Ray Ball

REVISION: Fama, Fisher, Jensen and Roll (1969): Retrospective Comments
Date Posted:Sun, 05 Dec 2021 19:15:10 -0600
This essay provides a retrospective view of one of Gene Fama’s many seminal papers, Fama, Fisher, Jensen, and Roll (1969). The paper was like none before it. Its contributions include (listed in what I regard as increasing order of importance): documenting share price behavior around the time of splits; implementing the first control for the market factor, hence creating the precursor to the influential Fama-French models; conducting the first event study; providing the first direct test of market efficiency; and demonstrating the wisdom and validity of Fama’s (1965) framing of stock price behavior in terms of information. The paper’s impact has been enormous, because at the time the research was conducted it was instrumental in reframing how we think about asset prices.

REVISION: On Earnings and Cash Flows as Predictors of Future Cash Flows
Date Posted:Tue, 20 Jul 2021 13:42:59 -0500
Do accruals-based earnings provide better information about future operating cash flows than do operating cash flows themselves, as predicted by the Financial Accounting Standards Board's conceptual framework (FASB 1978)? While this is a foundational issue in accounting, because it addresses the information added by accrual accounting methods, testing it remains unsettled. We show that when comparing the predictive ability of operating cash flows with that of an equivalent earnings measure calculated on an accrual basis, earnings outperform operating cash flows. The result becomes more pronounced when allowance is made for cross-sectional differences in the relation between firms' earnings and future cash flows. In fact, even "bottom line" earnings then have similar explanatory power as operating cash flows.

REVISION: Using Accounting Earnings and Aggregate Economic Indicators to Estimate Firm-level Systematic Risk
Date Posted:Wed, 13 Jan 2021 03:40:04 -0600
We revisit the literature on using accounting earnings to estimate firm-level systematic risk, using macroeconomic indicators rather than listed-firm indexes to measure aggregate risk. Conventional listed-firm indexes reflect an unrepresentative subset of aggregate assets and thus are expected to substantially mis-measure aggregate and systematic risk (Roll, 1977). That choice dictates using earnings rather than returns to measure firm-level outcomes. Earnings and macroeconomic indicators both are primarily realized annual outcomes and thus are better aligned in time than forward-looking returns for capturing the contemporaneous co-movements that underlie systematic risk. Our macroeconomic indicators are chosen to reflect shocks to aggregate supply and demand, providing a parsimonious model incorporating the two fundamental determinants of aggregate risk. We find that firms' earnings-based sensitivities (betas) to aggregate supply and demand shocks are negatively correlated, and ...

REVISION: Using Accounting Earnings and Aggregate Economic Indicators to Estimate Firm-level Systematic Risk
Date Posted:Mon, 04 Jan 2021 05:08:48 -0600
We revisit the literature on using accounting earnings to estimate firm-level systematic risk, using macroeconomic indicators rather than listed-firm indexes to measure aggregate risk. Conventional listed-firm indexes reflect an unrepresentative subset of aggregate assets and thus are expected to substantially mis-measure aggregate and systematic risk (Roll, 1977). That choice dictates using earnings rather than returns to measure firm-level outcomes. Earnings and macroeconomic indicators both are primarily realized annual outcomes and thus are better aligned in time than forward-looking returns for capturing the contemporaneous co-movements that underlie systematic risk. Our macroeconomic indicators are chosen to reflect shocks to aggregate supply and demand, providing a parsimonious model incorporating the two fundamental determinants of aggregate risk. We find that firms' earnings-based sensitivities (betas) to aggregate supply and demand shocks are negatively correlated, and ...

REVISION: FASB was Right: Earnings Beat Cash Flows when Predicting Future Cash Flows
Date Posted:Thu, 31 Dec 2020 05:29:56 -0600
Do accruals-based accounting earnings provide better information to investors about future operating cash flows than operating cash flows themselves, as predicted by FASB’s conceptual framework? The most recent evidence (Nallareddy et al., 2020) is that operating cash flows, measured correctly using cash flow statement data, consistently outperform earnings. However this evidence compares operating cash flows with “bottom line” earnings, handicapping earnings by including non-operating and transitory components with no corresponding operating cash flow. Operating earnings consistently dominate operating cash flow’s predictive ability in a battery of tests, especially after addressing cross-sectional differences among firms.

REVISION: FASB was Right: Earnings Beat Cash Flows when Predicting Future Cash Flows
Date Posted:Fri, 09 Oct 2020 05:58:27 -0500
Do accruals-based accounting earnings provide better information to investors about future operating cash flows than operating cash flows themselves, as predicted by FASB’s conceptual framework? The most recent evidence (Nallareddy et al., 2020) is that operating cash flows, measured correctly using cash flow statement data, consistently outperform earnings. However this evidence compares operating cash flows with “bottom line” earnings, handicapping earnings by including non-operating and transitory components with no corresponding operating cash flow. Operating earnings consistently dominate operating cash flow’s predictive ability in a battery of tests, especially after addressing cross-sectional differences among firms.

REVISION: FASB was Right: Earnings Beat Cash Flows when Predicting Future Cash Flows
Date Posted:Fri, 11 Sep 2020 09:24:59 -0500
Do accruals-based accounting earnings provide better information to investors about future operating cash flows than operating cash flows themselves, as predicted by FASB's conceptual framework? The most recent evidence (Nallareddy et al., 2020) is that operating cash flows, when measured correctly using cash ow statement data, consistently outperform earnings. However this evidence is based on \bottom line" earnings, which handicaps earnings by including non-operating components with no corresponding operating cash flow. Operating earnings consistently dominate operating cash flow's predictive ability in a battery of tests, especially after addressing cross-sectional differences among firms.

REVISION: Using Accounting Earnings and Aggregate Economic Indicators to Estimate Firm-level Systematic Risk
Date Posted:Wed, 15 Apr 2020 11:57:33 -0500
We revisit the literature on using accounting earnings to estimate firm-level systematic risk, using macroeconomic indicators rather than listed-firm indexes to measure aggregate risk. Conventional listed-firm indexes reflect an unrepresentative subset of aggregate assets and thus are expected to substantially mis-measure aggregate and systematic risk (Roll, 1977). That choice dictates using earnings rather than returns to measure firm-level outcomes. Earnings and macroeconomic indicators both are primarily realized annual outcomes and thus are better aligned in time than forward-looking returns for capturing the contemporaneous co-movements that underlie systematic risk. Our macroeconomic indicators are chosen to reflect shocks to aggregate supply and demand, providing a parsimonious model incorporating the two fundamental determinants of aggregate risk. We find that firms' earnings-based sensitivities (betas) to aggregate supply and demand shocks are negatively correlated, and ...

REVISION: Using Accounting Earnings and Aggregate Economic Indicators to Estimate Firm-level Systematic Risk
Date Posted:Wed, 29 May 2019 12:16:56 -0500
We revisit the literature on using accounting earnings to estimate firm-level systematic risk. We use macroeconomic indicators to measure undiversifiable aggregate risk; conventional listed-firm indexes reflect an unrepresentative subset of aggregate assets and are expected to substantially mismeasure risk (Roll, 1977). Earnings and macroeconomic indicators are realized annual outcomes that are well aligned for capturing the contemporaneous co-movements that underlie systematic risk, whereas stock returns incorporate changes in expected future outcomes. The macroeconomic indicators we use reflect changes in aggregate supply and demand, providing a parsimonious model incorporating the two fundamental determinants of aggregate outcomes. We find that firms' earnings-based sensitivities (betas) to aggregate supply and demand shocks are negatively correlated, and explain twice the cross-section of returns as conventional "index" betas. They are correlated with firm characteristics ...

REVISION: Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns
Date Posted:Sun, 20 Jan 2019 04:58:22 -0600
Book value of equity consists of two economically different components: retained earnings and contributed capital. We predict that book-to-market strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Retained earnings-to-market predicts the cross section of average returns in U.S. and international data and subsumes book-to-market. Contributed capital-to-market has no predictive power. We show that retained earnings-to-market -- and, by extension, book-to- market -- predicts returns because it is a good proxy for underlying earnings yield (Ball, 1978; Berk, 1995) and not because book value represents intrinsic value.

