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Abstract:
We examine the impact of incentives on accounting quality changes around IFRS adoption. In particular, we examine earnings management and timely loss recognition, constructs often used to assess accounting standards quality. While existing literature documents accounting quality improvements following IFRS adoption, we find that improvements are confined to firms with incentives to adopt. Further, we find that firms that resist IFRS have closer connections with banks and inside shareholders, which could explain these firms' lack of incentives to adopt IFRS. The overall results indicate that incentives dominate accounting standards in determining accounting quality.

IFRS, IAS, accounting quality, incentives, international accounting, regulation, standard setting

Abstract:
In this study we compare the timeliness and conservatism of reported earnings across the U.S. and U.K. GAAP regimes. We present a theoretical model of the differential speeds of recognition of good news and bad news. This suggests informative and relatively robust ways of measuring dimensions of conservatism in income recognition. The analysis shows the importance of distinguishing between delays in reporting good news and early recognition of bad news, when comparing conservatism across GAAP regimes. Empirical results suggest that the treatment of extraordinary items is important in assessing relative conservatism. The degree of conservatism of the U.S. GAAP regime appears significantly greater than for the U.K. GAAP regime, when estimated using ordinary earnings. However, when conservatism is estimated using earnings after extraordinary items we find that the gap is far less pronounced, and may even disappear. Our results further indicate that the main feature distinguishing the timeliness of earnings between the U.S. and U.K. is not the relative speed of recognition of bad news, but the much slower recognition of good news under U.S. GAAP.

Abstract:
In this study we compare the timeliness and conservatism of reported earnings across the U.S. and U.K. GAAP regimes. We present a theoretical model of the differential speeds of recognition of good news and bad news. This suggests informative and relatively robust ways of measuring dimensions of conservatism in income recognition. The analysis shows the importance of distinguishing between delays in reporting good news and early recognition of bad news, when comparing conservatism across GAAP regimes. Empirical results suggest that the treatment of extraordinary items is important in assessing relative conservatism. The degree of conservatism of the U.S. GAAP regime appears significantly greater than for the U.K. GAAP regime, when estimated using ordinary earnings. However, when conservatism is estimated using earnings after extraordinary items we find that the gap is far less pronounced, and may even disappear. Our results further indicate that the main feature distinguishing the timeliness of earnings between the U.S. and U.K. is not the relative speed of recognition of bad news, but the much slower recognition of good news under U.S. GAAP.

Abstract:
We examine whether UK GAAP to IFRS earnings reconciliations convey information. As a result of debt contracting, mandatory accounting changes are expected to affect the likelihood of violating existing covenants based on rolling GAAP, leading to a redistribution of wealth between shareholders and lenders. Consistent with this prediction, we find significant market reactions to IFRS reconciliation announcements. These market reactions are more pronounced among firms that face a greater likelihood and costs of covenant violation and early announcements. While the association between later announcements and weaker market reactions is consistent with contractual implications of technical changes to earnings, which investors quickly learn to predict, it is inconsistent with IFRS forcing all firms in the sample to reveal firm-specific information through accruals. Thus, by showing that mandatory IFRS also affects debt contracting, we expand on existing IFRS research that focuses on how accounting quality and cost of capital are impacted.

debt contracting, mandatory accounting change, International Financial Reporting Standards

Abstract:
This paper examines the executive compensation practices of listed U.K. retailing companies. We compare New Economy retailers (e-commerce/dot.coms) to more traditional retailers operating in the Old Economy. We also discriminate between recently floated retailers and their more seasoned counterparts. Using a sample of remuneration contracts for 549 directors in 72 listed U.K. companies in the New and Old Economy, we investigate the structure and level of executive (and non-executive) compensation defined as the sum of salary, annual bonus, and the values of executive stock options and long-term incentive plans (LTIPs). We investigate the extent to which the contract features are determined by firm characteristics, economic sector, and governance/ownership factors. In contrast to the U.S., where almost all executive stock options are issued at the money, there is a greater variety of practice in the U.K. with some options being granted substantially in the money. We, therefore, pay special attention to this U.K. institutional feature by producing a model designed to explain the cross-sectional variation in the moneyness of stock options at the date of issue. We also examine the determinants of a number of other contract features. These are: the time to maturity of the executive stock options, the leverage of the compensation package, the ratio of long-term pay relative to short-term pay, and pay performance sensitivity. We find that differences in compensation arrangements can be explained to a significant extent by differences in firm size, growth/growth opportunities, firm financial policy, ownership characteristics, and governance arrangements. We also find some systematic differences between the compensation arrangements of CEOs and other executives.

