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Abstract:
The work of Ohlson (1995) and Feltham and Ohlson (1995) had a profound impact on accounting research in the 1990's. In this paper, we first discuss this valuation framework, identify its key features, and put it in the context of prior valuation models. We then review the numerous empirical studies that are based on these models. We find that most of these studies apply a residual income valuation model, without the information dynamics that are the key feature of the Feltham and Ohlson framework. We find that few studies have adequately evaluated the empirical validity of this framework. Moreover, the limited evidence on the validity of this valuation approach is mixed. We conclude that there are many opportunities to refine the theoretical framework and to test its empirical validity. Consequently, the praise many empiricists have given the models is premature.

Abstract:
The work of Ohlson (1995) and Feltham and Ohlson (1995) had a profound impact on accounting research in the 1990's. In this paper, we first discuss this valuation framework, identify its key features, and put it in the context of prior valuation models. We then review the numerous empirical studies that are based on these models. We find that most of these studies apply a residual income valuation model, without the information dynamics that are the key feature of the Feltham and Ohlson framework. We find that few studies have adequately evaluated the empirical validity of this framework. Moreover, the limited evidence on the validity of this valuation approach is mixed. We conclude that there are many opportunities to refine the theoretical framework and to test its empirical validity. Consequently, the praise many empiricists have given the models is premature.

Abstract:
We document that firms' management of accounting earnings increased steadily from 1987 until the passage of the Sarbanes Oxley Act (SOX), with a significant increase during the period prior to SOX, followed by a significant decline after passage of SOX. However, the increase in earnings management preceding SOX was primarily in poorly performing industries. We also show that the informativeness of earnings increased steadily over time, and there was no significant change in earnings informativeness following the passage of SOX. Further, we find that earnings management increased the absolute informativeness of earnings, but reduced the informativeness for a given earnings surprise, as well as reduced the abnormal return for a given amount of earnings surprise. Finally, the evidence supports the hypothesis that the opportunistic behavior of managers, primarily related to the fraction of compensation derived from options, was significantly associated with earnings management in the period preceding SOX.

Earnings Management, Sarbanes Oxley Act

Abstract:
Three main approaches for examining the effect of accounting information in financial markets have emerged in the last three decades. We formally define information content, valuation relevance, and value relevance. Respectively, these approaches are based on Beaver (1968), Ball and Brown (1968), and tests of association between market values and accounting numbers. We systematically compare and contrast these paradigms to highlight their relative strengths and weaknesses, and to identify possible reasons why one method provides different results from another.

Implementing these research methods using data from the last three decades, we show that information content has remained constant while valuation relevance and value relevance have both declined. We find that our conclusions are robust with respect to return volatility, non-linearities of the valuation model used, earnings composition, and the earnings expectation model used. We conclude that the unrecognized disclosures released concurrently with earning sare likely to have contributed to this divergence.

Valuation, capital markets, relevance of accounting information, information content

Abstract:
We review research from the 1990s that examines the determinants and consequences of accounting choice, structuring our analysis around the three types of market imperfections that influence managers' choices: agency costs, information asymmetries, and externalities affecting noncontracting parties. We conclude that research in the 1990s made limited progress in expanding our understanding of accounting choice because of limitations in research design and a focus on replication rather than extension of current knowledge. We discuss opportunities for future research, recommending the exploration of the economic implications of accounting choice by addressing the three different reasons why accounting matters.

Abstract:
We review research from the 1990s that examines the determinants and consequences of accounting choice, structuring our analysis around the three types of market imperfections that influence managers? choices: agency costs, information asymmetries, and externalities affecting noncontracting parties. We conclude that research in the 1990s made limited progress in expanding our understanding of accounting choice because of limitations in research design and a focus on replication rather than extension of current knowledge. We discuss opportunities for future research, recommending the exploration of the economic implications of accounting choice by addressing the three different reasons why accounting matters.

Abstract:
The Sarbanes Oxley Act of 2002 (SOX) introduced several governance reforms that considerably increased the total risk exposure of CEOs. We examine the effects of these regulatory changes on compensation contracts of CEOs and their effect on risk taking subsequent to SOX. We find that while overall compensation did not change, salary and bonus compensation increased and option compensation decreased following the passage of SOX. The sensitivity of CEO's wealth to changes in shareholder wealth also decreased after SOX. These results indicate that the pay for performance sensitivity of CEO compensation has declined following SOX. Our results indicate that these changes reduced investments in research and development, and capital expenditures. We also document that the above changes in CEOs' pay for performance sensitivities and their risky investments following SOX are associated with a reduction in stock return volatility. However, we do not find any evidence indicating that these changes are associated with lower future operating performance.

