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Abstract:
Quality of earnings questions arise when firms that practice conservative accounting change the level of their investment in net operating assets: increases in net operating assets create "hidden reserves," depressing earnings, and decreases in investment release hidden reserves into earnings. This paper develops diagnostics that capture this joint effect of investment and conservative accounting and finds that the diagnostics forecast differences in future return on net operating assets from the current return on net operating assets. Moreover, the diagnostics forecast stock returns, indicating that the stock market does not appreciate how conservatism and investment combine to raise quality questions about reported earnings.

Abstract:
In this paper we provide insights into the manner in which (relatively sparse) accounting information, along with measures of internet usage, are employed by the market in the valuation of internet firms. Consistent with those who claim that financial statement information is of very limited use in the valuation of internet stocks, we are unable to detect a significant positive association between bottom-line net income and our sample firms' market prices; in fact, the association is actually negative. However, when we decompose net income into its components, we find gross profits to be positively and significantly associated with prices. In addition, both unique visitors and pageviews, as measures of internet usage, are found in most instances to provide incremental explanatory power (in some cases considerable) for stock prices. We also separately analyze the e-tailers, and the portal and content/community firms (the p/c firms) in our sample. For the e-tailers we find that bottom-line net income generally has a negative association with stock prices (as for the sample as a whole), while a positive and significant association exists for the p/c firms. In this respect, p/c firms' shares behave more like those of non-internet companies. Further, we find for the p/c firms that the incremental explanatory power of pageviews and of unique visitors is approximately the same; in contrast, pageviews has much greater incremental explanatory power for the e-tailers than does unique visitors. This suggests that pages viewed per visitor is an especially important metric for the e-tailers, as compared to the p/c firms.

Abstract:
This paper provides a structured financial statement analysis that informs about the sustainability (or persistence) of earnings and the P/E ratio. The P/E ratio measures the amount that investors pay for a dollar of current earnings. Investors buy future earnings, so should pay less for current earnings if the earnings cannot be sustained in the future. If earnings are temporarily high, investors should pay less per dollar of earnings than if earnings were temporarily depressed. While income statements identify some transitory items, the investor is still left with uncertainty as to whether the remaining earnings are sustainable. This paper estimates a model that supplies probabilities of the sustainability of earnings. The model aggregates information in the financial statements into a composite score that serves as a "red flag" about the sustainability of earnings. In out-of-sample prediction tests, the scoring reliably identifies non-sustainable earnings, and also explains cross-sectional differences in P/E ratios. The paper also finds that stock returns are predictable when traded P/E ratios differ from a line fitted to sustainable earnings scores. So, the analysis either points investors to stocks with different risk (and thus different expected returns) or to stocks where earnings are mispriced given the information about their sustainability.

sustainable earnings, Price/Earnings ratios, financial statement analysis

Abstract:
In light of the importance of revenues in the valuation of internet stocks, this paper examines the roles played by analysts, past revenues, and web usage data (unique visitors, pageviews, and minutes spent at a firm's web sites) in the forecasting of future revenues. In contrast to evidence from other industries, we find that analysts' revenue forecasts almost always underestimate the revenues of internet firms. Historical revenue growth is shown to have incremental predictive power over analysts' forecasts, more so for our sample of portal and content/community firms than for our e-tailer sample. Estimates of web usage growth, on the other hand, generally have significant incremental value for predicting the revenues of the e-tailers, but little predictive power for the revenues of the p/c firms. Finally, we examine whether measures of web traffic have incremental value in the prediction of revenues above time-series forecasts. This issue is especially important when valuing firms with little or no analyst coverage, where there is, of necessity, an increased reliance on historical revenues for forecasting purposes. We find that all three web usage metrics do have significant incremental predictive power.

