Accounting & Information Assurance

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The Value of Security Audits, Asymmetric Information and Market Impact of Security Breaches
(2004-08-10) Zhou, Lei; Gordon, Lawrence A.; Loeb, Martin P.; Accounting and Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation includes two essays on the economic aspects of information security. The first essay presents a principal-agent model for assessing the value of information security audits. The issue of information security investments is confounded by control problems arising from asymmetric information and conflicting managerial interests within the firm. By analyzing the impacts of asymmetric information and security audits, this study extends the literature in three ways. First, the degree of information asymmetry is formally measured, which allows one to study how different levels of information asymmetry affect information security investment decisions. Second, the intensity of an information security audit is explicitly modeled, and the interactions between information asymmetry and security audits are examined. This analysis provides conditions under which the benefit from security audits increases with the degree of information asymmetry. Third, the current research provides an analytic model that helps to explain existing empirical findings (e.g., Gordon and Smith, 1992) concerning the relation between information asymmetry and the value of audits. The second essay examines the economic costs of publicly announced information security breaches. Similar to Campbell et al. (2003), the current study applies the event study approach, but uses a larger sample and a more sophisticated market model (Fama and French, 1993). The results confirm those of Campbell et al. (2003) that security breaches involving confidential information cause significant market reactions and security breaches not involving confidential information only cause insignificant market reactions. Further investigations also suggest that the insignificance of market reactions to non-confidential events does not seem to vary with the nature of those events.
Herd behavior in voluntary disclosure decisions: An examination of capital expenditure forecasts
(2005-06-09) Brown, Nerissa Christine; Gordon, Lawrence A.; Wermers, Russell R.; Accounting and Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study documents behavior consistent with herding in voluntary disclosure decisions and investigates two possible reasons for this phenomenon. Based on theories of social learning and rational herds, herding in disclosure decisions may be due to managers' use of information reflected in the past disclosure decisions of other firms (informational herding), and/or managers' incentives to maintain or build a good reputation with investors (reputational herding). Employing a duration model for repeated events, I analyze the timing of capital expenditure forecasts for a broad sample of disclosing and nondisclosing firms. Results show that a firm's propensity to release capital expenditure forecasts is positively associated with the proportion of prior disclosing firms within its industry, thus, supporting arguments of herding. This association is significantly higher for less capital-intensive firms and firms operating in highly competitive industries which suggests that incentives to herd are greater for firms facing relatively high competition. To further distinguish between informational and reputational herding, I investigate whether the tendency to herd varies with the content and precision of other firms' forecasts, and with the level of managerial reputation. As predicted, I find that a firm's propensity to disclose increases with the precision of peer firms' forecasts and when peer forecasts signal a decrease in capital expenditures. Also, I find that herding is greater for managers that are comparably less reputable. Overall, the results confirm the existence of herd behavior in capital expenditure forecast decisions and that the behavior is driven partly by informational and reputational incentives. Extensive sensitivity analyses confirm the robustness of these results.
An Alternative Measure to Detect Intentional Earnings Management through Discretionary Accruals
(2005-06-10) Ibrahim, Salma Samir; Kim, Oliver; Accounting and Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study proposes an alternative measure of discretionary accruals that can be used in testing for intentional earnings management. Prior research has shown the prevalence of measurement error in all models used to estimate discretionary accruals (Healy (1985), DeAngelo (1986), Jones (1991) and modified Jones models (Dechow et al., 1995). The alternative measure proposed relies on the premise that managers use one or more components of accruals (accounts receivable, inventories, accounts payable, other working capital and depreciation) to manipulate bottom-line income in a given direction, consistent with their incentives. In other words, components of discretionary accruals are expected to be positively correlated. If they are not, this is an indication of high measurement error in the models estimating them. The alternative measure is tested in terms of its power (type II error) and specification (type I error) and compared to the traditional discretionary accruals measure. The power of the tests is measured in random samples with added accrual manipulation as well as a sample of firms targeted by the Securities and Exchange Commission for alleged fraud and a sample of firms that violated their debt covenants. The results indicate that the power of this alternative discretionary measure is higher than that of the traditional discretionary accruals measure. The specification (specificity) is tested in random samples chosen from the full sample as well as random samples chosen from extreme income and cash from operations observations and a sample in which discretionary accruals is a noisy measure of the estimated discretionary accruals. The results indicate that the specification of detecting earnings management behavior is improved by using the alternative discretionary accruals measure.