Sarbanes Oxley Act, Executive Compensation, Incentives, Regulation

Abstract:
We document that accrual-based earnings management increased steadily from 1987 until the passage of the Sarbanes Oxley Act (SOX) in 2002, followed by a significant decline after the passage of SOX. Conversely, the level of real earnings management activities declined prior to SOX and increased significantly after the passage of SOX, suggesting that firms switched from accrual-based to real earnings management methods after the passage of SOX. We also find evidence that the accrual-based earnings management activities were particularly high in the period immediately preceding SOX. Consistent with these results, we find that firms that just achieved important earnings benchmarks used less accruals and more real earnings management after SOX when compared to similar firms before SOX. Finally, our analysis provides evidence that the increases in accrual-based earnings management in the period preceding SOX were concurrent with increases in the fraction of equity based compensation.

Earnings Management, Sarbanse-Oxley Act, Executive Compensation

Abstract:
The value relevance of accounting disclosures is the focus of numerous accounting studies. Frequently, the studies operationalize value relevance as the R2 from regressions of stock prices on per share values of accounting earnings and book values of equity. Intertemporal or cross-sample differences in R2 are used as indicators that value relevance of accounting disclosures has changed over time or that value relevance differs across disclosure regimes. The main purpose of this paper is to analyze whether R2 indeed captures the intuitive notion of value relevance sought by the authors.

We model the effect of scale formally and show that scale induces two related problems of interpretation. First, the R2 from a scale-affected regression will, under fairly general conditions, be higher than the R2 from the same regression without scale effects. The second problem of interpretation occurs when comparing R2 between samples with different scale effects. Specifically, we show that R2 increases in the coefficient of variation (CV) of the scale factor.

Consistent with the predictions of our model, we show that the R2 in regressions of price on EPS and BVPS is positively correlated with the cross-sectional CV of the scale factor. Moreover, we find that the CV of the scale factor has increased considerably over the last four decades. Since there is a relation between R2 and CV of the scale factor, if the latter increases, then an increase in R2 is induced, even when there may have been no change, or possibly a decrease, in value relevance. As a result, time series comparisons of R2 are likely to result in erroneous inferences. For example, Collins, Maydew, and Weiss (1997) (CMW) and Francis and Schipper (1999) examine R2 over the last four decades and conclude that value relevance has increased. By replicating CMW we show that their conclusions result from the impact of changes in scale on the regression R2.

We propose two modified research approaches to measure whether there has been a change in value relevance as measured by R2. Each controls for changes in scale effects. First, we estimate proxies for the CV of the scale factor in each of the sample periods. We then analyze differences in the R2 across samples, after controlling for the CV of the scale factor. Second, we remove scale effects from each sample by deflating all observations by proxies for the scale factor. In both instances we find that the conclusions drawn by CMW and FS reverse and that value relevance, as measured by the regression R2, has decreased over the last four decades.

Abstract:
This study examines the properties of the R-squared metric frequently used in accounting research as a measure of value relevance. Analytical results show that the metric is unreliable in the presence of scale effects. Specifically, we show that the metric is upwardly biased for accounting studies, and the bias is increasing in the scale factor's coefficient of variation. We conclude that it is invalid to make cross-sample comparisons of R-squared, whether the samples are drawn cross-sectionally or over time, unless the researcher controls for differences in the coefficient of variation across the samples. Applying this theory empirically, our results show that the finding of increasing value relevance in Collins, Maydew, and Weiss (1997) and Francis and Schipper (1998) are attributable to over time increases in the coefficient of variation of scale. After controlling for these effects, we find that there has been a decline in value relevance as measured by R-squared.

