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Abstract:
Accounting in shaped by economic and political forces. It follows that increased worldwide integration of both markets and politics (driven by reductions in communications and information processing costs) makes increased integration of financial reporting standards and practice almost inevitable. But most market and political forces will remain local for the foreseeable future, so it is unclear how much convergence in actual financial reporting practice will (or should) occur. Furthermore, there is little settled theory or evidence on which to build an assessment of the advantages and disadvantages of uniform accounting rules within a country, let alone internationally. The pros and cons of IFRS therefore are somewhat conjectural, the unbridled enthusiasm of allegedly altruistic proponents notwithstanding. On the "pro" side of the ledger, I conclude that extraordinary success has been achieved in developing a comprehensive set of "high quality" IFRS standards, in persuading almost 100 countries to adopt them, and in obtaining convergence in standards with important non-adopters (notably, the U.S.). On the "con" side, I envisage problems with the current fascination of the IASB (and the FASB) with "fair value accounting." A deeper concern is that there inevitably will be substantial differences among countries in implementation of IFRS, which now risk being concealed by a veneer of uniformity. The notion that uniform standards alone will produce uniform financial reporting seems naive. In addition, I express several longer run concerns. Time will tell.

International accounting standards, IAS, IFRS, fair value accounting

Abstract:
The East Asian countries of Hong Kong, Malaysia, Singapore and Thailand provide a rare opportunity to study the interaction between the accounting standards under which financial statements are prepared and the incentives of managers and auditors who prepare them. Their accounting standards are largely derived from common law sources [UK, US and International Accounting Standards (IAS)], which are widely viewed as higher quality than code law standards. However, economic and political influences on preparers' incentives predict low quality financial reporting. We show that reported earnings in these countries generally are no higher in quality than in code law countries. We define quality as timeliness in incorporating economic income (particularly economic losses).

Countries frequently are classified in terms of accounting standards, or standard-setting institutions. Examples include international accounting literature and texts; compilation of transparency indexes; advocacy of financial reporting reform; and advocacy of International Accounting Standards (IAS). Our results imply this is incomplete and misleading without adequate consideration of preparer incentives.

Asia, Hong Kong, Malaysia, Singapore, Thailand, International Accounting Standards, information asymmetry, Financial reporting quality, transparency, timeliness, conservatism

Abstract:
International differences in the demand for accounting income predictably affect the way it incorporates economic income (dividend-adjusted change in market value) over time. We characterize the "shareholder" and "stakeholder" corporate governance models of common and code law countries respectively as resolving information asymmetry by public disclosure and private communication. Also, code law directly links accounting income to current payouts (to employees, managers, shareholders and governments). Consequently, code law accounting income is less timely, particularly in incorporating economic losses. Regulation, taxation and litigation cause variation among common law countries. The results have implications for security analysts, standard-setters, regulators, and corporate governance.

Abstract:
UK private and public companies face substantially equivalent regulation on auditing, accounting standards and taxes. We hypothesize that private-company financial reporting nevertheless is lower quality due to different market demand, regulation notwithstanding. A large UK sample supports this hypothesis. Quality is operationalized using Basu's (1997) time-series measure of timely loss recognition and a new accruals-based method. The result is not affected by controls for size, leverage, industry membership and auditor size, or by allowing endogenous listing choice. The result enhances understanding of private companies, which are predominant in the economy. It also provides insight into the economics of accounting standards.

Earnings quality, conservatism, loss recognition, private firms, economics of accounting standards, earnings time series, accruals

Abstract:
UK private and public companies face substantially equivalent regulation on auditing, accounting standards and taxes. We hypothesize that private-company financial reporting nevertheless is lower quality due to different market demand, regulation notwithstanding. A large UK sample supports this hypothesis. Quality is operationalized using Basu's (1997) time-series measure of timely loss recognition and a new accruals-based method. The result is not affected by controls for size, leverage, industry membership and auditor size, or by allowing endogenous listing choice. The result enhances understanding of private companies, which are predominant in the economy. It also provides insight into the economics of accounting standards.

Earnings quality; conservatism; loss recognition; private firms; economics of accounting standards; earnings time series; accruals.

