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Abstract:
This paper compares the value relevance of book value and dividends versus book value and reported earnings. Our work is motivated by recent research including Ohlson (1995), Feltham and Ohlson (1995), Bernard (1995), Burgstahler and Dichev (1997), Collins, Maydew and Weiss (1997), Barth, Beaver and Landsman (1998) and Hand and Landsman (1999).We justify modeling price in terms of book value and dividends in two ways. First, usingModigliani and Miller's (1959) argument, dividends may have a stronger correlation with permanent earnings than reported earnings. Second, we derive a model of price in terms of book value and dividends from basic analytical relationships.Three sets of findings are reported. First, overall, the variables, book value and dividends, have almost the same explanatory power as book value and reported earnings. Second, for firms with transitory earnings, dividends have greater explanatory power than earnings but book value and earnings have about the same explanatory power as book value and dividends. Most important, when earnings are transitory and book value is a poor indicator of value, dividends have the greatest explanatory power of the three variables. The value relevance ofdividends is confirmed further in statistical tests using holdout samples.

Abstract:
This paper compares the value relevance of book value and dividends versus book value and reported earnings. Our work is motivated by recent research including Ohlson (1995), Feltham and Ohlson (1995), Bernard (1995), Burgstahler and Dichev (1997), Collins, Maydew and Weiss (1997), Barth, Beaver and Landsman (1998) and Hand and Landsman (1999).

We justify modeling price in terms of book value and dividends in two ways. First, using Modigliani and Miller's (1959) argument, dividends may have a stronger correlation with permanent earnings than reported earnings. Second, we derive a model of price in terms of book value and dividends from basic analytical relationships.

Three sets of findings are reported. First, overall, the variables, book value and dividends, have almost the same explanatory power as book value and reported earnings. Second, for firms with transitory earnings, dividends have greater explanatory power than earnings but book value and earnings have about the same explanatory power as book value and dividends.

Most important, when earnings are transitory and book value is a poor indicator of value, dividends have the greatest explanatory power of the three variables. The value relevance of dividends is confirmed further in statistical tests using holdout samples.

Abstract:
We examine the association between voluntary corporate disclosure and the informativeness of stock prices. We measure corporate disclosure using the AIMR-FAF annual corporate disclosure ratings. We define price informativeness by the association between current stock returns and future earnings changes: more informative stock price changes contain more information about future earnings changes. To measure this association, we use the multiple regression model of Collins, Kothari, Shanken, and Sloan (1994), wherein current returns are regressed against both current and future earnings changes and future stock returns. The aggregated coefficients on the future earnings changes, which we refer to as the future ERC, is our measure of infomativeness (association).

We hypothesize and find that greater disclosure is associated with greater price informativeness (i.e., higher future ERC). This is the first empirical evidence that enhanced disclosure results in stock prices that are more informative about future earnings, indicating that greater disclosure provides information benefits to the stock market.

In addition, the method we use to document the benefits of enhanced voluntary disclosure can be applied in other cases of interest to both academics and policymakers, such as assessing the benefits of additional required disclosures.

Key Words: Voluntary disclosure

Abstract:
This paper presents a new approach to studying the effects of earnings management, by testing whether income smoothing, a particular form of earnings management, is associated with more informative stock prices. Stock price informativeness is defined as the amount of information about future earnings and cash flows reflected in current period stock returns, and ismeasured as the coefficient on future earnings (cash flows) in a regression of current stock return against current and future earnings (cash flows and accruals). I find that firms with greater smoothing have more informative stock prices, implying that managers use income smoothing to reveal their private information about the firm s future profitability.

