Published Works
The faculty and doctoral students publish regularly in some of the top academic journals around the globe. With each publication they show their commitment to expanding the knowledge of the accounting community as a whole. Making great strides in accounting research has helped keep this department number one.
Recent Publications
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The Evolution of Capital Structure and Operating Performance After Leveraged BuyOuts: Evidence from U.S. Corporate Tax Returns
Jonathan B Cohn (UT), Lillian F. Mills (UT), Erin M. Towery (UT)
Journal of Financial Economics (forthcoming)
Prior research on Leveraged Buyouts(LBO) concluded from available public data that operating performance improved post LBO. In in a broader dataset of public and private firms using confidential tax return data, we find little overall evidence of such improvements.
This study uses corporate tax return data to examine the evolution of firms' financial structure and performance after leveraged buyouts for a comprehensive sample of 317 LBOs taking place between 1995 and 2007. We find little evidence of operating improvements subsequent to an LBO, although consistent with prior studies, we do observe operating improvements in the set of LBO firms that have public financial statements. We also find that firms do not reduce leverage after LBOs, even if they generate excess cash flow. Our results suggest that effecting a sustained change in capital structure is a conscious objective of the LBO structure.
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Predicting Credit Losses: Loan Fair Values versus Historical Costs
Brett Wooten Cantrell (UT), John M. McInnis (UT), and Christopher G. Yust (UT)
The Accounting Review (forthcoming)
If you are looking at a bank’s financial statements to try to predict the extent to which their loans will go bad, you should look at historical loan costs minus the loan loss reserve rather than reported loan fair values. This is important because many people (including standard setters) claim loan fair values are better at predicting credit losses.
Standard setters and many investor groups have argued that fair values for loans provide more useful information about credit losses than historical cost information. Bankers and others generally disagree. We examine the ability of loan fair values to predict credit losses relative to the ability of net historical costs currently recognized under U.S. GAAP. Our analysis is important because credit losses in the banking sector can have severe and widespread economic effects, as the recent credit crisis demonstrates. Overall, we find that net historical loan costs are generally a better predictor of credit losses than loan fair values. Specifically, we find that historical cost information is more useful at predicting future net chargeoffs, non-performing loans, and bank failures over both short and long time horizons. Further tests indicate that the relative predictive ability of loan fair values improves in higher scrutiny environments, suggesting that a lack of scrutiny over loan fair values may contribute to our findings.
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Productivity-Target Difficulty, Performance-Based Pay and Outside-the-Box Thinking
Alan Webb (Waterloo), Michael G. Williamson (UT), and Yue May Zhang (Northeastern)
The Accounting Review (forthcoming)
Increasing productivity target difficulty and tying compensation to meeting/beating these targets encourage employees to work harder, but also encourages employees to use conventional task approaches rather than thinking outside-the-box to identify more efficient approaches.
In an environment where individual productivity can be increased through efforts directed at a conventional task approach and more efficient task approaches that can be identified by thinking outside-the-box, we examine the effects of productivity-target difficulty and pay contingent on meeting and beating this target (i.e., target-based pay). We argue that while challenging targets and target-based pay can hinder the discovery of production efficiencies, they can motivate high productive effort (i.e., motivate individuals to work harder and more productively using either the conventional task approach or more efficient task approaches when discovered). Results of a laboratory experiment support our predictions. Individuals both assigned an easy productivity target and paid a fixed wage identify a greater number of production efficiencies than those with either challenging targets or target-based pay. However, individuals with challenging targets and/or target-based pay have higher productivity per production efficiency discovered suggesting these control tools better motivate productive effort. Collectively, our results suggest that the ultimate effectiveness of these control tools will likely hinge on the importance of promoting the discovery of production efficiencies relative to motivating productive effort. In doing so, our results provide a better understanding of conflicting prescriptions from the practitioner literature and business press.
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Mitigating the Unintended Effect of Corporate Social Responsibilty Performance on Investors' Estimates of Fundamental Value
W. Brooke Elliott (Illinois), Kevin E. Jackson (Illinois), Mark E. Peecher (Illinois), and Brian J. White (UT)
The Accounting Review (forthcoming)
CSR performance subconsciously biases investors’ judgments about a firm's financial performance unless they explicitly assess CSR performance as part of their overall investment analysis.
