The risk disclosure measurement used in this study, developed based on UK annual reports, may limit the generalizability of findings to other countries. Practical implications The findings suggest that managers should revise their risk disclosure strategies to provide in-depth details on firm risk. Investors might require information and thorough assessment to evaluate investment risks when firms provide generic risk disclosures and smoothed earnings by consulting sources like financial intermediaries. Regulators should keep an eye on firms reporting boilerplate risk disclosures and on how smoothing earnings impacts the firm perceived risk following economic turmoil, to guide interventions that promote market stability. Originality/value The findings provide new insights into when and how managers use their financial reporting discretion to make firms appear less risky and, therefore, influence investors’ risk perceptions.

Gendered Relationship of Childbearing with Earnings Accumulated by Midlife in Two Nordic Welfare States

AbstractThe Nordic welfare states are considered advanced in terms of gender equality, but even in these countries women still take longer family leave and have lower earnings than men. This study provides new insights by assessing the differences in accumulated midlife earnings associated with childbearing between women and men in Finland and Sweden. We pay particular attention to the size of the gender gap in accumulated earnings across groups. We hypothesize that the gender gap will be larger among those with a larger number of children, among those with a lower level of education, and overall in Finland. The study is based on complete population register data, with highly accurate measures of earnings over decades. Our results show that by the age of 44, women born in 1974–1975 in Finland and Sweden had earned on average 32% and 29% less than men, respectively. Childbearing strongly modifies the gender gap, especially in Finland, and the highly educated have moderately smaller gaps in both countries. Our results show that, even the Nordic welfare states, despite their strong policy emphasis on gender equality and their success in achieving high levels of female labor force participation, are far from closing the gender gap in earnings accumulated over the first half of the life course. Our results also suggest that governments seeking to achieve gender equality should be cautious about providing long family-related leave with flat-rate compensation.

Women’s economic empowerment and intimate partner violence

This study explores the relationship between women’s economic empowerment and intimate partner violence (IPV), measured as women’s hospital visits for assault. Using longitudinal Swedish administrative data, I proxy women’s economic empowerment with a measure of potential relative earnings of married spouses caused by local changes in gender-specific labour demand. The findings reveal that an increase in potential relative earnings increases the probability of women’s hospital visits for injuries caused by assault, and the effect is particularly pronounced for women with low baseline bargaining power. Furthermore, exploiting detailed information on type of hospital visit, diagnosis and medical actions taken at the hospital, I show that the increase in hospital visits for assault is, at least in part, driven by an increase in care-seeking for IPV-related injuries rather than an increase in IPV itself.

Unions, technology and social class inequalities in the US, 1984–2019

Earnings inequality in the US has risen in recent decades, with social class inequalities being a central component of this trend. While technological change and de-unionisation are considered key contributors to increased earnings dispersion, their specific influence on inequalities between employees’ social classes has received limited attention. This study theoretically and empirically investigates the relationship between technological change, de-unionisation and the earnings trajectories of occupational classes from 1984 to 2019. The empirical analysis uses industry-level time-series cross-section data and industry-level measures of union density, computer investments and class earnings. Descriptive analyses show earnings growth for non-manual classes and stagnant or declining earnings for manual ones. Results provide limited evidence that computerisation affected classes differently in the industries where introduced. In contrast, industry-level de-unionisation reinforced class inequalities in two ways. First, unionisation exhibited a stronger association with lower-class earnings. Second, manual workers were more prevalent in industries that experienced substantial declines in union density.

Managers’ perception of product market competition and earnings management: a textual analysis of firms’ 10-K reports

PurposeIn this study, the author examines the effect of managers’ perception of product market competition on accruals and real earnings management.Design/methodology/approachThe author develops a new text-based measure of the emphasis managers place on product market competition by conducting a textual analysis of firms’ 10-K filings. Using this measure, the author conducts a battery of econometric analyses and robustness checks to investigate the impact of this measure of product market competition on measures of accruals and real earnings management.FindingsThis study finds robust evidence that when management perceives more competitive threats, they are more likely to engage in accruals-based earnings manipulation but are less likely to engage in real earnings management activity. The author argues that these findings are due to managers’ career concerns enticing them to manage earnings via accrual when competition is high, but that greater product market competition discourages real earning management activity as it can diminish firms’ competitiveness.Practical implicationsThe findings of this paper have important policy and practical implications since it signals that managers’ perceptions of product market competition is able to affect accounting choices, information environments and economic outcomes in firms.Originality/valueThis study develops a new text-based measure of managers’ perception of product market competition with the aid of GPT-4. The author then using this measure provides firm-level evidence on how this relates to earnings management.