Managerial compensation, remuneration committee, executive stock options, new economy

Abstract:
This paper examines the executive compensation practices of listed UK retailing companies. We compare New Economy retailers (e-commerce and dot.coms) to more traditional retailers operating in the "Old Economy". We also discriminate between recently floated retailers and their more seasoned counterparts. Using a sample of remuneration contracts for 552 CEOs, other executives and non-executives in 72 listed UK companies in the New and Old Economy, we investigate the structure and level of executive (and non-executive) compensation defined as the sum of salary, annual bonus, and the values of executive stock options and long-term incentive plans (LTIPs). We investigate the extent to which the contract features are determined by firm characteristics, economic sector and the composition of the remuneration committee. The contract features we examine are the time to maturity of the executive stock options, whether options were granted in-, at- or out of the money, and the leverage of the compensation package (in terms of the director's wealth gains through increases in the value of stock options and LTIPs relative to the director's cash pay). In stark contrast to US findings and to UK corporate governance guidelines, we find evidence that a large proportion of sample firms, particularly in the New Economy, issue executive stock options in-the-money, and that the composition of the remuneration committee has a significant impact on the moneyness of stock options.

Managerial Compensation, Remuneration Committee, Executive Stock Options, New Economy

Abstract:
This paper presents an empirical study of profit warnings issued by UK companies. The study adds value to the existing literature on warnings because it models the warning decision in a stock market economy that is significantly less litigious than the US. This in turn allows factors, other than the threat of litigation, to influence the decision to warn. In addition we produce evidence on the effect of a change in the London Stock Exchange rules relating to the release of price sensitive information on the frequency and timing of profit warnings.

The paper describes the profit warning experience of the London Stock Market for periods surrounding a change in the stock exchange rules governing the issuance of warnings in 1994. Given this background the paper then moves on to model a range of factors that potentially have influenced the decision to warn. Special attention is paid to the influence of ownership structure and bondholder/stockholder conflicts of interest on the decision to warn.

voluntary disclosure, profit warning, price sensitive information, management disclosures, earnings surprise

Abstract:
Disclosure of executive compensation schemes has been made mandatory over the past decade in many countries including the UK and the US. Firms however tend not to fully disclose the functional form of their executive compensation schemes. This paper provides a rationale for the lack of voluntary disclosure by firms.

It introduces a voluntary disclosure model in which executive compensation solves a moral hazard problem, the resolution of which depends on proprietary information. It provides conditions under which equilibria involving either disclosure or nondisclosure of the executive compensation scheme can obtain and shows that shareholders are better off precommitting not to disclose the executive compensation scheme whenever possible. It establishes that executive directors are better off too in the absence of disclosure of executive compensation schemes. It furthermore shows that mandating the disclosure of executive compensation may not increase the richness of investors' information set.