THE USEFULNESS OF EARNINGS, THE MAGNITUDE OF PRICE CHANGE, AND THE RETURN-EARNINGS COVARIANCE: BEYOND THE ERC AND R²
(2005-08-02) Cho, Myojung; Kim, Oliver; Accounting and Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study proposes the return-earnings covariance as a proxy for the usefulness of earnings inferred from the absolute magnitude of price changes associated with earnings information. It is argued that such measurement of the absolute usefulness of earnings information has been neglected in existing long-window studies. For example, the ERC and R² measure the marginal impact and the relative impact of earnings information on the stock price, respectively. It is demonstrated that the return-earnings covariance is a close proxy for the absolute magnitude of price change which is free from noise in both return and earnings. Thus, the return-earnings covariance can be used in long-window studies as well as short-window studies. Two covariance measures, the total covariance and the time distribution of weekly covariance are introduced and applied to empirical data to show new insights that can be obtained by the measures. The result indicates that the previously documented decrease on the value relevance of earnings over the past decades is mainly driven by the increasing influence of factors not directly related to earnings on the regression measures, not by a decrease in the absolute usefulness or timeliness of earnings. It is also found that the previously documented weak return-earnings relation over the short-window announcement period or contemporaneous return-earnings association for larger or more closely followed firms is due not only to more vigorous pre-disclosure information production activities of those firms, but also, and more importantly, to the weaker overall magnitude of price changes associated with earnings information of those firms.
Analysts' Superiority in Processing Public Information: Evidence from Recommendation Revisions
(2006-07-20) Wang, Zheng; Kim, Oliver; Accounting and Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
In this paper, I study analysts' superiority over the market in processing publicly disclosed earnings information by examining a sample of recommendation revisions issued subsequent to annual earnings announcements within a short period of thirty trading days. The main findings of this study are as follows: First, I provide strong evidence that these recommendation revisions convey valuable information to the market for clarifying the long term implications of recently released earnings. These revisions significantly alter the market's belief about the value implications of announced earnings, suggesting that analysts do have superiority over the market in processing pubic information. Also, the extent of this superiority is positively related to analysts' performance in picking stocks and forecasting earnings. Recommendation revisions issued by analysts with superior performance can make the market revise its assessment about the value implications of previous earnings to a much greater extent than those issued by analysts with moderate performance. Moreover, the extent of this superiority increases with the level of information complexity of earnings signals. Analysts' information is even more valuable to the market for reevaluating previous earnings when the earnings information is more difficult to analyze. Lastly, on average, the extent of this superiority declines after Regulation Fair Disclosure, but still remains significant, suggesting that analysts do not solely rely on inside information from the management to interpret public information. Actually, the decline in the extent of superiority is more likely due to a great increase in the number of revisions issued by analysts whose expertise is not in processing public information. Prior studies document that investors also use subsequent earnings announcements to adjust their estimate of the value implications of previous earnings. This study finds initial evidence that when analysts' information and subsequent earnings announcements provide consistent predictions on how previous earnings is misinterpreted, subsequent earnings announcements become less useful to investors for updating their beliefs regarding the implications of previously released earnings. This paper also compares the extent of analysts' superiority in processing publicly released earnings information across industries and find that analysts exhibit a greater degree of superiority for firms in the manufacturing and retail industry.
