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Research Opportunities in Management Accounting
Robert S. Kaplan
Journal of Management Accounting Research (1993)
Research Opportunities in Management Accounting (1) Limitations of statistical analysis to test emerging
theories The role for analytical research Role for design research vs. analysis research
The new research agenda for management accountants should encompass mode design and less analysis
The new research should like engineering and less like science
The new research should take basic principles and apply them to the new environment in which management accounting is being practiced
The researchers have to learn how to perform and evaluate research whose output is something new: a prototype, a management accounting system that seems to work, according to criteria they develop, in an actual setting
Research Opportunities in Management Accounting (2)
Role for Field Research “What-is” research
Tested theories that had been influential and in existence long enough for company practice to have change based on the theories
“What’s new” research Observing and documenting the changes and
innovations now underway in organizations Researchers associate themselves with the
organization to become intimately familiar with the circumstances of such experiments and the process of implementation and change
Research Opportunities in Management Accounting (3)
Role for Field Research “What’s new” research
The research output: Describe what practitioners believe and the
design principles that guided their action Document the historical circumstances that led
to the innovation, and the principles of learning the practitioner used
A priori predictions about the types of resistances the design innovation will encounter and its likelihood of success
The researcher must identify opportunistically innovating companies
Research Opportunities in Management Accounting (4) Role for Field Research
“What’s new” research Conduct in-dept observation and
documentation to describe the management accounting innovation
Describe practice Formulate theories that provide a
conceptual framework to explain the successful innovations The theories can then be tested using normal
science investigative methods when widespread adoption of the innovation begins to pervade practice
Research Opportunities in Management Accounting (5) Role for Field Research
“To-be” research Active participants in the change process Required when adoption of new methods is
slow or unlikely The researcher becomes like the
practitioner, a part of the design and implementation process, and hence come closer to developing not only a more complete theory of management accounting, but contributing to a more general theory of management
Research Opportunities in Management Accounting (6) Role for Field Research
“To-be” research Longitudinal action-oriented research Research on new settings
A management accounting innovation has yet to be tried in a particular setting
Active role of researcher: extend and customize the innovation to that setting
Design research: Developing and evaluating new systems Attempting to identify some of the different
or unique features that arose in the new settings
Being sensitive to implementation concerns
Research Opportunities in Management Accounting (7) Role for Field Research
“To-be” research Research on implementation
Explore the wide set of issues that arise when attempting to implement new management accounting concepts
Research on integration Who does what?
Situations still arise when normal science methods can and should be productively employed
The longitudinal and action research methods may require a greater maturity and knowledge of individual and organizational behavior
Field Research Methods in Management Accounting
S. Mark Young
Accounting Horizons (1999)
Introduction
Sources disciplines: anthropology, sociology and business
Unique characteristics: people interactions
Major influence: Kaplan (1983)
The Range of Field Research Methods (1)
Depends on levels of observation, interaction and participation with organizational members
Outsider vs. insider perception Adler and Adler (1987): based on the
degree of researcher involvement The Chicago School of Sociology Existential Sociology Ethnomethodology
The Range of Field Research Methods (2) The Chicago School of Sociology
Stages: Direct observation (observe members) Direct but detached interaction (interact with
members) Firsthand participation in member’s activities
(participate with members) Characters:
Researcher attempt to remain objective Researcher adopt an overt role and
acknowledge to organizational members that they are conducting a study
Strive to not become emotionally involved as organizational members to not risk influencing the environment they are studying
The Range of Field Research Methods (3) The Existential Sociology
Investigates participation Fundamental assumption: people in
organizations tend to present (at least) two sides of their behavior and activities Presented to outsiders (impression
management) Presented to insiders
Researcher rules: Shed their objective detachment Become an insider to the organization Establish relationships with organization
members to gather information and tp drwa on members’ subjective experiences
Use combination of overt and covert roles
The Range of Field Research Methods (4) Ethnomethodology
The peripheral membership role Researchers seek an insider’s viewpoint and
take part in social activities Researchers do not assume leadership roles or
participate in the core activities of the group Researchers may decide to restrict their
involvement because they do not want to participate in some of the group’s activities
The Active Membership Role Researchers moves into a more central role in
