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Abstract:
Survey evidence indicates widely held managerial beliefs that earnings volatility is negatively related to earnings predictability. In addition, existing research suggests that earnings volatility is determined by economic and accounting factors, and both of these factors reduce earnings predictability. We find that the consideration of earnings volatility brings substantial improvements in the prediction of both short and long-term earnings. Conditioning on volatility information also allows one to identify systematic errors in analyst forecasts, which implies that analysts do not fully understand the implications of earnings volatility for earnings predictability.

earnings volatility, earnings predictability

Abstract:
This paper examines how one aspect of earnings quality - discretionary accruals - affects subsequent capital investment pattern and efficiency. We find that, conditional on investment opportunities, investment in fixed assets in period t is less sensitive to internal cash flows for firms with large positive discretionary accruals in period t-1. We also find that, at a given level of capital investment in fixed assets in period t, the return on assets in period t +1 is lower for firms with large positive discretionary accruals in period t-1. The overall evidence suggests that firms with large positive discretionary accruals misallocate resources, and thus, impose dead-weight efficiency loss.

earnings quality, discretionary accruals, capital investment, investment efficiency

Abstract:
This paper presents a theory and empirical evidence that investigate the effects of poor matching on the properties of accounting earnings. The key intuition of this theory is that poor matching manifests as noise in the economic relation between revenues and expenses. As a result, poor matching decreases the correlation between contemporaneous revenues and expenses and increases the correlation between non-contemporaneous revenues and expenses. With regards to earnings effects, poor matching increases earnings volatility, decreases earnings persistence, and induces a negative autocorrelation in earnings changes. Since poor matching resolves over time, we expect that all of these effects are less pronounced over longer-horizon definitions of earnings. The empirical tests concentrate on documenting the effects of matching and the associated properties of earnings in a sample of the 1,000 largest U.S. firms over the last 40 years. We find a clear and economically substantial trend of declining contemporaneous correlation between revenues and expenses, while the correlation between revenues and non-contemporaneous expenses is increasing. We also find strong evidence of increased volatility of earnings, declining persistence of earnings, and increased negative autocorrelation in earnings changes. As expected, these trends are less pronounced for longer-horizon definitions of earnings. Based on this evidence we conclude that accounting matching has become worse over time and that this trend has produced a pronounced effect on the properties of the resulting earnings. This evidence also suggests that the FASB's stated goal of moving away from matching and towards more fair-value accounting is likely to continue and deepen the identified trends in the properties of earnings.

matching, earnings properties

Abstract:
This paper examines whether earnings management through accounting manipulation has an impact on subsequent corporate investments. Using a measure of earnings management based on the work of Kothari, Leone, and Wasley (2005), I find that investment level in firms with the most aggressive accounting practices is higher and is less sensitive to internal cash flows, whereas investment in firms with the least aggressive accounting practices is more sensitive to internal cash flows. Furthermore, earnings management induces investment inefficiency in the future. The findings suggest that financial reporting has an impact on real investment patterns and efficiency. This paper also provides cross-sectional evidence that corporate investments respond to the market assessment even when it differs from the managerial own assessment of the fundamentals.

earnings management, market efficiency, investmen, investment efficiency

Abstract:
This paper examines whether proprietary costs influence privately held firms' financing choice between private placements and public offerings. The financing choice determines whether proprietary information revealed to investors is also available to competitors. Using hand-collected information about privately held firms, I find both cross-sectional and time-series evidence that firms with higher proprietary costs are more likely to choose private placements instead of public offerings. First, in the cross-section, at the industry level, firms operating in more competitive product markets are more likely to choose private placements. Second, at the firm level, firms operating in multiple lines of business and more profitable firms are more likely to choose private placements. Third, in the time-series, an increase in product market competition is associated with an increase in the proportion of private placements by privately held firms. Finally, firms are more likely to choose private placements under the new segment reporting regime SFAS 131.

proprietary cost, private placements, public offerings, mandatory disclosure, segment reporting, corporate financing

Abstract:
Prior research shows that negative special items are less persistent than core earnings. However, the allocation of special items to periodic earnings entails significant measurement error which may induce the observed lower persistence. In this paper, we control for this measurement error by aggregating core earnings and special items over periods of one to five years, and testing whether the differential persistence is robust to longer aggregation periods.