Abstract:
During spring 2000, the Internet Stock Index declined 45%. Using a sample of internet firms, this paper investigates whether this decline was associated with new disclosures, such as earnings, analyst forecast revisions, and web-traffic measures, or to a "reassessment" by investors of pre-existing information. We find only modest evidence that the decline was associated with new disclosures. However, returns and post-decline stock prices are significantly explained by 1999 annual report data. When earnings are decomposed into gross profit and various expenses, traditional financial information contributes significantly more in explaining the cross-sectional returns and price levels than non-financial information.

valuation, internet firms, stock options, earnings, cash flows

Abstract:
During the spring of 2000, the market values of internet companies declined 61% in 10 weeks. Using a sample of internet direct and support (infrastructure) firms, this paper investigates whether the stock market decline could be attributed to new disclosures over the period (buy/sell recommendations, analyst forecast revisions, and web traffic measures) or to information that caused a "reassessment" of the implications of pre-existing accounting information. In addition, we focus attention on the non-cash purchases of goods and services using equity instruments, such as stock warrants and options. We find little evidence that the spring 2000 decline was precipitated by new disclosures of web traffic statistics, earnings or earnings forecasts. In contrast, the valuation of internet firms, particularly support firms, declined sharply in relation to certain 1999 accounting measures. Firms that earned greater gross profit in 1999 experienced a relatively smaller stock price decline in spring 2000, while firms that spent more on research and development in 1999 experienced a relatively larger stock price decline. Valuations before and after the downturn reflected the speed with which firms consumed cash and marketable securities as well as the use of equity instruments to acquire facilities, goods and services. Finally, we find evidence that employee stock option grants are viewed positively by investors, most likely due to their effect on employee retention.

Valuation, internet firms, stock options, earnings, cash flows

Abstract:
We analyze acquirers' wealth maximizing acquisition strategy when competing for a target. We allow acquirers to make either one-tier or two-tier offers. We show that a two-tier offer strategy will be used when target shareholders have sufficiently large differences in their valuations of the considerations offered, for example due to taxes. However, when shareholder heterogeneity is small, one-tier offers always defeat two-tier offers. Our model also explains the stylized fact that successful two-tier offers are over-subscribed (i.e., structured such that the number of shares tendered exceeds the number sought). Finally, for intermediate levels of valuation heterogeneity neither one- nor two-tier offers are uniquely optimal and acquirers will randomize their offer strategies or resort to preemptive offers, that is, offers that exceed the reservation value of their opponent. The latter is more likely to occur when the difference between the two acquirers' reservation values is high.

Abstract:
Prior studies document that, on average, analysts issue optimistic forecasts one year prior to the earnings announcement and revise their forecasts downward as the earnings announcement date approaches. We hypothesize that the initial analyst forecast is biased because analysts do not fully adjust their forecasts for conservatism. Consistent with our hypothesis, we find that the initial analyst forecast error is negatively associated with proxies for conservatism measured before the forecast is issued. That is, on average, analysts do not include in their initial forecasts information about conservatism even though that information is available at the time of the forecasts, contributing to the optimistic analyst forecast bias.

Accounting conservatism, analyst forecast error

Abstract:
We document that the passage of the Sarbanes-Oxley Act (SOX) coincided with an increase in voluntary delistings and deregistrations of foreign firms traded as American Depository Receipts (ADRs) from US stock markets. We examine the extent to which these exits were motivated by firms' costs of complying with SOX or by managers' or controlling shareholders' (MCOs) loss of control rents that resulted from corporate governance mandates of SOX. We find that compared to foreign firms that maintained their ADRs, foreign firms which voluntarily deregistered have weaker corporate governance, had a significantly less negative stock market reaction when SOX was passed, and suffered a significant price decline when they announced their intention to delist. There is also evidence supporting the argument that the delistings were motivated by firms' (as opposed to MCOs') compliance costs related to SOX. Taken together, our results demonstrate that both the agency problem (i.e., private benefit of control of the MCOs) and the compliance cost of SOX play a role in motivating foreign firms to withdraw from the US market.

Abstract:
There are two widely held views in the literature regarding management's motivations to manage earnings, and each has quite different implications for the resulting numbers' ability to predict future firm operating cash flows. One view is that earnings management is motivated by mangers' attempt to sustain the overvaluation of the firm's stock price and to enhance managers' personal welfare by disguising the true underlying economic performance of the firm (opportunistic perspective). An alternative view is that managers manage earnings to reveal private value-relevant information about the future prospects of a firm (informational perspective). Using a sample of firms that have restated earnings, we show that originally reported (managed) earnings of firms classified as managing earnings for opportunistic reasons are less predictive of future cash flows relative to the restated (unmanaged) numbers. Conversely, we find that originally reported (managed) earnings of firms classified as managing earnings for informational reasons exhibit greater predictive ability with respect to future cash flows relative to restated (unmanaged) numbers. Returns analysis corroborates our classification of firms into opportunistic and informational subsamples and provides evidence that supports Jensen's (2005) conjecture that overvaluation leads to value-destroying opportunistic earnings management. To the best of our knowledge, this study is the first to show that managed earnings exhibit different predictive ability of future cash flows depending on the apparent motivation behind the earnings management.