We provide theory and experimental evidence consistent with an unintended, causal relation between Corporate Social Responsibility (CSR) performance and investors’ estimates of fundamental value that can be attenuated by investors’ explicit assessment of CSR performance. Consistent with “affect-as-information” theory from psychology, we find that investors who are exposed to, but do not explicitly assess, CSR performance derive higher fundamental value estimates in response to positive CSR performance, and lower fundamental value estimates in response to negative CSR performance. Explicit assessment of CSR performance, however, significantly diminishes this effect, indicating that the effect among investors who do not explicitly assess CSR performance is unintended; i.e., they unintentionally use their affective reactions to CSR performance in estimating fundamental value. Supplemental findings shed light on consequences of these fundamental value estimates: investors who do not explicitly assess CSR performance rely on their unintentionally influenced estimates of fundamental value to increase the price they are willing to pay to invest in the stock of a firm with positive CSR performance. Overall, our theory and findings contribute to the CSR and affect literatures in accounting by revealing the contingent nature of how and to what extent CSR performance influences investors’ beliefs about firm value and the bids these investors are likely to make in equity markets.
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When are Enhanced Relationship Tax Compliance Programs Mutually Beneficial?
Lisa De Simone (UT), Richard Sansing (Dartmouth), and Jeri Seidman (UT)
The Accounting Review (forthcoming)
An enhanced relationship program is a program under which taxpayers commit to voluntarily disclosing uncertain tax positions to tax authorities in exchange for timely resolution of these uncertainties. Our model suggests that despite the inherent adversarial nature of the taxpayer-tax authority relationship, these programs are mutually beneficial in many settings because in the program, taxpayers claim fewer weak positions and tax authorities are able to avoid auditing strong positions (on which they recover less than their audit cost, on average.)
This study investigates the circumstances under which “enhanced relationship” tax compliance programs are mutually beneficial to taxpayers and tax authorities, as well as how these benefits are shared. We develop a model of taxpayer and tax authority behavior inside and outside of an enhanced relationship program. Our model suggests that, despite the adversarial nature of the relationship, an enhanced relationship program is mutually beneficial in many settings. The benefits are due to lower combined government audit and taxpayer compliance costs. These costs are lower because taxpayers are less likely to claim positions with weak support and the government is less likely to challenge positions with strong support inside the program. Further, we show that an increase in the ability of the tax authority to identify uncertain tax positions makes an enhanced relationship tax compliance program more attractive to both the taxpayer and the tax authority.
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The Role of Financial Reporting Quality in Mitigating the Constraining Effect of Dividend Policy on Investment Decisions
Santhosh Ramalingegowda (Georgia), Chuan-San Wang (Taiwan), and Yong Yu (UT)
The Accounting Review (forthcoming)
High quality financial reporting mitigates the risk that firms have to forgo valuable investment projects in order to pay dividends.
Miller and Modigliani’s (1961) dividend irrelevance theorem predicts that in perfect capital markets dividend policy should not affect investment decisions. Yet in imperfect markets, external funding constraints that stem from information asymmetry can force firms to forgo valuable investment projects in order to pay dividends. We find that high quality financial reporting significantly mitigates the negative effect of dividends on investments, especially on R&D investments. Further, this mitigating role of financial reporting quality is particularly important among firms with a larger portion of firm value attributable to growth options. In addition, we show that the mitigating role of high quality financial reporting is more pronounced among firms that have decreased dividends than among firms that have increased dividends. These results highlight the important role of financial reporting quality in mitigating the conflict between firms' investment and dividend decisions and thereby reducing the likelihood that firms forgo valuable investment projects in order to pay dividends.
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The Pricing Effects of Securities Class Action Lawsuits and Litigation Insurance
Judson Caskey
Journal of Law, Economics, and Organization (forthcoming)
Securities litigation only impacts firm value via transaction costs such as attorney fees, and litigation insurance reduces these transaction costs.
The price reactions to corrective disclosures often serve as a benchmark for settlements in securities class action lawsuits. When the firm bears litigation costs, this benchmark creates a feedback effect that exacerbates the price reaction to news that contradicts managers' earlier reports. Litigation insurance provides value in this setting by reducing the need for investors to price the effects of anticipated litigation. Insurance also affects how changes in the litigation environment impact the firm, with some changes having opposite effects on the frequency of lawsuits against uninsured and insured firms. The pricing behavior of rational investors eliminates the valuation impact of the portion of settlements paid to investors, similar to dividends. The valuation impact of litigation arises from transaction costs, such as attorney fees, that the firm can mitigate by constraining misreporting and by purchasing insurance.
