labour market structure and inequality a comparison of italy and the u s markets with rigid labour regulations and centralized wage setting are often thought to be inefficient but egalitarian using a model of off and on the job search and event history individual level data for italy and the u s we show that while the cross sectional wage distributions of young italian males are much more compressed than are the comparable distributions for young white u s males the estimated search model implies that the distribution of lifetime welfare is no more disperse in the u s than it is in italy our model implies that the high frequency of movements between labour market states leads to both a relatively equitable distribution of long run welfare in the u s and a high level of cross sectional inequality

the predictability of interim earnings over alternative quarters this study examines the predictability of earnings per share for the first second third and fourth quarterly reporting periods forecasts of quarterly earnings per share both by security analysts and time series models are analyzed the next section of the paper deals with the question of whether there is a significant difference in the accuracy with which each quarter can be forecasted the data in this section strongly indicate that such a difference exists the third section explores explanations for the findings of section 2 these include the relationship between fourthquarter variability and the integral versus discrete reporting methods section 4 contains the summary and conclusions

discretionary accounting choices and the predictive ability of accruals with respect to future cash flows using a sample of restatement firms and a meet or beat model to classify firms as making discretionary accounting choices for opportunistic meet or beat op mb reasons we show that originally reported earnings and accrual components are less predictive of future cash flows relative to the restated numbers we find the opposite is true for firms classified as making discretionary accounting choices for non op mb reasons we consider a number of competing explanations for these latter results our findings are most consistent with the informational hypothesis weakly consistent with conservative motivated efficient contracting hypotheses but inconsistent with opportunistic contracting and misapplication errors of gaap explanations

detecting earnings management a new approach this paper provides a new approach to test for accrual based earnings management our approach exploits the inherent property of accrual accounting that any accrual based earnings management in one period must reverse in another period if the researcher has priors concerning the timing of the reversal incorporating these priors can significantly improve the power and specification of tests for earnings management our results indicate that tests incorporating reversals increase test power by around 40 and provide a robust solution for mitigating model misspecification arising from correlated omitted variables

inventories and the concentration of suppliers and customers evidence from the chinese manufacturing sector this study investigates the links between supplier and customer base concentrations and inventory holdings in the chinese manufacturing sector using financial data from a cohort of 516 companies we find that firms that face higher supplier density benefiting from better co ordination with suppliers hold fewer inventories whereas firms with higher customer density retain larger inventories as a result of the bargaining power exercised by customers we then extend the analysis by investigating the impact of account payables receivables and bad debt reserves finding that inventory holdings are positively associated with the two forms of financing and negatively associated with bad debts this last relationship however becomes less severe when firms have access to large volumes of payables finally we show that the above results hold with varying degrees of similarity also when we partition the dataset into six homogenous industrial segments overall this study contributes to the growing literature on inventories and the structure of the supply chain by shedding new light on the importance of both supplier and customer densities as well as the volume of payables and receivables for inventory management

truthfulness in accounting how to discriminate accounting manipulators from non manipulators accountants preparing information are in a position to manipulate the view of economic reality presented in such information to interested parties these manipulations can be regarded as morally reprehensible because they are not fair to users they involve in an unjust exercise of power and they tend to weaken the authority of accounting regulators this paper develops a model for detecting earnings manipulators using financial statements ratios in a sample of spanish listed companies our results provide evidence that accounting data can be extremely useful in detecting manipulators this approach can be used by a large category of users of accounting information among which we can cite stock exchange supervisors or investing professionals

incentives discretion and asset valuation in closed end mutual funds this paper studies earnings management using 363 closed end mutual fund firm years of data closed end fund assets consist of unrestricted and restricted securities and realized and unrealized income while unrestricted securities are not subject to earnings management restricted security values are largely discretionary managerial valuation of restricted securities is modeled as contingent on unrestricted returns relative to a performance benchmark four unrestricted performance regions are identified known multi period compensation incentives become the basis for hypothesizing earnings management behaviors in the regions in the form of restricted security valuation across several benchmarks the results are consistent with multi period maximization rather than simpler single period compensation maximization or income smoothing funds with extreme unrestricted performance show relatively larger income decreasing earnings management and funds with slightly below benchmark returns show relatively larger income increasing earnings management than those slightly above these results clarify the relationship between complex earnings management behavior and managerial incentives

