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Abstract:
This paper investigates whether firms use discretion in accounting for deferred taxes to increase earnings and avoid reporting a loss. We find that firm-years with small scaled profits reduce (relative to the prior year) the proportion of the gross deferred tax asset reserved by the valuation allowance more than firm-years with small scaled losses. We find no evidence that the firm-years that have seemingly moved from having a small scaled loss to a small scaled profit using changes in the net deferred tax asset have greater expected future taxable income to support this change under SFAS 109. Our results also suggest that firms that increase earnings through the net deferred tax asset have relatively lower costs to managing earnings to avoid a loss, that is, these firms have a smaller pre-managed loss.

deferred taxes, valuation allowance, net deferred tax asset

Abstract:
This study presents the results of an experiment that examines how two underlying characteristics of pro forma earnings announcements, pro forma emphasis and the presence of a quantitative reconciliation, influence non-professional investors' and analysts' reliance on pro forma disclosures. The results indicate that the emphasis management places on pro forma earnings, not the mere presence of pro forma earnings, influences non-professional investors' judgments and decisions, but that this influence is mitigated by the presence of a quantitative reconciliation. Further analysis reveals that the influence of pro forma emphasis on nonprofessional investors' judgments and decisions seems to be the result of an unintentional cognitive effect as opposed to the perceived informativeness of the earnings figure emphasized by management. Analysts' judgments and decisions were also affected by the presence of reconciliation, but in the opposite direction to those of nonprofessional investors. Specifically, the presence of a quantitative reconciliation led analysts to view pro forma earnings as more reliable, increasing their reliance on the pro forma disclosure in judging the earnings performance of the firm.

Analysts, non-professional investors, pro forma earnings, reconciliations

Abstract:
Prior research suggests that managers strategically emphasize or highlight the pro forma earnings number within the earnings press release when it portrays better firm performance than the GAAP number, and that investors are influenced by this strategic disclosure decision. We extend this research by examining another important disclosure tool that managers may use to strategically emphasize pro forma earnings news - the acceleration or delay of the earnings announcement itself. Our results indicate that managers accelerate earnings announcements (relative to the expected announcement date) in quarters in which they disclose a pro forma earnings measure versus quarters in which they do not. We also find that the acceleration of earnings announcements containing pro forma earnings information increases with the level of (potentially opportunistic) manager exclusions of recurring expenses. Finally, we find that investors respond negatively to managers' recurring exclusions contained in accelerated earnings announcements. This result suggests that in the presence of strategic timing behavior, investors view these exclusions as opportunistic in contrast to conveying value-relevant "core" information. Additional results suggest that the attenuation of investors' response is more pronounced following the regulation of pro forma reporting (i.e., Section 401(b) of the Sarbanes-Oxley Act of 2002). Taken together, our results suggest that, while some managers strategically accelerate the timing of press releases containing pro forma earnings information to alter investors' perceptions, investors are not necessarily misled by this practice. Our results are relevant to standard-setters and regulators, who have expressed continued concern about managers' discretionary use of pro forma disclosures, and to those interested in the effect of regulatory intervention into pro forma reporting.

pro forma earnings, earnings announcement timing, managerial opportunism

Abstract:
While prior research suggests that managers “cater” or respond strategically to investor sentiment via various corporate financing and investment activities, limited empirical evidence exists on how investor sentiment affects firms’ disclosure and financial reporting strategies. We extend this research by examining how managers use their discretion in reporting adjusted (pro forma) earnings metrics in response to sentiment-induced biases in investors’ expectations of future firm performance. Using logit analysis, we find a positive association between the level of investor sentiment and the decision to report an adjusted earnings measure, suggesting that managers tend to report a more favorable earnings metric when investors hold optimistic beliefs about future firm performance. Further, our analyses suggest that as investor sentiment increases, managers (1) exclude higher levels of recurring and nonrecurring expenses in calculating the pro forma earnings figure and (2) place the pro forma figure more prominently within the earnings press release. We also find that managers’ catering behavior is more pronounced for firms whose stock valuations are especially sensitive to sentiment. Finally, additional analyses indicate that in some cases the association between investor sentiment and managers’ pro forma disclosure decisions at least partly reflects opportunistic motives. Taken together, our results suggest that managers use pro forma earnings disclosures to respond strategically to investors’ sentiment-driven expectations. This study is the first to explore the relation between investor sentiment and the type and placement of accounting information (and specifically alternative performance metrics) disclosed in earnings press releases.

