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Abstract:
Public firms that place equity privately experience positive announcements effects, with negative post-announcement stock-price performance. This finding is inconsistent with the underreaction hypothesis. Instead, it suggests that investors are overoptimistic about the prospects of firms issuing equity, regardless of the method of issuance. Further, in contrast to public offerings, private issues follow periods of relatively poor operating performance. Thus, investor overoptimism at the time of private issues is not due to the behavioral tendency to overweight recent experience at the expense of long-term averages.

Long-run performance, Market efficiency, Private placements, Behavioral finance, Equity issues, Operating performance

Abstract:
Public firms that place equity privately experience positive announcements effects, with negative post-announcement stock-price performance. This finding is inconsistent with the underreaction hypothesis. Instead, it suggests that investors are overoptimistic about the prospects of firms issuing equity, regardless of the method of issuance. Further, in contrast to public offerings, private issues follow periods of relatively poor operating performance. Thus, investor overoptimism at the time of private issues is not due to the behavioral tendency to overweight recent experience at the expense of long-term averages.

Abstract:
This study employs pro-forma company footnote disclosures to assess the value-relevance of employee stock option compensation expense using the fair value method as stipulated by Statement of Financial Accounting Standard No. 123. The study is motivated by the controversy surrounding the issue of accounting for employee stock options and the countervailing effects of issuing stock options on firm value. Although accounting regulators and the business community agree that employee stock options have value and therefore, are a form of compensation, critics of the FASB's proposed fair value method of accounting for employee stock options argue that measuring the compensation expense using contemporary models will result in unreliable and meaningless measures. Moreover, the expected future benefits from granting stock options suggest that this form of employee compensation is not a typical expense. We find a significant association between the disclosed compensation expense using the fair value method and firm value that is in the opposite direction from other income statement expenses. This result implies that the disclosed employee stock option expense is a value-relevant measure and the incentives derived from employee stock option plans provide value-increasing benefits to the firm. In addition, we find the positive association between the employee stock option expense and firm value is greater for firms with more growth opportunities.

Abstract:
This paper focuses on two distinct, but related, issues with respect to managers' incentives to report earnings that meet or exceed analysts' expectations. First, we assess the differential stock price sensitivity to earnings that meet or exceed analysts' expectations compared to those that do not. Second, we examine whether the market implicitly revises analysts' earnings forecasts for firms that systematically report earnings that exceed forecasts. We find that the earnings response coefficient (ERC) is significantly higher for firms that meet analysts' forecasts. Additionally, we find that the market recognizes and adjusts the forecast error of firms that exhibit a systematic pattern of reporting positive or negative unexpected earnings. The market fully adjusts for the systematic component of the forecast error when it is negative; however, only a partial adjustment is made when the systematic component is positive. Overall, our evidence suggests that managers who try to report earnings that meet analysts' forecasts are responding to two market incentives. First, the market provides a premium to positive forecast errors and assigns a higher multiple to the level of positive unexpected earnings. Second, though the market recognizes systematic bias in analysts' forecasts, it does not fully adjust for systematically positive forecast errors. Our evidence provides, at a minimum, a partial explanation for managers' fixation on reporting positive unexpected earnings.

Abstract:
Several recent studies have documented an equity premium (penalty) to beating (missing) analysts' forecasts after controlling for the magnitude of the forecast error. In this study, we analyze this equity premium when firms appear to be engaging in some form of earnings management (e.g., accounting earnings management or real earnings management) to meet analysts' expectations. Our results indicate that the equity premium to meeting analysts' forecasts exists only when firms do not engage in earnings management. However, firms that engage in earnings management to meet forecasts are rewarded in that they avoid the significant penalty associated with missing forecasts. The evidence mostly indicates that the market does not discriminate between real earnings management and accounting earnings management. Our results are robust to a battery of sensitivity tests that attempt to control for measurement error in our earnings management models and other confounding effects; such as size, growth, the passage of Sarbanes-Oxley, and the reporting of losses.

earnings forecasts, financial analysts, real earnings management, meet or beat expectations

Abstract:
The purpose of this paper is to examine the importance attached to revenue forecasts by firms and the market, and whether these forecasts are value-relevant conditional on earnings forecasts. We address two related questions. First, we examine whether the capital market reaction to earnings (and revenue) announcements bears an association with revenue forecast errors, conditional on earnings forecast errors. Second, we investigate whether there exist differential valuation effects associated with meeting or exceeding analysts' revenue expectations over and above meeting/exceeding analysts' earnings expectations.