monetary and financial interactions in the business cycle this paper develops a computable general equilibrium model in which endogenous agency costs can potentially alter business cycle dynamics the model resembles the influential theoretical work of ben bernanke and mark gertler 1989 two sources of shocks are considered productivity shocks and monetary shocks the model is parametrized to match key features of u s aggregate activity the principal result of the analysis is that agency costs add very little to the basic business cycle dynamics copyright 1995 by ohio state university press

aggregate consequences of limited contract enforceability we study a general equilibrium model in which entrepreneurs finance investment with optimal financial contracts because of enforceability problems contracts are constrained efficient we show that limited enforceability amplifies the impact of technological innovations on aggregate output this implies that economies with lower enforceability of contracts are characterized by greater macroeconomic volatility a key assumption for the amplification result is that defaulting entrepreneurs are not excluded from the market

performance shocks and misreporting we propose a parsimonious stochastic model of reported earnings that links misreporting to performance shocks our main analytical prediction is that misreporting leads to a negative second order autocorrelation in the residuals from a regression of current earnings on lagged earnings we also propose a stylized dynamic model of earnings manipulation and demonstrate that both earnings smoothing and target beating considerations result in the same predictions of negative second order autocorrelations empirically we find that the distribution of this measure is asymmetric around zero with 27 of the firms having significantly negative estimates using this measure we specify a methodology to estimate the intensity of misreporting and to create estimates of unmanipulated earnings our estimates of unmanipulated earnings are more correlated with contemporaneous returns and have higher volatility than reported earnings with respect to economic magnitude we find that in absolute terms median misreporting is 0 7 of total assets moreover firms in our sample subject to sec aaers have significantly higher estimates of manipulation intensity

accrual reversals earnings and stock returns we show that accruals consist of at least two distinct underlying processes one with positive serial correlation and the other with negative serial correlation we also find that the accrual reversals characterizing the negatively serially correlated process are predominantly good accruals that correctly anticipate fluctuations in working capital accrual estimation error is the least persistent component of earnings while accruals relating to firm growth are less persistent than cash flows finally the mispricing of accruals appears to be driven by a combination of accrual estimation error and firm growth

accounting conservatism and firm investment efficiency abstract we argue that conservatism improves investment efficiency in particular we predict that it resolves debt equity conflicts facilitating a firm s access to debt financing and limiting underinvestment this permits the financing of prudent investments that otherwise might not be pursued our empirical results confirm these predictions we find that more conservative firms invest more and issue more debt in settings prone to underinvestment and that these effects are more pronounced in firms characterized by greater information asymmetries we also find that conservatism is associated with reduced overinvestment even for opaque investments such as research and development

foreign earnings management of us multinational companies the role of decision rights us multinational corporations mncs need to allocate decision rights between parent companies and subsidiaries to manage global operations this article examines how the allocation of decision rights affects foreign earnings management of mncs i find that the extent of foreign earnings management increases when parents retain centralized decision rights but internal cross border frictions between parents and their foreign subsidiaries and the external local legal environment in which foreign subsidiaries operate can mitigate foreign earnings management despite parents having centralized decision rights this study provides evidence on how the decision structures of mncs affect where earnings are managed

self insurance and inequality abstract recent works have stressed that precautionary savings can provide a level of insurance against unemployment risks that is comparable to the current unemployment insurance ui system in average this paper reconsiders this result by laying stress on the implied insurance and wealth inequalities in an incomplete market model calibrated on the french labor market self insurance is found to increase the permanent inequality in this set up due to the history dependence of consumption in the presence of borrowing constraints this result is fostered when one turns to transitory inequalities as some unemployed persons can be potentially liquidity constrained at a given period