investor sentiment, pro forma earnings, corporate disclosure, catering theory

Abstract:
We investigate a key assumption underlying much of the experimental research in financial accounting that graduate business students are a reasonable proxy for nonprofessional investors. We investigate this assumption using two settings: (a) an experimental setting from a recent paper that relies on this assumption, and (b) by using a proprietary dataset from a publicly traded company's investor relations website. Our analysis reveals that, on average, early MBA students (i.e., students beginning the "core" MBA classes) acquire information as well as nonprofessional investors but that they are unable to integrate that information with other information when making investment-related judgments and decisions. In contrast, select MBA students (i.e., students who have completed the core and elected to take a financial analysis course) acquire and integrate information as well as nonprofessional investors when making investment-related judgments and decisions. Further tests reveal that early MBA students with significant work experience (e.g., greater than five years) perform better than less experienced, early MBA students and not significantly different from nonprofessional investors. Our results suggest that using graduate business students as a proxy for nonprofessional investors is a valid methodological choice, provided researchers give careful consideration to aligning their tasks with the appropriate level of education and/or work experience.

Investor sophistication, behavioral research in accounting, stock options

Abstract:
This study presents the results of an experiment that examines how sensitivity disclosures influence investors' judgments of the reliability of financial statement items. A sensitivity disclosure uses "parameters" to describe the slope of change in a financial statement item value in response to change in an input that underlies the item. Since sensitivity can be depicted using any two points along the slope of change, managers can choose different parameters to communicate the same sensitivity. In our experiment, we manipulate the magnitude of the parameters (i.e., points along the slope of change) used in the sensitivity disclosure for the capitalized software development asset of a hypothetical firm. The results indicate that investors' reliability judgments decrease as the reported parameters increase. Mediation analysis provides evidence that the effect of parameters on investors' reliability judgments occurs through their impact on the size of the set of alternative financial statement item values investors perceive as a result of observing the sensitivity information. Additional evidence suggests that the effect of parameters reflects an unintentional reliance on the set of alternative values made available by the parameters, rather than a conscious response to a perceived management signal about reliability through parameter choice. This study has implications for disclosure requirements given the increasing acceptance of measurement attributes that require estimation (e.g., fair value), and improves our understanding of how disclosures influence investors' reliability judgments.

sensitivity disclosure, reliability, judgment and decision-making, nonprofessional investor

Abstract:
We examine how accounting transparency and investor base jointly affect financial analysts’ expectations of mispricing (i.e., expectations of stock price deviations from fundamental value). These two factors interactively amplify analysts’ expectations of mispricing, with analysts expecting a larger positive deviation when a firm’s most important investors are described as sophisticated investors with a shorter-term horizon (transient institutions) rather than a longer-term horizon (dedicated institutions) and the firm’s disclosures more transparently reveal income-increasing earnings management. Results are consistent with analysts anticipating that transient institutional investors are more likely than dedicated institutional investors to try to earn short-term profits by enacting trading strategies around the effects of unsophisticated investors’ sentiment. Specifically, results are consistent with analysts anticipating that transient institutional investors are less likely to immediately take actions that put corrective pressure on price (allowing the effects of unsophisticated investors’ sentiment to persist) when a firm manages near-term earnings more transparently, whereas they are more likely to do so with less transparent disclosure. Our theory and findings extend the accounting disclosure literature by identifying a boundary condition to the supposition that disclosure transparency mitigates expected mispricing, and by providing evidence that analysts’ pricing judgments are influenced by their anticipation of different sophisticated investors’ reactions to firm disclosures.

analysts, expected mispricing, institutional investor, disclosure transparency

Abstract:
In this paper we use a unique dataset to investigate the relationship between nonprofessional investors' information choices and their portfolio returns. We also investigate the role investing experience plays in this relationship. We find that nonprofessional investors earn lower returns as their use of unfiltered information (e.g., SEC filings) increases relative to their use of filtered information (e.g., Value Line analysts reports), and that investment experience not only moderates but actually reverses this negative relationship. Specifically, less (more) experienced nonprofessional investors earn lower (higher) returns as their use of unfiltered information increases. Our results suggest that this effect is driven by investors' ability to understand and use unfiltered information as they gain investing experience, not by a shift in their information choices. These findings are particularly relevant in the current reporting environment where greater numbers of inexperienced investors are entering the markets and recent legislation (e.g., Sarbanes Oxley Act of 2002) requires firms to disclose more detailed financial information.

Nonprofessional Investors, Information Choice, Unfiltered Information

Abstract:
We investigate a key assumption underlying much of the experimental research in financial accounting that graduate business students are a good proxy for non-professional investors. To conduct our investigation, we categorize recent experimental studies in financial accounting based on the relative level of integrative complexity inherent in each study's task. We then conduct experiments using two tasks, one that is relatively low in integrative complexity and one that is relatively high in integrative complexity, and compare the responses of two groups of MBA students and non-professional investors.