New: Ball and Brown (1968) After Fifty Years
Date Posted:Tue, 15 Jan 2019 10:34:02 -0600
The Editor commissioned this replication of Ball and Brown (1968) for a special issue of the Pacific-Basin Finance Journal commemorating the 50th anniversary of its publication. We also describe the background to the original paper and its research design, and offer observations on its interpretation, its impact on the literature and practice, some negative consequences, and its relation to papers published around the same time. One of the pleasing attributes of our original paper is that its results consistently replicate, the implication being that the research design and its implementation uncovered a universal relation between accounting earnings and changes in firm values. The current replication is in two dimensions: time; and geography, with an emphasis on Pacific Basin countries. In the USA and in a selection of 16 other countries, annual accounting earnings continue to contain a large proportion of the information that investors trade into share prices over the year, though ...

REVISION: Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns
Date Posted:Mon, 10 Sep 2018 07:06:44 -0500
Book value of equity consists of two economically different components: retained earnings and contributed capital. We predict that book-to-market strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Retained earnings-to-market predicts the cross section of average returns in U.S. and international data and subsumes book-to-market. Contributed capital-to-market has no predictive power. We show that retained earnings-to-market -- and, by extension, book-to- market -- predicts returns because it is a good proxy for underlying earnings yield (Ball, 1978; Berk, 1995) and not because book value represents intrinsic value.

REVISION: Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns
Date Posted:Wed, 18 Jul 2018 13:24:54 -0500
Book value of equity consists of two economically different components: retained earnings and contributed capital. We predict that book-to-market strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Retained earnings-to-market predicts the cross section of average returns in U.S. and international data and subsumes book-to-market. Contributed capital-to-market has no predictive power. We show that retained earnings-to-market -- and, by extension, book-to- market -- predicts returns because it is a good proxy for underlying earnings yield (Ball, 1978; Berk, 1995) and not because book value represents intrinsic value.

REVISION: Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns
Date Posted:Mon, 25 Sep 2017 13:58:09 -0500
We delve into what causes the relation between book-to-market and the cross section of stock returns. Book value of equity consists of two main components that we expect contain different information about expected returns: retained earnings and contributed capital. Retained earnings-to-market subsumes book-to-market's power to predict the cross section of stock returns in pre- and post-Compustat U.S. data as well as in international data. Contributed capital-to-market has no predictive power. Retained earnings represent the accumulated difference between earnings and dividends. We show that retained earnings-to-market's predictive power stems entirely from accumulated earnings. Our thesis is that retained earnings-to-market---and, by extension, book-to-market---predicts returns because it is a good proxy for earnings yield (Ball,1978; Berk, 1995).

REVISION: Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns
Date Posted:Tue, 07 Mar 2017 23:40:53 -0600
Book value of equity consists of two main parts: retained earnings and contributed capital. Retained earnings-to-market subsumes book-to-market's predictive power in the cross section of stock returns, despite comprising only 42% of book value on average. Contributed capital has no predictive power. Retained earnings represent the difference between accumulated past earnings and accumulated past dividends. We find that the predictive power of retained earnings arises entirely from accumulated past earnings. Our results imply that book-to-market predicts returns because it is a proxy for earnings yield (Ball, 1978). These results cast doubt on the notion that book-to-market identities over- and undervalued securities.

REVISION: Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns
Date Posted:Wed, 01 Mar 2017 13:01:42 -0600
Book value of equity consists of two main parts: retained earnings and contributed capital. Retained earnings-to-market subsumes book-to-market's predictive power in the cross section of stock returns, despite comprising only 42% of book value on average. Contributed capital has no predictive power. Retained earnings represent the difference between accumulated past earnings and accumulated past dividends. We find that the predictive power of retained earnings arises entirely from accumulated past earnings. Our results imply that book-to-market predicts returns because it is a proxy for earnings yield (Ball, 1978). These results cast doubt on the notion that book-to-market identities over- and undervalued securities.

REVISION: Internet Appendix to 'Contractibility and Transparency of Financial Statement Information Prepared under IFRS: Evidence from Debt Contracts around IFRS Adoption'
Date Posted:Tue, 28 Feb 2017 21:46:13 -0600
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Why We Do International Accounting Research
Date Posted:Sat, 09 Jul 2016 05:09:46 -0500
This essay was a Keynote Address at the Third International Conference of the Journal of International Accounting Research in São Paulo Brazil. It addresses the question of why the volume and quality of international accounting research have grown rapidly in recent years. It begins by asking why we do accounting research and moves on to discuss the reasons for conducting international accounting research. These include: to better understand others (and in the process, to better understand ourselves); to provide more replication options; to exploit differences in national institutional structures when investigating the determinants and effects of institutional variables on accounting; to address some limitations of within-jurisdiction research; and to obtain a wider range of changes to exploit (the paradigm example being the advent of IFRS). I then offer some concluding comments. Despite its somewhat presumptuous title, I do not presume to speak for others; the essay reflects a purely ...

REVISION: IFRS – Ten Years Later
Date Posted:Sat, 09 Jul 2016 04:57:07 -0500
A decade ago, the near-simultaneous adoption of IFRS in over one hundred countries could fairly have been described as a “brave new world” in financial reporting. Any systems innovation, and especially an innovation of such importance and magnitude, thrusts those involved (companies, users and accountants) into the unknown. There was good reason to expect success, based largely on widespread enthusiasm for international standards and, behind that, recognition of the strong forces of globalization. Nevertheless, there were risks involved and there was limited a priori evidence to guide the decision makers. A decade later, this is still the case. Globalization remains a potent economic and political force, and drives the demand for globalization in accounting. Nevertheless, most political and commercial activity remains local, so adoption of uniform rules does not by itself lead to uniform reporting behavior around the world. For many of the claimed benefits of IFRS adoption to be ...

REVISION: IFRS – Ten Years Later
Date Posted:Mon, 18 Apr 2016 11:41:27 -0500
A decade ago, the near-simultaneous adoption of IFRS in over one hundred countries could fairly have been described as a “brave new world” in financial reporting. Any systems innovation, and especially an innovation of such importance and magnitude, thrusts those involved (companies, users and accountants) into the unknown. There was good reason to expect success, based largely on widespread enthusiasm for international standards and, behind that, recognition of the strong forces of globalization. Nevertheless, there were risks involved and there was limited a priori evidence to guide the decision makers. A decade later, this is still the case. Globalization remains a potent economic and political force, and drives the demand for globalization in accounting. Nevertheless, most political and commercial activity remains local, so adoption of uniform rules does not by itself lead to uniform reporting behavior around the world. For many of the claimed benefits of IFRS adoption to be ...

REVISION: IFRS – Ten Years Later
Date Posted:Wed, 09 Mar 2016 06:15:17 -0600
A decade ago, the near-simultaneous adoption of IFRS in over one hundred countries could fairly have been described as a “brave new world” in financial reporting. Any systems innovation, and especially an innovation of such importance and magnitude, thrusts those involved (companies, users and accountants) into the unknown. There was good reason to expect success, based largely on widespread enthusiasm for international standards and, behind that, recognition of the strong forces of globalization. Nevertheless, there were risks involved and there was limited a priori evidence to guide the decision makers. A decade later, this is still the case. Globalization remains a potent economic and political force, and drives the demand for globalization in accounting. Nevertheless, most political and commercial activity remains local, so adoption of uniform rules does not by itself lead to uniform reporting behavior around the world. For many of the claimed benefits of IFRS adoption to be ...

New: Contractibility and Transparency of Financial Statement Information Prepared Under IFRS: Evidence from Debt Contracts Around IFRS Adoption
Date Posted:Sun, 06 Mar 2016 19:09:06 -0600
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Why We Do International Accounting Research
Date Posted:Fri, 29 Jan 2016 11:02:48 -0600
This essay was a Keynote Address at the Third International Conference of the Journal of International Accounting Research in São Paulo Brazil. It addresses the question of why the volume and quality of international accounting research have grown rapidly in recent years. It begins by asking why we do accounting research and moves on to discuss the reasons for conducting international accounting research. These include: to better understand others (and in the process, to better understand ourselves); to provide more replication options; to exploit differences in national institutional structures when investigating the determinants and effects of institutional variables on accounting; to address some limitations of within-jurisdiction research; and to obtain a wider range of changes to exploit (the paradigm example being the advent of IFRS). I then offer some concluding comments. Despite its somewhat presumptuous title, I do not presume to speak for others; the essay reflects a purely ...