Abstract:
Despite its popularity, the asymmetric timeliness coefficient has been challenged as a valid measure of conditional conservatism. We propose a model in which accounting income contemporaneously incorporates one component of price revision, incorporates another with a lag unless below a threshold (e.g., losses), invariably incorporates another with a lag, and adds uncorrelated “noise.” We demonstrate validity in this framework. We derive a negative relation between asymmetric timeliness coefficients and the proportion of price changes associated with growth option expectation revisions (proxied by market-to-book), due to lagged recognition. We conclude much criticism of the coefficient misconstrues research objectives.

conditional conservatism, asymmetric timeliness, earnings

Abstract:
Financial reporting around the time of IPOs is consistent with listed firms reporting more conservatively than previously as private firms, consistent with the results in Ball and Shivakumar (2005). We hypothesize that IPO firms supply the higher quality financial reports demanded by public investors, who face higher information asymmetry than private investors. The market mechanisms for enforcing this demand include monitoring by internal and external auditors, boards, analysts, rating agencies, the press and other parties. Once public, firms are subject to greater regulatory scrutiny and penalties. From the point of releasing the public prospectus document onwards, IPO firms face a greater threat of shareholder litigation and regulatory action if they do not meet higher reporting standards. The evidence is overwhelmingly in favor of this hypothesis. We show that the evidence reported by Teoh, Welch and Wong (1998) in support of the alternative hypothesis, that IPO firms opportunistically inflate earnings to influence the IPO price, is unreliable for a variety of reasons. We provide cleaner evidence, from samples of U.K. and U.S. IPOs, that IPO prospectus financials are conservative by several standards. We conjecture that the types of bias we observe in conventional estimates of 'discretionary' accruals occur in a broad genre of studies on earnings management around large transactions and events.

IPO, earnings management, conservatism, earnings quality

Abstract:
Financial reporting around the time of IPOs is consistent with listed firms reporting more conservatively than previously as private firms, consistent with the results in Ball and Shivakumar (2005). We hypothesize that IPO firms supply the higher quality financial reports demanded by public investors, who face higher information asymmetry than private investors. The market mechanisms for enforcing this demand include monitoring by internal and external auditors, boards, analysts, rating agencies, the press and other parties. Once public, firms are subject to greater regulatory scrutiny and penalties. From the point of releasing the public prospectus document onwards, IPO firms face a greater threat of shareholder litigation and regulatory action if they do not meet higher reporting standards. The evidence is overwhelmingly in favor of this hypothesis. We show that the evidence reported by Teoh, Welch and Wong (1998) in support of the alternative hypothesis, that IPO firms opportunistically inflate earnings to influence the IPO price, is unreliable for a variety of reasons. We provide cleaner evidence, from samples of U.K. and U.S. IPOs, that IPO prospectus financials are conservative by several standards. We conjecture that the types of bias we observe in conventional estimates of "discretionary" accruals occur in a broad genre of studies on earnings management around large transactions and events.

IPO, earnings management, conservatism, earnings quality

Abstract:
This short essay is based on a presentation at the panel discussion on Big Unanswered Questions in Accounting at the American Accounting Association Meetings in 2007. It poses the question: what is the actual economic role of financial reporting? and discusses why this question is important, why it is unanswered, and what types of inventive research design are needed to help answer it. Examples are given of the types of questions involved.

financial reporting, accounting, research design

Abstract:
This short essay is based on a presentation at the panel discussion on "Big Unanswered Questions in Accounting" at the American Accounting Association Meetings in 2007. It poses the question "what is the actual economic role of financial reporting?" and discusses why this is an important question, why it is unanswered, and the types of inventive research design needed to help answer it. Examples of the types of questions involved are given.

financial reporting, accounting, research design

Abstract:
We investigate the role of accrual accounting in the asymmetrically timely recognition of unrealized gains and losses (i.e., prior to the actual realization of those losses in cash). This role of accrual accounting has not been directly recognized in the literature. We show that non-linear accruals models are a substantial specification improvement, explaining up to three times the amount of variation in accruals as conventional linear specifications such as Jones (1991). Conversely, we conclude that conventional linear accruals models, by omitting the role of accruals in asymmetrically timely loss recognition, offer a comparatively poor specification of the accounting accrual process. We also conclude that linear specifications of the relation between earnings and future cash flows, ignoring the implications of asymmetrically timely loss recognition (conditional conservatism), substantially understate the ability of current earnings to predict future cash flows. These findings have important implications for our understanding of accrual accounting, and for researchers using estimates of discretionary accruals, earnings management and earnings quality from misspecified linear accruals models.

accruals, timely recognition, gain/loss recognition, accruals model

Abstract:
We hypothesize debt markets - not equity markets - are the primary influence on association metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) RSQ, because debt covenants utilize reported numbers. Equity markets do not rate financial reporting consistently with these metrics, because (among other things) they control for the total information incorporated in equity prices.

