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Abstract:
We examine whether application of International Accounting Standards is associated with higher accounting quality. The application of IAS reflects the combined effects of features of the financial reporting system, including standards, their interpretation, enforcement, and litigation. We find that firms applying IAS from 21 countries generally evidence less earnings management, more timely loss recognition, and more value relevance of accounting amounts than do a matched sample of firms applying non-US domestic standards. Differences in accounting quality between the two groups of firms in the period before the IAS firms adopt IAS do not account for the post-adoption differences. We also find that firms applying IAS generally evidence an improvement in accounting quality between the pre- and post-adoption periods. Although we cannot be sure that our findings are attributable to the change in the financial reporting system rather than to changes in firms' incentives and the economic environment, we include research design features to mitigate the effects of both.

IAS, IASB, International Accounting Standards, International Accounting Standards Board, International Financial Reporting Standards

Abstract:
We find, as predicted, that the differential ability of accrual and cash flow components of earnings to help forecast future abnormal earnings and the persistence of the components results in the components having different valuation implications. We base our tests on Ohlson (1999) applied to fourteen industries. We find: (1) Accruals and cash flows aid in forecasting future abnormal earnings incremental to abnormal earnings and equity book value. (2) Accruals and cash flows provide explanatory power for equity market value incremental to equity book value and abnormal earnings. (3) There is evidence that accruals and cash flows valuation coefficients are consistent with the Ohlson model.

Abstract:
We find, as predicted, that the differential ability of accrual and cash flow components of earnings to help forecast future abnormal earnings and the persistence of the components results in the components having different valuation implications. We base our tests on Ohlson (1999) applied to fourteen industries. We find: (1) Accruals and cash flows aid in forecasting future abnormal earnings incremental to abnormal earnings and equity book value. (2) Accruals and cash flows provide explanatory power for equity market value incremental to equity book value and abnormal earnings. (3) There is evidence that accruals and cash flows valuation coefficients are consistent with the Ohlson model.

Abstract:
This paper offers a view of the relevance of value relevance research for financial accounting standard setting that contrasts with the view offered in Holthausen and Watts (2001) (hereafter HW). A key conclusion of HW is that value relevance research offers little or no insight for standard setting. As active participants in value relevance research, our purpose is to clarify the relevance of the value relevance literature to financial accounting standard setting. Because we are discussants of HW, we only address issues raised in that paper. In particular, HW is limited in scope to a discussion of the relevance of the value relevance literature for financial accounting standard setting; it does not comprehensively review the value relevance literature. Accordingly, our discussion is similarly limited. A key conclusion of our paper is that the value relevance literature provides fruitful insights for standard setting.

This paper also clarifies several misconceptions articulated in HW regarding value relevance research. In particular, in contrast with HW, we conclude: (1) value relevance research provides insights into questions of interest to standard setters and other non-academic constituents. (2) A primary focus of the FASB and other standard setters is equity investment. The possible contracting and other uses of financial statements in no way diminish the importance of value relevance research. (3) Empirical implementations of extant valuation models can be used to address questions of value relevance despite their simplifying assumptions. (4) Value relevance research can accommodate conservatism, and can be used to study its implications for the relation between accounting amounts and equity values. (5) Value relevance studies are designed to assess whether particular accounting amounts reflect information that is used by investors in valuing firms' equity, not to estimate firm value. (6) Value relevance research employs well-established techniques for mitigating the effects of various econometric issues that arise in value relevance studies.

Value relevance

Abstract:
This paper offers a view of the relevance of value relevance research for financial accounting standard setting that contrasts with the view offered in Holthausen and Watts (2001) (hereafter HW). A key conclusion of HW is that value relevance research offers little or no insight for standard setting. As active participants in value relevance research, our purpose is to clarify the relevance of the value relevance literature to financial accounting standard setting. Because we are discussants of HW, we only address issues raised in that paper. In particular, HW is limited in scope to a discussion of the relevance of the value relevance literature for financial accounting standard setting; it does not comprehensively review the value relevance literature. Accordingly, our discussion is similarly limited. A key conclusion of our paper is that the value relevance literature provides fruitful insights for standard setting.