TO TELL OR NOT TO TELL: MARKET VALUE OF VOLUNTARY DISCLOSURES OF INFORMATION SECURITY ACTIVITIES
(2006-11-24) Sohail, Tashfeen; Gordon, Lawrence A.; Loeb, Martin P.; Accounting and Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study measures the economic consequences of information security activities, in general, and more specifically the market value of disclosures of information security activities. Since information security activities are primarily non-revenue generating, management tends to view them as the cost-of-doing-business, with no impact on firm value. Furthermore, managers are reluctant to share the details, because that they do not want to attract the attention of hackers. However, voluntary disclosures of information security can help reduce information asymmetry, which leads to belief revisions by investors, and hence corrects the misspecifications (if any) of the firm's market value. In other words, voluntary disclosures of security activities are signaling mechanisms. The objective of this dissertation is to develop a taxonomy of disclosures of information security activities, and empirically test the value relevance of such disclosures. Based on a sample of 1,637 disclosing firms, the empirical results provide support for the argument that voluntary disclosures of information security activities are value-relevant. Industry-wide analyses support the disclosure taxonomy developed, and highlight that firms which are technology and data-dependent, have the most impact from these discretionary disclosures of information security activities. These results are robust to various sensitivity checks, including matched-pair design, returns model, and the model that corrects for self-selection bias. The main contributions of this research are three-fold: 1) it adds to the discretionary disclosure literature by supporting the signaling hypothesis, 2) it adds to the extant literature on value-relevance vis-à-vis the importance of intangible voluntary disclosures, and 3) it adds to the information security literature concerning the value of information security-related activities to organizations. Future directions highlight the rich stream of potential research, based on the dataset collected as a part of this study
MANDATING DISCLOSURE OF R&D BENEFITS AND COSTS TO EXTRACT MANAGERS' PRIVATE INFORMATION: OBSTACLES AND PRACTICAL CONSIDERATIONS
(2007-07-19) Yen, Ai-Ru; KIM, OLIVER; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study suggests that mandating managers to disclose information about the net benefit of R&D outside financial statements is worth to be considered as one potential approach to improve the market's valuation of R&D and to improve managers' R&D-related decision making process. A transition of the R&D reporting practice from cost focused to net benefit focused is viewed necessary. A stream of two mandatory reporting systems is established for the transition to take place more smoothly. It is expected that information asymmetry can be reduced after information about R&D net benefit becomes publicly available. This study contributes to the literature in three ways. First, this is the first study which seriously considers the direct disclosure of net benefit of R&D as a way to improve the R&D reporting practice. Second, this study proposes a stream of reporting systems in the transition. The current R&D reporting practice can be transited gradually toward the desirable R&D reporting practice following the stream. Finally, this study points out that both market participants and firms will be potentially benefited in the transition. Not only the negative impact of information asymmetry will be reduced but also some potential subsidiary benefits will be provided by the transition.
Internal Control, Enterprise Risk Management, and Firm Performance
(2007-08-02) Tseng, Chih-Yang; Gordon, Lawrence A; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation investigates two research questions arising from the regulation of internal controls required by Sarbanes-Oxley Act of 2002 (SOX). The first research question asks whether better internal controls can enhance firm performance? To address this question, the relation between market-value and internal control is estimated by a residual income model. Firms with weak internal controls are identified as those that disclose material weaknesses in internal controls in periodic filings from August 2002 to March 2006, as required by SOX. The empirical results, based on a sample of 708 firm-years with the disclosures of material weaknesses, show that firms with weak internal controls have lower market-value. Building on the' efforts for SOX to improve internal controls, more and more firms are starting to adopt Enterprise Risk Management (ERM), because sound internal control system rests on adequate and comprehensive analysis of enterprise-wide risks. In light of this trend triggered by SOX, the second research question in this dissertation asks whether implementation of ERM has an impact on firm performance? The basic approach to answer this question uses a contingency perspective, since all risks arise from the firm's internal and external environment. More specifically, the basic argument states that the relation between ERM and firm performance is contingent on the proper match between ERM and five key contingency variables: environment uncertainty, industry competition, firm size, firm complexity, and monitoring by the firm's board of directors. A sample of 114 firms disclosing the implementation of ERM in their 2005 10Ks and 10Qs are identified by keyword search in EDGAR database. In developing the proper match, high performing firms are defined as those with greater than 2% one-year excess return to develop the proposed proper match. An ERM index (ERMI) is constructed based on the Committee of Sponsoring Organizations (COSO) ERM's (2004) definition of four objectives: strategy, operation, reporting, and compliance. The contingency view is supported by the empirical evidence, since the deviation from the proposed proper match is found negatively related to firm performance.