Executive compensation, disclosure, regulation

Abstract:
We explore the capital market consequences of achieving analyst earnings expectations, distinguishing between expectations achieved through earnings guidance and earnings management. We consider three earnings management tools: real earnings management, working capital accruals management, and classification shifting. Our results show that the market does not reward firms that meet or just beat analyst expectations through earnings management. Of the remaining meet or just beat firms, the market rewards those with positive forecast revisions during the period and those that engage in earnings forecast guidance. Rational pricing tests show that this market reaction is in line with information on future performance with one exception: the market temporarily undervalues some firms that neither guide forecasts nor manage earnings to beatable targets. While our evidence suggests a conservative market reaction to achieving analyst expectations, it also shows that earnings forecast guidance is informative rather than opportunistic. In line with this evidence, additional tests show that managers of U.K. firms guide forecasts when capital market intermediation is high and the firm's earnings are difficult to predict.

analyst expectations, market reward, earnings guidance, classification shifting, rational pricing

Abstract:
Financial Reporting Standard No 3 (FRS3) regulated the reporting of financial performance by UK firms from 1993 until the adoption of International Financial Reporting Standards in 2005. FRS3 outlawed extraordinary items, but allowed a clearer distinction between recurring and transitory income by giving firms discretion over the classifications of unusual (i.e. exceptional) items and the option to disclose alternative EPS. Through these provisions FRS3 increased the scope for classificatory choices as a means to highlight persistent profitability. We examine the impact of FRS3 on classificatory smoothing by UK firms and document a significant rise in this practice post-FRS3. We find that this increase is due mainly to deviations of net income from expected earnings inducing a significantly higher level of classificatory smoothing post-FRS3. Additional analysis shows that earnings are substantially more persistent at the pre-exceptional level post-FRS3. Overall, our results suggest greater use of classificatory choices to highlight sustainable profitability after the change in performance reporting regime.

classificatory income smoothing, extraordinary and exceptional items, sustainable profitability, earnings persistence

Abstract:
We examine the asymmetric timelines of reported earnings in recognising bad news in the context of corporate refocusing activity by UK listed companies. This provides an opportunity to examine a specific set of accounting transactions intricately linked with earnings conservatism, since refocusing activities are: (i) commonly associated with bad news; (ii) typically associated with large material charges; (iii) likely to be part of a strategic plan with the internal decision preceding the formal public announcement; and (iv) widespread, in the sense that a material proportion of firms undertake refocusing activities every year. Our results show that refocusing firm-years exhibit a significantly higher level of earnings conservatism than non-refocusing firm years. Our findings provide strong corroborating evidence in favour of Basu's original hypothesis and give an insight into the dynamics of earnings conservatism.

Conservatism, refocusing, restructuring

Abstract:
We complement recent research (Ball et al. 2003) which suggests that country-level incentives (i.e. legal origin and the level of capital market development) are the main determinants of the quality of financial reporting. Using a newly developed Brazilian Corporate Governance Index (BCGI) we perform an experiment in the poor quality accounting and governance Brazilian environment. We find that superior governance practices at the firm-level and cross-listing have a first-order effect on the informativeness of accounting reports. The earnings quality of Brazilian firms with good governance is similar to the quality previously reported for firms based in common law developed countries.

corporate governance, financial accounting, emerging markets, Brazil

Abstract:
We investigate the impact of a new framework for reporting financial performance on managerial choice between inter-temporal and classificatory income smoothing. Financial Reporting Standard No3 (FRS3): Reporting Financial Performance required UK firms to disclose net income per share, but also allowed for more discretion in classifying exceptional items by broadening their definition, enhancing their disclosure, and allowing disclosures of alternative earnings measures. FRS3 counterbalanced the additional discretion with rigorous transparency requirements. We predict that UK firms reacted rationally to this enhanced flexibility in classificatory choices and substituted classificatory smoothing for inter-temporal smoothing through abnormal accruals to offset temporary shocks in performance and highlight sustainable profitability. The results of descriptive and multivariate analysis show a significant decline in income smoothing using abnormal accruals post-FRS3. The decline pertains to firms that used classificatory choices to a greater extent post-FRS3 to smooth income and is robust to controls for the effect of concurrent corporate governance regulation. Our results suggest that enhancing both disclosure and classification discretion within the income statement can reduce the cost of income smoothing.