The Perspective of Cash Flow Risks on Earnings Measurement

The Perspective of Cash Flow Risks on Earnings Measurement

Company-specific financial and corporate governance factors affecting the quality of earnings: Empirical study on the Spanish stock market

The concept of earnings quality has been widely analyzed after several cases of companies reporting false earnings and experiencing dramatic collapses. Hence, the need for stakeholders to be knowledgeable about the current situation and future prospects of the companies they are involved with. To aid the system, this paper aims to find company-specific financial and corporate governance factors that can act as determinants of the quality of earnings. The researchers took a sample of the companies listed in the Spanish stock market under IBEX 35 over the period 2017–2021. To test the hypotheses, panel, and cross-sectional regressions were run on Stata with the different quality of earnings measured as the dependent variables. The results showed that a company’s earnings age and earnings growth positively impact earnings quality, while its performance and liquidity have a negative impact. Company size can have positive or negative effects based on the chosen quality of earnings measure. Moreover, the different measures of earnings quality reacted differently to independent variables.

Asset Volatility and Financial Sustainability

This study observes how companies’ fundamental-based asset volatility impacts their financial sustainability. Accounting literature documents that net assets value accumulates previous earnings management. The asset balance change reflects biased earnings measurement, and abnormal asset fluctuation signals aggressive earnings management. This paper uses delisting as a proxy to observe how asset volatility can interact with abnormal earnings fluctuation to impact firms’ sustainability. The study uses two groups of regression and a Principal Component Analysis (PCA) Logistic Regression approach to observe how asset volatility impacts companies’ delisting risk. It borrows the Six Sigma methodologies to measure the volatility of financial statement items. Then the PCA analysis reduces the data dimensions to twelve factors. The analysis shows that assets’ abnormal fluctuation is a risk signal concurring with the extant earnings management literature. One takeaway from this study is that companies must disclose detailed explanations if asset volatility is beyond a red line. As Statement of Financial Accounting Standards (SFAS) 151 requires direct disclosure of abnormal excess capacity costs, companies must disclose abnormal asset volatility. The paper contributes to the literature from two perspectives. First, this paper captures firms’ sustainability from the accounting perspective with fundamental measures from quarterly financial reports. It provides a comprehensive way to detect aggressive earnings management risks. Second, the PCA logistic regression model offers a comprehensive analysis to derive useful information from many attributes.

The value relevance of EBITDA and book values: Evidence from the Johannesburg Stock Exchange

Orientation: This paper stems from Ohlson’s valuation framework, where residual income as a variable was substituted by the non-Generally Accepted Accounting Practices (GAAP) measure of earnings before interest, taxes, depreciation and amortisation (EBITDA).Research purpose: The primary purpose was to determine whether EBITDA, together with the book value of equity (BV), could be shown to be value relevant by means of an intrinsic equity evaluation model. Secondary hereto was to focus on the value relevance of the residual between EBITDA and traditional bottom-line earnings, namely interest, taxes, depreciation and amortisation (ITDA).Motivation for the study: The concern is that the current evidence value relevance of EBITDA offered in the literature has been premised on relative valuation approaches, meaning they are primarily anecdotal.Research approach/design and method: Cross-sectional ordinary least square regression analyses were applied from the top 100 largest companies listed on the JSE, from 1995 to 2017.Main findings: The results demonstrated that EBITDA, ITDA and BV accounted for significant variations in equity share prices when controlling for the confounding effects of scale, growth and the incidence of reported accounting losses.Practical/managerial implications: Ultimately, these findings should be seen to confirm the validity of EBITDA as an alternative input to bottom-line earnings in the valuation of equity shares.Contribution/value add: The study extends the debate by providing an alternative perspective based upon Ohlson’s residual income valuation framework, in respect of which there has currently been a paucity of evidence.

Firm Attributes and Earnings Predictability of Listed Manufacturing Companies in Nigeria