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The Effect of Political Sensitivity and Bargaining Power on Taxes: Evidence from Federal Contractors
Lillian F. Mills (UT), Sarah E. Nutter (George Mason), Casey M. Schwab (Georgia)
The Accounting Review (forthcoming)
Contractors whose contracts are large absolutely or in proportion to their revenues pay more taxes, consistent with political cost theory. However, this relationship is unwound by greater bargaining power, such as enjoyed by sole-source or defense contractors.
We investigate whether politically sensitive contractors pay higher taxes and whether their bargaining power reduces these tax costs. Using federal contractor data, we develop a new composite measure of political sensitivity that captures both the political visibility arising from federal contracts and the importance of federal contracts to the firm. We proxy for bargaining power using the firm-level proportion of contract revenues not subject to competition, the firm-level proportion of contract revenues arising from defense contracts, and industry-level concentration ratios. We find that politically sensitive firms pay higher federal taxes, all else equal. However, firms with greater bargaining power incur fewer tax-related political costs. Our study provides new evidence on the political cost hypothesis in a tax setting and the first evidence of the interactive effects of a firm’s political sensitivity and bargaining power on tax-related political costs.
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Dividend Policy at Firms Accused of Accounting Fraud
Judson Caskey (UT) and Michelle Hanlon (MIT)
Contemporary Accounting Research
By comparing dividend policies of firms accused of accounting fraud to those not accused of accounting fraud, it is determined that dividend paying status is negatively associated with the probability of committing accounting fraud.
Recent studies and some policy experts have posited that dividends indicate higher quality earnings. In this study, we test this conjecture by comparing the dividend policies of firms accused of accounting fraud to those of firms not accused of accounting fraud. Specifically, we examine whether alleged fraud firms are as likely to be dividend payers as non-fraud firms and whether managers of dividend-paying fraud firms increase dividends at the same rate as managers of non-fraud firms. Our data reveal that dividend paying status is negatively associated with the probability of committing accounting fraud. In addition, we also find that, during the alleged fraud period, the earnings-dividends relation is weaker for the alleged fraud firms relative to firms not accused of fraud. Finally, using propensity score match tests, the data provide evidence that managers of alleged fraud-firms increase dividends less often than managers of firms not accused of fraud, consistent with the alleged fraud firms not being able to match the dividend policies of firms not accused of fraud. Overall, our results suggest that dividends, especially dividend increases, are associated with higher earnings quality.
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Group Audits, Group-Level Controls, and Component Materiality: How Much Auditing Is Enough
Trevor Stewart (Rutgers) and William Kinney (UT)
The Accounting Review
Through the application of a Bayesian group audit model, it is determined that group-level controls and structured subgroups of components are central to efficient group audits.
Auditing standards now mandate that group auditors determine and implement appropriate component materiality amounts, which ultimately affect group audit scope, reliability, and value. However, standards are silent about how these amounts should be determined and methods being used in practice vary widely, lack theoretical support, and may either fail to meet the audit objective or do so at excessive cost. We develop a Bayesian group audit model that generalizes and extends the single-component audit risk model to aggregate assurance across multiple components. The model formally incorporates group auditor knowledge of group-level structure, controls, and context as well as component-level constraints imposed by statutory audit or other requirements. Application of the model yields component materiality amounts that achieve the group auditor's overall assurance objective by finding the optimal solution on an efficient materiality frontier. Numerical results suggest group-level controls and structured subgroups of components are central to efficient group audits.
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Are analysts’ forecasts naïve extensions of their own forecasts?
Andrew Call (Georgia), Shuping Chen (UT), and Yen H. Tong (Singapore)
Contemporary Accounting Research
Analysts’ cash flow forecasts are not simply naïve extensions of their own earnings forecasts, but that they reflect meaningful and useful accrual adjustments.