search financial market frictions and monetary transmission this paper evaluates the implications of search and matching frictions in the financial market for the bank lending channel of monetary policy borrowers and lenders participate in a decentralized loan market for the purpose of establishing long term credit relationships and the provision of loanable funds to productive firms locating credit relationships is costly in terms of time and real resources and the interest rate is negotiated via a bargaining mechanism this structure is incorporated into an otherwise standard monetary business cycle framework and used to study how such frictions in the credit market contribute to explaining the contemporaneous impact and propagation of monetary growth shocks and inflation while anticipated inflation negatively impacts real activity it can also increase loan market participation and the inflow of newly established credit relationships it is shown that i bargaining and costly search mitigates the traditional inflation tax effect of monetary injections and ii the existence of long term lending relations tends to dampen liquidity effects monetary shocks in this environment lead to larger liquidity effects relative to the frictionless case and are capable of generating persistence in the nominal interest rate labor consumption and output it can also explain the excess volatility of credit creation relative to output and the observation that overall credit creation can lead output over the business cycle

conservatism and cross sectional variation in the post earnings announcement drift accounting conservatism allows me to identify a previously undocumented source of predictable cross sectional variation in standardized unexpected earnings autocorrelations viz the sign of the most recent earnings realization and present evidence that the market ignores this variation loss effect it is possible to earn returns higher than from the bernard and thomas 1990 strategy by incorporating this feature additionally the paper shows that the loss effect is different from the cross quarter effect shown by rangan and sloan 1998 and it is possible to combine the two effects to earn returns higher than either strategy alone thus the paper corroborates the bernard and thomas finding that stock prices fail to reflect the extent to which quarterly earnings series differ from a seasonal random walk and extends it by showing that the market systematically underestimates time series properties resulting from accounting conservatism

the welfare costs of worker displacement abstract recent work has documented the large persistent earnings losses associated with the displacement of high tenure workers in this paper we assess the welfare costs of this risk assuming that workers do not have access to insurance markets we find that the cost is substantial on the same order of magnitude as the cost associated with unemployment risk we also argue that long duration unemployment insurance is likely to exacerbate this cost and that government financed severance payments are a far more effective way of dealing with the displacement risk

zombie board board tenure and firm performance we show that board tenure exhibits an inverted u shaped relation with firm value and accounting performance the quality of corporate decisions such as m a financial reporting quality and ceo compensation also has a quadratic relation with board tenure our results are consistent with the interpretation that directors on the job learning improves firm value up to a threshold at which point entrenchment dominates and firm performance suffers to address endogeneity concerns we use a sample of firms in which an outside director suffered a sudden death and find that sudden deaths that move board tenure away from toward the empirically observed optimum level in the cross section are associated with negative positive announcement returns the quality of corporate decisions also follows an inverted u shaped pattern in a sample of firms affected by the death of a director

how has the financial crisis affected earnings management a european study the article aims to investigate whether and how in the european union eu the burst of the 2008 financial crisis affected misrepresentation of financial information due to earnings management by analysing a sample of 11 844 firm year observations listed in the eu over the period 2006 2012 an event study methodology allows us to calculate and compare country by country abnormal accruals over the estimation period and over the event period our findings validate our research hypothesis and suggest a decrease of misrepresentation in the large majority of the european countries after the burst of the financial crisis the results take part in the debate in the accounting literature about the change of earnings management over a financial crisis and have several implications for standard setters and regulators that could learn how the common incentives of entities to attract potential investors during a crisis could lead them to provide a high quality financial reporting

the role of accruals in asymmetrically timely gain and loss recognition we investigate the role of accrual accounting in the asymmetrically timely recognition incorporation in reported earnings of gains and losses timely recognition requires accruals when it precedes complete realization of the gains and losses in cash we show that nonlinear accruals models incorporating the asymmetry in gain and loss recognition timelier loss recognition or conditional conservatism offer a substantial specification improvement explaining substantially more variation in accruals than equivalent linear specifications conversely conventional linear accruals models by omitting the loss recognition asymmetry exhibit substantial attenuation bias and offer a comparatively poor specification of the accounting accrual process linear specifications also understate the ability of current earnings to predict future cash flows these findings have implications for our understanding of accrual accounting and conservatism as well as for researchers estimating discretionary accruals earnings management and earnings quality