REVISION: Deflating Profitability
Date Posted:Sat, 12 Dec 2015 05:23:01 -0600
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as bottom-line net income, cash flows, and dividends. One potential explanation for the measure’s predictive ability is that its numerator - gross profit - is a “cleaner” measure of economic profitability. An alternative explanation lies in the measure’s deflator. We find that net income equals gross profit in predictive power when they have consistent deflators. Deflating profit by the book value of total assets results in a variable that is the product of profitability and the ratio of the market value of equity to the book value of total assets, which is priced. We then construct an alternative measure of profitability, operating profitability, which better matches current expenses with current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross ...

REVISION: Contractibility and Transparency of Financial Statement Information Prepared under IFRS: Evidence from Debt Contracts around IFRS Adoption
Date Posted:Mon, 02 Nov 2015 03:10:48 -0600
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns
Date Posted:Mon, 21 Sep 2015 05:14:46 -0500
Accruals are the non-cash component of earnings. They represent adjustments made to cash flows to generate a profit measure largely unaffected by the timing of receipts and payments of cash. Prior research uncovers two anomalies: expected returns increase in profitability and decrease in accruals. We show that cash-based operating profitability (a measure that excludes accruals) outperforms measures of profitability that include accruals. Further, cash-based operating profitability subsumes accruals in predicting the cross section of average returns. An investor can increase a strategy's Sharpe ratio more by adding just a cash-based operating profitability factor to the investment opportunity set than by adding both an accruals factor and a profitability factor that includes accruals.

REVISION: Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns
Date Posted:Thu, 17 Sep 2015 02:55:50 -0500
Accruals are the non-cash component of earnings. They represent adjustments made to cash flows to generate a profit measure largely unaffected by the timing of receipts and payments of cash. Prior research uncovers two anomalies: expected returns increase in profitability and decrease in accruals. We show that cash-based operating profitability (a measure that excludes accruals) outperforms measures of profitability that include accruals. Further, cash-based operating profitability subsumes accruals in predicting the cross section of average returns. An investor can increase a strategy's Sharpe ratio more by adding just a cash-based operating profitability factor to the investment opportunity set than by adding both an accruals factor and a profitability factor that includes accruals.

REVISION: Contractibility and Transparency of Financial Statement Information Prepared under IFRS: Evidence from Debt Contracts around IFRS Adoption
Date Posted:Thu, 06 Aug 2015 22:26:44 -0500
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Internet Appendix to 'Contractibility and Transparency of Financial Statement Information Prepared under IFRS: Evidence from Debt Contracts around IFRS Adoption'
Date Posted:Thu, 06 Aug 2015 22:24:11 -0500
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns
Date Posted:Wed, 08 Jul 2015 00:36:01 -0500
Accruals are the non-cash component of earnings. They represent adjustments made to cash flows to generate a profit measure largely unaffected by the timing of receipts and payments of cash. Prior research uncovers two anomalies: expected returns increase in profitability and decrease in accruals. We show that a cash-based operating profitability measure (that excludes accruals) outperforms other measures of profitability (that include accruals) and subsumes accruals in predicting the cross section of average returns. An investor can increase a strategy's Sharpe ratio more by adding just a cash-based operating profitability factor to the investment opportunity set than by adding both an accruals factor and a profitability factor that includes accruals.

REVISION: Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns
Date Posted:Sat, 18 Apr 2015 10:08:13 -0500
Accruals are the non-cash component of earnings. They represent adjustments made to cash flows to generate a profit measure largely unaffected by the timing of receipts and payments of cash. Prior research finds that expected returns increase in firm profitability. However, firms with high accruals generate lower returns than firms with low accruals, and this "accrual anomaly" strengthens when evaluated using asset pricing models that include a profitability factor. We show that a cash-based operating profitability measure (that excludes accruals) outperforms other measures of profitability (that include accruals) and subsumes accruals in predicting the cross section of average returns. Surprisingly, an investor can increase a strategy's Sharpe ratio more by adding just a cash-based operating profitability factor to his investment opportunity set than by adding both an accruals factor and a profitability factor that includes accruals.

REVISION: Contractibility of Financial Statement Information Prepared Under IFRS: Evidence from Debt Contracts
Date Posted:Sat, 11 Apr 2015 00:27:02 -0500
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns
Date Posted:Wed, 01 Apr 2015 11:57:58 -0500
Accruals are the non-cash component of earnings. They represent adjustments made to cash flows to generate a profit measure largely unaffected by the timing of receipts and payments of cash. Prior research finds that expected returns increase in firm profitability. However, firms with high accruals generate lower returns than firms with low accruals, and this "accrual anomaly" strengthens when evaluated using asset pricing models that include a profitability factor. We show that a cash-based operating profitability measure (that excludes accruals) outperforms other measures of profitability (that include accruals) and subsumes accruals in predicting the cross section of average returns. The cash-based operating profitability measure explains expected returns over a ten year horizon, which is inconsistent with initial mispricing of earnings or its cash and accruals components.

REVISION: Appendix of 'Contractibility of Financial Statement Information Prepared Under IFRS: Evidence from Debt Contracts'
Date Posted:Wed, 01 Apr 2015 00:10:03 -0500
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Contractibility of Financial Satement Information Prepared Under IFRS: Evidence from Debt Contracts
Date Posted:Tue, 31 Mar 2015 06:29:28 -0500
A significant reduction in accounting-based debt covenants follows mandatory IFRS adoption, consistent with reduced contractibility of accounting information. We describe several properties of IFRS that could reduce contractibility, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair-valued. Overall, IFRS rules appear to sacrifice debt contracting ...

REVISION: Fama, Fisher, Jensen and Roll (1969): Retrospective Comments
Date Posted:Tue, 13 Jan 2015 01:39:00 -0600
This essay provides a retrospective view of one of Gene Fama’s many seminal papers, Fama, Fisher, Jensen, and Roll (1969). The paper was like none before it. Its contributions include (listed in what I regard as increasing order of importance): documenting share price behavior around the time of splits; implementing the first control for the market factor, hence creating the precursor to the influential Fama-French models; conducting the first event study; providing the first direct test of market efficiency; and demonstrating the wisdom and validity of Fama’s (1965) framing of stock price behavior in terms of information. The paper’s impact has been enormous, because at the time the research was conducted it was instrumental in reframing how we think about asset prices.

REVISION: Aggregate Earnings and Why They Matter
Date Posted:Thu, 08 Jan 2015 01:07:45 -0600
The accounting literature has traditionally focused on firm-level studies to examine the capital market implications of earnings and other accounting variables. We first develop the arguments for studying capital market implications at the aggregate level as well. A central issue is that diversification makes equity investors at least partially and potentially almost completely immune to several firm-level properties of earnings by holding diversified portfolios. Diversification is particularly important when assessing the welfare consequences of random errors in accounting measurement (imperfect accruals) and, to the extent it is independent across firms, of deliberate manipulation (earnings management). Consequently, some firm-level metrics of association, timeliness, value relevance, conservatism and other earnings properties do not map easily into investor welfare. Similarly, earnings-related risk manifests itself to equity investors largely through systematic earnings risk ...

REVISION: Aggregate Earnings and Why They Matter
Date Posted:Fri, 19 Dec 2014 08:59:18 -0600
The accounting literature has traditionally focused on firm-level studies to examine the capital market implications of earnings and other accounting variables. We first develop the arguments for studying capital market implications at the aggregate level as well. A central issue is that diversification makes equity investors at least partially and potentially almost completely immune to several firm-level properties of earnings by holding diversified portfolios. Diversification is particularly important when assessing the welfare consequences of random errors in accounting measurement (imperfect accruals) and, to the extent it is independent across firms, of deliberate manipulation (earnings management). Consequently, some firm-level metrics of association, timeliness, value relevance, conservatism and other earnings properties do not map easily into investor welfare. Similarly, earnings-related risk manifests itself to equity investors largely through systematic earnings risk ...