Income smoothing, accruals, classificatory choices, regulation

Abstract:
We investigate whether the choice of valuation model affects the forecast accuracy of the target prices that investment analysts issue in their equity research reports, controlling for factors that influence this choice. We examine 490 equity research reports from international investment houses for 94 UK-listed firms published over the period 07/2002-06/2004. We use four measures of accuracy: (i) whether the target price is met during the 12-month forecast horizon (met_in); (ii) whether the target price is met on the last day of the 12-month forecast horizon (met_end); (iii) the absolute forecast error (abs_err); and (iv) the forecast error of target prices that are not met at the end of the 12-month forecast horizon (miss_err). Based on met_in and abs_err, price-to-earnings (PE) outperform DCF models, while based on met_end and miss_err the difference in valuation model performance is insignificant. However, after controlling for variables that capture the difficulty of the valuation task, the performance of DCF models improves in all specifications and, based on miss_err, they outperform PE models. These findings are robust to standard controls for selection bias.

Equity valuation, investment analysts, target price accuracy, valuation model choice

Abstract:
This paper analyses the relationship between institutional shareholdings and CEO cash-based remuneration. Uniquely to this field of research we specifically model the different elements of cash-based remuneration separately to account for the timing differences relating to their award and performance criteria. We document 5 significant empirical regularities. First, controlling for firm size, the presence of a large institutional shareholding, or high concentration of institutional shareholdings, significantly reduces the magnitude of salary and bonuses. Second, institutional shareholdings significantly increase the positive relationship between bonus remuneration and firm performance. Third, the presence of a large institutional shareholding, or high concentration of institutional shareholdings, reduces the rates of increase in salary, benefits and bonuses. Fourth, the magnitude of salary and benefits are negatively related to firm performance. This implies that CEOs are taking their contracted salary regardless of firm performance. Fifth, the standard practice of modelling salary and bonuses together produces misleading results. We demonstrate that as salary and bonuses are payments for different reasons and relate to different time periods over which performance is measured they should be modelled separately.

Executive Remuneration, Institutional Investors

Abstract:
This paper explores the relationship between institutional shareholdings and CEO turnover. Uniquely to this field of research we separately model the institutions that have large blocks of shareholdings from those with smaller blocks. We show that the likelihood of a CEO being forced from office is negative and significantly related to firm performance and, conditional on poor performance, positive and significantly related to the presence of a large institutional shareholding or high concentration of institutional shareholdings.

Institutional Investors, CEO Turnover

Abstract:
This paper provides new evidence on the relationship between managerial incentives and firm risk using a hand-collected database of 3307 executive year observations. We find that the relation between pay performance sensitivity and firm risk exhibits a nonlinear relationship with firm size: for small to medium-sized quoted companies there is a negative relation between pay performance sensitivity and risk consistent with the standard agency theory model; but for large quoted companies the relationship becomes unstable under different model specifications. We argue that the model of compensation practices advanced by Aggarwal and Samwick (1999) does not apply to all ranges of the company size distribution and, indeed, for all types of directors. Also, the support found for the model advanced by Core and Guay (2001) is not robust to different model specifications. We conclude that neither model can fully explain the relationship between pay performance sensitivity and risk in the UK.

Executive Compensation, Pay for Performance, Pay Performance Sensitivity, Firm Risk

Abstract:
We examine whether UK firms engage in earnings management or forecast guidance to ensure that their reported earnings meet analyst earnings expectations. We explore two earnings management mechanisms: a) positive abnormal working capital accruals and b) classification shifting of core expenses to non-recurring items. We find no evidence of a positive association between income-increasing abnormal working capital accruals and the probability of meeting analyst forecasts. Instead we find evidence consistent with a subset of larger firms shifting small core expenses to other non-recurring items to just hit analyst expectations with core earnings. We also find that the probability of meeting analyst expectations increases with downward guided forecasts. Overall our results suggest that UK firms are more likely to engage in earnings forecast guidance or, for a subset of larger firms, in classification shifting rather than in accruals management to avoid negative earnings surprises.