Our results indicate that revenue forecast errors bear a significantly positive, but a non-linear association with the announcement-period market returns. We also find that this association is stronger for high-growth firms relative to low-growth firms, but does not depend on (i) earnings stability and the extent of consensus among analysts with respect to earnings expectations, and (ii) whether a firm is profitable or not. Finally, our results suggest that for "profit" firms, the act of meeting revenue forecasts invokes a positive market reaction that is independent of the magnitude of the revenue forecast error.

Revenue forecasts; Earnings forecasts; Financial analysts; Valuation; Meet or beat; Expectations

Abstract:
We investigate whether short sellers and analysts differ in their use of fundamental and other information that prior research shows to be predictive of future returns. Remarkably, we find that short interest is significantly associated in the expected direction with all eleven predictive variables considered. In contrast, we find that analysts tend to positively recommend stocks with high growth, high accruals, and low book-to-market ratios -- despite these variables having a negative association with future returns. We also investigate the profitability of using short positions in trading. We find sizable market-adjusted returns (almost 20 percent) from a zero-investment strategy that 1) shorts firms with highly favorable analyst recommendations (buy signal) but high short interest (sell signal), and 2) buys firms with highly unfavorable analyst recommendations (sell signal) but low short interest (buy signal). Overall, our results suggest that short interest incorporates publicly available information more accurately than analyst recommendations, which suggests that short sellers can serve the role as an alternative information intermediary for investors.

analysts' recommendations, short sellers, trading strategy

Abstract:
The primary purpose of this paper is to investigate the value relevance of fundamental analysis under the types of economic conditions that commonly occur in developing countries. By considering changes in key components of operating performance (e.g., changes in gross margin or changes in expenses relative to sales), fundamental analysis has the potential to capture more completely the value relevance of accounting information. Despite this potential, the literature on the value relevance of fundamental analysis is very limited in comparison to the vast literature investigating the value relevance of the two key summary measures provided in financial statements: earnings and book value. Furthermore, little is known about the advantage, if any, of fundamental analysis over summary measures in economic settings that are significantly different from that of the United States. This paper uses Mexico as a setting in which to explore further the value relevance of fundamental analysis. Mexico differs from the U.S. in two important respects that may influence the incremental value of fundamental analysis: First, during the 1990s, Mexican businesses had to cope with a rapidly changing business climate. Second, Mexican companies have reported replacement-cost, price-level-adjusted (RCPLA) information in the primary financial statements since 1984. Under RCPLA accounting, all balances reported on the financial statements, including the prior year amounts, are rolled forward into purchasing power at the end of the most recent period.

We find that fundamental analysis has incremental value relevance in comparison to earnings. Of particular interest, fundamental signals based on line-item components of the 1994 financial statements, but not earnings, provided value relevant information about the effects of the December 1994 devaluation on the market's expectation about changes in future cash flows. This study makes a direct contribution to understanding the value relevance of fundamental analysis and accounting for changing prices. In addition, the study adds to a recent literature investigating the interaction between economic change and the value relevance of financial statement information.

Fundamental analysis; Replacement cost; Price-level adjusted

Abstract:
Firm management typically claims that voluntary accounting method changes (VACs) are made to enhance the informativeness of earnings by better matching accounting practices with economic reality. In contrast, skeptics argue that managers adopt new accounting procedures to opportunistically manage earnings and influence their firm's stock price. In this paper, we investigate these alternative motives for VACs. Specifically, we investigate whether VACs cause equity prices to deviate from their fundamental values in the short-term by studying the long-run stock price performance for a sample of firms that voluntarily change accounting methods. In addition, we investigate changes in earnings informativeness by examining the behavior of earning response coefficients and the relationship between earnings and future cash flows in years surrounding the VAC event. In contrast to prior research, we find little evidence that a strategy based solely on the earnings effect of a VAC can generate abnormal returns. While we find weak evidence of post-VAC abnormal returns for extreme VACs, this result appears to be driven by the accruals anomaly documented in Sloan (1996). Our evidence further suggests that earnings informativeness is not significantly altered by voluntary changes in accounting methods. Taken together, our evidence suggests the market recognizes the financial statement effects of alternative acceptable accounting methods and efficiently processes the valuation implications of VACs.