the organization Researchers ascend to a higher level of insider
status by interacting with members as colleagues and co-participants in the groups’ core activities
The Range of Field Research Methods (5) Ethnomethodology
The complete membership role Researchers literally go native and become
bona fide members of a group with co-equal status in all ways
Type: opportunist vs. convert Management accounting
Chicago school Field research in management accounting is still
its infancy and many researchers are in a “learning-by-doing” phase of their own development
Many of researchers have been schooled in the logical empiricist tradition
Contributions of Field Research to The Management Accounting Literature
Testing and developing theories with data not obtainable using other research methods
Raising new research questions Informing other research methods Understanding the limitations of the
outsider’s view
Advancing Our Use of Field Methods
Learning by doing Apprenticeships with field researchers Forge relation with managers and
business people involved with their own institutions
Joint the practitioner forums Formal coursework: field research,
training in specific techniques, and study on philosophy of science
Directions in Accounting Research: NEAR and FAR
Accounting Horizons (1996)
William H. Beaver
Factors Affecting Directions in Accounting Research (1)
Exogenous factors: arise “outside” of the influence of the accounting academic community Applications from other disciplines (Finance,
Information Economics, Behavioral Sciences) Greater data availability at lower cost (CRSP,
COMPUSTAT, I/B/E/S, GLOBAL VANTAGE, OSIRIS) Changes in the financial reporting environment
(changes in event, transaction, and nature of the regulatory oversight: changes in accounting standards)
Factors Affecting Directions in Accounting Research (2)
Endogenous factors: are those that largely lie within the influence of the academic accounting community Journals (Journal of Accounting Research –
empirical accounting research; Journal of Accounting and Economics – positive accounting theory research)
Annual conferences Sections of the profession association Promotion policies at colleges and universities Creative process of talented individuals
NEAR Directions Sources:
Accounting doctoral seminar on security price research at Stanford
Research currently in progress See Figure 1 at page 116 Features of NEAR:
The number of nodes in which research is actively taking place
The proportion of research that is taking place in nodes that are subcategories of subcategories
There is an paucity of research that has opened “new” nodes at a higher level in the hierarchy (synthesis vs. fragmentation)
Personal Examples of NEAR (1) The Pricing of Discretionary Accruals
“Accrual Management” node Test the relationship of security prices and
discretionary portion of loan loss Discretionary and non-discretionary Particular industry and particular accrual Findings: indicate that the nondiscretionary
portion is negatively priced and, as predicted, the discretionary portion is significantly less negative priced
Personal Examples of NEAR (2) The Value-Relevance of SFAS No. 107: Fair
Value Disclosures “Accounting Data as Measurement” node SFAS 107 vs. SFAS 33: similarities and
differences Dependent variable: the difference between
market value and the book value of equity; Independent variable: the difference between SFAS 107 fair value and the respective book values of five categories, investment securities, loans, deposits, long-term debt and off-balance sheet items
Selection of dependent variable: level vs. event study
Old vs. new passion of estimation technique
Personal Examples of NEAR (3) The price-earnings relation – A simultaneous equation
approach “Information Content of Prices” node and “Earnings
Response Coefficients” node New applications of econometrics tool: simultaneous
equation approach Relative Importance of Book Value and Earnings
“Accounting Data as Measurement” node Initial findings: the importance of the balance sheet
in explaining valuation increases with financial difficulty and is higher for industries where intangible assets are less likely
Conservatism and Delayed Recognition in Accrual Accounting
Features of FAR Trends in accounting research
Outstanding accounting research is likely to be a blend of theory, empirical analysis and institutional knowledge
The emphasis on contextual rather than generic research (need particular samples, specific reporting issues, and the collection of distinctive data bases)
The “wild card” factors: Change in the financial reporting environment The creativity of individual researchers Syntheses
Perspectives on Recent Capital Market Research The Accounting Review (2002)
William H. Beaver
Introduction
Market efficiency Feltham-Ohlson modeling Value relevance Analysts’ behavior Discretionary behavior
Market Efficiency [1] Market efficiency and the regulation of financial
reporting Market efficiency and investment decisions –
resource allocation and production efficiency Market efficiency and researchers (set of
inference, variable measurement, and interpretations)
Earlier studies: confirmed the market efficiency Recent studies: post-earnings announcement
drift; market-to-book ratios and its refinements; contextual accounting issues
Market Efficiency [2] Post-Earnings Announcement Drift Market-to-Book Ratios and Extensions
Abnormal return associated with portfolio strategies based on market-to-book ratios
Extensions: (1) market-to-value ratios; and (2) analysts’ biased forecasts
Contextual Accounting Issues The price of accrual and cash flow information The IPO puzzle etc
Market Efficiency [3] How can widely disseminated and examined data used
with simple portfolio strategies that require no knowledge of accounting be associated with abnormal returns?