REVISION: Fama, Fisher, Jensen and Roll (1969): Retrospective Comments
Date Posted:Wed, 29 Oct 2014 14:08:42 -0500
This essay provides a retrospective view of one of Gene Fama’s many seminal papers, Fama, Fisher, Jensen, and Roll (1969). The paper was like none before it. Its contributions include (listed in what I regard as increasing order of importance): documenting share price behavior around the time of splits; implementing the first control for the market factor, hence creating the precursor to the influential Fama-French models; conducting the first event study; providing the first direct test of market efficiency; and demonstrating the wisdom and validity of Fama’s (1965) framing of stock price behavior in terms of information. The paper’s impact has been enormous, because at the time the research was conducted it was instrumental in reframing how we think about asset prices.

REVISION: Deflating Profitability
Date Posted:Thu, 09 Oct 2014 04:22:45 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as bottom-line net income, cash flows, and dividends. One potential explanation for the measure’s predictive ability is that its numerator—gross profit—is a “cleaner” measure of economic profitability. An alternative explanation lies in the measure’s deflator. We find that net income equals gross profit in predictive power when they have consistent deflators. Deflating profit by the book value of total assets results in a variable that is the product of profitability and the ratio of the market value of equity to the book value of total assets, which is priced. We then construct an alternative measure of profitability, operating profitability, which better matches current expenses with current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit. ...

REVISION: Mandatory IFRS Adoption, Fair Value Accounting and Accounting Information in Debt Contracts
Date Posted:Fri, 19 Sep 2014 23:47:56 -0500
A significant reduction in accounting-based debt covenants and increase in non-accounting covenants follows mandatory IFRS adoption. No such effects are observed in non-adopting countries. Moreover, the changes in covenant usage are associated with measures of the difference between prior domestic standards and IFRS, defined in terms of both general and fair value accounting standards. We propose this shift is due to several aspects of IFRS that are unfavourable to debt contracting, including increased flexibility given managers when selecting among and applying accounting rules, increased rule-making uncertainty, and increased emphasis on fair value accounting. Fair valuing incorporates shocks that are transitory or even reverse before debt maturity, making earnings a poorer predictor of debt service capacity (Li, 2010). Fair values are subjective and manipulable. The IFRS option to fair value the firm’s own liabilities inhibits leverage covenants, where debt’s historical face value ...

REVISION: Deflating Profitability
Date Posted:Fri, 15 Aug 2014 02:14:11 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as bottom-line net income, cash flows, and dividends. One potential explanation for the measure's predictive ability is that its numerator - gross profit - is a "cleaner" measure of economic profitability. An alternative explanation lies in the measure's deflator. We find that net income equals gross profit in predictive power when they have consistent deflators. We show that deflating profit by the book value of total assets interacts profitability with the ratio of the market value of equity to the book value of total assets, which is priced. We then construct an alternative measure of profitability, operating profitability, which better matches current expenses with current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit. It predicts ...

REVISION: Deflating Profitability
Date Posted:Wed, 21 May 2014 07:25:51 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as earnings, cash flows, and dividends. One potential explanation for the measure's predictive ability is that its numerator – gross profit – is a cleaner measure of economic profitability. An alternative explanation lies in the measure's deflator. We find that net income equals gross profit in predictive power when both measures are constructed using consistent deflators. We then construct an alternative measure of profitability, operating profitability, which better matches current expenses with current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit.

REVISION: Deflating Profitability
Date Posted:Tue, 13 May 2014 11:53:44 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as earnings, cash flows, and dividends. One potential explanation for the measure's predictive ability is that its numerator --- gross profit --- is a cleaner measure of economic profitability. An alternative explanation lies in the measure's deflator. We find that net income equals gross profit in predictive power when both measures are constructed using consistent deflators. We then construct an alternative measure of profitability, operating profitability, which better matches current expenses with current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit.

REVISION: Deflating Gross Profitability
Date Posted:Tue, 29 Apr 2014 06:39:27 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as earnings, cash flows, and dividends. One potential explanation for the measure's predictive ability is that its numerator --- gross profit --- is a cleaner measure of economic profitability. An alternative explanation lies in the measure's deflator. We find that net income equals gross profit in predictive power when both measures are constructed using consistent deflators. We then construct an alternative measure of profitability, operating profitability, which better matches current expenses with current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit.

REVISION: Deflating Gross Profitability
Date Posted:Tue, 08 Apr 2014 04:00:43 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as earnings, cash flows, and dividends and is negatively correlated with the value premium. One potential explanation for the measure's predictive ability is that its numerator - gross profit - is a "cleaner" measure of economic profitability. An alternative explanation lies in the measure's deflator. We find that net income equals gross profit in predictive power when both measures are constructed using consistent deflators. We then construct an alternative measure of profitability, operating profitability, based on economic intuition about which expenses most closely relate to current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit.

REVISION: Deflating Gross Profitability
Date Posted:Mon, 07 Apr 2014 02:33:51 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as earnings, cash flows, and dividends and is negatively correlated with the value premium. One potential explanation for the measure's predictive ability is that its numerator - gross profit - is a "cleaner" measure of economic profitability. An alternative explanation lies in the measure's deflator. We find that net income equals gross profit in predictive power when both measures are constructed using consistent deflators. We then construct an alternative measure of profitability, operating profitability, based on economic intuition about which expenses most closely relate to current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit.

REVISION: Deflating Gross Profitability
Date Posted:Thu, 27 Mar 2014 14:48:28 -0500
Gross profit scaled by book value of total assets predicts the cross-section of average returns. Novy-Marx (2013) concludes that it outperforms other measures of profitability such as earnings, cash flows, and dividends and is negatively correlated with the value premium. One potential explanation for the measure's predictive ability is that its numerator - gross profit - is a "cleaner" measure of economic profitability. An alternative explanation lies in the measure's deflator. We find that net income equals gross profit in predictive power when both measures are constructed using consistent deflators. We then construct an alternative measure of profitability, operating profitability, based on economic intuition about which expenses most closely relate to current revenue. This measure exhibits a far stronger link with expected returns than either net income or gross profit.

REVISION: Fama, Fisher, Jensen and Roll (1969): Retrospective Comments
Date Posted:Sun, 16 Feb 2014 01:14:19 -0600
This commissioned essay provides a retrospective view of one of Gene Fama’s many seminal papers, Fama, Fisher, Jensen, and Roll (1969). The paper was like none before it. Its contributions include (listed in what I regard as increasing order of importance): documenting share price behavior around the time of splits; implementing the first control for the market factor, hence creating the precursor to the influential Fama-French models; conducting the first event study; providing the first direct test of market efficiency; and demonstrating the wisdom and validity of Fama’s (1965) framing of stock price behavior in terms of information. The paper’s impact has been enormous, because at the time the research was conducted it was instrumental in reframing how we think about asset prices.

New: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Wed, 27 Nov 2013 20:31:10 -0600
A substantial literature investigates conditional conservatism, defined as asymmetric accounting recognition of economic shocks ("news"), and how it depends on various market, political, and institutional variables. Studies typically assume the Basu [1997] asymmetric timeliness coefficient (the incremental slope on negative returns in a piecewise-linear regression of accounting income on stock returns) is a valid conditional conservatism measure. We analyze the measure's validity, in the context of a model with accounting income incorporating different types of information with different lags, and with noise. We demonstrate that the asymmetric timeliness coefficient varies with firm characteristics affecting their information environments, such as the length of the firm's operating and investment cycles, and its degree of diversification. We particularly examine one characteristic, the extent to which "unbooked" information (such as revised expectations about rents and growth ...

REVISION: Ball and Brown (1968): A Retrospective
Date Posted:Sat, 14 Sep 2013 23:47:27 -0500
This essay provides a retrospective view on our co-authored paper, Ball and Brown (1968). The retrospective was commissioned by Gregory Waymire, then President of the American Accounting Association. It describes how we both came to be PhD students at the University of Chicago and set about researching the relation between earnings and share prices. It outlines the background against which we conducted the research, including the largely a priori accounting research literature at the time and the electric atmosphere and radical new ideas then in full bloom at Chicago. We describe some of the principal research choices we made, and their strengths and weaknesses. We also describe the reception our research received and how the related literature subsequently unfolded.