Overvaluation, Earnings Management, Restatements, Cash Flows, Accruals

Abstract:
Abarbanell and Lehavy provide evidence that analysts' forecast errors are not normally distributed exhibiting a high occurrence of extreme negative forecast errors (left-tail asymmetry) and a high occurrence of small positive forecast errors (middle asymmetry). This is important for researchers who rely on techniques that are sensitive to the distributional assumptions of analysts' forecast errors. Many of the conclusions drawn by Abarbanell and Lehavy, however, are based on visual impressions (as opposed to formal empirical tests) or based on methods that are very sensitive to the empirical methods used (e.g., whether the serial correlation of forecast errors is caused by the left-tail asymmetry).

Analysts forecasts, analysts bias, analysts under/overreaction to information, analysts loss function, discretionary accruals

Abstract:
Abarbanell and Lehavy provide evidence that analysts' forecast errors are not normally distributed exhibiting a high occurrence of extreme negative forecast errors (left-tail asymmetry) and a high occurrence of small positive forecast errors (middle asymmetry). This is important for researchers who rely on techniques that are sensitive to the distributional assumptions of analysts' forecast errors. Many of the conclusions drawn by Abarbanell and Lehavy, however, are based on visual impressions (as opposed to formal empirical tests) or based on methods that are very sensitive to the empirical methods used (e.g., whether the serial correlation of forecast errors is caused by the left-tail asymmetry).

Abstract:
Abarbanell and Lehavy provide evidence that analysts' forecast errors are not normally distributed exhibiting a high occurrence of extreme negative forecast errors (left-tail asymmetry) and a high occurrence of small positive forecast errors (middle asymmetry). This is important for researchers who rely on techniques that are sensitive to the distributional assumptions of analysts' forecast errors. Many of the conclusions drawn by Abarbanell and Lehavy, however, are based on visual impressions (as opposed to formal empirical tests) or based on methods that are very sensitive to the empirical methods used (e.g., whether the serial correlation of forecast errors is caused by the left-tail asymmetry).

Analysts' forecasts, analysts' bias, analysts' under/overreaction to information, analysts' loss function, discretionary accruals.

Abstract:
We examine the ongoing performance of forecast analysts who change their brokerage affiliation and/or the companies they follow. On average, analysts who leave a brokerage house exhibit a decline in the forecast accuracy relative to all other analysts who follow the same company(s) as they approach the replacement date. Analysts joining a new brokerage house and/or follow new companies, however, do not become more accurate as they gain experience. This result is consistent with our finding of commonalities in analysts' performance across all the companies they follow, suggesting differential levels of innate or native abilities among analysts. The results also indicate that situational factors such as brokerage size and industry specialization by the brokerage have a positive impact on forecast accuracy. For example, large brokerage houses tend to be associated with analysts who issue more accurate forecasts. Similarly, analyst turnover within a brokerage has a detrimental effect on forecast accuracy of the remaining analysts. Overall, the results suggest that situational or brokerage related factors have a significant effect on analysts' forecast accuracy.

Abstract:
We document that earnings announcement-day premia persist beyond the sample period of earlier studies, over different disclosure environments and remain robust to the refinement of using the expected announcement day rather than the actual announcementday. A portfolio of announcing firms yields returns in excess of the corresponding risk.Excluding announcers from a well-diversified portfolio, while reducing the standarddeviation of that portfolio, also reduces its Sharpe ratio, indicating that this strategyresults in a less favorable risk-return trade-off. Finally, we provide evidence that the premia are dramatically reduced when the announcement risk is reduced through preannouncements. In addition, we document that the continued presence of this premia islikely to result from limits to arbitrage. These findings are consistent with the view that the announcement period returns are likely to represent compensation for announcement risk.

Abstract:
We examine the factors underlying the presence of earnings announcement premia. We find that the premia persist beyond the sample period examined in prior studies (ending in 1988), although they decline in magnitude after 1988. Further, premia are lower on the expected than the actual earnings announcement dates. We document that increases in voluntary disclosures result in lower premia, despite the increase in return volatility over time. Finally, our evidence suggests that the premia are not completely eliminated because of the costs of arbitrage.