Single-country studies shed little light on the relative influences of debt and equity, because their firms operate under a homogeneous reporting regime. International data are consistent with our hypothesis. This is a fundamental issue in accounting.

reporting quality, association studies, conservatism, timeliness, international

Abstract:
We hypothesize debt markets - not equity markets - are the primary influence on "association" metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) R2, because debt covenants utilize reported numbers. Equity markets do not rate financial reporting consistently with these metrics, because (among other things) they control for the total information incorporated in equity prices. Single-country studies shed little light on the relative influences of debt and equity, because their firms operate under a homogeneous reporting regime. International data are consistent with our hypothesis. This is a fundamental issue in accounting.

reporting quality, association studies, conservatism, timeliness, international

Abstract:
We quantify the relative importance of earnings announcements in providing new information to the share market, using the r-squared in a regression of securities' calendar year returns on their four quarterly earnings announcement window returns. The r-squared, which averages approximately five to nine percent, measures the proportion of total information incorporated in share prices over a year that is associated with earnings announcements. We conclude that the average quarterly announcement is associated with approximately one to two percent of total annual information and one quarter of one percent of annual trading volume, thus providing only a modest amount of incremental information to the market. The results are consistent with the view that the primary economic role of reported accounting earnings is not to provide timely new information to the share market, and by inference lies elsewhere, for example in settling contracts (Watts and Zimmerman, 1986) and in disciplining prior expectational information (Gigler and Hemmer, 1998; Ball, 2001). We also report increased information during earnings announcement windows in recent years, particularly in larger firms, due in part to increased concurrent releases of management forecasts. There is a convex relation between relative informativeness during earnings event windows and firm size. There is no evidence of abnormal information arrival in the weeks surrounding earnings announcements. Substantial information is released in analyst forecast revisions prior to earnings announcements, but not after.

earnings, timeliness, analyst forecasts, management forecasts, efficiency

Abstract:
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What caused the scandalous behavior? Why was there such a rash of accounting scandals at one time? Who killed Arthur Andersen – the SEC, or the market? Did fraudulent accounting kill Enron, or just keep it alive for too long? What is the social cost of financial reporting fraud? Does the US in fact operate a “principles-based” or a “rules-based” accounting system? Was there market failure? Or was there regulatory failure? Or both? Was the Sarbanes-Oxley Act a political and regulatory over-reaction? Does the U.S. follow an ineffective regulatory model?

Abstract:
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What caused the scandalous behavior? Why was there such a rash of accounting scandals at one time? Who killed Arthur Andersen - the SEC, or the market? Did fraudulent accounting kill Enron, or just keep it alive for too long? What is the social cost of financial reporting fraud? Does the US in fact operate a "principles-based" or a "rules-based" accounting system? Was there market failure? Or was there regulatory failure? Or both? Was the Sarbanes-Oxley Act a political and regulatory over-reaction? Does the U.S. follow an ineffective regulatory model?

Abstract:
A principal-components analysis demonstrates that common earnings factors explain a substantial portion of firm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the systematic components of earnings and returns is stable over time. We also show that the earnings factors are priced, in the sense that the sensitivities of securities' returns to the earnings factors explain a significant portion of the cross-sectional variation in returns, even controlling for return risk. This suggests earnings performance is an underlying source of priced risk. Our evidence that the information sets of returns and earnings are jointly determined implies cash-flow risk and return risk are not fully separable, and raises the possibility that it is the common variation of earnings and returns that is priced.

Aggregate earnings, aggregate returns, excess volatility, anomalies

Abstract:
We examine the complementarity between voluntary disclosure and reporting audited financial statement outcomes. We test the “confirmation” hypothesis, that reporting audited, backward-looking outcomes disciplines and hence enhances the precision and credibility of managers’ disclosure of private forward-looking information. Using management earnings forecasts as the voluntary disclosure variable, we report that committing to higher audit fees (a measure of the extent of financial statement verification and thus the accuracy and freedom from manipulation of reported outcomes), is associated with more frequent and more specific management forecasts, and with a larger market reaction to forecasts. These relations are not driven by litigation risk and are robust to a variety of controls. Disclosure of private information and audited financial reporting play complementary roles, which implies they cannot be evaluated separately.