This paper also clarifies several misconceptions articulated in HW regarding value relevance research. In particular, in contrast with HW, we conclude: (1) value relevance research provides insights into questions of interest to standard setters and other non-academic constituents. (2) A primary focus of the FASB and other standard setters is equity investment. The possible contracting and other uses of financial statements in no way diminish the importance of value relevance research. (3) Empirical implementations of extant valuation models can be used to address questions of value relevance despite their simplifying assumptions. (4) Value relevance research can accommodate conservatism, and can be used to study its implications for the relation between accounting amounts and equity values. (5) Value relevance studies are designed to assess whether particular accounting amounts reflect information that is used by investors in valuing firms' equity, not to estimate firm value. (6) Value relevance research employs well-established techniques for mitigating the effects of various econometric issues that arise in value relevance studies.

Abstract:
We address whether IAS as applied by non-US firms results in accounting amounts that are comparable to those resulting from US GAAP as applied by US firms. We assess comparability using value relevance of equity book value and net income, and the correlation between net incomes. We find US firms applying US GAAP generally have higher value relevance of accounting amounts than non-US firms applying IAS. Value relevance generally became more comparable after non-US firms applied IAS than when they applied non-US domestic standards; we find more consistent evidence for an increase in net income comparability. We also find that value relevance and net income comparability are higher for both IAS adoption and IAS sample years after 2005. Findings indicate that value relevance is more comparable for firms in common law countries; the increase in net income comparability after non-US firms apply IAS holds for both common and code law IAS firms. Our findings suggest that widespread application of IAS by non-US firms has enhanced financial reporting comparability with US firms, but differences remain.

IAS, IASB, International Accounting Standards, International Accounting Standards Board, International Financial Reporting Standards, US GAAP, Comparability, Comparable Financial Reporting Standards

Abstract:
This study uses Ohlson's (1995 and 2001) accounting-based equity valuation model to structure tests of four explanations for the anomalously positive pricing of dividends reported by Rees (1997) and Fama and French (1998). First, we find that dividends are not simply a proxy for publicly available information that helps predict future abnormal earnings. Second, although dividends act as if they signal managers' private information about future profitability, they remain positively priced for firms with low incentives to signal. Third, dividends do not signal management's willingness to abstain from incurring agency costs. Fourth, however, controlling for one-year-ahead realized forecast errors yields a pricing of dividends that is very close to that of dividend displacement. After showing that dividends are not simply a proxy for analysts' misforecasting, we conclude that dividends appear to be positively priced because they are a proxy for the mispricing by investors of current earnings or book equity.

Abstract:
This paper employs Ohlson's (1995, 1998) accounting based equity valuation model to structure an empirical assessment of the pricing of dividends in stock prices. We address two questions. First, to what extent does the pricing of dividends reflect Modigliani and Miller?s (1958, 1961) one-to-one displacement property? Second, what explains the direction and magnitude of any divergence from dividend displacement? Using annual cross-sections of NYSE, AMEX and NASDAQ firms over the period 1974-1996, we find robust evidence that dividends are materially positively priced, sharply contrasting with the negative relation predicted by dividend displacement. We also find that the positive pricing of dividends is at least three times larger for loss firms than for profit firms. Our explanation for these results is that managers of loss firms use dividends to signal future profitability, while to a lesser degree managers of profit firms use dividends to alleviate concerns about the misuse of free cash flow. We conclude that dividends are a component of, and rich proxy for, other information about future abnormal earnings that is reflected in price but is not yet captured by current financial statements.