How can studies of arcane disclosure find that such disclosures are apparently reflected in prices, yet more visible variables, such as earnings and book value, are not?
How can studies of security return in the very short run shwo evidence of relatively rapid response, and yet have evidence of abnormal returns that appear to persist for year after the portfolio formation date?
How can the body of research in aggregate show that prices both lead and lag accounting data?
Feltham-Ohlson Modeling [1]
Key Feartures of F-O Modeling Parsimonious assumptions – the value of equity
= the present value of expected future dividends, the clean surplus relation, and some form of a linear information dynamic
Provides a role for many importance features of the accounting system: clean surplus, book value, earnings, transitory components of earnings, conservatism, delayed recognition
Feltham-Ohlson Modeling [2]
Key Feartures of F-O Modeling Stimulated considerable empirical research
Both book value and earnings are significant pricing factors The relative importance of book value is inversely related
to the financial health of the firm The coefficient on earnings is lower for firms with low
return on equity The coefficient on positive earnings is positive and
significant, while the coefficient on losses is insignificantly different from zero
Accrual vs. cash flow components of earnings are priced significantly differently from one another. In general, the accrual components are associated with a lower coefficient
Feltham-Ohlson Modeling [3]
Criticisms of the F-O Approach The model has no endogenous demand for
accounting data vs. F-O models do not attempt to derive a demand for accounting
There is no information asymmetry and that hence no strategic uses of accounting data arise within the F-O framework
Some aspects of the models are unsupported by the empirical data
Value-Relevance Research [1] Examines the association between a security
price-based dependent variable and a set of accounting variables
What are the distinctive characteristics? Value-relevance research demands an in-depth
knowledge of accounting institutions, accounting standards, and the specific features of the reported numbers
Timeliness of information is not an overrding issue (event studies, level of stock prices and the accounting data)
Value-Relevance Research [2] Why Is Timeliness Not the Key Issue?
Delayed recognition Earnings announcements are largely preempted by the
disclosure of other information vs. the cost of obtaining the prior information
Key role of financial statements is to summarize relevant information parsimoniously and in a manner consistent with the underlying concept
The financial statements are not intended to list only those assets, liablities, revenues, and expenses not preempted by other publicly available information
Timeliness is only one dimension Implication for research: change vs. level
Value-Relevance Research [3] What Is the Conceptual Foundation of
Value-Relevance Research? Combination of a valuation theory plus
contextual accounting arguments that allow researchers to predict how accounting variables relate to the market value of equity
Valuation models Earnings-only approach – MM (1996): present
value of permanent future earnings Balance-sheet approach F-O models: book value of equity and the present
value of expected future abnormal earnings
Value-Relevance Research [4] What Have We Learned?
Is it priced? Is it priced consistently with some
theoretical value? Is a particular accounting number priced
equal to or differently from similar accounting numbers?
Addressess questions relating to footnote information and nonfinancial intangle assets
Value-Relevance Research [5] The Role of Value-Relevance Research
Help articulate the nature of the issues and provide a paradigm or language with which to frame the questions of interest
Provide a theory Provide empirical evidence
Unresolved Issues Market efficiency Econometric issues Other puposes of financial statements
Research on Analysts’ Behavior [1]
Analysts are among the major information intermediaries who use and interpret accounting data
Security prices reflect the results of their analysis
Analysts rely on a rich set of publicly available data – assess the importance of accounting data relative to the total mix of information
Research on Analysts’ Behavior [2]
What Have We Learned? Analysts’ forecasts are optimistics Analysts employed by investment firms that
are associated wth the underwriting of the firm’s securities issue more optimistic forecasts
Analysts’ forecasts tend to be revised downward during the year
Analysts with better forecasting ability appear to have a higher profitability of survival
Research on Analysts’ Behavior [3]
What Have We Learned? Analysts’ forecast outperform the best statistical models Analysts’ forecast do not reflect all of the information in
the past earnings series (the forecast errors are serially correlated and analysts underestimate the persistency of earnings)
Capital markets appera to reflect naively analysts’ forecast in prices – abnormal returns associated with MTB and MTV strategis
Analysts’ forecasts appear to be a parsimonious way to capture “other information”
Analyst coverage is greater for firms with more institutional investor and more intagible assets
Research on Analysts’ Behavior [4]
Unresolved Issues Need a better understanding of the
incentives of analysts with respect to forecasting
Identification the other information besides accounting data that influences analysts’ forecasts
Research on Discretionary Accruals [1]
Motives for Accrual Management Opportunistics vs. signaling Compensation contracts, debt
covenants, capital market pricing, taxes, litigation, and regulatory behavior
Multiple motives: opposing or reinforcing?