Multiple Audiences and Corporate Disclosure
(2007-08-28) Yang, Jing-Wen; Kim, Oliver; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study contributes to literature in three ways: first, it draws a full picture about the determinants of a firm's voluntary disclosure decision; second, it aims at tackling the mixed results found about the relation between competition and disclosure; and third, it shows evidence that it is possible that a firm would change its disclosure behaviors across time. The examination is based on the concept that management's communication could reach out to multiple audiences. While a firm could be concerned about the responses from investors and competitors when deciding disclosure-or-not, union and government could also come into consideration. In addition, how the concern about competitors would affect a firm's voluntary disclosure could depend on different interpretations about competition. Whether a firm is thinking of the abnormal profit that it has earned or the cost advantage that it has possessed, different interpretations about competition result in different predictions about the relation between competition and disclosure, and this could have caused mixed results in previous studies. Measuring a firm's disclosure level by the number of information items disclosed within a year, I found that a firm would disclose less in the face of a union's bargaining power and the litigation threat from outside blockholders. Such concerns are even more salient when it comes to revealing proprietary information. In addition, I found that a larger firm would disclose more information about itself, proprietary or not. Higher incentives for a large firm to give more information might come from both demand and supply of information about it. Furthermore, after controlling for other factors, I only found evidence that supports the argument that less competition (in the sense of market power) would cause less disclosure. The results did not, however, show that a firm facing more competition (in the sense of barriers to entry) would choose to disclose less. Finally, the findings also indicated that a firm's disclosure policy could be not as "sticky" as claimed in previous studies, especially when it comes to disclosing proprietary information. A firm might change its attitudes towards disclosure in the face of different political environment.
A theoretical and empirical study of computing earnings per share
(2008-08-04) Zhang, Mei; Kim, Oliver; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
In this dissertation, I propose a theoretic foundation to compute earnings per share (EPS) for firms with both common shares and dilutive securities outstanding. I derive a new EPS measure, market EPS, which is defined as the expectation of the future earnings per share. From the view of investors, market EPS naturally captures EPS information in stock prices. It is compared to basic EPS and diluted EPS, which are suggested in the dual presentation under the current U.S. rule. The comparisons show that market EPS is below the range defined by basic EPS and diluted EPS as long as the expected future abnormal earnings is zero. This indicates a weakness behind the thinking of the current rule. I also find that the diluted EPS by the treasury stock method overstates market EPS more than that by the if-converted method. In addition, given all conditions the same, the upward bias of diluted EPS of growth firms is smaller than that of non-growth firms. To support the proposed theory, I conduct an empirical study using a dataset containing 3130 firm-year employee stock option plans from 1997 to 2006. The results show that diluted EPS under the rule is, on average, larger than market EPS by 1%. Furthermore, the bias is larger for firms that are heavy users of employee stock options and for firms that have higher earnings volatility.