We examine the sophistication of analysts’ cash flow forecasts to better understand what accrual adjustments, if any, analysts make when forecasting cash flows. As a preliminary step, we first demonstrate that prior empirical tests used to evaluate the sophistication of analysts’ cash flow forecasts are not diagnostic. We then present three sets of evidence to triangulate our conclusion that analysts’ cash flow forecasts incorporate meaningful accrual adjustments. First, we review a stratified random sample of 90 analyst reports and find that the majority of these analysts include explicit adjustments for working capital and other accruals in their cash flow forecasts. Second, using a large sample of analysts’ cash flow forecasts from 1993-2008, we find that these forecasts outperform time-series cash flow forecasts in correctly predicting the sign and magnitude of accruals. Finally, we find a significant market reaction to analysts’ cash flow forecast revisions, suggesting that investors find these revisions informative. Collectively, our findings demonstrate that analysts’ cash flow forecasts are not simply naïve extensions of their own earnings forecasts, but that they reflect meaningful and useful accrual adjustments. These findings are relevant to researchers who examine analysts’ cash flow forecasts in a variety of settings, and to investors and practitioners who employ these forecasts for valuation purposes.
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Home country investor protection, ownership structure and cross-listed firms' compliance with SOX-mandated internal control deficiency disclosures
Guojin Gong (Penn State), Bin Ke (Nanyang), and Yong Yu (UT)
Contemporary Accounting Research
Home-country investor protection and ownership structure influences cross-listed firms' (non)compliance with U.S. disclosure rules.
We examine whether home country investor protection and ownership structure affect cross-listed firms’ compliance with SOX-mandated internal control deficiency (ICD) disclosures. We develop a proxy for the likelihood of ICD misreporting during the Section 302 reporting regime based on Ashbaugh-Skaife et al. (2007). For cross-listed firms domiciled in weak investor protection countries, we have three main findings. First, firms whose managers control their firms and have voting rights in excess of cash flow rights have a higher likelihood of ICD misreporting than other firms during the Section 302 reporting regime. Second, there is a positive association between the likelihood of ICD misreporting and voluntary deregistration from the SEC prior to the Section 404 effective date. Third, for firms that chose not to deregister, there is a positive association between the likelihood of ICD misreporting and the reporting of previously undisclosed ICDs during the Section 404 reporting regime. We do not find similar evidence for cross-listed firms domiciled in strong investor protection countries. Our evidence is consistent with the hypothesis that for cross-listed firms domiciled in weak investor protection countries, managers who have the ability and incentive to expropriate outside minority shareholders are reluctant to disclose ICDs in order to protect their private control benefits.
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Testing Analytical Models Using Archival or Experimental Methods
Shane S. Dikolli (Duke), J. Harry Evans (Pittsburgh), Jeffrey Hales (Georgia Tech), Michal Matejka (Arizona), Don Moser (Pittsburgh), and Michael G. Williamson (UT)
Accounting Horizons
This paper highlights the advantages and disadvantages of combining an analytical model with archival or experimental data in a single study. It concludes with a brief discussion of how such studies are likely to fare in the journal review process.
Analytical models can quite naturally complement empirical data, whether archival or experimental. This article begins by discussing the advantages and disadvantages of combining an analytical model with archival or experimental data in a single study. We next describe how models are typically used in empirical research and discuss when including an analytical model is more versus less useful. Finally, we offer examples of more and less successful combinations of analytical models and empirical data, along with a brief discussion of how such studies are likely to fare in the journal review process.
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Reward System Design and Group Creativity: An Experimental Investigation
Clara Xiaoling Chen (Illinois), Michael G. Williamson (UT), and Flora H. Zhou (Illinois)
The Accounting Review
Our results advance the burgeoning management accounting literature on creativity-contingent incentives by suggesting that reward systems are more likely to promote creativity through collaborative, rather than independent individual, efforts. We also provide important insights into when and why tournament pay can boost creativity in organizations.
In an environment where three-person groups develop a creative solution to an important problem, we examine whether the efficacy of either individual or group-based creativity-contingent incentives depends on whether they take the piece-rate or tournament form. We predict and find that group (intergroup) tournament pay increases group cohesion and collaborative efforts, which ultimately lead to a more creative group solution relative to group piece-rate pay. While individual (intragroup) tournament pay increases individual efforts, we find that it does not enhance the creativity of group solutions relative to individual piece-rate pay. Our results advance the burgeoning management accounting literature on creativity-contingent incentives by demonstrating that reward systems are more likely to promote group creativity through collaborative efforts rather than independent individual efforts. We also provide important insights into when and why tournament pay can boost group creativity in organizations. In doing so, we contribute to a better understanding of observations from practice suggesting that organizations valuing creativity often induce intergroup competition.