We find lower persistence of special items only for firms with low core (pre-special items) profitability. For these firms, negative special items have no association with future bottom line earnings for all aggregation periods. In contrast, for high core profitability firms, negative special items exhibit significant persistence, and the persistence increases with the aggregation period. In particular, when earnings are aggregated over five years, we find no difference in the persistence of negative special items and core earnings.

special items, measurement error, persistence

Abstract:
A causal relationship between disclosure practices and cost of capital is difficult to establish because cost of capital reflects both disclosure practices (information risk) and fundamentals that are being disclosed (fundamental risk). To separate information risk from fundamental risk, this paper employs an examination of a unique institutional setting in which certain Chinese companies have two classes of shares that entitle their holders to identical cash flow and voting rights but are available to mutually exclusive sets of investors: A shares to domestic investors and B shares to foreign investors. Because the fundamental risk is theoretically identical, the price differential between A and B shares should reflect differential information risk for A and B shares, as determined by disparity in public disclosure available to domestic and foreign investors.

I find that disparity in public disclosure available to domestic and foreign investors is related to the cross-sectional variation in both the level and change in price differentials between A and B shares. First, the greater the disparity in information disclosed to domestic and foreign investors, the greater the level of price differentials. Second, in response to an exogenous shock, the greater the disparity in information disclosed to domestic and foreign investors, the smaller the decline in price differentials. Finally, the impact of disclosure practices on price differentials is muted on the Shenzhen Stock Exchange (SZSE). It is presumably because the majority of foreign investors on SZSE are from Hong Kong and they incur a relatively lower information acquisition cost to overcome disparity in public disclosure.

Disclosure, Information risk, Fundamental risk, Information cost, Language, Distance

Abstract:
This paper examines how one aspect of earnings quality - discretionary accruals - affects subsequent capital investment pattern and efficiency. We find that, conditional on investment opportunities, investment in fixed assets in period t is less sensitive to internal cash flows for firms with large positive discretionary accruals in period t-1. We also find that, at a given level of capital investment in fixed assets in period t, the return on assets in period t +1 is lower for firms with large positive discretionary accruals in period t-1. The overall evidence suggests that firms with large positive discretionary accruals mis-allocate resources, and thus, impose dead-weight efficiency loss.

earnings quality, discretionary accruals, capital investment, investment

Abstract:
Most proponents of using profit margins in a forecasting model suggest that unusual items be removed from income to create a "core" profit margin. We investigate the appropriateness of this assumption over short and long horizons. Specifically, we explore the association between profit margins and special items over windows of increasing length, from one to five years.

We find the association between past special items and future profit margins differs markedly between firms with low and high core profitability. For low profitability firms, past special items have no association with future profit margins, even over windows of five years. In sharp contrast, for high profitability firms, negative special items are associated with lower future profit margins. This suggests that some firms maintain high core profitability by becoming serial chargers and special items differ from core earnings only to the extent that the allocation process induces timing errors in reported earnings.

Special items, persistence, core earnings, earnings aggregation, profit margins

Abstract:
We present a theory that poor matching manifests as noise in the economic relation of advancing expenses to earn revenues. As a result, poor matching decreases the correlation between contemporaneous revenues and expenses, increases earnings volatility, decreases earnings persistence, and induces a negative autocorrelation in earnings changes. The empirical tests document these effects in a sample of the 1,000 largest U.S. firms over the last 40 years. We find a clear and economically substantial trend of declining contemporaneous correlation between revenues and expenses, increased volatility of earnings, declining persistence of earnings, and increased negative autocorrelation in earnings changes. The combined evidence suggests that accounting matching has become worse over time and that this trend has a pronounced effect on the properties of the resulting earnings. This evidence also suggests that the standard setters' stated goal of moving away from matching and towards more fair-value accounting is likely to continue and deepen the identified trends in the properties of earnings.

matching principle, fair-value accounting, earnings properties

Abstract:
We examine stock sales as a managerial incentive to help explain the discontinuity around the analyst forecast benchmark. We find that the likelihood of just meeting versus just missing the analyst forecast is strongly associated with subsequent managerial stock sales. Moreover, we provide evidence that managers manage earnings prior to just meeting the threshold and selling their shares. Finally, the relation between just meeting and subsequently selling shares does not hold for non-manager insiders, who arguably cannot affect the earnings outcome, and is weaker in the presence of an independent board, suggesting that good corporate governance mitigates this strategic behavior.

analyst forecasts, earnings, managerial compensation, insider trading, corporate governance