Controlling shareholders, audit committee effectiveness, and earnings quality: the case of Thailand
(2010) Kiatapiwat, Wilasinee; Kim, Oliver; Cheng, Shijun; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study examines the associations of controlling shareholders and audit committee effectiveness with earnings quality. A sample of non-financial Thai listed firms is used in the study because Thailand provides a useful setting for the study of ownership concentration. A unique data set on the voting rights of controlling shareholders and audit committee characteristics is used to test the hypotheses of whether controlling shareholders and audit committees with strong governance characteristics affect the quality of earnings. Earnings quality is measured using (1) Basu's (1997) asymmetric timeliness measure of accounting conservatism, and (2) absolute abnormal accruals estimated from the Dechow and Dichev (2002) and the Jones (1991) models and its variations. Audit committee effectiveness is measured using a composite index comprising four audit committee characteristics. The empirical results show that firms with a controlling shareholder, on average, are associated with both lower accounting conservatism (lower earnings quality) and lower absolute abnormal accruals (higher earnings quality) than firms with no controlling shareholder. Further analysis shows that family- and the government-controlled firms and firms whose controlling shareholders have voting rights below 75%, in particular, are associated with lower accounting conservatism and absolute abnormal accruals. Although the results imply both lower and higher earnings quality for firms with a controlling shareholder compared to firms with no controlling shareholder, the lower (higher) absolute abnormal accruals (earnings quality) simply reflects less conservative accounting practice by firms with a controlling shareholder. The results provide no evidence that audit committees with strong governance characteristics are associated with earnings quality.
THE INFLUENCE OF PUBLIC EQUITY OWNERSHIP ON EARNINGS MANAGEMENT THROUGH THE MANIPULATION OF OPERATIONAL ACTIVITIES
(2011) Kim, Yura; KIMBROUGH, MICHAEL D; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This paper examines whether public equity firms and private equity firms with public debt exhibit different degrees of real earnings management, defined as the manipulation of operational activities in order to influence reported earnings. Public equity firms face intense capital market scrutiny that their private equity counterparts do not. Therefore, this study's comparison of the two types of firms provides insight on the impact of capital market pressure on real earnings management behaviors. The impact of capital market pressure is not clear ex ante. On the one hand, the scrutiny associated with the public equity markets may play a disciplining role that leads firms to refrain from activities that distort reported earnings. On the other hand, the penalties faced by public equity firms that fail to meet earnings benchmarks may put additional pressure on top managers to report positive and improved earnings and hence, may lead to greater distortion of reported earnings through the manipulation of operational activities. Consistent with the latter possibility, I find that public equity firms are more likely than private equity firms to opportunistically alter normal operations to improve earnings by cutting R&D spending, by pushing sales through discounts and promotions, and by lowering costs of sales through overproduction. I find no difference in abnormal discretionary expenses between public equity and private equity firms. Although private equity firms with public debt do not face the same capital market pressure that public equity firms face, they are not immune from incentives to engage in real earnings management. Specifically, I find that private equity firms with public debt engage in a greater degree of real earnings management as their debt moves closer to default. Given that debt claims become more like equity claims as a firm's debt moves closer to default, this finding suggests that public debtholders exert similar pressure to public equity holders when their claims become more equity-like. Moreover, private equity firms with public debt that do engage in real earnings management appear to emphasize the zero earnings benchmark, consistent with prior research, suggesting that this benchmark is of primary importance to creditors. In addition, I assess the performance implications of capital market-induced real earnings management, by examining its association with one-year ahead industry-adjusted return on assets (ROA). I find that public equity firms that just meet earnings benchmarks while altering real operating activities suffer from lower future industry-adjusted ROA than private equity firms that just meet earnings benchmarks while altering real operating activities. The finding for the public equity firms validates concerns that operating decisions made in response to capital market pressure may negatively impact future firm performance. On the other hand, the results for private equity firms indicate that alterations of operating activities made in the absence of capital market pressure are more likely to be strategically sound.