New: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Fri, 02 Aug 2013 01:52:21 -0500
A substantial literature investigates conditional conservatism, defined as asymmetric accounting recognition of economic shocks (“news”), and how it depends on various market, political and institutional variables. Studies typically assume the Basu (1997) asymmetric timeliness coefficient (the incremental slope on negative returns in a piecewise-linear regression of accounting income on stock returns) is a valid conditional conservatism measure. We analyze the measure’s validity, in the ...

REVISION: Ball and Brown (1968): A Retrospective
Date Posted:Thu, 01 Aug 2013 06:03:30 -0500
This essay provides a retrospective view on our co-authored paper, Ball and Brown (1968). The retrospective was commissioned by Gregory Waymire, then President of the American Accounting Association. It describes how we both came to be PhD students at the University of Chicago and set about researching the relation between earnings and share prices. It outlines the background against which we conducted the research, including the largely a priori accounting research literature at the time and ...

REVISION: Ball and Brown (1968): A Retrospective
Date Posted:Thu, 01 Aug 2013 06:03:26 -0500
This essay provides a retrospective view on our co-authored paper, Ball and Brown (1968). The retrospective was commissioned by Gregory Waymire, then President of the American Accounting Association. It describes how we both came to be PhD students at the University of Chicago and set about researching the relation between earnings and share prices. It outlines the background against which we conducted the research, including the largely a priori accounting research literature at the time and ...

REVISION: Mandatory IFRS Adoption, Fair Value Accounting and Accounting Information in Debt Contracts
Date Posted:Mon, 29 Jul 2013 16:52:12 -0500
A significant fall in accounting-based debt covenants and increase in non-accounting covenants follows mandatory IFRS adoption. Covenant substitution increases in the difference between prior domestic GAAP and IFRS. No such effects are observed in a non-adopting country control group. We attribute these results primarily to the IASB’s fair-value orientation. We argue that fair valuing adds transitory shocks to earnings that make it an inferior variable in the context of long term debt ...

REVISION: Mandatory IFRS Adoption, Fair Value Accounting and Accounting Information in Debt Contracts
Date Posted:Sat, 15 Jun 2013 09:40:15 -0500
A significant fall in accounting-based debt covenants and increase in non-accounting covenants follows mandatory IFRS adoption. Covenant substitution increases in the difference between prior domestic GAAP and IFRS. No such effects are observed in a non-adopting country control group. We attribute these results primarily to the IASB’s fair-value orientation. We argue that fair valuing adds transitory shocks to earnings that make it an inferior variable in the context of long term debt ...

REVISION: Accounting Informs Investors and Earnings Management is Rife: Two Questionable Beliefs
Date Posted:Wed, 15 May 2013 15:35:48 -0500
This short essay is based on a presentation at the panel discussion on “The Most Incorrect Beliefs in Accounting” at the American Accounting Association Meetings in 2012. It addresses the inordinate amount of attention given in the literature to accounting’s role in providing new information for equity investors, and to allegedly rampant “earnings ...

REVISION: Accounting Informs Investors and Earnings Management is Rife: Two Questionable Beliefs
Date Posted:Sun, 03 Feb 2013 17:18:08 -0600
This short essay is based on a presentation at the panel discussion on “The Most Incorrect Beliefs in Accounting” at the American Accounting Association Meetings in 2012. It addresses the inordinate amount of attention given in the literature to accounting’s role in providing new information for equity investors, and to allegedly rampant “earnings ...

REVISION: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Thu, 10 Jan 2013 02:08:49 -0600
A substantial literature investigates conditional conservatism, defined as asymmetric accounting recognition of economic shocks (“news”), and how it depends on various market, political and institutional variables. Studies typically assume the Basu (1997) asymmetric timeliness coefficient (the incremental slope on negative returns in a piecewise-linear regression of accounting income on stock returns) is a valid conditional conservatism measure. We analyze the measure’s validity, in the ...

REVISION: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Tue, 08 Jan 2013 01:23:20 -0600
A substantial literature investigates conditional conservatism, defined as asymmetric accounting recognition of economic shocks (“news”), and how it depends on various market, political and institutional variables. Studies typically assume the Basu (1997) asymmetric timeliness coefficient (the incremental slope on negative returns in a piecewise-linear regression of accounting income on stock returns) is a valid conditional conservatism measure. We analyze the measure’s validity, in the ...

REVISION: On Estimating Conditional Conservatism
Date Posted:Mon, 03 Dec 2012 01:51:20 -0600
The concept of conditional conservatism has provided new insight into financial reporting and has stimulated considerable research since Basu (1997) developed it. While the concept encapsulated in the adage “anticipate no profits but anticipate all losses” is reasonably clear, estimating it is the subject of some discussion, notably by Dietrich et al. (2007), Givoly et al. (2007), and Ball, Kothari and Nikolaev (2011). Recently, Patatoukas and Thomas (2011) report important evidence of ...

REVISION: Mark-to-Market Accounting and Information Asymmetry in Banks
Date Posted:Tue, 21 Aug 2012 00:43:21 -0500
We examine the relation between mark-to-market (MTM) accounting for securities and information asymmetry among bank investors. Relative to historical cost, MTM incorporates more timely information in financial statements. The primary effect of more timely disclosure most likely is to reduce information asymmetry. Nevertheless, models in which public information triggers private information acquisition imply some offsetting increase in asymmetry due to differential information production among ...

REVISION: Mark-to-Market Accounting and Information Asymmetry in Banks
Date Posted:Sun, 19 Aug 2012 02:36:48 -0500
We examine the relation between mark-to-market (MTM) accounting for securities and information asymmetry among bank investors. Relative to historical cost, MTM incorporates more timely information in financial statements. The primary effect of more timely disclosure most likely is to reduce information asymmetry. Nevertheless, models in which public information triggers private information acquisition imply some offsetting increase in asymmetry due to differential information production among ...

New: The Information Value of the Annual Earnings Report
Date Posted:Mon, 13 Aug 2012 06:07:47 -0500
This working paper is the first draft of our co-authored publication, "An Empirical Evaluation of Accounting Income Numbers," Journal of Accounting Research 6, 1968, pp.159-78. While undated, it subsequently was presented at the November 1967 Seminar on the Analysis of Security Prices organized by the Center for Research in Security Prices (CRSP) at the University of Chicago. It was included in the November 1967 Proceedings of the Seminar on the Analysis of Security Prices. In 1986, the ...

REVISION: The Effect of Mark-to-Market Accounting for Financial Assets and Liabilities on Financial Reporting
Date Posted:Tue, 14 Feb 2012 17:18:07 -0600
We hypothesize and report robust evidence that mark-to-market (MTM) accounting for banks’ securities suffers from a hitherto undocumented detrimental effect: it reduces financial reporting transparency and creates information asymmetry in the market for banks’ shares. We observe this effect for securities that SFAS 115 classifies as “trading” securities requiring MTM treatment, and also for other financial assets and liabilities when firms exercise their option under SFAS 159 to use MTM ...

REVISION: On Estimating Conditional Conservatism
Date Posted:Sun, 20 Nov 2011 19:28:43 -0600
The concept of conditional conservatism has provided new insight into financial reporting and has stimulated considerable research since Basu (1997) developed it. While the concept encapsulated in the adage “anticipate no profits but anticipate all losses” is reasonably clear, estimating it is the subject of some discussion, notably by Dietrich et al. (2007), Givoly et al. (2007), and Ball, Kothari and Nikolaev (2011). Recently, Patatoukas and Thomas (2011) report important evidence of ...

New: Audited Financial Reporting and Voluntary Disclosure as Complements: A Test of the Confirmation Hypo
Date Posted:Fri, 11 Nov 2011 00:57:21 -0600
We examine the 'confirmation' hypothesis that audited financial reporting and disclosure of managers’ private information are complements, because independent verification of outcomes disciplines and hence enhances disclosure credibility. Committing to higher audit fees (a measure of financial statement verification) is associated with management forecasts that are more frequent, specific, timely, accurate and informative to investors. Because private information disclosure and audited ...