Abstract:
This paper presents a new approach to studying the effects of earnings management, by testing whether income smoothing, a particular form of earnings management, is associated with more informative stock prices. Stock price informativeness is defined as the amount of information about future earnings and cash flows reflected in current period stock returns, and is measured as the coefficient on future earnings (cash flows) in a regression of current stock return against current and future earnings (cash flows and accruals). I find that firms with greater smoothing have more informative stock prices, implying that managers use income smoothing to reveal their private information about the firm's future profitability.

income smoothing, stock price informativeness

Abstract:
This paper uses a new approach to examine whether income smoothing garbles earnings information or improves the informativeness of past and current earnings about future earnings and cash flows. We measure income smoothing by the negative correlation of a firm's change in discretionary accruals with its change in pre-managed earnings. Using the approach of Collins, Kothari, Shanken and Sloan (1994), we find that the change in the current stock price of higher-smoothing firms contains more information about their future earnings than does the change in the stock price of lower-smoothing firms. This result is robust to decomposing earnings into cash flows and accruals and to controlling for firm size, growth, future earnings variability, private information search activities, and cross-sectional correlations.

Income smoothing, future earnings response coefficient (FERC), earnings management, informativeness

Abstract:
This paper uses a new approach to examine whether income smoothing garbles earnings information or improves the informativeness of past and current earnings about future earnings and cash flows. We measure income smoothing by the negative correlation of a firm's change in discretionary accruals with its change in pre-managed earnings. Using the approach of Collins, Kothari, Shanken and Sloan (1994), we find that change in the current stock price of higher-smoothing firms contains more information about their future earnings than does change in the stock price of lower-smoothing firms. This result is robust to decomposing earnings into cash flows and accruals and to controlling for firm size, growth, future earnings variability, private information search activities, and cross-sectional correlations.

Income smoothing, earnings management

Abstract:
We examine earnings management behavior around SEOs, focusing on both real activities and accrual-based manipulation, and how this behavior varies over time and cross-sectionally. Although research has addressed the issues of earnings management around SEOs and earnings management via real activities manipulation, ours is the first paper to put these two issues together. We make three contributions to the literature. First, we document that firms use real, as well as accrual-based, earnings management tools around SEOs. Second, consistent with the expectation that the Sarbanes-Oxley Act (SOX) has made accrual-based earnings management more costly, we find that firms have substituted from accrual to real earnings management after SOX. Finally, we show how the tendency for firms to trade-off real versus accrual-based earnings management activities around SEOs varies cross-sectionally. We find that firms choices vary predictably as a function of the firm s ability to use accrual management and the costs of doing so. Our model is a first step in examining how firms trade-off between real versus accrual methods of earnings management.

Abstract:
We examine earnings management behavior around SEOs, focusing on both realactivities and accrual-based manipulation, and how this behavior varies over time andcross-sectionally. Although research has addressed the issues of earnings managementaround SEOs and earnings management via real activities manipulation, ours is the firstpaper to put these two issues together. We make three contributions to the literature.First, we document that firms use real, as well as accrual-based, earnings managementtools around SEOs. Second, consistent with the expectation that the Sarbanes-Oxley Act(SOX) has made accrual-based earnings management more costly, we find that firmshave substituted from accrual to real earnings management after SOX. Finally, we show how the tendency for firms to tradeoff real versus accrual-based earnings managementactivities around SEOs varies cross-sectionally. We find that firms choices vary predictably as a function of the firm s ability to use accrual management and the costs of doing so. Our model is a first step in examining how firms tradeoff between real versus accrual methods of earnings management.

Abstract:
We examine earnings management behavior around SEOs, focusing on both real activities and accrual-based manipulation. Although research has addressed the issues of earnings management around SEOs and earnings management via real activities manipulation, ours is the first paper to put these two issues together. We make three contributions to the literature. First, we document that firms use real, as well as accrual-based, earnings management tools around SEOs. Second, we show how the tendency for firms to tradeoff real versus accrual-based earnings management activities around SEOs varies cross-sectionally. We find that firms choices vary predictably as a function of the firms ability to use accrual management and the costs of doing so. Our model is a first step in examining how firms tradeoff between real versus accrual methods of earnings management. Third, we compare the economic costs of accrual versus real earnings management around SEOs, by examining the effect of each type of earnings management on the firms future performance. We provide the first evidence on this important issue by showing that the costs of real earnings management are likely greater than the costs of accrual earnings management, at least in the SEO context.