Determining the Impact of Multiple Consecutive Years of Financial Reporting Quality Issues on Investment Efficiency
(2012) Wilford, Amanda Lyn; Gordon, Lawrence A; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Prior research recognizes that there is a positive relation between financial reporting quality and investment efficiency. The primary object of this dissertation is to examine how financial reporting quality in multiple consecutive years impacts investment efficiency. I use material weaknesses in internal control (MW) as a proxy for poor financial reporting quality and I examine the impact of poor financial reporting quality in multiple consecutive years using an OLS regression model. The results indicate there is a progressively negative impact on investment efficiency tied to the number of consecutive years in which firms report MW. Additionally, I examine whether investment specific financial reporting quality issues have a greater impact on investment efficiency than all other types of financial reporting quality issues. My results suggest that investment specific financial reporting quality issues are driving the negative impact on investment efficiency. These results imply that managers can reduce investment inefficiency by focusing their resources on remediating (correcting) financial reporting quality issues (MW) associated with investment. Current internal control research identifies firms as having either strong or weak internal control dependent upon (1) the presence or absence of MW or (2) the number of MW. This research essentially treats each MW as being of equal importance, Thus, as a secondary objective of this dissertation, in Appendix B, I develop a metric for internal control using the Analytic Hierarchy Process (AHP) to provide a weighting scheme for the different types of MW. Based on Audit Analytics (which separates MW into 21 different categories), I engage 18 participants in an AHP exercise to determine which types of MW have the greatest impact on the financial statements. The results indicate that auditors and managers find MW related to Personnel Weaknesses have the greatest impact on the financial statements. AHP results in weights that are then applied to the 21 different categories of MW. These weights are applied to firms based upon the types of MW reported and the sum of the weights is the measure used for the internal control metric. I then perform a simple OLS regression to test the relation between the internal control metric and stock market returns (Appendix C). I find that a positive relation exists between strong internal controls (as measured by the newly constructed metric) and stock market returns.
International Financial Reporting Standards and Cross-Border Mergers and Acquisitions
(2012) Zhu, Wenjie; Gordon, Lawrence A; Loeb, Martin P; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This dissertation investigates the economic impact of global accounting harmonization. Particularly I focus on its influence on macro level cross-border M&A investments. I posit that mandatory IFRS adoption lowers the systemic information noise embedded in countries' accounting standards. This reduces the associated information processing costs and enhances the economic role accounting standards play on cross-border M&A flows. After mandatory IFRS adoption, a 1% increase in accounting standards disparity suppresses bilateral M&A flows by around 2%; decrease in accounting standards disparity helps promote bilateral M&A flows when paired countries' governance infrastructure gap is relatively wider. I do not find these associations significant prior to mandatory IFRS adoption. Overall, this dissertation documents an evolving economic role accounting standards play on bilateral cross-border M&A flows, and supports International Accounting Standards Board's advocacy in adopting a uniform set of accounting standards globally. Moreover, it further analyses the current adoption demand for IFRS from the U.S. firms.
Financial Reporting: A Look At Different Settings
(2013) Felix, Robert; Cheng, Dr. Shijun; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
The first of two essays examines whether financial reporting is influenced when a firm shares a director with a "central" firm. Central firms are those which are well-connected within the network of firms formed by shared board of directors. Centrality is a driver of influence and since social networks are a channel to spread information, central firms could transmit reporting practices. However, because financial reporting style is presumably firm specific, the central firm's reporting may not be effective for a focal firm. I examine the effect of central firm conservatism and discretionary accruals on the same focal firm attributes. The results show that focal firm conservatism is influenced by that of the central firm after the two firms become interlocked and that influence is concentrated in the first year. However, a firm adopted central firm discretionary accruals over a longer time horizon. The finding was robust to a variety of alternate explanations. Overall, the findings shed light on how financial reporting spreads through a network and adds to our understanding of how influence occurs between two interlocked firms. The second essay examines municipal reporting manipulation. Municipalities use fund accounting to separately track each activity in self-balancing set of accounts. I focus on the general fund, the largest fund, which uses governmental accounting, and the enterprise fund, which accounts for business-like operations and uses corporate-like accounting. Municipalities have a different organizational objective than corporations and could desire to report a small increase in the general fund bottom line to avoid taxpayer's backlash or they could wish to build up their fund balance to for future use. The enterprise fund incentives are also unclear. I find that operating transfers between funds (discretionary accruals) are used in the general (enterprise), but not the enterprise (general), fund to systematically manipulate its bottom line downward. Accordingly, each fund is manipulated downwards using a method that is in line with its accounting system. Further analysis shows that the general fund results are more pronounced in municipalities with heavy citizen involvement. The findings also highlight that institutional factors do not impact both funds in the same manner.