REVISION: The Effect of Mark-to-Market Accounting for Trading Securities on Financial Reporting Transparency a
Date Posted:Mon, 24 Oct 2011 17:41:16 -0500
We hypothesize and report robust evidence that mark-to-market accounting (also known as “fair value” accounting) for banks’ securities that are classified under current accounting rules as “trading” securities suffers from a hitherto unreported detrimental effect: it reduces financial reporting transparency and creates information asymmetry in the market for banks’ shares. Securities classified under accounting rules as “available-for-sale” or as “held-to-maturity” are not expected to and do ...

REVISION: The Effect of Mark-to-Market Accounting for Trading Securities on Financial Reporting Transparency a
Date Posted:Sun, 23 Oct 2011 06:39:42 -0500
We hypothesize and report robust evidence that mark-to-market accounting (also known as “fair value” accounting) for banks’ securities that are classified under current accounting rules as “trading” securities suffers from a hitherto unreported detrimental effect: it reduces financial reporting transparency and creates information asymmetry in the market for banks’ shares. Securities classified under accounting rules as “available-for-sale” or as “held-to-maturity” are not expected to and do ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Tue, 30 Aug 2011 18:00:35 -0500
A principal-components analysis demonstrates that common earnings factors explain a substantial portion of ?rm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Wed, 24 Aug 2011 09:01:12 -0500
A principal-components analysis demonstrates that common earnings factors explain a substantial portion of ?rm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the ...

REVISION: Audited Financial Reporting and Voluntary Disclosure as Complements: A Test of the Confirmation Hypo
Date Posted:Mon, 04 Jul 2011 05:01:50 -0500
We examine the “confirmation” hypothesis, that audited, backward-looking financial outcomes and disclosure of managers’ private forward-looking information are complements, because independent audit disciplines and hence enhances disclosure credibility. Committing to higher audit fees (a measure of the extent of financial outcome verification and thus the accuracy and freedom from manipulation of reported outcomes), is associated with management forecasts that are more frequent, specific, ...

REVISION: On Estimating Conditional Conservatism
Date Posted:Wed, 02 Mar 2011 17:47:23 -0600
Patatoukas and Thomas (2010) identify an important empirical regularity with the potential to bias estimates of conditional conservatism (asymmetric earnings timeliness) and argue that it is caused by scale effects. They advise researchers to avoid using conditional conservatism estimates or making inferences from prior research using them, a view we regard as excessively alarmist. Our theoretical and empirical analyses suggest the explanation lies in the correlation between the expected ...

REVISION: On Estimating Conditional Conservatism
Date Posted:Wed, 16 Feb 2011 18:17:56 -0600
Patatoukas and Thomas (2010) identify an important empirical regularity with the potential to bias estimates of conditional conservatism (asymmetric earnings timeliness) and argue that it is caused by scale effects. They advise researchers to avoid using conditional conservatism estimates or making inferences from prior research using them, a view we regard as excessively alarmist. Our theoretical and empirical analyses suggest the explanation lies in the correlation between the expected ...

REVISION: On Estimating Conditional Conservatism
Date Posted:Sat, 12 Feb 2011 15:02:17 -0600
Patatoukas and Thomas (2010) identify an important empirical regularity with the potential to bias estimates of conditional conservatism (asymmetric earnings timeliness) and argue that it is caused by scale effects. They advise researchers to avoid using conditional conservatism estimates or making inferences from prior research using them, a view we regard as excessively alarmist. Our theoretical and empirical analyses suggest the explanation lies in the correlation between the expected ...

REVISION: Audited Financial Reporting and Voluntary Disclosure as Complements: A Test of the Confirmation Hypo
Date Posted:Sun, 23 Jan 2011 10:45:01 -0600
We examine the “confirmation” hypothesis, that audited, backward-looking financial outcomes and disclosure of managers’ private forward-looking information are complements, because independent audit disciplines and hence enhances disclosure credibility. Committing to higher audit fees (a measure of the extent of financial outcome verification and thus the accuracy and freedom from manipulation of reported outcomes), is associated with management forecasts that are more frequent, specific, ...

REVISION: Audited Financial Reporting and Voluntary Disclosure as Complements: A Test of the Confirmation Hypo
Date Posted:Thu, 17 Jun 2010 14:55:23 -0500
We examine the “confirmation” hypothesis, that audited, backward-looking financial outcomes and disclosure of managers’ private forward-looking information are complements, because independent audit disciplines and hence enhances disclosure credibility. Committing to higher audit fees (a measure of the extent of financial outcome verification and thus the accuracy and freedom from manipulation of reported outcomes), is associated with management forecasts that are more frequent, specific, ...

REVISION: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Tue, 27 Apr 2010 10:43:01 -0500
Despite its popularity, the asymmetric timeliness coefficient has been challenged as a valid measure of conditional conservatism. We propose a model in which accounting income contemporaneously incorporates one component of price revision, incorporates another with a lag unless below a threshold (e.g., losses), invariably incorporates another with a lag, and adds uncorrelated “noise.” We demonstrate validity in this framework. We derive a negative relation between asymmetric timeliness ...

REVISION: The Global Financial Crisis and the Efficient Market Hypothesis: What Have We Learned?
Date Posted:Thu, 10 Dec 2009 21:29:02 -0600
The sharp economic downturn and turmoil in the financial markets, commonly referred to as the “global financial crisis,” has spawned an impressive outpouring of blame. The efficient market hypothesis - the idea that competitive financial markets ruthlessly exploit all available information when setting security prices - has been singled out for particular attention. Like all good theories, market efficiency has major limitations, even though it continues to be the source of important and ...

REVISION: The Global Financial Crisis and the Efficient Market Hypothesis: What Have We Learned?
Date Posted:Wed, 02 Dec 2009 09:57:31 -0600
The sharp economic downturn and turmoil in the financial markets, commonly referred to as the “global financial crisis,” has spawned an impressive outpouring of blame. The efficient market hypothesis - the idea that competitive financial markets ruthlessly exploit all available information when setting security prices - has been singled out for particular attention. Like all good theories, market efficiency has major limitations, even though it continues to be the source of important and ...

REVISION: The Global Financial Crisis and the Efficient Market Hypothesis: What Have We Learned?
Date Posted:Fri, 20 Nov 2009 12:08:44 -0600
The sharp economic downturn and turmoil in the financial markets, commonly referred to as the “global financial crisis,” has spawned an impressive outpouring of blame. The efficient market hypothesis - the idea that competitive financial markets ruthlessly exploit all available information when setting security prices - has been singled out for particular attention. Like all good theories, market efficiency has major limitations, even though it continues to be the source of important and ...

New: The Complementary Roles of Audited Financial Reporting and Voluntary Disclosure: A Test of the Confi
Date Posted:Sat, 17 Oct 2009 16:40:50 -0500
We examine the complementarity between voluntary disclosure and reporting audited financial statement outcomes. We test the “confirmation” hypothesis, that reporting audited, backward-looking outcomes disciplines and hence enhances the precision and credibility of managers’ disclosure of private forward-looking information. Using management earnings forecasts as the voluntary disclosure variable, we report that committing to higher audit fees (a measure of the extent of financial statement ...

How Naive Is the Stock Market's Use of Earnings Information?
Date Posted:Thu, 03 Sep 2009 23:42:47 -0500
Rendleman Jones and Latane (1987) and Bernard and Thomas (1990) report evidence supporting their hypothesis that investors use a "naive" seasonal random walk model in forming expectations of quarterly earnings. Using the Bernard and Thomas (1990) data we show that the market acts as if it: (1) does not use a seasonal random walk model; (2) does incorporate past earnings changes in forming expectations; (3) does use the correct signs in exploiting serial correlation in seasonally-differenced ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Sun, 02 Aug 2009 11:31:12 -0500
A principal-components analysis demonstrates that common earnings factors explain a substantial portion of firm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Thu, 30 Jul 2009 08:56:39 -0500
A principal-components analysis demonstrates that common earnings factors explain a substantial portion of firm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the ...

REVISION: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Fri, 15 May 2009 09:52:06 -0500
Despite its popularity, the asymmetric timeliness coefficient has been challenged as a valid measure of conditional conservatism. We propose a model in which accounting income contemporaneously incorporates one component of price revision, incorporates another with a lag unless below a threshold (e.g., losses), invariably incorporates another with a lag, and adds uncorrelated “noise.” We demonstrate validity in this framework. We derive a negative relation between asymmetric timeliness ...