Earnings Announcements, Announcement Premium, Preannouncements

Abstract:
We document that earnings announcement-day premia persist beyond the sample period of earlier studies, over different disclosure environments and remain robust to the refinement of using the expected announcement day rather than the actual announcement day. A portfolio of announcing firms yields returns in excess of the corresponding risk. Excluding announcers from a well-diversified portfolio, while reducing the standard deviation of that portfolio, also reduces its Sharpe ratio, indicating that this strategy results in a less favorable risk-return trade-off. Finally, we provide evidence that the premia are dramatically reduced when the announcement risk is reduced through preannouncements. In addition, we document that the continued presence of this premia is likely to result from limits to arbitrage. These findings are consistent with the view that the announcement period returns are likely to represent compensation for announcement risk.

Earnings announcements, risk, diversification, risk-return tradeoff, limits to arbitrage

Abstract:
This study examines the impact of regulatory capital and its components (i.e., earnings, loan loss provisions, charge-offs and growth) on bank managers' financing decisions and investors' interpretations of those decisions. This paper is related to two streams of research. We add to the corporate finance literature that seeks to explain the market's reaction to security issuances by improving specification through use of a set of homogenous firms. We extend the accounting literature that links regulatory capital increasing options with bank performance by examining whether investors infer that performance.

We find that managers' financing choices reflect their private information regarding the levels of regulatory capital and earnings in the issuance year and possibly their private information regarding regulatory capital and loan loss provisions in subsequent years. We document a negative market reaction to capital-increasing issuances and a positive reaction to capital-decreasing issuances. A cross-sectional analysis of that market reaction indicates that investors infer managers' expectations of earnings in the issuance year and regulatory capital in subsequent years.

Banks, capital regulation, security issuances, accounting

Abstract:
Bradshaw, Richardson, and Sloan (BRS) find a negative relation between their comprehensive measure of corporate financing activities and future stock returns and future profitability. Noticing that accounting accruals are increases in net operating assets on a company's balance sheet, we question whether it is possible to distinguish between the 'external financing anomaly' documented by BRS and the 'accrual anomaly' first documented by Sloan (1996). We show that once controlling for total accruals, the relation between external financing activities and future stock returns is attenuated and not statistically significant. These findings are consistent with Richardson and Sloan (2003).

External financing, Analysts' forecasts, Accruals, Capital Markets, Market Efficiency

Abstract:
Modern economies are characterized by a separation of ownership and control. The information asymmetry between investors and entrepreneurs and the agency problems that result from the separation of ownership and control cause corporate information environments to develop endogenously. We discuss and provide a framework for analyzing the three main decisions that shape the corporate information environment in a capital markets setting: (1) managers’ voluntary reporting and disclosure decisions, (2) reporting and disclosures mandated by regulators, and (3) reporting decisions by third-party intermediaries (analysts). We review and critique current research on disclosure regulation, information intermediaries, and the determinants and economic consequences of corporate disclosure and financial reporting decisions. We conclude that in the last ten years, research has generated a number of useful insights. Despite this progress, we call for researchers to consider interdependencies between the various decisions that shape the corporate information environment and highlight changes in the economic financial environment that raise new and interesting issues for researchers to address.

Financial Reporting, Information Environment, Disclosure, Analyst Forecasts

Abstract:
We document that accrual-based earnings management increased steadily from 1987 untilthe passage of the Sarbanes Oxley Act (SOX) in 2002, followed by a significant declineafter the passage of SOX. Conversely, the level of real earnings management activitiesdeclined prior to SOX and increased significantly after the passage of SOX, suggesting that firms switched from accrual-based to real earnings management methods after the passage of SOX. We also find evidence that the accrual-based earnings management activities were particularly high in the period immediately preceding SOX. Consistent with these results, we find that firms that just achieved important earnings benchmarks used less accruals and more real earnings management after SOX when compared to similar firms before SOX. Finally, our analysis provides evidence that the increases in accrual-based earnings management in the period preceding SOX were concurrent withincreases in the fraction of equity based compensation.

Abstract:
We document that accrual-based earnings management increased steadily from 1987 until the passage of the Sarbanes Oxley Act (SOX) in 2002, followed by a significant decline after the passage of SOX. Conversely, the level of real earnings management activities declined prior to SOX and increased significantly after the passage of SOX, suggesting that firms switched from accrual-based to real earnings management methods after the passage of SOX. We also document that the accrual-based earnings management activities were particularly high in the period immediately preceding SOX. Consistent with these results, we find that firms that just achieved important earnings benchmarks used less accruals and more real earnings management after SOX when compared to similar firms before SOX. In addition, our analysis provides evidence that the increases in accrual-based earnings management in the period preceding SOX were concurrent with increases in equity-based compensation. Our results suggest that stock-option components provide a differential set of incentives with regards to accrual-based earnings management. We document that while new options granted during the current period are negatively associated with income-increasing accrual-based earnings management, unexercised options are positively associated with income-increasing accrual-based earnings management.