Earnings predictability is a measure of how well the past earnings of a firm can explain its current earnings. Earnings measurement is very important in accounting since the performance of the firm can be seen by a wide range of users. The primary role of the financial statement is to disclose the financial statement information to internal and external users in a timely and reliable manner. This study was to ascertain the relationship between firm attributes and earnings predictability of quoted manufacturing companies in Nigeria. The population of the study consisted of all the listed manufacturing companies in Nigeria for the year ending 2021. Purposive sampling was used to sample 12 manufacturing firms that were continuously listed and actively trading on the floor of the Nigerian Exchange Group (NXG) Ltd. during the period 2017 to 2021 and whose financial statements are available and have been consistently submitted to NXG for the period under study. The ex post facto research design was used to establish the effect of firm attributes on earnings predictability. The firm attributes reviewed were firm size, age, leverage and liquidity, while earnings predictability was measured by operational cash flows on total assets. Panel regression data using a pooled estimate of ordinary least squares method was used for data analysis. The result revealed that firm age, firm size, firm leverage and firm liquidity all have weak effects on the dependent variable. Based on the findings, it was concluded that firm attributes have weak but positive effects on earnings predictability. It was recommended that manufacturing companies should provide quality earnings reports stating the earnings per share, operational cash flow, and total assets. This will showcase the accrual quality which could assist investors in estimating future earnings thereby making decisions to avoid security mispricing.

Trivialization of the bottom line and losing relevance of losses

The purpose of this article is to illustrate the growing limitations of the current methods of calculating earnings, particularly when earnings is a negative number. Earnings, presumably the most important output of a financial reporting system, is not a singular metric. It is obtained by subtracting numerous expense line items from revenues, both of which are calculated after applying a diverse, and often inconsistent, set of accounting conventions. Despite this apparent deficiency, earnings could be informative of recurring profits, if revenues are measured correctly and expenses are traced to revenues. However, both principles are increasingly violated for the cohorts of firms listed in the last 30 years, which now constitute over 80% of the set of listed firms. Revenues of recent cohorts do not capture many events that create recurring cash flows. Their operating expenses are dominated by intangible outlays that are unmatched to current revenues. As a result, newer cohorts’ profits and profit margins, especially when negative, offer little to inform future profits. Given that revenue and expense recognition rules are unlikely to change anytime soon, the current developments raise a question: Should the reporting of the summary measure of earnings be voluntary instead of mandatory?

Effect of Earnings Measurement on Stock Price of Consumer Goods Firms in Nigeria

The study evaluated the effect of earnings measurements on the share price of consumer goods firms in Nigeria. The objectives of the study were to ascertain the effect of earnings per share, dividend per share, return on asset on share price of consumer goods firms in Nigeria. The study adopted an ex-post-facto research design, covering the period between 2012 and 2021. Secondary data were extracted from the annual reports and accounts of the sampled consumer goods firms in Nigeria. A multiple regression technique was used for the data analysis. From the analysis of the study, it was revealed that earnings per share and dividend per share has a positive and significant effect on the share price of consumer goods firms in Nigeria. Return on assets has a positive and nonsignificant effect on the share price of consumer goods firms in Nigeria. This implies that that earnings per share and dividend per share are the major determinants of share price. It was recommended therefore that consumer goods firms in Nigeria should strive to increase their earnings per share by ensuring that high profits are maintained so that the demands for their share price will continue to increase, which in turn cause a significant rise in their share price. They should strive to increase their dividend per share by ensuring that high revenue and profits are maintained. They should also balance the trade-off between dividend payout and retained earnings so that the demands for their share price will continue to increase, which in turn cause a significant rise in their quotation price. They should strive to make consistent profit to ensure that the return on asset of these companies continued to increase significantly.

Board political connections and tradeoff between market and nonmarket advantages: Evidence from corporate financial information disclosure

We explore the extent to which board political connections shape the firm’s disclosure behavior. We focus on the disclosure of non-GAAP earnings measures and argue that board political connections reduce the firm’s propensity to report non-GAAP earnings through two mechanisms: the reduction in capital market pressure (insulating effect) and the concerns about public scrutiny (constraining effect). Our theory is tested and supported by an analysis of U.S.-listed firms in the period 2003-2019. We further exploit the variation in firms’ media exposure to identify the primary mechanism underlying this disclosure strategy and find that the constraining effect plays a more important role than the insulating effect in driving the financial reporting behavior of politically connected firms.

The information content of mandatory and discretionary non-GAAP earnings

PurposeThis paper aims to investigate the pricing of discretionary earnings in South Africa. This is a unique setting, as South African listed firms also report mandatory non-GAAP earnings (“headline earnings”).Design/methodology/approachResults are based on multivariate regression analyses for South African firms that report from 2010 to 2019.FindingsFindings show that the value-relevance of discretionary earnings exceeds that of both GAAP earnings and headline earnings. In addition, placement of discretionary earnings reconciliations communicates information about the decision-usefulness of earnings.Originality/valueDiscretionary earnings remain the most value-relevant earnings measure, despite the divergent decision-useful characteristics offered by headline earnings and GAAP earnings. Therefore, the most decision-useful earnings reflect unique industry or firm characteristics rather than the assurance arising from regulation.