REVISION: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Thu, 14 May 2009 17:54:12 -0500
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

REVISION: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Wed, 29 Apr 2009 20:35:57 -0500
The literature has embraced the Basu (1997) asymmetric timeliness coefficient as a valid measure of conditional conservatism. The coefficient is the incremental slope on negative returns in a piecewise-linear regression of accounting income on stock returns. We present a simple, intuitive analysis demonstrating the validity of this model. We also demonstrate a negative relation between market-to-book ratios and asymmetric timeliness coefficients, due to different accounting vs. economic ...

New: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Tue, 28 Apr 2009 22:29:30 -0500
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

New: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Tue, 28 Apr 2009 22:29:27 -0500
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

REVISION: Earnings Quality in U.K. Private Firms
Date Posted:Sun, 26 Apr 2009 17:17:36 -0500
UK private and public companies face substantially equivalent regulation on auditing, accounting standards and taxes. We hypothesize that private-company financial reporting nevertheless is lower quality due to different market demand, regulation notwithstanding. A large UK sample supports this hypothesis. Quality is operationalized using Basu's (1997) time-series measure of timely loss recognition and a new accruals-based method. The result is not affected by controls for size, leverage, ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Tue, 17 Mar 2009 14:08:28 -0500
A principal-components analysis demonstrates that common earnings factors explain a substantial portion of firm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the ...

The Effect of International Institutional Factors on Properties of Accounting Earnings
Date Posted:Mon, 09 Mar 2009 01:43:09 -0500
International differences in the demand for accounting income predictably affect the way it incorporates economic income (dividend-adjusted change in market value) over time. We characterize the "shareholder" and "stakeholder" corporate governance models of common and code law countries respectively as resolving information asymmetry by public disclosure and private communication. Also, code law directly links accounting income to current payouts (to employees, managers, shareholders and ...

Incentives versus Standards: Properties of Accounting Income in Four East Asian Countries, and Impli...
Date Posted:Mon, 09 Mar 2009 01:41:22 -0500
The East Asian countries of Hong Kong, Malaysia, Singapore and Thailand provide a rare opportunity to study the interaction between the accounting standards under which financial statements are prepared and the incentives of managers and auditors who prepare them. Their accounting standards are largely derived from common law sources [UK, US and International Accounting Standards (IAS)], which are widely viewed as higher quality than code law standards. However, economic and political ...

Earnings Quality in U.K. Private Firms
Date Posted:Mon, 09 Mar 2009 01:39:37 -0500
UK private and public companies face substantially equivalent regulation on auditing, accounting standards and taxes. We hypothesize that private-company financial reporting nevertheless is lower quality due to different market demand, regulation notwithstanding. A large UK sample supports this hypothesis. Quality is operationalized using Basu's (1997) time-series measure of timely loss recognition and a new accruals-based method. The result is not affected by controls for size, leverage, ...

REVISION: Incentives Versus Standards: Properties of Accounting Income in Four East Asian Countries
Date Posted:Sat, 07 Feb 2009 15:26:37 -0600
The East Asian countries of Hong Kong, Malaysia, Singapore and Thailand provide a rare opportunity to study the interaction between the accounting standards under which financial statements are prepared and the incentives of managers and auditors who prepare them. Their accounting standards are largely derived from common law sources [UK, US and International Accounting Standards (IAS)], which are widely viewed as higher quality than code law standards. However, economic and political ...

REVISION: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Sat, 07 Feb 2009 15:21:22 -0600
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

REVISION: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Thu, 27 Nov 2008 13:38:43 -0600
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

REVISION: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Wed, 12 Nov 2008 18:41:47 -0600
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

REVISION: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Tue, 07 Oct 2008 18:56:18 -0500
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Wed, 01 Oct 2008 18:27:47 -0500
A principal-components analysis demonstrates that earnings factors explain a significant portion of firm-level earnings variation, suggesting earnings shocks are not fully diversifiable as prior literature has concluded (e.g., Vuolteenaho, 2002). Furthermore, the principal components of earnings and returns display canonical correlations of up to 0.70, suggesting aggregate earnings and return risks are similar. The earnings factors also are correlated with macroeconomic indicators, suggesting ...

REVISION: Market and Political/Regulatory Perspectives on the Recent Accounting Scandals
Date Posted:Wed, 24 Sep 2008 03:49:18 -0500
Not surprisingly, the recent accounting scandals look different when viewed from the perspectives of the political/regulatory process and of the market for corporate governance and financial reporting. We do not have the opportunity to observe a world in which either market or political/regulatory processes operate independently, and the events are recent and not well-researched, so untangling their separate effects is somewhat conjectural. This paper offers conjectures on issues such as: What ...

REVISION: How Much New Information is There in Earnings?
Date Posted:Thu, 21 Aug 2008 18:47:22 -0500
We quantify the relative importance of earnings announcements in providing new information to the share market, using the r-squared in a regression of securities' calendar year returns on their four quarterly earnings announcement window returns. The r-squared, which averages approximately five to nine percent, measures the proportion of total information incorporated in share prices over a year that is associated with earnings announcements. We conclude that the average quarterly announcement ...

REVISION: How Much New Information is There in Earnings?
Date Posted:Tue, 29 Jul 2008 20:52:28 -0500
We quantify the relative importance of earnings announcements in providing new information to the share market, using the r-squared in a regression of securities' calendar year returns on their four quarterly earnings announcement window returns. The r-squared, which averages approximately five to nine percent, measures the proportion of total information incorporated in share prices over a year that is associated with earnings announcements. We conclude that the average quarterly announcement ...

REVISION: How Much New Information is There in Earnings?
Date Posted:Tue, 15 Jul 2008 06:45:43 -0500
We quantify the relative importance of earnings announcements in providing new information to the share market, using the r-squared in a regression of securities' calendar year returns on their four quarterly earnings announcement window returns. The r-squared, which averages approximately five to nine percent, measures the proportion of total information incorporated in share prices over a year that is associated with earnings announcements. We conclude that the average quarterly announcement ...

REVISION: How Much New Information is There in Earnings?
Date Posted:Wed, 09 Jul 2008 18:33:05 -0500
We quantify the relative importance of earnings announcements in providing new information to the share market, using the r-squared in a regression of securities' calendar year returns on their four quarterly earnings announcement window returns. The r-squared, which averages approximately five to nine percent, measures the proportion of total information incorporated in share prices over a year that is associated with earnings announcements. We conclude that the average quarterly announcement ...

REVISION: What is the Actual Economic Role of Financial Reporting?
Date Posted:Sat, 31 May 2008 19:10:56 -0500
This short essay is based on a presentation at the panel discussion on Big Unanswered Questions in Accounting at the American Accounting Association Meetings in 2007. It poses the question: what is the actual economic role of financial reporting? and discusses why this question is important, why it is unanswered, and what types of inventive research design are needed to help answer it. Examples are given of the types of questions involved.

REVISION: What is the Actual Economic Role of Financial Reporting?
Date Posted:Wed, 28 May 2008 18:36:42 -0500
This short essay is based on a presentation at the panel discussion on "Big Unanswered Questions in Accounting" at the American Accounting Association Meetings in 2007. It poses the question: "what is the actual economic role of financial reporting?" and discusses why this question is important, why it is unanswered, and what types of inventive research design are needed to help answer it. Examples are given of the types of questions involved.

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Tue, 27 May 2008 18:05:11 -0500
A principal-components analysis demonstrates that earnings factors explain a significant portion of firm-level earnings variation, suggesting earnings shocks are not fully diversifiable as prior literature has concluded (e.g., Vuolteenaho, 2002). Furthermore, the principal components of earnings and returns display canonical correlations of up to 0.70, suggesting aggregate earnings and return risks are similar. The earnings factors also are correlated with macroeconomic indicators, suggesting ...

REVISION: How Much New Information is There in Earnings?
Date Posted:Wed, 12 Mar 2008 06:07:12 -0500
We quantify the relative importance of earnings announcements in providing new information to the share market, using the r-squared in a regression of securities' calendar year returns on their four quarterly earnings announcement window returns. The r-squared, which averages approximately five to nine percent, measures the proportion of total information incorporated in share prices over a year that is associated with earnings announcements. We conclude that the average quarterly announcement ...