Seasoned Equity Offerings, Earnings Management, Real Earnings Management

Abstract:
Roll (1988) observes low R2 statistics for common asset pricing models due to vigorousfirms-specific returns variation not associated with public information. He concludes (p. 56) that this implies â¬Seither private information or else occasional frenzy unrelated to concrete information.â¬?We show that firms and industries with lower market model R2 statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Rollâ¬"s first interpretation ⬠higher firms-specific returns variation as a fraction of total variation signals more information-laden stock prices and, therefore, more efficient stock markets.

Abstract:
Roll [1988] observes low R2 statistics for common asset pricing models due to vigorous firms-specific return variation not associated with public information. He concludes (p. 56) that this implies "either private information or else occasional frenzy unrelated to concrete information." We show that firms and industries with lower market model R2 statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Roll's first interpretation - higher firms-specific return variation as a fraction of total variation signals more information-laden stock prices and, therefore, more efficient stock markets.

Abstract:
Roll (1988) observes low R2 statistics for common asset pricing models due to vigorous firms-specific returns variation not associated with public information. He concludes (p. 56) that this implies "either private information or else occasional frenzy unrelated to concrete information." We show that firms and industries with lower market model R2 statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Roll's first interpretation - higher firms-specific returns variation as a fraction of total variation signals more information-laden stock prices and, therefore, more efficient stock markets.

Stock price informativeness; Functional efficiency

Abstract:
This paper presents both a new approach to studying the consequences of accounting choice and a unique sample to examine the effects of accounting choice in the R&D context. We investigate the effect of firms decision to capitalize R&D expenditures on the amount of information about future earnings reflected in current stock returns, as captured by the association between current-year returns and future earnings (FERC). We use a sample of U.K. firms, which includes both R&D capitalizers and expensers. An important feature of our tests is our use of a two equation system to control for the endogeneity of the accounting choice (i.e., self selection). Proponents of capitalization claim that it enables management to better communicate information about the success of projects and their probable future benefits. Consistent with this, we find that capitalization is associated with higher FERC than expensing.

Research & Development, Informativeness, Capitalization

Abstract:
This paper presents both a new approach to studying the consequences of accounting choice and a unique sample to examine the effects of accounting choice in the R&D context. We investigate the effect of firms' decision to capitalize R&D expenditures on the amount of information about future earnings reflected in current stock returns, as captured by the association between current-year returns and future earnings (FERC). We use a sample of U.K. firms, which includes both R&D capitalizers and expensers. An important feature of our tests is our use of a two equation system to control for the endogeneity of the accounting choice (i.e., self selection). Proponents of capitalization claim that it enables management to better communicate information about the success of projects and their probable future benefits. Consistent with this, we find that capitalization is associated with higher FERC than expensing.

research & development, informativeness, capitalization

Abstract:
We investigate whether the market prices the change in net trading assets as an operating or non-operating activity or some mixture of the two, and whether this market pricing is consistent with the (fundamental) association of the change in net trading assets with future cash flows from operations. Our investigation is motivated by the observation that despite the classification of the cash flows on trading positions as operating under FAS 102 trading is economically a hybrid operating/non-operating activity. Reflecting this hybrid nature, we hypothesize and find that the change in net trading assets has a less positive association with returns and future CFO than do the pure operating components of cash flows and accruals, and that it has a more positive association with returns and future CFO than do the pure non-operating components of cash flows. To the best of our knowledge, our paper is the first to propose and test hypotheses about the valuation implications of such hybrid cash flows and accruals.