The more we know about fundamentals the less we agree on price? Evidence from earnings announcements.
(2014) Gallo, Lindsey; Hann, Rebecca; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study investigates whether an earnings announcement that decreases disagreement about fundamentals can simultaneously increase disagreement about price. Kondor (2012) develops a rational expectations model in which the presence of short-horizon investors can lead to a polarization of higher-order beliefs about price (i.e., beliefs regarding the opinions of other investors), even as a public announcement reduces disagreement about fundamentals. I empirically investigate this theoretical finding using analyst forecast dispersion and implied volatility to proxy for differences of opinion about fundamentals and price, respectively. I predict and find a positive association between the presence of short-horizon traders and both the likelihood and extent of divergence between changes in price disagreement and earnings disagreement around earnings announcements characterized by decreasing forecast dispersion (i.e. earnings announcements that decrease disagreement about fundamentals). Further, I document that the association is stronger following good news announcements than following bad news announcements consistent with more precise public signals triggering higher-order disagreement. In additional analysis, I employ abnormal announcement period volume to measure disagreement about price. Using this alternative measure, I continue to document a positive association between short-horizon ownership and the extent of divergence. Taken together, these findings suggest that higher-order beliefs play an important role in the way market participants react to public announcements.
When do targets' past financial results matter most to acquirers? The role of disruption of targets' existing operations
(2014) Rabier, MaryJane Raffaella; Kimbrough, Michael D; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
A target's past earnings and past earnings quality are informative about the performance of its stand-alone operations while its book value is informative about its adaptation value, which is the potential value from alternative uses of its resources. The information in past earnings and past earnings quality about a target's stand-alone operations is likely to be more important to acquirers that intend to keep the target's operations intact post-merger while the information in book value about its adaptation value is likely to be more important to acquirers that anticipate significant disruption of the target's operations. Using acquirer industry classification and a self-constructed index as alternative approaches to measuring anticipated disruption of target operations, I find evidence consistent with these predictions. Specifically, I find that acquirers assign greater discounts to targets' pre-merger earnings performance and pre-merger earnings quality in setting their bids as anticipated disruption of targets' operations increases. In addition, acquirers place greater weight on targets' pre-merger book values in setting their bids as anticipated disruption increases. These findings provide important insights into the conditions under which particular types of accounting information are most useful in the merger context.
THE HIDDEN FACE OF THE MEDIA: HOW FINANCIAL JOURNALISTS PRODUCE INFORMATION
(2015) Li, Congcong; Hann, Rebecca; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
This study investigates how the media produces information. Using a sample of 296,497 Wall Street Journal news articles, I find that news articles written by experienced and reputable financial journalists are more informative about future earnings. I then examine the source of such information advantage by studying the detailed quotes from news articles. I further find that these journalists rely more heavily on first-hand access to management, institutional investors, and other external experts, an important channel through which they produce informative news. Interestingly, however, this information advantage is present only when the experienced and reputable journalists remain independent -- for those journalists that repeatedly cover the same firm or rely primarily on information from management, the networking information advantage is completely muted. Further, I perform two additional tests. In the first test, I employ news articles about firm fundamentals, and in the second I use a revised measure of information content by including Dow Jones Business News. I continue to find that the information advantage of experienced and reputable journalists obtains only when these journalists remain independent. These results suggest that the quality of the media as an information intermediary depends critically on individual journalists' ability to access information from industry networks and provide unbiased news.