Abstract:
In 1968, Beaver published his seminal paper on the information content of earnings announcements, establishing that both trading volume and return volatility increase at the time of earnings announcements. Thirty-some years after Beaver's study, concerns have been raised about a perceived degradation in the informativeness of earnings because of the increasing availability of timely non-accounting information and the increasing rate of technological innovation and change not reflected in the accounting system in a timely manner.

In this paper we examine changes over the past thirty years in the information content of earnings using the two metrics from Beaver (1968): abnormal trading volume and volatility. In contrast to the conventional wisdom, we find no evidence of a decline in the informativeness of accounting information over the past thirty years, as measured by both abnormal trading volume and return volatility around quarterly earnings announcements. If anything, our results suggest an increase over time in the informativeness of quarterly earnings announcements. Variables reflecting changes in firm-specific factors account for a portion of the observed increase.

Abstract:
This paper tests the sharply differing predictions that emerge in Ohlson?s (1995) model from two assumptions about other information v that is reflected in a firm?s equity market value but not in its current financial statements. We find that neither assumption cleanly fits the data. If v is assumed to be zero, the regression multiple relating dividends to equity market value is reliably positive when it is predicted to be negative. Alternatively, if v impacts future abnormal earnings via Ohlson?s modified AR(1) information dynamic, then the signs on the multiples on current period net income and net capital stock outflows are positive and negative, respectively, when they should be the opposite. Our explanation for these anomalies is that dividends play a profitability-signaling role that is ruled out by Ohlson?s model. Consistent with this, we find that the multiple relating dividends to equity market value is more positive for loss firms, and that Ohlson?s information dynamics are violated in that larger dividends are associated with larger future abnormal earnings, especially for loss firms. Surprisingly, holding constant this profitability-signaling role of dividends, equity market values appear reasonably consistent with v being zero. This implies that the role of information outside key aggregate accounting numbers in current financial statements in setting prices may be more limited than previously thought. Equivalently, current accounting rules may capture the economic information reflected in stock prices in a more timely manner than is typically thought.

Abstract:
This study uses out-of-sample equity value estimates to determine whether earnings disaggregation, imposing valuation model linear information (LIM) structure, and separate industry estimation of valuation model parameters aid in predicting contemporaneous equity values. We consider three levels of earnings disaggregation: aggregate earnings, cash flow and total accruals, and cash flow and four major components of accruals. For pooled estimations, imposing the LIM structure results in significantly smaller prediction errors; for by-industry estimations, it does not. However, by-industry prediction errors are substantially smaller, suggesting the by-industry estimations are better specified. Mean prediction errors are smallest when disaggregating earnings into cash flow and major accrual components; median prediction errors are smallest when disaggregating earnings into cash flow and total accruals. These findings suggest that (1) If concern is with errors in the tails of the equity value prediction error distribution, then earnings should be disaggregated into cash flow and the major accrual components; otherwise earnings should be disaggregated only into cash flow and total accruals. (2) Imposing the LIM structure is not costly; (3) Valuation of abnormal earnings, accruals, accrual components, equity book value, and other information varies significantly across industries.

Accruals, Valuation, Out-of-sample prediction

Abstract:
I identify issues that bank regulators need to consider if fair value accounting is used for determining bank regulatory capital and when making regulatory decisions. In financial reporting, US and international accounting standard setters have issued several disclosure and measurement and recognition standards for financial instruments and all indications are that both standard setters will mandate recognition of all financial instruments at fair value. To help identify important issues for bank regulators, I briefly review capital market studies that examine the usefulness of fair value accounting to investors, and discuss marking-to-market implementation issues of determining financial instruments' fair values. In doing so, I identify several key issues. First, regulators need to consider how to let managers reveal private information in their fair value estimates while minimising strategic manipulation of model inputs to manage income and regulatory capital. Second, regulators need to consider how best to minimise measurement error in fair values to maximise their usefulness to investors and creditors when making investment decisions, and to ensure bank managers have incentives to select investments that maximise economic efficiency of the banking system. Third, cross-country institutional differences are likely to play an important role in determining the effectiveness of using mark-to-market accounting for financial reporting and bank regulation.

