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Abstract:
This study provides evidence that mutual fund trading in response to the release of analyst information destabilizes U.S. stock prices. Specifically, we show that, during the 1995 to 2006 period, mutual funds "herd" (trade together) into stocks with consensus sell-side analyst upgrades and (especially) herd out of stocks with consensus downgrades. Further, downgraded stocks heavily sold by herds initially underperform, then outperform their size, book-to-market, and momentum benchmarks, while upgraded stocks that are heavily bought exhibit the opposite pattern. An investment strategy that exploits these reversals generates a benchmark-adjusted return exceeding six percent per year. Moreover, the sharpest return reversals occur when mutual funds with poor recent performance ("unskilled fund managers") herd in selling stocks they own in common following a consensus analyst downgrade. The response of herds to analyst revisions and the resulting stock return reversals have both increased from 1985 to 2006, which is consistent with the rapidly increasing proportion of unskilled mutual fund managers over this period. Overall, our evidence indicates that herding by mutual fund managers with short-term reputational concerns in response to the release of sell-side analyst information leads to significant stock return reversals.

mutual funds, stock market efficiency

Abstract:
This study documents evidence consistent with herding in voluntary disclosure decisions in the context of capital expenditure forecasts and investigates two possible reasons for this behavior. Theories of rational herds suggest that herding in disclosure decisions may be due to either (1) the influence of information reflected in peer firms' past disclosure decisions (informational herding), and/or (2) managers' concern for their reputations (reputational herding). Using duration analysis for repeated events, we examine the timing of capital expenditure forecasts for a broad sample of disclosing and nondisclosing firms. We predict and find that the propensity to release capital expenditure forecasts is positively associated with the proportion of prior disclosing firms within the same industry, thus, providing evidence of herding. We also find that this positive association is even higher for firms in highly concentrated industries and firms with low barriers to entry. This finding suggests that firms facing relatively high industry competition may have greater incentives to herd. To provide further evidence of the underlying sources of this behavior, we examine whether the tendency to herd varies with the information content and specificity of prior same-industry forecasts, and with the level of managerial reputation. Our findings show that managers are more likely to disclose their expenditure plans when prior peer forecasts signal a decrease in future capital spending and when prior peer forecasts are more precise. Furthermore, we find that less reputable managers exhibit greater tendencies to herd in their disclosure decisions. These findings indicate that informational and reputational factors are both significant sources of herding in voluntary disclosure decisions.

herding, disclosure

Abstract:
Prior studies of internal control disclosures under the 2002 Sarbanes-Oxley Act (SOX) provide limited evidence on the impact of internal control regulation on reporting quality. Moreover, there is scant empirical evidence on the reporting quality effects of mandatory internal control reforms in non-U.S. regulatory regimes. Thus, it is still an open question whether internal control regulation leads to systematic improvements in reporting quality. We examine this issue, with specific focus on the 1998 German legislation on control and transparency (KTG). In particular, we examine whether German firms experience an increase in earnings quality following the 1998 internal control reform. Using both a differences and difference-in-differences research design, our results suggest that after the KTG reform, German firms experience an increase in timely loss recognition and a decrease in earnings management as indicated by various measures of earnings smoothing and managing toward small positive earnings. These results are robust to various sensitivity analyses. Taken together, our results are consistent with the achievement of one of the main goals of internal control regulation¿increased earnings quality through effective internal control.

internal controls, earnings quality, international accounting, KonTraG (KTG), Sarbanes-Oxley

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:
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