An Integrated Analysis of the Corporate General Counsel's Impact on Accounting Choices and Legal Risk
(2015) Ham, Charles; Kimbrough, Michael; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
Companies are increasingly relying on highly paid corporate general counsels (GCs) to help manage the risks of costly regulatory sanctions and shareholder lawsuits associated with their firms' accounting and overall business practices. While recent research documents the role of the GC on specific decisions in isolation, whether and how GCs fulfill their intended role of managing their firms' expected legal costs remains an open question. I document several ways in which GCs affect the expected legal costs associated with their firms' accounting choices. The analysis is based on the insight that the expected legal costs associated with the firm's accounting choices depend on three factors: (1) the extent to which the firm undertakes legally risky accounting practices, (2) the likelihood that such practices are detected by outsiders, and (3) the severity of penalties outsiders impose on the firm upon detection. Managers can affect the first factor by taking the external legal environment as given and altering their internal decisions accordingly, whereas managers can affect the latter two factors by altering the firm's external legal environment through their influence on the intensity of outside monitoring and enforcement. I provide evidence that the GC decreases the firm's expected legal costs via all three factors. First, firms with an influential GC (GC firms) display a preference for real earnings management relative to accrual earnings management and GC firms accelerate the recognition of losses in earnings, both of which entail less legal risk. Second, firms that make aggressive accounting choices are less likely to be targeted by SEC enforcement actions in the presence of an influential GC. This finding indicates that GCs are able to advise their firms about how to use accounting discretion in a way that avoids unwanted regulatory scrutiny. Third, GC firms are less likely to be sued following a restatement announcement. When their firms are sued, the lawsuits are more likely to be dismissed and the settlement amounts are lower. These findings indicate that the GC's advocacy is associated with a reduction in the severity of penalties outsiders impose on the firm when improper accounting choices are discovered. The analyses culminate with an examination of the GC's effect on the firm's overall corporate risk and the market's assessment of the GC's contribution to the firm. I find that GC firms are associated with lower corporate risk as measured by the volatility of future stock returns and lower levels of future risky investments in the form of capital expenditures and research and development expenditures. Finally, the market responds favorably in years that firms appoint a GC to the top management team, consistent with the market perceiving the net impact of GCs' activities to be value enhancing.
NONDISCLOSURE – A GOOD NEWS SIGNAL?
(2016) Lee, Kyungran; Kimbrough, Michael D; Business and Management: Accounting & Information Assurance; Digital Repository at the University of Maryland; University of Maryland (College Park, Md.)
I examine the implications of nondisclosure in a setting where there is a credible signal as to the proprietary nature of the undisclosed information. Specifically, I investigate the market and analysts' response to firms’ application to the Securities and Exchange Commission (SEC) for a confidential treatment order (CTO), which allows firms to redact required disclosures from SEC filings when the redacted information is proprietary. I find that the market and analysts react favorably to the voluntary nondisclosure of proprietary information using the SEC confidential treatment process. Market and analysts reactions are more favorable to the redaction of information that is more likely to have proprietary value, such as information related to research and development. In addition, I show that the redacting firms experience superior accounting performance compared to their peers in the years following the redaction, consistent with the market and analysts’ response to the redaction. However, I find that analysts engage in more intense private information search in response to a CTO redaction. This finding suggests that, although a CTO redaction can signal the nature of undisclosed information, analysts believe that the signal is not fully revealing of the economic magnitude of the undisclosed information. Overall, this study’s findings indicate that a firm's willingness to submit to the CTO approval process serves as a credible signal of the proprietary nature of the withheld information. The results of this study suggest a possible role for a credible signaling channel to facilitate communication between insiders and outsiders regarding the nature of withheld information.