Fair values, financial instruments, information asymmetry

Abstract:
In this study, we extend the findings of Barth, Beaver, Hand, and Landsman (1999) by providing empirical evidence that for three levels of disaggregated earnings, (1) the structure provided by the Feltham-Ohlson model aids in predicting equity market values, and (2) forecasting of equity market values based on firms partitioned into industry groupings is superior to constraining all firms to have the same model parameters. We also find that disaggregating earnings into cash flows and total accruals generally yields better forecasts of equity market values. However, the efficacy of further disaggregation of total accruals into its primary components for forecasting equity market values appears to be industry-specific.

Abstract:
We examine whether the price response to bad and good earnings shocks changes as the relative level of the market changes. The study is based on a complete sample of annual earnings announcements during the period 1988 to 1998. The relative level of the market is based on the difference between the current market P/E the average market P/E over the prior 12 months. We find that the stock price response to negative earnings surprises increases as the relative level of the market rises. Furthermore, the difference between bad news and good news earnings response coefficients rises with the market.

Abstract:
We provide evidence that the asymmetrical price reaction to bad news at earnings announcements is most pronounced when overall market price-earnings ratios are high. This finding is consistent with both unwarranted investor optimism and investor uncertainty. However, evidence also indicates that the difference between earnings responses to good and bad news exhibit a U-shape in the level of the market, which is consistent with Veronesi's (1999) model of investor uncertainty. However, the response to both good and bad news increases at low market levels. Although this is inconsistent with Veronesi (1999), it may be attributable to the leverage effect discussed in Black (1976).

Abstract:
In this study we compare the ability of alternative accounting methods for employee stock options (ESOs) to reflect firm value using the Ohlson [1995, 1999] and Feltham-Ohlson [1999] valuation models for a sample of 85 computer software firms. The three methods we compare are APB 25, ESO expense recognition based on SFAS 123 disclosures, and asset recognition at grant date based on the Exposure Draft: Accounting for Stock-Based Compensation. We estimate abnormal earnings forecasting and valuation equations for each accounting method. Findings suggest that the method of recognition of an asset at grant date best reflects the market?s valuation of ESO transactions. A robustness test indicates the asset may have a useful life longer than the option vesting period. An additional robustness test indicates that findings are not the result of endogeneity bias.

Abstract:
We examine how analysts respond to public information when setting stock recommendations. We model the determinants of analysts' recommendation changes following large stock price movements. We find evidence of an asymmetry following large positive and negative returns. Following large stock price increases, analysts are equally likely to upgrade or downgrade. Following large stock price declines, analysts are more likely to downgrade. This asymmetry exists after accounting for investment banking relationships and herding behavior. This result suggests recommendation changes are "sticky" in one direction, with analysts reluctant to downgrade. Moreover, this result implies that analysts' optimistic bias may vary through time.

Analyst Recommendations

Abstract:
This study examines how analysts respond to public information when setting their stock recommendations. Specifically, for a sample of stocks that experience large stock price movements, we model the determinants of analysts' recommendation changes. Using an ordered probit model based on all available IBES stock recommendations from 1993 to 1999, we find evidence of an asymmetry following large positive and negative returns. Large stock price changes are associated with more frequent changes in analyst's recommendations. Following large stock price increases, analysts are equally likely to upgrade or downgrade. Following large stock price declines, however, analysts are much more likely to downgrade the company's stock. This asymmetry exists even after accounting for investment banking relationships and herding behavior. Further, this asymmetry cannot be explained by differences in the predictability of future returns. This result suggests that recommendation changes are "sticky" in one direction, with analysts reluctant to downgrade securities. Moreover, this result implies that analysts' optimistic bias is not static, but varies through time.