Our results suggest that using MBA students as a proxy for non-professional investors is a valid methodological choice, provided researchers give careful consideration to aligning a task's integrative complexity with the appropriate level of MBA student. MBA students who have completed their core MBA courses and are enrolled in or have completed a financial statement analysis course are a good proxy for non-professional investors in tasks that are relatively low in integrative complexity. Though less definitive, the majority of our tests also suggest that these students are a good proxy for non-professional investors in tasks that are relatively high in integrative complexity. However, care must be taken when using students in the first-year core financial accounting course. In tasks that are relatively low in integrative complexity, these students perform similarly to non-professional investors except when they are asked to make an investment decision. In tasks that are relatively high in integrative complexity, these students acquire information similarly to non-professional investors, but they do not appear to integrate the information in a similar manner.

sophistication, behavioral research in accounting, stock options

Abstract:
Restatements are economically significant events that damage investor trust in a firm’s financial reporting. We conduct an experiment to investigate how using online video to announce a restatement interacts with the level of responsibility a manager assumes for the restatement to influence investors’ perceptions of management’s trustworthiness and post-restatement investment decisions. We examine the use of online video for restatement disclosure due to video’s recent, explosive growth as a corporate communication tool. Our results reveal that when the CEO’s firm is the only firm restating, participants viewing the restatement announcement online via video make larger investments in the firm and are more confident in the firm’s future ability to meet analysts’ expectations than are participants who view the restatement announcement online via text. However, we do not observe this effect when the CEO’s firm and its industry peers are restating. Our results also reveal that participants’ perceptions of management’s trustworthiness mediate the influences of disclosure venue and assumed responsibility on post-restatement investment decisions. These findings are important given the dramatic increase in the number of restatements over time, the resultant deterioration of investor trust, and the Security and Exchange Commission’s recent emphasis on transitioning from traditional, paper-based to new, Internet-based disclosure venues.

trust, investor, investment decision, responsibility, disclosure venue, online video

Abstract:
This study presents the results of an experiment that examines how two underlying characteristics of pro forma earnings announcements, pro forma emphasis and the presence of a quantitative reconciliation, influence non-professional investors' and analysts' reliance on pro forma disclosures. The results indicate that the emphasis management places on pro forma earnings, not the mere presence of pro forma earnings, influences non-professional investors' judgments and decisions, but that this influence is mitigated by the presence of a quantitative reconciliation. Further analysis reveals that the influence of pro forma emphasis on nonprofessional investors' judgments and decisions seems to be the result of an unintentional cognitive effect as opposed to the perceived informativeness of the earnings figure emphasized by management. Analysts' judgments and decisions were also affected by the presence of reconciliation, but in the opposite direction to those of nonprofessional investors. Specifically, the presence of a quantitative reconciliation led analysts to view pro forma earnings as more reliable, increasing their reliance on the pro forma disclosure in judging the earnings performance of the firm.

Analysts, non-professional investors, pro forma earnings, reconciliations

Abstract:
In this paper we investigate the relationship between non-professional investors' information choices and their portfolio returns. We also investigate the role investing experience plays in this relationship. We find that non-professional investors earn lower returns as their use of unfiltered information (e.g., SEC filings) increases relative to their use of filtered information (e.g., Value Line analyst reports). We also find that investing experience mitigates this negative relationship. The latter result appears to be driven by investors' use of unfiltered (as opposed to filtered) information as they gain investing experience.

Abstract:
We investigate a key assumption underlying much of the experimental research in financial accounting that graduate business students are a good proxy for non-professional investors. To conduct our investigation, we categorize recent experimental studies in financial accounting based on the relative level of integrative complexity inherent in each study's task. We then conduct experiments using two tasks, one that is relatively low in integrative complexity and one that is relatively high in integrative complexity, and compare the responses of two groups of MBA students and non-professional investors.

Our results suggest that using MBA students as a proxy for non-professional investors is a valid methodological choice, provided researchers give careful consideration to aligning a task's integrative complexity with the appropriate level of MBA student. MBA students who have completed their core MBA courses and are enrolled in or have completed a financial statement analysis course are a good proxy for non-professional investors in tasks that are relatively low in integrative complexity. Though less definitive, the majority of our tests also suggest that these students are a good proxy for non-professional investors in tasks that are relatively high in integrative complexity. However, care must be taken when using students in the first-year core financial accounting course. In tasks that are relatively low in integrative complexity, these students perform similarly to non-professional investors except when they are asked to make an investment decision. In tasks that are relatively high in integrative complexity, these students acquire information similarly to non-professional investors, but they do not appear to integrate the information in a similar manner.

sophistication, behavioral research in accounting, stock options