Assessing data from summary questions about earnings and income

In short surveys, or in surveys that prioritise other content domains, earnings and income are often elicited using small sets of summary questions. This contrasts with the detailed questions recommended for surveys that focus on earnings and income, that ask source by source. We evaluate earnings and income data collected with summary questions in a series of recent web-surveys: the Understanding Society COVID-19 Study. The fact that many COVID-19 Study respondents also contemporaneously answered the main annual Understanding Society survey provides individual- and household-level validation data. We find that measures of household earnings and income in the COVID-19 Study are noisier than those from the main annual Understanding Society survey, and that there is evidence of systematic under-reporting for household totals. However, for most measures and samples, we find that measurement errors in the COVID-19 Study are substantively uncorrelated with true values. We conclude that the COVID-19 Study collected valuable data on earnings and income, and more broadly, that summary questions on earnings or income can be a useful data collection tool.

Upotreba alternativnih mera učinka u proceni finansijskih performansi osiguravajućih društava u Republici Srbiji

The purpose of this paper is to evaluate the financial performance of insurance companies by applying an alternative financial metric in combination with cash flows. The sample includes 16 insurance companies operating in the Republic of Serbia during the period between 2017 and 2021. The authors provide evidence that indicators based on cash flows provide greater informational value compared to earnings measures based solely on accrual categories. It was found that the majority of the observed insurance companies have a value of earnings quality indicators greater than 0 during the five-year period. There are fluctuations in the values of earnings quality indicators, but they are not statistically significant. The research results may be of interest to insurance company managers, investors, analysts, and other stakeholders.

Do High-Quality Auditors Improve Non-GAAP Reporting?

ABSTRACT Prior research finds that clients of high-quality auditors report higher-quality GAAP earnings. We extend this research to investigate whether auditor quality is associated with the quality of voluntarily disclosed non-GAAP earnings measures. Using a sample of Australian firms disclosing annual non-GAAP metrics, we find that clients of high-quality auditors are more likely to voluntarily disclose non-GAAP earnings numbers. However, clients of high-quality auditors make adjustments in calculating non-GAAP earnings (non-GAAP exclusions) that are less predictive of future earnings and less value relevant than those of other firms. These results indicate that their adjustments are of higher quality. We also find similar results for U.S. firms using a sample of quarterly non-GAAP earnings disclosures. Overall, our evidence indicates that commonly used indicators of audit quality for GAAP reporting are positively associated with the quality of voluntarily disclosed non-GAAP earnings measures. JEL Classifications: J33; M41.

The information content of alternative performance measures in the European context

The discretionary nature of alternative performance measures raises the question of their information content, particularly in the European Union where, unlike the United States, there is no specific regulation but only a recommendation without coercive power. Based on hand-collected data in press releases of French and UK firms, we show that non-GAAP earnings measures are more informative compared with GAAP counterparts. However, the alternative performance measures may be used opportunistically when firms fall short of certain accounting earnings benchmarks.

Trends in inequalities in the prevalence of dementia in the United States

This paper presents estimates of the prevalence of dementia in the United States from 2000 to 2016 by age, sex, race and ethnicity, education, and a measure of lifetime earnings, using data on 21,442 individuals aged 65 y and older and 97,629 person-year observations from a nationally representative survey, the Health and Retirement Study (HRS). The survey includes a range of cognitive tests, and a subsample underwent clinical assessment for dementia. We developed a longitudinal, latent-variable model of cognitive status, which we estimated using the Markov Chain Monte Carlo method. This model provides more accurate estimates of dementia prevalence in population subgroups than do previously used methods on the HRS. The age-adjusted prevalence of dementia decreased from 12.2% in 2000 (95% CI, 11.7 to 12.7%) to 8.5% in 2016 (7.9 to 9.1%) in the 65+ population, a statistically significant decline of 3.7 percentage points or 30.1%. Females are more likely to live with dementia, but the sex difference has narrowed. In the male subsample, we found a reduction in inequalities across education, earnings, and racial and ethnic groups; among females, those inequalities also declined, but less strongly. We observed a substantial increase in the level of education between 2000 and 2016 in the sample. This compositional change can explain, in a statistical sense, about 40% of the reduction in dementia prevalence among men and 20% among women, whereas compositional changes in the older population by age, race and ethnicity, and cardiovascular risk factors mattered less.

Is conservatism demanded by performance measurement in compensation contracts? Evidence from earnings measures used in bonus formulas

Is conservatism demanded by performance measurement in compensation contracts? Evidence from earnings measures used in bonus formulas