Abstract:
This paper examines how conservative accounting affects the relation between accounting data and firm value. The analysis shows that conservative accounting can be characterized equivalently in terms of book value, earnings, or book rate of return. Furthermore, capitalized earnings generally provide a less biased estimate of equity value than book value does. In addition, firm growth affects the way earnings and book value are combined in valuation. A weighted average of book value and capitalized earnings, with the weight on earnings being an increasing and convex function of growth, yields an asymptotically unbiased estimate of equity value. When growth is positive, the weight on book value is negative.

Abstract:
This paper examines how conservative accounting affects the relation between accounting data and firm value. The analysis shows that conservative accounting can be characterized equivalently in terms of book value, earnings, or book rate of return. Furthermore, capitalized earnings generally provide a less biased estimate of equity value than book value does. In addition, firm growth affects the way earnings and book value are combined in valuation. A weighted average of book value and capitalized earnings, with the weight on earnings being an increasing and convex function of growth, yields an asymptotically unbiased estimate of equity value. When growth is positive, the weight on book value is negative.

Abstract:
This paper presents evidence of anomalies in internet firms' stock returns surrounding their quarterly earnings announcements. There is a general runup in prices in the days prior to the earnings announcements, followed by a price reversal lasting for several days. The magnitude of the market-adjusted returns associated with these price movements exceeds 11 percent over a 10-day period. We find little evidence to suggest that these returns can be explained either by the earnings news disclosed or by risk changes. Additional analyses suggest that these return patterns are driven, at least in part, by price pressure.

capital market, internet, stock returns, earnings announcement, price pressure

Abstract:
This paper presents evidence of persistent anomalies in internet firms' stock returns surrounding their quarterly earnings announcements. There is a general run-up in prices in the days prior to the earnings announcement, which extends through the market opening on the day subsequent to the release. This is followed by a price reversal lasting for several days. The magnitude of the market-adjusted returns associated with these price movements exceeds 11 percent over a 10-day period. There is little evidence to suggest that these returns can be explained either by the earnings news disclosed or by changes in risk around the earnings announcements. Additional analyses suggest that these return patterns are driven, at least in part, by price pressure which exists in the days before internet firms' earnings announcements. A trading strategy designed to exploit these price patterns would have generated a daily return of more than 1 percent over the sample period.

Abstract:
We study the optimal accounting policy when a firm can control the information quality through costly and noncontractible action. It is shown that the desirable accounting has two features: (i) the accounting report aggregates, rather than reporting directly, the underlying information; (ii) the accounting has a conservative bias. By invoking the conservatism principle, which serves as a commitment to an apparently inefficient accounting scheme given the ex post information quality, firms are induced to spend more effort in controlling information quality ex ante. As a result, a biased accounting system improves the overall information quality and enhances the welfare of accounting information users. In equilibrium the information users' welfare decreases with a firm's private cost of information quality control and increases with a firm's benefits from favorable accounting reports.

Accounting Conservatism, Information Aggregation, Information Quality

Abstract:
The principles that govern the recognition of revenues (and expenses) are the key determinants of the properties of accrual accounting information. This paper studies the revenue recognition question from a stewardship perspective. Our results show that it is optimal to carry products at their historical costs until revenues are realized. Revenues are considered realized when the amount of associated cash flows can be measured in an objective and verifiable fashion. In contrast, we demonstrate that mark-to-market accounting, although sensible from an equity valuation perspective, generally does not provide efficient aggregation of raw information to solve the stewardship problems. In particular, mark-to-market accounting based on anticipated performance of the manager does not necessarily induce the manager to actually deliver such performance. Our analysis also identifies situations where the realization principle needs to be modified with the asset valuation rule of lower-of-cost-or-market. Such results highlight that conservatism may be a desirable feature of accounting measurements for managerial performance evaluation purposes.

Abstract:
We study the immediate and delayed market response to SEC EDGAR 10-K filings. Unusual trading volumes and stock price movements are documented during the days around the 10-K filing dates. The abnormal price movements are positively associated with future accounting profitability, indicating that 10-K filings contain useful information about future firm performance. In addition, investors' reaction to 10-K information seems sluggish, as evidenced by the stock price drift during the twelve month period after 10-K filing. We find that investors' under-reaction tends to be stronger for firms with more complex 10-K filings.