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The Timeliness of Earnings News and Litigation Risk
Dain Donelson (UT), John McInnis (UT), Richard Mergenthaler (Iowa), and Yong Yu (UT)
The Accounting Review
By revealing bad earnings news on a timely basis, managers can significantly reduce the chance of securities litigation. Earlier studies suggested that bad earnings “warnings” actually triggered lawsuits, but we use a new research approach and find that timely disclosure clearly reduces the threat of litigation.
This study investigates whether the timely revelation of bad earnings news is associated with a lower incidence of litigation. The timeliness of earnings news is captured by a new measure based on the evolution of the consensus analyst earnings forecast. Holding total bad earnings news and other determinants of litigation constant, we find that earlier revelation of bad earnings news lowers the likelihood of litigation. This result holds for both settled and dismissed lawsuits. Further, we reconcile our findings with prior work that measures timeliness using managerial warnings via press releases. These tests suggest our findings are attributable to the ability of our timeliness measure to capture bad earning news revealed through disclosure channels beyond press releases.
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Managerial Reporting, Overoptimism, and Litigation Risk
Volker Laux and Phillip Stocken
Journal of Accounting and Economics
We show that a heightened threat of litigation can increase incentives for managerial misreporting.
We examine how the threat of litigation affects an entrepreneur’s reporting behavior when the entrepreneur (i) can misrepresent his privately observed information, (ii) pays legal damages out of his own pocket, and (iii) is optimistic about the firm’s prospects relative to investors. We find higher expected legal penalties imposed on the culpable entrepreneur do not always cause the entrepreneur to be more cautious but instead can increase misreporting. We highlight how this relation depends crucially on the extent of entrepreneurial overoptimism, legal frictions, and the internal control environment.
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Perceived Auditor Independence and Audit Litigation: The Role of Nonaudit Services Fees
Jaime Schmidt
The Accounting Review
The study provides evidence that auditor fees (and in particular, non-audit service fees) play a role in the initiation and resolution of auditor litigation following a restatement.
This study investigates whether audit litigants act as if they believe jurors will associate auditor-provided nonaudit services (NAS) with impaired auditor independence, and thus substandard auditor performance. Using GAAP-based financial statement restatements disclosed from 2001 – 2007 as an indicator for audit failure, I find that the amount of nonaudit (NAS) fees and the ratio of NAS fees to total fees is positively associated with the likelihood that a restatement results in audit litigation. I also find that when plaintiff attorneys argue that auditor independence was impaired due to dependence on client fees and, in particular, NAS fees, restatement-related audit litigation is more likely to result in an auditor settlement and a larger amount of settlement. These results suggest that audit litigants act as if they believe NAS fees will strengthen the case against the auditor, and thus affect the court resolution if the lawsuit is taken to verdict.
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Stock option vesting conditions, CEO turnover, and myopic investment
Volker Laux
Journal of Financial Economics
This paper shows that the optimal design of stock option vesting conditions in executive compensation is more subtle than conventional views suggest. For example, it shows that long vesting periods can backfire and induce myopic investment behavior.
Corporations have been criticized for providing executives with excessive incentives to focus on short-term performance. This paper shows that investment in short-term projects has beneficial effects in that it provides early feedback about CEO talent, which leads to more efficient CEO replacement decisions. Due to the threat of CEO turnover, the optimal design of stock option vesting conditions in executive compensation is more subtle than conventional views suggest. For example, I show that long vesting periods can backfire and induce excessive short-term investments. The study generates new empirical predictions regarding the determinants and impacts of stock option vesting terms in optimal contracting.
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The Extent of Implicit Taxes at the Corporate Level and the Effect of TRA86
Ross Jennings, Connie D. Weaver and William J. Mayew
Contemporary Accounting Research
When Congress passes a tax break like a credit for buying equipment, competitive forces may shift that explicit benefit to other parties, like the supplier in the form of higher prices, employees in the form of higher wages, or customers in the form of lower prices. Prior to the landmark Tax Reform Act of 1986, the benefits of nearly all tax preferences for corporations were shifted to others, but after TRA86, we find that corporations retain about two-thirds of the benefits. Thus, after TRA86, explicit tax preferences increase the after-tax income of the corporations receiving the preferences.