Analyst Recommendations

Abstract:
We use the residual income valuation framework to compare the equity valuation implications of four approaches to employee stock options (ESOs) accounting proposed by regulators: APB 25 "recognize nothing", SFAS 123 preferred "recognize ESO expense", FASB Exposure Draft "recognize and expense ESO asset" and "recognize ESO asset and ESO liability". Our theoretical analysis shows that only a version that involves grant date recognition of an asset and a liability, and subsequent marking-to-market of the liability, results in accounting numbers that accurately reflect the dilution effects of ESOs on current shareholder value. The other accounting methods lead to overstatement of current equity value. Out-of-sample and in-sample empirical tests are used to assess value relevance of the four accounting methods. The out-of-sample tests compare contemporaneous equity market value predictions based on each of the four methods. The in-sample tests compare the model explanatory power from estimating equations relating to each of the four accounting methods. The out-of-sample tests indicate the method with grant date asset and liability recognition has the lowest prediction errors, followed by the Exposure Draft method, the SFAS 123 method, and the APB 25 method. Findings from the in-sample tests are largely consistent with our theoretical expectations and provide support for the grant date recognition of an ESO asset and liability.

Employee stock options, value relevance

Abstract:
This study addresses whether asset securitizations are really asset sales or a form of secured borrowing, by estimating cross-sectional equity valuation regressions to assess whether the stock market treats securitized assets and liabilities held by a special purpose entity (SPE) as assets and liabilities of the sponsor-originator (S-O). Overall, we find that the market views the SPE assets and liabilities as belonging to the S-O, i.e., the risk and rewards of ownership of the transferred assets reside with the S-O and not the SPE. Results from a boot-strapping simulation that controls for scale by randomly assigning SPE assets and liabilities from one S-O to another provide evidence that scale bias is an unlikely explanation for finding the market views SPE assets and liabilities as belonging to the S-O. Findings from specifications in which we permit coefficients to differ for S-O firms with high and low relative levels of retained interest indicate that whereas the market views asset securitizations by low retained interest S-O firms as sales, i.e., risk transfer has taken place, it views asset securitizations by high retained interest S-O firms as secured borrowings, i.e., risk transfer is incomplete. We also show that although the market views securitizations by regulated and unregulated S-Os as secured borrowing, there is suggestive evidence that regulated firms have greater incentives to use securitizations to achieve off-balance sheet financing.

securitizations, SPE, SFAS 140, guarantee

Abstract:
We provide evidence that firms with more transparent earnings enjoy a lower cost of capital. We develop an earnings transparency measure that captures cross-sectional and intertemporal variation in the extent to which earnings and change in earnings covary contemporaneously with stock returns. We find that firms with more transparent earnings have a lower cost of capital as reflected in cross-sectional variation in subsequent excess returns and mean differences in returns, after controlling for the Fama-French and momentum factors. We also find that more transparent earnings are significantly negatively associated with expected equity cost of capital. Prior research reports a significant relation between a value relevance measure, which bears some resemblance to our earnings transparency measure, and cost of capital. We show that these relations are not significant after correcting for cross-sectional correlation in residuals, which is consistent with the measure used in prior research lacking intertemporal variation.

accounting procedures, asset pricing, financial statements, risk

Abstract:
This study addresses potential simultaneity bias and underidentification in the Hayn (1995) and Basu (1997) piecewise linear specifications. First, we replicate the original studies. Before moving to simultaneous estimation, we test the robustness of the original Basu specification to standard error clustering, and provide evidence that in single-equation estimation, both the Basu and Hayn results survive standard error clustering but with increased standard errors. Next, we specify an exactly identified system of simultaneous equations that incorporates the Basu (1997) and Hayn (1995) specifications, and perform two-stage least squares estimation to remove simultaneity bias. The two-stage least squares procedure using the sample period 1963-1990 produces an 'asymmetric timeliness coefficient' that is not significantly different from zero at conventional levels, even before correcting for times series and cross sectional dependence via standard error clustering. Using two-stage least squares with two-way clustered standard errors, the 'asymmetric timeliness coefficient' is not significant at conventional levels using any sample period we consider. Further, the main effect price response coefficient increases compared with the OLS benchmark, consistent with the removal of coefficient bias. The companion equation in the simultaneous system can be viewed as an alternate formulation of the Hayn (1995) specification. Interestingly, the Hayn (1995) result persists under all specifications. This is consistent with evidence in Beaver et al. (1997) that simultaneity bias is particularly problematic for return response coefficients as compared to earnings response coefficients.