Abstract:
We investigate whether the market prices the change in net trading assets as an operating or non-operating activity or some mixture of the two, and whether this market pricing is consistent with the (fundamental) association of the change in net trading assets with future cash flows from operations (CFO). Our investigation is motivated by the observation that - despite the classification of the cash flows on trading positions as operating under FAS 102 - trading is economically a hybrid operating/non-operating activity. Reflecting this hybrid nature, we hypothesize and find that the change in net trading assets has a less positive association with returns and future CFO than do the pure operating components of cash flows and accruals, and that it has a more positive association with returns and future CFO than do the pure non-operating components of cash flows. To the best of our knowledge, our paper is the first to propose and test hypotheses about the valuation implications of such hybrid cash flows and accruals.

Classification, cash flows, accruals, trading, banks

Abstract:
This paper uses a new approach to examine whether income smoothing garbles earnings information or improves the informativeness of past and current earnings about future earnings and cash flows. We measure income smoothing by the negative correlation of a firm s change in discretionary accruals with its change in pre-managed earnings. Using the approach of Collins, Kothari, Shanken and Sloan (1994), we find that change in the current stock price of higher-smoothing firms contains more information about their future earnings than does change in the stock price of lower-smoothing firms. This result is robust to decomposing earnings into cash flows and accruals and to controlling for firm size, growth, future earnings variability, private information search activities, and cross-sectional correlations.

Abstract:
We examine the association between voluntary corporate disclosure and the informativeness of stock prices. We measure corporate disclosure using the AIMR-FAF annual corporate disclosure ratings. We define price informativeness by the association between current stock returns and future earnings changes: more informative stock price changes contain more information about future earnings changes. To measure this association, we use the multiple regression model of Collins, Kothari, Shanken, and Sloan (1994), wherein current returns are regressed against both current and future earnings changes and future stock returns. The aggregated coefficients on the future earnings changes, which we refer to as the future ERC, is our measure of informativeness (association).We hypothesize and find that greater disclosure is associated with greater price informativeness (i.e., higher future ERC). This is the first empirical evidence that enhanced disclosure results in stockprices that are more informative about future earnings, indicating that greater disclosure provides information benefits to the stock market.In addition, the method we use to document the benefits of enhanced voluntary disclosure can be applied in other cases of interest to both academics and policymakers, such as assessing the benefits of additional required disclosures.

Abstract:
Despite the classification of the cash flows on trading positions as operating under SFAS No. 102, trading is economically a hybrid operating/non-operating activity. As a consequence of this hybrid nature, we hypothesize and find that the change in net trading assets has a less positive association with returns and future CFO than do the pure operating components of cash flows and accruals, and it has a more positive association with returns and future CFO than do the pure non-operating components of cash flows. Our paper is the first to propose and test hypotheses about the valuation implications of such hybrid cash flows and accruals.

Trading, cash flows, accruals, classification, market pricing, banks

Abstract:
We examine how a firm's decision to capitalize vs expense R&D costs affects how the firm manages earnings with R&D. We find that expensers engage in real earnings management, cutting R&D expenditures to meet earnings benchmarks. Capitalizers, however, cut R&D expense to meet benchmarks, without cutting R&D expenditures. Thus, they engage in accrual earnings management. This is the first empirical evidence we are aware of on how accounting choices affect subsequent earnings management decisions. Our findings are consistent with recent models showing that managers substitute to real earnings management when tighter accounting standards restrict accrual management, and suggest that restricting R&D capitalization results in (potentially more costly) real management.