does religion mitigate earnings management evidence from china using a sample of 11 357 firm year observations from the chinese stock market for the period of 2001 2011 we investigate whether and how religion can mitigate earnings management specifically based on geographic proximity based religion variables we provide strong and robust evidence to show that religion is significantly negatively associated with the extent of earnings management suggesting that religion can serve as a set of social norms to mitigate corporate unethical behavior such as earnings management our findings also reveal that the negative association between religion and earnings management is less pronounced for firms with closer distance to the regulatory centers than for their counterparts implying the substitutive effects between religion and the distance to regulators the proxy for regulatory intensity on mitigating earnings management the above results are robust to different measures of earnings management various religion variables and a variety of sensitivity tests

post listing performance and private sector regulation the experience of london s alternative investment market abstract we investigate the experience of companies listing and raising capital on the aim which is privately regulated and relies on nominated advisors who compete for listings and provide regulatory oversight aim firms underperform newly listed firms on traditionally regulated exchanges based on post listing returns and failure rates comparable to firms listing on the unregulated us pink sheets and exhibit abnormally high pre listing accruals and post listing reversals high quality auditors and nomads partially mitigate underperformance suggesting that aim firms have limited ability to bond through more stringent oversight underperformance is particularly pronounced for firms with higher proportions of retail investors

debt covenant violation and manipulation of accruals abstract this paper examines the abnormal accruals of a sample of 94 firms that reported debt covenant violations in annual reports we expect debt covenant restrictions to influence accounting choices in the year preceding and the year of violation time series and cross sectional models are used to estimate normal accruals in the year prior to violation both models indicate that abnormal total and working capital accruals are significantly positive in the year of violation there is evidence of positive abnormal working capital accruals after controlling for management changes and auditor going concern qualifications

discussion of are executive stock options associated with future earnings abstract hanlon rajgopal and shevlin conclude that grant of stock options to executives is associated with a positive impact on future operating performance this discussion comment examines the impact of endogeneity model structure and the choice of a benchmark model on this conclusion while some results indicate that there is a position relation between stock option grants and operating performance alternative econometric approaches produce distinctly different results

why do accruals predict earnings abstract higher accruals are associated with lower subsequent earnings we show this phenomenon can be explained by the way sales profits and working capital respond to changes in a firm s product markets empirically high accruals predict high subsequent sales growth but a long lasting drop in both profits and profitability accruals also predict an increase in future competition suggesting that accruals are correlated with abnormally high and in equilibrium transitory true profitability that attracts new entrants to the industry overall the predictive power of accruals is better explained by product market effects than by measurement error in accruals or diminishing returns from investment

the role of unemployment insurance in an economy with liquidity constraints and moral hazard the potential welfare benefits of unemployment insurance along with the optimal replacement ratio are studied using a quantitative dynamic general equilibrium model to provide a role for unemployment insurance agents in our economy face exogenous idiosyncratic employment shocks and are unable to borrow or insure themselves through private markets in the absence of moral hazard replacement ratios as high as 65 are optimal and the welfare benefits of unemployment insurance are quite large however if there is moral hazard and the replacement ratio is not set optimally but is instead set to an empirically plausible value the economy can be much worse off than it would be without unemployment insurance

executive overconfidence and the slippery slope to financial misreporting abstract a detailed analysis of 49 firms subject to aaers suggests that approximately one quarter of the misstatements meet the legal standards of intent in the remaining three quarters the initial misstatement reflects an optimistic bias that is not necessarily intentional because of the bias however in subsequent periods these firms are more likely to be in a position in which they are compelled to intentionally misstate earnings overconfident executives are more likely to exhibit an optimistic bias and thus are more likely to start down a slippery slope of growing intentional misstatements evidence from a high tech sample and a larger and more general sample support the overconfidence explanation for this path to misstatements and aaers