We examine the extent of implicit taxes at the corporate level and the effect on implicit taxes of the Tax Reform Act of 1986 (TRA86) in the United States. Using a variety of specifications, we find consistent evidence that implicit taxes eliminate virtually all of the cross-sectional differences in explicit tax preferences prior to TRA86, and then abruptly decline and eliminate only about one-third of the cross-sectional differences in tax preferences in years following TRA86. We triangulate this evidence that implicit taxes declined following TRA86 by also providing evidence (a) of a decline in the relation between changes in tax preferences and changes in pre-tax returns, (b) of an increase in the persistence of tax-related earnings changes, (c) that these dramatic economic changes are priced by investors. Finally, we provide evidence suggesting that the decline in implicit taxes after TRA86 is driven at least in part by expansion of aggressive tax planning and use of tax shelters. Taken together these results indicate that TRA86 had a profound and lasting effect on implicit taxes at the corporate level.
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A Post-SOX Examination of Factors Associated with the Size of Internal Audit Functions
Urton L. Anderson, Margaret H. Christ, Karla M. Johnstone, and Larry Rittenberg
Accounting Horizons
This paper develops and test a model that can be used to assist internal audit directors and audit committees in answering the question of how much of the organization’s resources should be dedicated to the internal audit function.
This study develops and tests a conceptual model articulating factors associated with internal audit function size in the post-SOX era. These factors include audit committee characteristics, internal audit characteristics and mission, internal audit activities performed by others (including outsourced providers and other divisions within the organization), and organization characteristics. Results of a survey of 173 public and private companies reveal that internal audit function size is positively associated with: (1) better audit committee governance, (2) greater organizational experience of the chief audit executive, (3) missions involving IT auditing, (4) the use of sophisticated audit technologies, (5) the use of a staffing model in which internal audit is used for rotational leadership development, (6) organization size, and (7) the number of foreign subsidiaries that the organization possesses. Further, internal audit function size is inversely associated with: (1) the percentage of internal audit employees that are Certified Internal Auditors, and (2) the extent of assurance and compliance activities outsourced to outsiders. These results contribute to prior literature on internal audit function size by considering a variety of factors that are associated with internal audit function size in the contemporary era.
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Do financial analysts’ long-term growth forecasts matter? Evidence from stock recommendations and career outcomes
Boochun Jung, Philip B. Shane, and Sunny Yanhua Yang
Journal of Accounting and Economics
Not all analysts forecast or publish their long-term growth forecasts. Those that choose to publish their long-term forecasts issue more valuable recommendations and have more favorable career outcomes.
Prior literature portrays long-term growth (LTG) forecasts as nonsensical from a valuation perspective. Instead, we hypothesize that LTG forecasts signal high effort and ability to analyze firms’ long-term prospects. We document stronger market response to stock recommendation revisions of analysts who publish accompanying LTG forecasts. We also hypothesize and find that these analysts are less likely to leave the profession or move to smaller brokerage houses. Consistent with Reg. FD’s intention to promote fundamental analysis of long-term earnings prospects, post-Reg. FD observations drive our results. Overall, we identify previously undocumented benefits accruing to analysts who publish LTG forecasts.
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Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation
Dain Donelson, John McInnis and Richard Mergenthaler.
Contemporary Accounting Research
A disproportionate number of firms appear to just avoid losses, earnings declines, and miss analyst forecasts. While many academics attribute these findings to pervasive earnings management, others disagree. Our analysis of firms known to have manipulated earnings supports the earnings management explanation.
A heated debate exists as to whether discontinuities in earnings distributions are indicative of earnings management. While many studies attribute discontinuities in earnings distributions to earnings management, other studies argue that earnings discontinuities are artifacts of sample selection and research design. Overall, there is limited direct evidence of a connection between earnings discontinuities and earnings management. In this study, we provide direct evidence linking earnings management to earnings discontinuities for a sample of firms that settle securities class action lawsuits and restate earnings from the alleged GAAP violation period. We compare the distribution of restated (“unmanaged”) earnings to originally reported (“managed”) earnings. We find that discontinuities are not present in the distribution of analyst forecast errors and earnings changes using unmanaged earnings but are present using managed earnings. The discontinuity in the earnings level distribution is attenuated, but not eliminated, on an unmanaged basis. These shifts among our sample of firms are caused by earnings management and cannot be explained by sample selection or research design issues. Our findings are important because we provide the first evidence of a link between intentional manipulations of earnings and discontinuities in earnings distributions. Overall, our evidence supports the use of earnings discontinuities as an indicator of earnings management.