Voluntary disclosures, earnings announcements, confirmation hypothesis

Abstract:
The sharp economic downturn and turmoil in the financial markets, commonly referred to as the “global financial crisis,” has spawned an impressive outpouring of blame. The efficient market hypothesis - the idea that competitive financial markets ruthlessly exploit all available information when setting security prices - has been singled out for particular attention. Like all good theories, market efficiency has major limitations, even though it continues to be the source of important and enduring insights. Despite the theory’s undoubted limitations, the claim that it is responsible for the current worldwide crisis seems wildly exaggerated. This essay discusses many of those claims. These include claims that belief in the notion of market efficiency was responsible for an asset bubble, for investment practitioners miscalculating risks, and for regulators worldwide falling asleep at the switch. Other claims are that the collapse of Lehman Bros. and other large financial institutions implies market inefficiency, and that an efficient market would have predicted the crash. These claims are without merit. Despite the evidence of widespread anomalies and the advent of behavioral finance, we continue to follow practices that assume efficient pricing.

market efficiency, asset bubbles, financial crisis

Abstract:
The East Asian countries of Hong Kong, Malaysia, Singapore and Thailand provide a rare opportunity to study the interaction between the accounting standards under which financial statements are prepared and the incentives of managers and auditors who prepare them. Their accounting standards are largely derived from common law sources [UK, US and International Accounting Standards (IAS)], which are widely viewed as higher quality than code law standards. However, economic and political influences on preparers' incentives predict low quality financial reporting. We show that reported earnings in these countries generally are no higher in quality than in code law countries. We define quality as timeliness in incorporating economic income (particularly economic losses).

Countries frequently are classified in terms of accounting standards, or standard-setting institutions. Examples include international accounting literature and texts; compilation of transparency indexes; advocacy of financial reporting reform; and advocacy of International Accounting Standards (IAS). Our results imply this is incomplete and misleading without adequate consideration of preparer incentives.

Asia, Hong Kong, Malaysia, Singapore, Thailand, International Accounting Standards, information asymmetry, Financial reporting quality, transparency, timeliness, conservatism

Abstract:
Research on trading rule profitability usually simulates trading on historical data. These data usually are obtained from files such as CRSP, which estimate closing prices as the last trade (at the closing bid or the closing ask, or neither), or the bid-ask average (in the absence of a last trade). A trading rule could not normally be implemented at these prices, for even a smaller number of shares. A simulated contrarian strategy transforms noise in closing price estimates into return biases, by buying at predominantly bid prices and shorting at ask, which is not implementable for most investors. The bias in estimated contrarian portfolio returns is severe. For example, when returns are calculated from successive bid prices of NASDAQ stocks, short-term contrarian profits largely disappear

Abstract:
We conjecture that accounting depreciation reduces the over- and under-investment problem in acquiring and utilizing fixed assets. By forcing the agent to cover depreciation charges of assets the agent proposes to buy, the agent commits to generate cash flows in excess of depreciation charges (through either additional revenues or cost savings). Moreover, the book value of undepreciated historical cost commits the agent to maintain the asset's productive capacity. Various accounting techniques, including incorporating depreciation charges in product costs, operating budgets, and performance measures, help ensure commitments are recovered, thereby reducing the incentives to over- or under-invest in capital assets. Moreover, writing down assets when actual performance persistently falls below budget resets the remaining commitment level to a more realistically achievable level. Preliminary tests provide evidence consistent with one of the paper's implications.

Abstract:
We argue that accounting depreciation either is the firm s calculation of the cost of a durable factor, or is information used in determining (implicitly or explicitly) the factor cost. Simple competitive-economic theory then implies a relation between accounting depreciation and product prices. We hypothesize that this relation is strengthened by various accounting techniques, including the inclusion of depreciation charges in standard costs, budgets and actual performance measures, as well as asset write-offs when actual performance persistently falls below budget. Evidence from two steel industry samples shows a significant relation between percentage changes in accounting depreciation and product prices. The data are too aggregate to provide a direct test of the hypothesis, so we plan a more direct test on product-level data.

Abstract:
Rendleman Jones and Latane (1987) and Bernard and Thomas (1990) report evidence supporting their hypothesis that investors use a "naive" seasonal random walk model in forming expectations of quarterly earnings. Using the Bernard and Thomas (1990) data we show that the market acts as if it: (1) does not use a seasonal random walk model; (2) does incorporate past earnings changes in forming expectations; (3) does use the correct signs in exploiting serial correlation in seasonally-differenced quarterly earnings; but (4) underestimates the magnitude of the serial correlation. This evidence remains anomalous in the sense that it is consistent with neither the theory of efficient markets nor the "naive expectation model" hypothesis nor "behaviorial finance" theories.