Research on Discretionary Accruals [2]
What Have We Learned? Earnings management identification:
Generic models of discretionary accruals Tests based on discontonuities in the
reported earnings distribution Account-specific models of discretionary
behavior Combination
Research on Discretionary Accruals [3]
What Have We Learned? Earnings management motivation:
Avoid a loss Avoid an eanrings decline Avoid falling below analysts’ forecasts Meeting the earnings forecasts
EM appears to be widespread and relatively easy to detect, at least as estimated by extant techniques
Research on Discretionary Accruals [4]
What Have We Learned? EM:
Accrual management Hedging activities Altering research and development
expenditures Combination
Capital markets appear to price differently the nondiscretionary and discretionary components of an accrual
Research on Discretionary Accruals [5]
Estimation of Discretionary and Nondiscretionary accruals Jones (1991) model: parsimonious model Use sector-specific variables for investigating sector-
specific accruals
Unresolved Issues Identification of discretionary accruals The nature of the discretion may be known but not
contractible Incentives and costs to eliminate discretionary
behavior are unclear, and discretionary behavior may be an equilibrium outcome, albeit not a “first best” solution
Empirical Research on Accounting Choice
Thomas D. FieldsThomas Z. LysLinda Vincent
Journal of Accounting and Economics (2001)
Introduction [1]
Market imperfections and accounting choice
Definition of accounting choice The motives behind the accounting
choice decision Accounting research: the determinants
and implication of accounting choice Literature review
Introduction [2]
Structure of review: Review and summarize the results of research
bearing on accounting choice (focusing on the 1990s)
Assess the extent to which knowledge of the importance of accounting choice has increased beyond that of the 1970s and 1980s
Conclusions about the importance and implications of accounting choice research
Suggestions for future avenues of research into accounting choice
Introduction [3]
Organization of review: Agency costs: contractual issues – mitigate
agency costs Information asymmetric: informed vs. less
infromed parties – disseminate privately held information
Externalities: third-party contractual and non-contractual relations – quality and quantity of financial disclosures, which in turn have welfare and policy implications in the presence of externalities
Introduction [4]
Brief conclusions: Accounting research has made modest progress in
advancing the state of knowledge beyond what was known in the 1970s and 1980s
Researchers generally focus on refinaing knowledge of specific accounting choice or on narrow problems that accounting choices are presumed to address
Accounting research generally fail to distinguish appropriately between what is endogenous and exogenous
A comprehensive theory is currently unavailable and possibly unattainable: limit to use of accounting choice and ignore the major role of accounting in normal, day-to-day situations
Introduction [5]
Opportunities Evidence be gathered on whether the alleged
attempts to manage financial disclosures by self-interested managers are successful; that is, what are the economic implications of the accounting choices”
More emphasis on the costs and benefits of addressing the three types of market imperfections driving accounting choice
Reseachers develop better theoretical models and more refined economectric techniques with the explicit goal of guiding empirical research and articulating expected results from such empirical research
Reasons for Accounting Choices [1]
Accounting choices in accounting principles
Accounting choices and information asymmetries
Accounting choices and issues of consistency and comparability
Accounting choices and efficient contracting
Reasons for Accounting Choices [2]
Accounting choices and mixed motives
Accounting choices: cost vs. benefit – optimal level of discretion
Accounting choices and earnings management: intention and opportunity
Reasons for Accounting Choices [3]
Zero accounting choices: Disputes over interpretation of the code Detail rules for all facts and circumtances New situations required new accounting rules Accounting flexibility mitigates manager’s attempt to
obtain desired accounting results by means of real decisions
Accounting choices as part of an optimal solution to an agency problem
Accounting choices made can be informative
Accounting choices: cost (?) vs. benefits (?)