meeting analyst expectations, abnormal accruals, earnings forecast guidance, classification shifting

Abstract:
Previous research documents a number of potential scaling problems when estimating accounting based valuation models using cross-sectional data. The differences in size across observations cast doubts over the robustness of estimated coefficients and measures of fit. Several solutions have been proposed without reaching a consensus. We demonstrate analytically that, under certain conditions, the standard deviation of market capitalization changes is an efficient deflator for the cross-sectional estimation of Ohlson's (1995) unbiased accounting valuation model. Our empirical tests confirm this, as we show that the largest observations do not unduly affect the estimation results, the number of influential observations decreases notably and we obtain estimated coefficients not significantly different from the theoretical values derived from the Ohlson (1995) information dynamics.

Abstract:
No abstract available.

Abstract:
This study examines the seasoned equity issues of companies traded on the London Stock Exchange. Recent regulatory changes have allowed UK firms more discretion in choice of issue approach, and this has led many firms to issue through placing in preference to a rights issue. Having first documented the trend towards increasing use of placings, we go on to identify an interesting subset of placings that are less likely to be anticipated by the market, and find a significant positive market reaction to such placings, which contrasts with the significant negative reaction we find for issues by rights. We also examine the choice of seasoned equity issuance method, focusing on the choice between placings versus rights issues. We develop a model to explain the choice of equity issue method that achieves a high level of predictive accuracy.

Abstract:
This paper provides new evidence on the effect of compensation consultants on CEO pay. We find that the use of a compensation consultant has an increasing effect on the level of total CEO compensation, which is consistent with the “ratcheting up” effect of consultants on CEO pay argued by the managerial power approach. However, we also find that this influence on pay levels mainly stems from an increase in equity based compensation. In contrast, we report a negative influence of consultants on basic (cash) pay. In addition, we model the choice of hiring a consultant and show that it can be explained by economic determinants, e.g. firm size, firm governance, firm’s propensity to hire outside consultancy, complexity of the contract. The existence of a powerful CEO does not increase the likelihood of hiring a pay consultant. The results are robust to several model specifications, different controls for firm and governance characteristics and tests for selection bias. Our results indicate that compensation consultants have a positive effect on the structure of CEO pay since they encourage incentive based compensation. We also show that economic determinants, rather than CEO power, explain the decision to hire compensation consultants. Overall, we offer new evidence suggesting that pay consultants contribute to the solution of the executive pay determination problem and are not part of the problem; our results cast doubts on the conclusions of the managerial power approach regarding the role of compensation consultants. This study offers insights to the positive effect the hiring of a pay consultant could have towards the design of a CEO pay contract.

Corporate Governance, Compensation Consultants, Executive Compensation, Managerial Power Approach

Abstract:
No abstract available.

Abstract:
We examine disagreement between management and Thomson Datastream over the persistence of earnings components. Using income statement and footnote disclosures, we identify the source and properties of disputed items. Disagreements typically reflect opaque reporting practices (for example, in the case of discontinued operations). Incremental and relative value relevance tests suggest that the majority of management-specific adjustments reflect appropriate classification of earnings components by insiders. Nevertheless, evidence consistent with strategic disclosure does emerge for a subset of management adjustments.

Non-GAAP earnings, Transitory items, Disagreement

Abstract:
This paper provides evidence on the level and composition of the pay of the top executives of a sample of UK Public Listed Companies. The study uses hand collected data on the compensation for 698 CEO years and 2609 other-executive years over the period 1995-2000. In order to focus on the consequences of exceptional performance, our sample is stratified to include sub-samples of PLCs experiencing extreme positive and negative stock-price performance.

With regard to management compensation, we find clear differences in the treatment of executives across our three sub-samples. Consistent with standard contracting theory, the executives of exceptionally well-performing firms fare better than the executives of mid-performing firms, who in turn fare better than the executives of poorly performing firms. In particular, we find that the executives of exceptionally poorly performing firms experience mean cuts in their salaries and bonuses. That trend also applies to equity-based compensation. It should be mentioned though that a time-series investigation reveals an increased participation and value in the equity-based schemes provided to CEOs and other executives of poorly performing firms. This is against the agency theory prediction that agents refrain from risk sharing in more volatile corporate environments.