accounting changes, market efficiency, accruals anomaly, earnings management, earnings quality

Abstract:
Firm management typically claims that voluntary accounting method changes (VACs) are made to enhance the informativeness of earnings by better matching accounting practices with economic reality. In contrast, skeptics argue that managers adopt new accounting procedures to opportunistically manage earnings and influence their firm's stock price. In this paper, we investigate these alternative motives for VACs. Specifically, we investigate whether VACs cause equity prices to deviate from their fundamental values in the short-term by studying the long-run stock price performance for a sample of firms that voluntarily change accounting methods. In addition, we investigate changes in earnings informativeness by examining the behavior of earning response coefficients and the relationship between earnings and future cash flows in years surrounding the VAC event. In contrast to prior research, we find little evidence that a strategy based solely on the earnings effect of a VAC can generate abnormal returns. While we find weak evidence of post-VAC abnormal returns for extreme VACs, this result appears to be driven by the accruals anomaly documented in Sloan (1996). Our evidence further suggests that earnings informativeness is not significantly altered by voluntary changes in accounting methods. Taken together, our evidence suggests the market recognizes the financial statement effects of alternative acceptable accounting methods and efficiently processes the valuation implications of VACs.

Accounting changes, accruals anomaly, market efficiency, earnings management, earnings fixation

Abstract:
Recent studies in the accounting literature provide evidence of an equity price premium whenever firms meet or exceed analysts' earnings forecasts. That is, the market perceives the act of meeting earnings forecasts as a signal about future firm performance. Financial analysts typically issue revenue forecasts in addition to earnings forecasts. In this study, we examine whether meeting or exceeding revenue forecasts serves as an additional signal to the market in pricing earnings performance. Consistent with our hypotheses, we show that the market premium (penalty) to meeting or beating (not meeting) earnings forecasts is accentuated when revenue forecasts are also met (not met). In fact, the premium to meeting earnings forecasts is completely eliminated when revenue forecasts are missed. Consistent with previous research, we document a significant association between revenue forecast errors and quarterly abnormal returns. However, we show that this association becomes insignificant after allowing for shifts in the equity price premium depending on whether earnings and revenue forecasts are met. Thus, the value of meeting revenue forecasts is arguably of greater importance to market participants than the magnitude of the revenue forecast error. Finally, we find some evidence that the magnitude of the earnings response coefficient jointly depends on whether the earnings and revenue forecasts are met or not, however, this result is not robust to a non-linear specification of the association between returns and forecast errors.

Revenue forecasts, Earnings forecasts, Financial analysts, Valuation, Meet or beat expectations

Abstract:
Recent studies in the accounting literature provide evidence of a market premium whenever firms meet or exceed analysts' earnings forecasts. Financial analysts typically issue revenue forecasts in addition to earnings forecasts. In this study, we draw our motivation from the cue consistency theory to examine whether meeting or exceeding revenue forecasts serves as an additional cue to the market in pricing earnings performance. Consistent with this theory, we show that the market premium (penalty) to meeting or beating (not meeting) earnings forecasts is accentuated when revenue forecasts are also met (not met). Meeting earnings forecasts but not meeting revenue forecasts generally results in a significantly negative market penalty, and the magnitude of the earnings response coefficient jointly depends on whether the earnings and revenue forecasts are met or not. Finally, consistent with previous research, we document a significant association between revenue forecast errors and quarterly abnormal returns. However, we show that after allowing for differential market reactions depending on whether earnings and revenue forecasts are met, this association becomes insignificant. This result suggests that the value of meeting revenue forecasts is arguably of greater importance to market participants than the magnitude of the revenue forecast error.

Revenue forecasts, earnings forecasts, financial analysts, valuation, meet or beat, expectations

Abstract:
This paper examines the effect of managerial stock option incentives on the accuracy and information content of firms' voluntary earnings guidance. Prior research suggests that managers manipulate earnings downwards before receiving stock option awards to increase the value of their grants. Similar incentives could lead managers to distort earnings guidance around stock option grants, but the effect of option incentives on the timeliness and usefulness of earnings guidance has received little attention. We show that managers provide more pessimistic guidance before stock option awards than afterwards, consistent with manipulation. However, pre-grant guidance improves upon existing consensus earnings forecasts and is similar to post-grant guidance in bias and accuracy, suggesting that option incentives do not lead managers to distort pre-grant guidance. Furthermore, investors and analysts react similarly to pre- versus post-grant guidance, suggesting that market participants view these two types of guidance as equally informative. Finally, firms that award stock options provide more frequent guidance and have lower absolute analyst forecast errors than other firms, consistent with stock options increasing managerial incentives to disclose information about earnings. Overall, our study indicates that although stock option plans may induce selective disclosure consistent with managers' self-interest, they contribute to an improved overall information environment for the firm.