the ability of earnings to predict future earnings and cash flow this paper examines the value relevance of earnings by testing their ability to predict two future benefits of equity investment earnings and cash flow from operations previous research discussed below has given an incomplete view of earnings predictive ability as it has typically focused on short horizons while ignoring the longer term benefits that are also valued as in ohlson 1990 i test earnings ability to predict future earnings and future cash flow from operations1 one through eight years ahead using annual data from

earnings quality evidence from the field abstract we provide insights into earnings quality from a survey of 169 cfos of public companies and in depth interviews of 12 cfos and two standard setters cfos believe that i above all high quality earnings are sustainable and repeatable specific characteristics include consistent reporting choices backing by actual cash flows and absence of one time items and long term estimates ii about 50 of earnings quality is driven by non discretionary factors such as industry and macro economic conditions iii in any given period about 20 of firms manage earnings to misrepresent economic performance and for such firms 10 of eps is typically managed iv earnings manipulation is hard to unravel from the outside but peer comparisons and lack of correspondence between earnings and cash flows provide helpful red flags in addition cfos disagree with current standard setting on a number of issues including the sheer number of promulgated rules the top down approach to rule making the neglect of the matching principle and the emphasis on fair value accounting they indicate that a rules based culture makes the audit function centralized and mechanical and hinders the development of audit professionals a summary impression from our work is that cfos view earnings quality as more of a single and unconditional characteristic in contrast to current research where measures of earnings quality are strongly conditional on the decision setting this cfo view is related to their idea of one number a single earnings metric that shapes both their interactions with external stakeholders and internal decision making

moral hazard optimal unemployment insurance and experience rating abstract this paper is concerned with evaluating alternative unemployment insurance ui schemes in a dynamic economy with moral hazard we consider changes in the size and duration of ui benefits and the effects of experience rating and use a dynamic contracting approach to determine a benchmark optimal allocation radical changes in the current ui system increase welfare but not by much a move to full experience rating has distributional effects but the aggregate effects are negligible

employee stock options equity valuation and the valuation of option grants using a warrant pricing model we investigate the use of a warrant pricing approach to incorporate employee stock options esos into equity valuation and to account for the dilutive effect of esos in the valuation of option grants for financial reporting purposes our valuation approach accounts for the jointly determined nature of eso and shareholder values the empirical results show that our stock price estimate exhibits lower prediction errors and higher explanatory powers for actual share price than does the traditional stock price estimate we use our valuation approach to assess the implications of dilution on the fair value estimates of eso grants we find that the fair value is overstated by 6 if we ignore the dilutive feature of esos furthermore this bias is larger for firms that are heavy users of esos small and r d intensive and for firms that have a broad based eso compensation plan

assessing empirical research in managerial accounting a value based management perspective this paper applies a value based management framework to critically review empirical research in managerial accounting this framework enables us to place the exceptionally diverse set of managerial accounting studies from the past several decades into an integrated structure our synthesis highlights the many consistent results in prior research identifies remaining gaps and inconsistencies discusses common methodological and econometric problems and suggests fruitful avenues for future managerial accounting research

a contracting perspective on earnings quality abstract this paper analyzes the impact of signal to noise ratios and the autocorrelation of a performance measure on the principal s welfare in dynamic agencies with renegotiation we consider the impact of changes in the persistent transitory and reversible components of accounting earnings on its usefulness in valuation versus contracting increasing the persistent components and reducing the reversible components are generally desirable for valuation but not for contracting eliminating transitory components of earnings is generally desirable for valuation but not necessarily for contracting we discuss the contracting implications of differences in the autocorrelations of accounting earnings versus stock returns

discretionary behavior with respect to allowances for loan losses and the behavior of security prices abstract the study examines the capital market pricing of discretionary and nondiscretionary components of a major accrual in the banking industry the allowance for loan losses the analysis employs a two stage approach in which the allowance account is first decomposed into estimates of its nondiscretionary and discretionary components the second stage evaluates the market s valuation of the estimates of the components evidence suggests that the capital market perceives the allowance to be comprised of two components a nondiscretionary component which is negatively priced and a discretionary component whose incremental pricing coefficient is positive