Conservatism, Earnings Persistence, Returns-Earnings Relation

Abstract:
This study examines how analysts respond to public information when setting their stock recommendations. Specifically, for a sample of stocks that experience large stock price movements, we model the determinants of analysts' recommendation changes. Using an ordered probit model based on all available IBES stock recommendations from 1993 to 1999, we find evidence of an asymmetry following large positive and negative returns. Large stock price changes are associated with more frequent changes in analyst's recommendations. Following large stock price increases, analysts are equally likely to upgrade or downgrade. Following large stock price declines, however, analysts are much more likely to downgrade the company's stock. This asymmetry exists even after accounting for investment banking relationships and herding behavior. Further, this asymmetry cannot be explained by differences in the predictability of future returns. This result suggests that recommendation changes are "sticky" in one direction, with analysts reluctant to downgrade securities. Moreover, this result implies that analysts' optimistic bias is not static, but varies through time.

Analyst recommendations

Abstract:
This study examines whether the information content of earnings announcements increases in countries following mandatory IFRS adoption. We examine two measures of information content from Beaver (1968), abnormal return volatility and abnormal trading volume, across 16 countries before and after they mandated adoption of IFRS, relative to 11 countries that retained domestic accounting standards. The evidence suggests that information content, as measured by abnormal return volatility at earnings announcements, increased in countries that mandated adoption of IFRS relative to those that maintained domestic accounting standards. There is less evidence of an association between IFRS adoption and abnormal trading volume at earnings announcements. We find that increases in abnormal return volatility are concentrated in countries with Scandinavian, German, and French legal origin versus English legal origin.

IFRS, Earnings Announcements, Information Content

Abstract:
We examine the determinants and consequences of the split of options between executive and non-executive employees. We find that the proportion of options granted to executives is lower the stronger is firm governance. For the sample as a whole, the relation between options and both operating income and valuation is weaker for executive options than for options to lower-level employees. Splitting the sample between weak and strong governance firms, for the weak (strong) governance firms, the relation between executive options and firm performance and valuation is weaker (stronger) relative to non-executive options. Results are robust to controls for the endogeneity of option granting choice. Taken as a whole, our results suggest that firms with relatively weak governance tend to give a larger proportion of options to executives and appear to receive relatively less benefit from those options.

Employee Stock Options, Executive Stock Options, Broad-Based Options, Governance

Abstract:
The longstanding debate over the proper definition of earnings - whether investors when setting stock prices focus primarily on GAAP earnings or other measures like operating cash flow - is both misguided and theoretically unresolvable. The biggest problem faced by investors in evaluating earnings reports is not their inability to understand the effects of the different accounting methods companies use when aggregating accounting line items into reported net income. More challenging, and more critical to the investment process, is getting complete and reliable information about the line items themselves. The authors' underlying premise is that investors, when provided sufficient information about these components of earnings, can combine or reconfigure them in whatever way they find most useful. But without sufficient and reliable information about the individual line items, investors will find it difficult to understand how earnings are generated and thus to produce the forecast of future earnings necessary to value a company.

In the past few years, there have been significant rule changes in accounting for employee options, derivatives, and special purposes entities. The authors evaluate the extent to which the new rules encourage disclosures that are helpful from a valuation perspective. Although there has been some progress, financial reporting in each of the three areas continues to fall well short of providing the complete, disaggregated data required to value a firm with confidence.