Management disclosures, stock options, agency theory, analyst forecasts, information environment

Abstract:
Existing research provides competing theories about how dispersion of investor beliefs might affect stock prices. We measure changes in dispersion of investor beliefs around earnings announcements using changes in the dispersion of individual analysts' forecasts. We find that the three-day market response to earnings announcements is negatively associated with changes in dispersion, consistent with the cost of capital hypothesis. The results hold after controlling for the current earnings surprise, forecast revisions of future earnings, and reported earnings relative to various earnings thresholds. Our study provides new insight about the information contained in earnings announcements that is incremental to the magnitude and timing of cash flows.

Dispersion of beliefs, cost of capital, equity call option, market friction, announcement returns

Abstract:
Existing research provides competing theories as to how dispersion of investor beliefs might affect stock prices. We measure changes in dispersion of investor beliefs around earnings announcements using changes in the dispersion of individual analysts' forecasts. We find that the three-day market response to earnings announcements is negatively associated with changes in dispersion, consistent with the cost of capital hypothesis. The results hold after controlling for the current earnings surprise, forecast revisions of future earnings, and reported earnings relative to various earnings thresholds. Our study provides new insight about the information contained within earnings announcements that is incremental to the magnitude and timing of cash flows.

Dispersion of beliefs, cost of capital, equity call option, market friction, announcement returns

Abstract:
In this study, we examine how institutional ownership affects the quality and riskiness of the financial statement audit. We hypothesize that institutional investors can influence corporate policy to employ governance mechanisms that reduce their monitoring costs. Our evidence shows that firms are more likely to hire a Big 4 auditor (our proxy for audit quality) when long-term institutional ownership is high, suggesting that long-term institutional investors view high quality audits as a viable means of improving corporate governance while reducing their direct monitoring costs. We find no association between auditor choice and short-term institutional ownership. Next, we find that auditors charge higher fees (our proxy for audit risk) when short-term institutional ownership is high, consistent with short-term investors creating greater incentives for managers to act myopically. We find no association between audit fees and long-term institutional ownership. Taken together, our evidence suggests that dedicated long-term institutional investors demand higher quality audits to enhance corporate monitoring, and that short-term institutional ownership is positively associated with higher audit risk.

audit quality, institutional ownership, monitoring, audit risk, corporate governance

Abstract:
We examine the association between quarterly stock returns and total earnings news conditional on the timing in which earnings information is revealed to the market. Evidence in prior research suggests that managers try to avoid reporting a negative earnings surprise and that market participants place greater weight on the information contained in earnings announcements than on earnings forecast revisions during a quarter (Soffer et al. 2000; Bartov et al. 2002). This notion is consistent with recency theory in the context of individual judgment and decision-making behavior (Hogarth and Einhorn, 1992). We extend prior research by investigating the descriptive validity of recency theory to a comprehensive set of potential earnings paths. Our evidence suggests, contrary to conclusions in the prior literature, that investors do not always assign more weight to earnings surprises than to analyst forecast revisions. Rather, our results suggest that the market response to earnings news is more consistent with prospect theory, an alternative cognitive psychology theory developed by Kahneman and Tversky (1979).

earnings surprises, analysts' forecast revisions, value relevance, recency theory, prospect theory

Abstract:
This study examines the performance of a trading strategy based on the prediction of firms concurrently reporting a positive earnings change and meeting analysts' earnings forecasts. The evidence indicates that a model predicting both earnings thresholds concurrently can yield excess returns that are incremental to predicting only one earnings threshold. Further, I find that the prediction of forecast errors is relatively more important than predicting earnings changes as the incremental benefit from predicting earnings changes concurrently with forecast errors is small relative to a model that predicts only forecast errors. The results hold while controlling for various risk factors and known anomalies.