R&D, earnings management, capitalization, expensing

Abstract:
This study investigates the effect of firms' adoption of SFAS No. 131 segment disclosure rules on the stock market's ability to predict the firms' earnings, as captured by the forward earnings response coefficient (FERC). The FERC is the association between current-year returns and next-year earnings. SFAS No. 131, effective for fiscal years beginning after December 15, 1997, arguably increased both the quantity and quality of segment disclosure. Consistent with the standard's intended qualitative effects, pre-131 multi-segment firms experienced a significant increase in FERC after adopting SFAS No. 131. Consistent with the standard's intended quantitative effects, many pre-131 single-segment firms began disclosing multiple segments, and those that did experienced an increase in FERC. However, pre-131 single-segment firms that remained single segment (i.e., were unaffected by SFAS No. 131) had no change in FERC, indicating that the increase in FERC for 131-affected firms is not due to some other event concurrent to the adoption of SFAS No. 131. These results are robust under numerous procedures that control for characteristics of the sample firms and their earnings, providing strong evidence that SFAS No. 131 resulted in an increase in stock price informativeness for affected firms. Thus, we provide the first empirical price-based evidence that SFAS No. 131 provided more information (about future earnings) to the market, as the standard's proponents have suggested.

SFAS No. 131, segment reporting, forward earnings response coefficient

Abstract:
We investigate two explanations for the declining contemporaneous linear relation between annual stock returns and accounting earnings over the past 30 years: (1) earnings increasingly reflect news with a lag relative to stock prices and (2) earnings increasingly reflect good and bad news in an asymmetric fashion. We hypothesize and find that annual earnings have a weaker association with current price changes and a stronger association with lagged price changes over time. We hypothesize and find that annual earnings reflect current positive price changes less strongly and current negative price changes more strongly over time. We also find that asymmetry with respect to lagged price changes is increasingly important over time. Strikingly, we find that, since the mid-1980s, the aggregation of earnings over a four-year window does increasingly less to reduce the importance of lags and asymmetry.

capital markets, returns-earnings relation, earnings lags, earnings asymmetry

Abstract:
We develop and test a model of corporate dividend policy based on the permanent income hypothesis (PIH) of Friedman (1957). The PIH implies that dividends are non-stationary and that the response of dividends to a change in earnings is positively related to the persistence of the change in earnings. Using a sample of 337 firms over the 40 year period from 1950-1989, we find the data to be strongly consistent with both implications of the PIH. We also find that earnings and dividends are not co-integrated, indicating that factors other than the permanent component of earnings, such as tax policy, clientele effects, transaction costs, etc. may have a significant impact on the long-run behavior of dividends, and implying that a properly specified dividend model relates the changes in dividends to changes in earnings. This contrasts with the implicitly co- integrated (levels) dividend model of Lintner (1956). Thus, we propose a new non co-integrated corporate dividend policy model that unifies the Lintner model with the PIH. Additionally, our evidence on the non-stationarity of dividends has implications for the stock market rationality debate, and the association between dividend changes and earnings persistence is consistent with Miller's )1987) proposition that dividend changes signal earnings persistence.

Abstract:
We examine the relation across firms and industries between the stock market's valuation of R&D expenditures and the fundamental benefits due to, and the risk of, the R&D outlays. We hypothesize and find that the market's valuation of R&D varies across firms and industries, and that it is positively correlated with the R&D's fundamental benefits, and negatively correlated with the R&D's risk. This is the first empirical evidence that the market's valuation of R&D varies cross-sectionally and, more importantly, that the valuation differences are meaningfully related to measures of the investments' fundamental benefits and risks.

Abstract:
We compare the accuracy of analyst (I/B/E/S consensus) and earnings-to-price ratio (E/P)-based forecasts of annual earnings across firms. We find that generalizations of Beaver Lambert and Morse's (BLM 1980) E/P-based forecasting model are more accurate than analyst forecasts both for most firms and on average though analyst forecasts are more accurate for the two lowest and the highest E/P decile firms. This result reflects prior research's finding that analyst forecasts are biased and do not fully incorporate the implications of the current annual price and earnings changes for future earnings. Only when the errors in analyst forecasts due to these sources comprise a relatively unimportant portion of the subsequent earnings change (i.e. in the extreme E/P deciles) do analysts beat E/P-based models.