the relation between earnings and cash flows abstract a model of earnings cash flows and accruals is developed assuming a random walk sales process variable and fixed costs and that the only accruals are accounts receivable and payable and inventory the model implies earnings better predict future operating cash flows than current operating cash flows and the difference varies with the operating cash cycle also the model is used to predict serial and cross correlations of each firm s series the implications and predictions are tested on a 1337 firm sample over 1963 1992 both earnings and cash flow forecast implications and correlation predictions are generally consistent with the data

credit markets and the propagation of monetary policy shocks this paper analyzes the propagation of monetary policy shocks through the creation of credit in an economy models of the monetary transmission mechanism typically feature responses which last for a few quarters contrary to what the empirical evidence suggests to propagate the impact of monetary shocks over time these models introduce adjustment costs by which agents find it optimal to change their decisions slowly this paper presents another explanation that does not rely on any sort of adjustment costs or stickiness in our economy agents own assets and make occupational choices banks intermediate between agents demanding and supplying assets our interpretation is based on the way banks create credit and how the monetary authority affects the process of financial intermediation through its monetary policy as the central bank lowers the interest rate by buying government bonds in exchange for reserves high productive entrepreneurs are able to borrow more resources from low productivity agents we show that this movement of capital among agents sets in motion a response of the economy that resembles an expansionary phase of the cycle

does basel ii affect the market valuation of discretionary loan loss provisions we use a sample of banks from 24 european countries to investigate whether the adoption of the basel ii capital accord in 2008 affects the market valuation of discretionary loan loss provisions dllps although basel ii lowers the incentives of internal ratings based irb banks to recognize income increasing dllps in an opportunistic manner it has no such impact on the remaining banks which adopt the standardized methodology we use this setup in a difference in difference did design where standardized banks act as a control group our evidence supports the three hypotheses that for irb relative to standardized banks basel ii is associated with i less income increasing dllps and ii less income smoothing via dllps which enhances the informational content of dllps about future loan losses and leads to iii higher market valuation of dllps our findings are timely and have policy implications for future regulatory developments in the banking industry

predicting accounting misconduct the role of firm level investor optimism motivated by a large literature on how firm specific resources such as leadership and management skills strategies organizational capabilities and intellectual properties drive firm performance we propose and find that heterogeneity in investor optimism regarding firm specific attributes plays a very important role in influencing the managerial propensity to manipulate financial statements when firm level investor optimism is moderate the incidence of accounting misconduct increases but it decreases when investors are highly optimistic further market reaction to the announcement of financial restatements is more negative when investors held more optimistic firm specific beliefs at the time of initial misstatement these findings are robust to alternative firm specific optimism measures linked to analysts general investors and unsophisticated individual investors controls for market wide consumer sentiment unexplained by macroeconomic factors economy wide and industry level optimism potential selection bias and reverse causality our analysis highlights the importance of firm level investor optimism in predicting preventing and detecting accounting misconduct

initial evidence on the role of accounting earnings in the bond market we document that 1 the incidence of bond trade increases during the days surrounding earnings announcements 2 there is a bond price reaction to the announcement of earnings and 3 there is a positive association between annual bond returns and both annual changes in earnings and annual analysts forecast errors all of these effects are larger when earnings convey bad news or when the underlying bond is more risky taken together our results suggest that the nonlinear payoff structure of bond securities affects the role of accounting earnings in the bond market

on the persistence and pricing of industry wide and firm specific earnings cash flows and accruals economic theory suggests that the industry wide component of firm performance is more persistent than the firm specific component this paper tests whether investors fail to fully appreciate the relatively higher lower persistence of industry wide firm specific earnings consistent with predictions we find that the industry wide component of earnings is a significant predictor of future stock returns we show that this form of mispricing is distinct from the accrual anomaly sloan 1996 a hedge portfolio trading strategy that exploits signals from both industry fundamentals and accounting accruals generates abnormal returns in excess of either strategy alone additional evidence suggests that the market underreacts overreacts to industry wide cash flows firm specific accruals but correctly prices both industry wide accruals and firm specific cash flows