Earnings thresholds, trading strategy, market efficiency

Abstract:
This paper presents evidence for international markets about the characteristics of financial analysts who are able to provide more accurate earnings forecasts than their peers. The evidence is provided for ten individual countries and for country groups formed on the basis of a similar culture and corporate governance. While prior studies document that forecast accuracy in the U.S. is associated with several analyst characteristics, this topic has not been investigated in an international setting. We predict that differences in culture and corporate governance will cause the influence of some of the characteristics to differ by country. We find that relative forecast accuracy is influenced by years of experience, size of the analyst's employer, and frequency of forecast issuance in many of the countries and show that the significance of experience and employer is conditional on the type of culture and corporate governance of the country.

Abstract:
Investors' need for forward-looking accounting information is greatly increased when an economic shock occurs during a reporting period. This is particularly true when the shock occurs late in the reporting period, so that current earnings information cannot be extrapolated to the future. Under these conditions, earnings lose value relevance and investors are forced to rely on other information. The basic idea underlying this paper is that, when the value-relevance of earnings is reduced by severe economic change, the detailed performance information provided in financial statements may still be useful in predicting future earnings and cash flows. Currency devaluations provide a natural experimental setting to investigate the effects of severe economic change. The findings from this setting likely extend to other instances in which firms encounter an economic shock during a reporting period (e.g., a terrorist attack, an oil embargo, or a labor strike).

The specific setting we investigate is the December 1994 peso devaluation in Mexico. The economic shock from the peso devaluation was typical of other currency devaluations. Inflation increased dramatically from 7 percent in calendar 1994 to 52 percent in 1995, and stock prices dropped by about 50 percent. A unique aspect of the 1994 Mexican devaluation is that most of the exchange rate decline occurred during the final week of December. The timing of the peso devaluation produces an ideal research setting: First, 1994 earnings cannot be extrapolated to the future so investors need alternative information. Second, we can use annual report data to test whether pre-shock accounting information can provide forward-looking information about post-shock operating performance and stock returns.

Associations with contemporary returns show that earnings in the year of the devaluation lose value relevance (as expected), but fundamental signals, which incorporate the more detailed accounting information provided in financial statements, retain considerable explanatory power (25 percent). After the devaluation, fundamental signals based on changes in selling and administrative expenses and changes in gross margin are significant in several analyses, including predictions of future earnings, analysts' forecast revisions, and analysts' forecast errors. Because analysts underutilize those signals, an opportunity exists after the devaluation for a substantial profit from a zero investment trading strategy.

Abstract:
This study evaluates the relation between security returns and funds-based earnings components. We document that proxies for market expectations of the components that are based on measures of historical serial- and cross-dependencies are substantially more accurate than random-walk proxies. Moreover, we detect significantly higher valuations of the operating cash flow component of earnings, relative to current accruals when market expectations are represented using the dependency-based predictions. Such differential valuation is not detectable for random-walk representations. Contrary to results in Ali (1994), we find incremental information in unexpected cash flows over the whole spectrum (moderate and extreme) of unexpected cash flow realizations.

Abstract:
This paper investigates earnings and risk changes for a sample of firms that issued equity in a private placement. The study is motivated by empirical findings that announcements of public and private sales of equity are associated with opposite stock price effects. We find that earnings increase significantly subsequent to the equity offer and that postoffer earnings changes are positively correlated with announcement period stock price effects. We do not find evidence that private equity sales convey information about the underlying riskiness of firms? assets. These results suggest that private placements of equity convey favorable information to investors about future earnings and contrast with evidence from earlier studies that announcements of public equity issues convey unfavorable information about future prospects.

Abstract:
This study examines the usefulness and the speed in processing of annual earnings announcements and SEC filings by non-U.S. companies listed on either the New York or American Stock Exchange. Intraday trading data and a methodology developed in Cready (1988) and Cready and Mynatt (1991) are utilized to determine if the above characteristics are related to investor wealth. The results indicate that annual earnings announcements of non-U.S. companies are useful to both institutional and individual investors. With respect to the SEC filings, no unexpected trading activity was detected surrounding the filing dates for the entire sample period (1983-1992) for either institutional or individual investors. However, when the sample was restricted to post-1988 filings, which corresponds to a dramatic rise in the market value of non-U.S. equity securities listed in the U.S., the information in the SEC filings was found to be useful to both institutional and individual investors. Finally, for both the earnings announcements and the post-1988 SEC filings, institutional investors appear to process the information more quickly than do individual investors, and the value of the the information increases with investor wealth.