Abstract:
This study addresses three research questions relating to total exclusions, special items, and other exclusions. Are each of these pro forma exclusion components forecasting irrelevant? Are each of the exclusion components value irrelevant? Are the valuation multiples on the exclusion components justified by their ability to forecast future profitability as predicted by the Ohlson (1999) model? Findings are generally consistent with the market-inefficiency results presented in Doyle et al. (2003). Total exclusions are valued negatively by the market despite the prediction that total exclusions will be valued positively. Valuation results also suggest that stocks with positive other exclusions are overpriced.

Abstract:
No abstract available.

Abstract:
We investigate whether the equity market reacted differentially to the various classes of asset writedowns that occurred during the Financial Crisis of 2007-2008. We analyze announcement effects on stock returns, stock price bid-ask spreads, volatility implied in option prices of bank equities, and trading volume. None of the announcements has a significant effect on stock returns. We predict and find evidence of an increase in bid-ask spreads associated with retained interest and CDO writedown announcements, and loan loss announcements. The magnitude of the spread increase is greatest for retained interest writedowns. Relatedly, we also predict and find that implied equity volatility increases with retained interest writedown announcements, which is consistent with such announcements increasing investor uncertainty. In contrast, consistent with loan losses reducing investor uncertainty, we predict and find the large loan loss announcements are associated with a decrease in implied volatility. Lastly, we also predict and find evidence of an increase in abnormal trading volume with each of the three impairment announcements, which is consistent with such announcements increasing investor disagreement. Taken together, our findings provide strong evidence that retained interest writedowns result in a large increase in investor uncertainty. The significant increase in spreads and implied volatility in particular suggest that investors became concerned that implicit guarantees associated with assets retained from securitizations could expose banks to the risk of substantial future losses far in excess of the recognized losses.

securitizations, asset writedowns, retained interest, information asymmetry, financial crisis, financial institutions

Abstract:
We present a comprehensive analysis of the association between stock returns, quarterly earnings forecast errors, and quarter-ahead and year-ahead earnings forecast revisions. We find that forecast errors and the two forecast revisions have significant effects on stock prices, indicating each conveys information content. Findings also show that the fourth quarter differs from other quartersthe relative importance of the forecast error (quarter-ahead forecast revision) is lower (higher). We also find a marked upward shift over time in the forecast error and forecast revision coefficients, consistent with the I/B/E/S database reflecting an improved quality of both earnings forecasts and actual earnings.

Abstract:
Using a comprehensive sample of switches to and from the largest auditors (i.e., the Big N), we examine empirically whether the sensitivity of Big N auditor switches to client risk and misalignment changed between the pre- and post-Enron periods. Although we find an increase in the sensitivity to client misalignment, the sensitivity to client risk generally decreases. The results are consistent with Big N auditors rebalancing their audit client portfolios in response to post-Enron capacity constraints arising from the supply of former Arthur Andersen clients and the audit demands imposed by Sarbanes-Oxley rather than increasing their sensitivity to client risk. Additional evidence indicates that the Sarbanes-Oxley demand shock did not affect Big N auditor switching behavior incremental to the initial Andersen supply shock.

Auditor change, audit risk, audit firm portfolios

Abstract:
We examine whether the price response to bad and good earnings shocks changes as the relative level of the market changes. The study is based on a complete sample of annual earnings announcements during the period 1988 to 1998. The relative level of the market is based on the difference between the current market P/E and the average market P/E over the prior 12 months. We find that the stock price response to negative earnings surprises increases as the relative level of the market rises. Furthermore, the difference between bad news and good news earnings response coefficients rises with the market.