With regard to loss of tenure, we find, consistently with current literature, that the CEOs of poorly performing firms are significantly more likely to be dismissed. This turnover though does not seem to directly affect the CEOs' emoluments during the year of departure. We argue that the effect of turnover on CEOs' wealth depends on whether departure affects their ability to find an equally lucrative new job.

Managerial compensation, executive turnover, pay for performance

Abstract:
This paper reports a replication and extension of the Fundamental Information Analysis of Lev & Thiagarajan (1993). Using data for a large sample of UK companies we examine the improvements in explanatory value that are achievable by allowing for both macro-economic state and industry variation in the response parameters of non-earnings signals. We interpret this evidence as a test of the beliefs of previous researchers who have suggested that the influence of non-earnings signals is likely to be more conditional than the influence of earnings. In particular we find that the most informative non-earnings signals are those relating to the operating margins and/or cost management of the firm. The final section of the paper reports the UK evidence for the existence of an inverse relation between the Lev & Thiagarajan measure of earnings quality and earnings response coefficients. In contrast to Lev & Thiagarajan we find no significant relation for UK companies.

Abstract:
This paper reviews two books by leading management accounting researchers which rely on advances in the economics of internal organisation for their theoretical foundation. The review relates the theoretical content of the two books to the broader research agendas of information economics and transaction costs economics. In addition, the review attempts to identify areas where alternative theoretical perspectives might be used to address the main weaknesses of models based on conventional notions of economic rationally.

Abstract:
The empirical relationships between stock prices/returns, earnings and book value are informative about characteristics of accounting quality: conservatism in measurement of earnings and book value; earnings persistence; and earnings timeliness. In this paper we analyse the comparative accounting quality characteristics of the U.S. and U.K. GAAP regimes. We examine large panel data sets over a nineteen year period, controlling for inter- and intra-GAAP regime differences in firm size and industry membership. Our main findings are (i) U.S. earnings were less permanent; (ii) earnings were more timely in the U.K.; (iii) there is weak evidence that earnings recognition is more conservative in the U.S.

Abstract:
We extend the Kothari-Zimmerman (1993) study of price- earnings models to a more general accounting based valuation model. In this more general setting earnings response coefficients are not usually equal to the reciprocal of the firm's cost of equity capital. Moreover the price-earnings models considered by Kothari and Zimmerman (1993) can lead to upward biased estimates of the true earnings response coefficient. Using data for UK companies we first replicate the findings of Kothari and Zimmerman and then present new evidence that rejects the simple price earnings model in favour of the general model.

Abstract:
This paper provides further evidence on the effect of compensation consultants on CEO pay. We find that the use of a compensation consultant has an increasing effect on the level of total CEO compensation, which is consistent with the “ratcheting up” effect of consultants on CEO pay argued by the managerial power approach. However, we also find that this positive influence on pay levels mainly stems from an increase in equity based compensation. In contrast, we report a negative influence of consultants on basic (cash) pay. In addition, we model the choice of hiring a consultant and show that it can be explained by economic determinants, e.g. firm size, firm governance, firm’s propensity to hire outside consultancy, complexity of the contract. The existence of a powerful CEO does not increase the likelihood of hiring a pay consultant. These results indicate that compensation consultants have a positive effect on the structure of CEO pay since they encourage incentive based compensation. Overall, we offer new evidence suggesting that pay consultants contribute to the solution of the executive pay determination problem and are not part of the problem; our results cast doubts on the conclusions of the managerial power approach regarding the role of compensation consultants. The results are robust to several model specifications, different controls for firm and governance characteristics and tests for selection bias.

Compensation Consultants, Executive Pay, Managerial Power Theory, Pay-Performance Sensitivity