New: What is the Actual Economic Role of Financial Reporting?
Date Posted:Sun, 10 Feb 2008 04:16:24 -0600
This short essay is based on a presentation at the panel discussion on "Big Unanswered Questions in Accounting" at the American Accounting Association Meetings in 2007. It poses the question "what is the actual economic role of financial reporting?" and discusses why this is an important question, why it is unanswered, and the types of inventive research design needed to help answer it. Examples of the types of questions involved are given.

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Thu, 03 Jan 2008 18:42:25 -0600
This paper applies a principal-components analysis to earnings and demonstrates that earnings factors explain a significant portion of firm-level earnings variation, suggesting earnings shocks are not fully diversifiable. The principal components of earnings and returns display canonical correlations of up to 0.70, and the earnings factors are correlated with macroeconomic indicators, suggesting they reflect real business conditions. Moreover, the return sensitivities to earnings factors ...

REVISION: Is Financial Reporting Shaped By Equity Markets or By Debt Markets? An International Study of Timeli
Date Posted:Mon, 17 Dec 2007 07:35:57 -0600
We hypothesize debt markets - not equity markets - are the primary influence on association metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) RSQ, because debt covenants utilize reported numbers. Equity markets do not rate financial reporting consistently with these metrics, because (among other things) they control for the total information incorporated in equity prices. Single-country studies shed little light on the ...

REVISION: Is Financial Reporting Shaped by Equity Markets or by Debt Markets? An International Study of Timeli
Date Posted:Thu, 13 Dec 2007 22:30:30 -0600
We hypothesize debt markets - not equity markets - are the primary influence on association metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) RSQ, because debt covenants utilize reported numbers. Equity markets do not rate financial reporting consistently with these metrics, because (among other things) they control for the total information incorporated in equity prices. Single-country studies shed little light on the ...

REVISION: Is Financial Reporting Shaped by Equity Markets or by Debt Markets? An International Study of Timeli
Date Posted:Mon, 10 Dec 2007 07:12:40 -0600
We hypothesize debt markets - not equity markets - are the primary influence on "association" metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) RSQ, because debt covenants utilize reported numbers. Equity markets do not rate financial reporting consistently with these metrics, because (among other things) they control for the total information incorporated in equity prices. Single-country studies shed little light on the ...

New: Earnings Quality at Initial Public Offerings
Date Posted:Sat, 08 Dec 2007 07:36:14 -0600
Financial reporting around the time of IPOs is consistent with listed firms reporting more conservatively than previously as private firms, consistent with the results in Ball and Shivakumar (2005). We hypothesize that IPO firms supply the higher quality financial reports demanded by public investors, who face higher information asymmetry than private investors. The market mechanisms for enforcing this demand include monitoring by internal and external auditors, boards, analysts, rating ...

New: Earnings Quality at Initial Public Offerings
Date Posted:Sat, 08 Dec 2007 07:33:36 -0600
Financial reporting around the time of IPOs is consistent with listed firms reporting more conservatively than previously as private firms, consistent with the results in Ball and Shivakumar (2005). We hypothesize that IPO firms supply the higher quality financial reports demanded by public investors, who face higher information asymmetry than private investors. The market mechanisms for enforcing this demand include monitoring by internal and external auditors, boards, analysts, rating ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Tue, 27 Nov 2007 14:37:15 -0600
We report there is a significant systematic component in earnings, that it is correlated with macroeconomic variables, and that it is priced (i.e., partly explains the cross-section of asset returns). A principal-components analysis of earnings shows that earnings factors explain a significant portion of firm-level volatility in earnings, suggesting earnings are not diversifiable. The earnings factors are similar in relative magnitude to equivalent factors in returns. Further, the earnings ...

REVISION: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Thu, 25 Oct 2007 20:48:49 -0500
The literature has embraced the Basu (1997) asymmetric timeliness coefficient as a valid measure of conditional conservatism. The coefficient is the incremental slope on negative returns in a piecewise-linear regression of accounting income on stock returns. We present a simple, intuitive analysis demonstrating the validity of this model. We also demonstrate a negative relation between market-to-book ratios and asymmetric timeliness coefficients, due to different accounting vs. economic ...

REVISION: Is Financial Reporting Shaped by Equity Markets or by Debt Markets? An International Study of Timeli
Date Posted:Mon, 01 Oct 2007 21:03:07 -0500
We hypothesize debt markets - not equity markets - are the primary influence on "association" metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) R2, because debt covenants utilize reported numbers. Equity markets do not rate financial reporting consistently with these metrics, because (among other things) they control for the total information incorporated in equity prices. Single-country studies shed little light on the ...

REVISION: Econometrics of the Basu Asymmetric Timeliness Coefficient and Accounting Conservatism
Date Posted:Thu, 12 Jul 2007 19:09:00 -0500
Following its introduction in Basu (1997) and its application in an international context in Ball, Kothari, and Robin (2000), the asymmetric timeliness coefficient has been embraced by the accounting literature as a valid measure of conditional conservatism, which Basu (1997, p. 7) defines as "the accountant's tendency to require a higher degree of verification to recognize good news as gains than to recognize bad news as losses." The coefficient is estimated from a piecewise-linear regression ...

REVISION: Is Financial Reporting Shaped By Equity Markets or By Debt Markets? An International Study of Timeli
Date Posted:Sun, 13 May 2007 20:23:33 -0500
We hypothesize debt markets - not equity markets - are the primary influence on "association" study metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) RSQ, because debt covenants utilize reported accounting numbers. Equity markets do not rate financial reporting consistently with these metrics, which control for the total information incorporated in equity prices. Single-country studies cannot shed light on the relative ...

REVISION: Is Financial Reporting Shaped By Equity Markets or By Debt Markets? an International Study of Timeli
Date Posted:Tue, 08 May 2007 13:14:15 -0500
We hypothesize debt markets - not equity markets - are the primary influence on "association" study metrics studied since Ball and Brown (1968). Debt markets demand high scores on timeliness, conservatism and Lev's (1989) RSQ, because debt covenants utilize reported accounting numbers. Equity markets do not rate financial reporting consistently with these metrics, which control for the total information incorporated in equity prices. Single-country studies cannot shed light on the relative ...

REVISION: Aggregate Earnings and Asset Prices
Date Posted:Tue, 20 Mar 2007 09:29:33 -0500
We report there is a significant systematic component in earnings, that it is correlated with macroeconomic variables, and that it is priced (i.e., partly explains the cross-section of asset returns). A principal-components analysis of earnings shows that earnings factors explain a significant portion of firm-level volatility in earnings, suggesting earnings are not diversifiable. The earnings factors are similar in relative magnitude to equivalent factors in returns. Further, the earnings ...

New: International Financial Reporting Standards (IFRS): Pros and Cons for Investors
Date Posted:Wed, 13 Sep 2006 17:30:40 -0500
Accounting in shaped by economic and political forces. It follows that increased worldwide integration of both markets and politics (driven by reductions in communications and information processing costs) makes increased integration of financial reporting standards and practice almost inevitable. But most market and political forces will remain local for the foreseeable future, so it is unclear how much convergence in actual financial reporting practice will (or should) occur. Furthermore, ...

New: Earnings Quality at Initial Public Offerings
Date Posted:Tue, 25 Jul 2006 02:04:56 -0500
Financial reporting around the time of IPOs is consistent with listed firms reporting more conservatively than previously as private firms, consistent with the results in Ball and Shivakumar (2005). We hypothesize that IPO firms supply the higher quality financial reports demanded by public investors, who face higher information asymmetry than private investors. The market mechanisms for enforcing this demand include monitoring by internal and external auditors, boards, analysts, rating ...

The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition
Date Posted:Mon, 17 Jan 2005 09:34:51 -0600
We investigate the role of accrual accounting in the asymmetrically timely recognition of unrealized gains and losses (i.e., prior to the actual realization of those losses in cash). This role of accrual accounting has not been directly recognized in the literature. We show that non-linear accruals models are a substantial specification improvement, explaining up to three times the amount of variation in accruals as conventional linear specifications such as Jones (1991). Conversely, we ...