Abstract:
We use the Ohlson (1995, 1999) and Feltham-Ohlson (1999) valuation models to compare the extent to which Accounting Principles Board Opinion 25: Accounting for Stock Issued to Employees (APB 25), Statement of Financial Accounting Standards No. 123: Accounting for Stock-Based Compensation (SFAS 123), and the Exposure Draft: Accounting for Stock-Based Compensation reflect the market's assessment of the effects of employee stock options on firm value for a sample of 85 profitable computer software firms. Findings from the SFAS 123 approach indicate the market appears to value ESO expense not as an expense but as an asset. Most notably, the results suggest that investors perceive that employee stock options create an intangible asset that they value more highly than other assets of the firm. The Exposure Draft approach, according to our findings, best captures the market's perception of the economic effect of employee stock options (ESO) on firm value for profitable computer software companies. However, we find a conflict in (1) the positive manner in which investors appear to value ESO expense, and (2) the negative relation between current ESO expense and future abnormal earnings. This conflict could be a an artifact of the restrictiveness of the abnormal earnings forecasting equation we estimate, although it also calls into question whether investors in profitable software companies assess correctly the effect of ESOs on profitable software firms value.

Abstract:
This study examines the relation between fair value disclosures under Statement of Financial Accounting Standards No. 107 (SFAS 107) and bank share prices. Our goal is to determine whether fair value disclosures explain cross-sectional variation in bank common share prices beyond that provided by the reported book value of common equity and other potentially informative disclosures in a way consistent with our predictions. As predicted, we find that fair values of securities and loans possess significant incremental explanatory power and are reflected positively in bank share prices. However, contrary to our predictions, the fair values of deposits, long-term debt, and off-balance sheet items provide no incremental explanatory power. One specification that includes a proxy for "core deposit" intangibles -- a variables not covered by SFAS 107 -- indicates that core deposits are reflected positively in bank share prices.

Abstract:
This study provides evidence that fair value estimates of loans, securities and long-term debt disclosed under SFAS No. 107 provide significant explanatory power for bank share prices beyond that provided by related book values. In contrast to Eccher et al. (1996) and Nelson (1996), we consistently find incremental explanatory power for loans' fair values. Relatively stronger findings are obtained using a set of significant conditioning variables, including nonperforming loans, and interest-sensitive assets and liabilities. The joint significance of these loan-related variables and loans' fair values indicates that loans' fair values do not reflect completely loan default and interest rate risk. The loans coefficient is significantly larger for banks with higher regulatory capital, which is consistent with market participants discounting unrealized gains on loans disclosed by less healthy banks. The findings are robust with respect to the inclusion of additional explanatory variables and to a first differences formulation.

Abstract:
Many of the Financial Accounting Standards Board's current agenda items relate to measuring financial instruments' fair values, many of which have option-like characteristics. This study presents evidence on the potential practical applicability of using option pricing theory to account for one financial instrument and its components, corporate debt. We implement two alternative versions of the binomial option pricing approach to estimate values for corporate debt and its components, including straight debt and conversion, call, put, and sinking fund features. Comparisons of total debt model estimates to available market values indicate they are quite close when equity volatility is implied by the model; model estimates generally exceed market values when it is forced to equal the historical estimate. Components' value estimates empirically are sensitive to estimation order. Most notably, call and conversion features affect each other's estimates, and both affect put feature's estimates. Sensitivity analyses of model estimates to dividend payout and equity volatility assumptions indicate that they vary little with all but extreme changes in these parameters.

Abstract:
This study tests hypotheses about effects of the abandonment option on equity book value and net income valuation characteristics. As predicted, pricing multiples on and explanatory power of book equity (net income) increase (decrease) as firms approach liquidation or bankruptcy. Also, pricing multiples on and explanatory power of book equity (net income) are higher (lower) for approximately one-half of Compustat firms classified as less financially healthy, providing evidence inferences are not limited to firms approaching extreme financial distress. Net income and equity book value valuation characteristics vary predictably across three illustrative industries, selected based on extent of unrecognized intangible assets.