managerial optimism and earnings smoothing abstract this paper empirically examines how ceo optimism affects earnings smoothing and earnings surprises the main finding is that optimistic managers smooth earnings more than rational managers and are associated with smaller in absolute value earnings surprises a possible theoretical explanation is offered for these results based on a combination of the torpedo effect the innate behavior of optimists and the risk of litigation prosecution for over reporting earnings

an empirical investigation of dynamic ordering policies adaptive base stock policy is a well known tool for managing inventories in nonstationary demand environments this paper presents empirical tests of this policy using aggregate firm level data first we extend a single item adaptive base stock policy in previous literature to a multi item case second we transform the policy derived for the multi item case to a regression model that relates firm level inventory purchases to firm level sales and changes in sales forecasts we focus on two research questions can the adaptive base stock policy explain cross sectional ordering behaviors under sales growth to the extent that the adaptive base stock policy fails to explain ordering behaviors under sales growth are there frictions that explain such a finding our empirical results demonstrate disparities in ordering behaviors between firms experiencing high and moderate sales growth contrary to theoretical prediction this implies that inventory purchases are a function of not only current sales and changes in sales forecast but also past sales growth as potential explanations for this departure from theoretical prediction we show that both future demand dynamics and inventory holding risks depend on past sales growth in addition we find that firms inventory holding risks may also be affected by purchasing constraints imposed by supply chain contracts our results provide managerial implications for practitioners and inform future theoretical research this paper was accepted by martin lariviere operations management

understanding the relation between accruals and volatility a real options based investment approach abstract accruals are fundamental to financial reporting and are the underlying innovation of accounting despite this accounting research has provided little understanding of how economic forces affect a firm s level of accruals and limited guidance for forming expectations of accruals based on ex ante firm characteristics we consider accruals as a form of investment and examine whether theoretical predictions from a real options based investment framework provide insight into the relation between accruals and the ex ante expected volatility faced by the firm specifically the theory predicts that higher volatility dampens investment because firms prefer to wait and see instead of investing immediately consistent with this theory we document a robust negative relation between year ahead net working capital accruals and expected volatility we also predict and find that the negative association between year ahead net working capital accruals and expected volatility is less pronounced for distressed firms and more pronounced for firms with a longer operating cycle and that current asset accruals are more sensitive to volatility than current liability accruals finally we find that the residuals from an investment based expected accrual model outperform those from the widely used performance adjusted modified jones model in identifying companies that just meet or beat analysts earnings forecasts collectively our findings suggest that the investment perspective of accruals and in particular the real options based investment framework provide useful insights for forming expectations of accruals

what motivates managers choice of discretionary accruals abstract the papers by subramanyam 1996 and kasanen kinnunen and niskanen kkn 1996 both consider why managers manipulate accounting accruals subramanyam finds that discretionary accruals are associated with several performance measures and concludes that managers accrual choices increase the informativeness of accounting earnings however a strong competing alternative is that the jones model systematically mismeasures discretionary accruals so that they contain a significant non discretionary component unlike many us studies kkn find strong evidence of earnings management in finland where finnish managers set earnings to satisfy the demand for dividends by keiretsu like institutional investors

do analysts sacrifice forecast accuracy for informativeness analysts deviate from management guidance to correct for perceived earnings management although the deviations reduce forecast accuracy they improve forecast informativeness bringing the forecasts closer to the unmanaged earnings and reducing accruals mispricing an implicit assumption in the literature is that more accurate analyst forecasts i e estimates that are closer to the reported earnings are better for investors and that analysts objective is to forecast the reported managed earnings accurately our analysis suggests that this is not necessarily the case and that an inaccurate forecast can actually be more informative than an accurate one prior studies on analysts deviations from management guidance focus on analysts incentives to issue estimates that managers can beat these studies implicitly assume that analysts side with management against the interests of their clients our analysis indicates that analysts could also deviate from management guidance to provide useful valuation