Abstract:
We examine the link between information asymmetry and firms' cost of capital by testing the changes in expected returns around earnings announcements - exogenous and frequent events that are known to affect information asymmetry. Prior literature finds that stock returns tend to increase before earnings announcements. We document that this returns increase occurs for firms that are expected to have an increase in information asymmetry before earnings. In particular, we show that high analyst forecast coverage and high forecast dispersion during the quarter are predictors of pre-announcement increase in information asymmetry - as measured by price impact and bid-ask spreads - and are correspondingly associated with the increase in returns before earnings. Overall, our evidence supports the view that higher information asymmetry leads to higher expected returns, and suggests that firms' cost of equity changes over the fiscal quarter as a function of information asymmetry.

Information asymmetry, cost of equity, earnings announcements

Abstract:
This paper studies the relationship between information's properties (for example, reliability, relevance) and public disclosure policy. It is shown that the optimal accounting system often involves a carefully balanced combination of mandatory and voluntary disclosure, with mandatory reporting focused on reliable information. The emphasis on reliability causes the welfare-maximizing mandatory report to consistently lag the financial market in incorporating certain value-relevant information. It is also demonstrated that the financial reporting as a whole (mandatory as well as voluntary disclosure) exhibits asymmetric timeliness in capturing good versus bad news.

Reliability, Relevance, Disclosure

Abstract:
This study tests and finds that stock prices before earnings announcements reflect investor aversion to negative news. Specifically, we find that there is a one-sided returns reversal at earnings announcements. Earnings announcements that are preceded by price decreases trigger positive returns reactions, on average, while those preceded by price increases have zero announcement returns. Furthermore, the price decreases before earnings announcements are associated with a higher likelihood of negative news, and reflect an extra discount, one that is consistent with investor aversion to loss in share value. The phenomenon can also reflect, as we show, compensation (discount) that risk-averse market makers require when buying stocks before earnings announcements. Taken together, the evidence suggests that there is asymmetric reaction to negative and positive information on the upcoming earnings announcements, or in specific that negative news looms larger than positive news.

Loss aversion, earnings announcements, returns reversal

Abstract:
Earnings announcements and 10-K filings are two important channels through which companies release financial information to the public. Earnings announcements, particularly for large firms, are often accompanied by intensive media coverage. In contrast, 10-K filings are usually of much lower profile, attracting little investor attention. Limited attention hypothesis suggests that investors’ failure to devote enough attention to an economic event leads to underreaction, and the degree of underreaction should decrease with the amount of investor attention. In this paper we document evidence consistent with this hypothesis. First, we show that among large firms, investors under-react more to the information contained in 10-K filings than earnings announcements. Second, underreaction to earnings announcements tends to be stronger for small firms than large firms. In contrast, investor underreaction to 10-K information is similar between the two groups of firms. Third, we find that companies report their earnings and 10-Ks earlier when there is a higher demand for such information, and document a negative relationship between the degree of underreaction and the timeliness of such information release. Finally, we show that the recent ruling by SEC to accelerate 10-K filing has little impact on the degree of investors’ underreaction to 10-K information.

stock price drift, earnings, 10-K, limited attention

Abstract:
In this paper we study the reclassification of unrealized holding gains and losses for available-for-sale securities and cash-flow-hedge. These gains and losses, which have previously been recognized on a firm’s balance sheets, become part of the net income at the time of reclassification. We document a significant positive association between this reclassified amount and firms’ stock prices. This is a puzzling finding given that such gains and losses have been recognized in banks’ previous financial statements. We also document that firms reclassify substantially more gains than losses into the income statement for available-for-sale securities. In contrast, the reclassified amounts of gains and losses are roughly even for cash-flow hedge. Analysis of future stock return further indicates that investors may be misled by the inflated amount of reclassified net gains for available-for-sale securities.

Available-for-sale, Cash-flow Hedge, Reclassification, Earnings Management, Stock Returns