Earnings Management, Real Earnings Management, Sarbanes Oxley Act, Executive Compensation

Abstract:
The Sarbanes Oxley Act of 2002 (SOX) introduced several governance reforms thatconsiderably increased the total risk exposure of CEOs. We examine the effects of these regulatory changes on compensation contracts of CEOs and their effect on risk taking subsequent to SOX. We find that while overall compensation did not change, salary and bonus compensation increased and option compensation decreased following the passageof SOX. The sensitivity of CEO s wealth to changes in shareholder wealth also decreasedafter SOX. These results indicate that the pay for performance sensitivity of CEOcompensation has declined following SOX. Our results indicate that these changesreduced investments in research and development, and capital expenditures. We also document that the above changes in CEOs pay for performance sensitivities and theirrisky investments following SOX are associated with a reduction in stock returnvolatility. However, we do not find any evidence indicating that these changes areassociated with lower future operating performance.

Abstract:
Gu and Xue (this issue) study the disciplining effect of independent analysts on the accuracy and forecast relevance of the forecasts of non-independent analysts. One of the intriguing results is that while independent analysts issue inferior forecasts, their presence appears to reduce the forecast bias, improve the forecast accuracy and increase the forecast relevance of forecasts issued by non-independent analysts. We explore alternative explanations for the Gu-Xue results. Our evidence of endogenous entry and exit of independent analysts provides a more compelling explanation for the reported results.

independent analysts, forecast accuracy, endogenous entry

Abstract:
We document that firms management of accounting earnings increased steadily from1987 until the passage of the Sarbanes Oxley Act (SOX), with a significant increaseduring the period prior to SOX, followed by a significant decline after passage of SOX.However, the increase in earnings management preceding SOX was primarily in poorlyperforming industries. We also show that the informativeness of earnings increasedsteadily over time, and there was no significant change in earnings informativeness following the passage of SOX. Further, we find that earnings management increased the absolute informativeness of earnings, but reduced the informativeness for a given earnings surprise, as well as reduced the abnormal return for a given amount of earnings surprise. Finally, the evidence supports the hypothesis that the opportunistic behavior of managers, primarily related to the fraction of compensation derived from options, was significantly associated with earnings management in the period preceding SOX.

Abstract:
Bradshaw, Richardson, and Sloan (BRS) find a negative relation between their comprehensive measure of corporate financing activities and future stock returns and future profitability. Noticing that accounting accruals are increases in net operatingassets on a company s balance sheet, we question whether it is possible to distinguish between the external financing anomaly documented by BRS and the accrual anomaly first documented by Sloan (1996). We show that once controlling for total accruals, the relation between external financing activities and future stock returns is attenuated and not statistically significant. These findings are consistent with Richardson and Sloan (2003).

External financing, Analysts forecasts, Accruals, Capital Markets, Market Efficiency

Abstract:
We develop a research approach to analyze the conditions under which earnings levels versus earnings changes better explain long-window stock returns. Using a general model of the earnings-return relation, we show that the choice between earnings levels versus changes depends on whether earnings are transitory or permanent. Further, we show that the apparent empirical success of the levels model is due to the statistical property that earnings levels over long windows are highly correlated with the theoretically correct measures of unexpected earnings. Finally, our analysis also has implications for studies of the relative information content of accounting earnings and other measures of performance such as Economic Value Added and residual income.

Abstract:
In this paper we compare two matched samples of 117 corporations whose auditors are and are not sued, to provide information on lawsuits. Lawsuits tend to be filed against auditors of client firms that have liquidity problems and poor stock price performance. There is little evidence of poorer accounting performance or accounting manipulation in the year in which wrongdoing is alleged to have occurred. The likelihood of a lawsuit against an auditor is greater if the audit report is qualified, the less structured is the audit and the larger the proportion of the auditor's revenues generated by the client.

We also use multivariate models to compare the two samples. However, the multivariate analysis' data requirements reduce the number of observations in each sample to 21. Nevertheless, the multivariate analysis also suggests that we can discriminate between the litigation and control firms using the variables that are significant in the univariate analysis.