Classification of Accounting Choice [1]
The presence of agency costs and the absence of complete markets Accounting choice and contractual
arrangements: efficient contracting perspective
Examples: executive compensation agreements and debt covenants – ex ante vs. ex post setting
There are potential conflicts among multiple goals in the choice of accounting methods
Classification of Accounting Choice [2]
The presence of information asymmetries: attempts to influence asset prices Ex ante: information transfer from well-
informed to less-informed Ex post: self-interest motives
Influence external parties other than actual and potential owners of the firm
Classification of Accounting Choice [3]
Literature review: Research on accounting choices Period: 1990s Sources: (1) Journal of Accounting and Economics; (2)
Accounting Review; and (3) Journal of Accounting Research Major categories of choice-based research US GAAP Exclude managerial choices about eanrings
announcemenet and other kinds of announcements involving accounting numers
Behavioral, experimental, analytical, and empirical Rely on market imperfections and assume individual
decision makers are rational
Prior Literature Reviews [1] Late 1960s and 1970s
Assume that market are efficient Examines the association between stock returns
and accounting information Research question: whether investors could ‘see
through’ alternative accounting practices to the underlying firm economics
Hypothesis: absent effects on the firm’s cash flows, investors do not alter their assessment of share prices based on alternative accounting methods
Methodology limitation
Prior Literature Reviews [2]
Late 1970s Research on Manager’s motives for the choice of
accounting techniques Investigation of the effects of accounting choice on
contractual arrangements Bernards (1989): economic consequences of
mandated accounting changes – little or no evidence of associated stock price effects
Holthausen and Leftwich (1983): fim size and leverages are the only two significant variables explaining choices of accounting techniques
Watts and Zimmerman (1990): ex ante vs. ex post and mixed motives
Contractual Motivations [1] Contractual arrangements and financial
accounting numbers: management compensation contracts bond covenants
Contractual arrangements and accounting choice
The results in general suggest that: managers select accounting methods to increase their compensation and to reduce the likelihood of bond covenant violations
Contractual Motivations [2] Internal Agency Conflicts – Executive
Compensation Background:
Reporting flexibility and the associated increased compensation are a relatively low cost compromise
Manipulating accruals may results in lower wealth losses to principals that manipulating real activity
Interest alignment Market rationality and anticipation
Contractual Motivations [3] Internal Agency Conflicts – Executive
Compensation Evidence of managerial opportunism:
Healy (1985) – lower and upper bound Clinch and Magliolo (1993) – absence of cash
flow effects Gaver et al (1995) vs. Healy (1985) - income
smoothing Holthausen et al (1995) vs. Healy (1985):
methodology Chen and Lee (1995) support Healy (1985) – big
bath behavior
Contractual Motivations [4] Internal Agency Conflicts – Executive
Compensation Evidence of managerial opportunism:
Ittner et al (1997) expand Healy (1985): non-financial measures
Gaver and Gaver (1998) support Healy (1985): asymmetric function
Guidry et al (1999) support Healy (1985) – different business units within a singel corp
Other several studies
Contractual Motivations [5] Internal Agency Conflicts – Executive
Compensation Problem with endogeneity:
The contract itself is endogenous (the obvious opportunities for self-serving behavior should have been anticipated and priced
Other checks and balances exist The models use to detect accrual management
are not very powerful and may not be able to differentiate between accruals management and real performance
Contractual Motivations [6] Internal Agency Conflicts – Executive
Compensation Problem with endogeneity:
The studies implicitly take the conditioning event as exogenous
Only part of the compensation function, usually the cash bonus is analyzed, without condisering the effect on total compensation (includin stock ownership)
Managerial opportunism is usually defined as maximizing the current period’s net income whereas there are different forms of managerial opportunism
Alternative explanations are not explored
Contractual Motivations [7] Internal Agency Conflicts – Executive
Compensation Managerial opportunism vs. value
maximization Summary:
Managers exploit their accounting discretion to take advantage of the incentives provide by bonus plans
However, little is known about whether such manipulations actually result in higher payouts, or about the impanct of earnings management on other corporate goals
Contractual Motivations [8] External Agency Conflicts – Bond Covenants
Research questions: Why lending agreements rely on reported accounting
numbers Why these contracts allow companies discretion to
select and change accounting methods subsequent to the debt issuance
Assumption: Floating GAAP Less costly to monitor The difficulty in specifying frozen GAAP Impposes fewer restrictions on corporate activities,
particularly investments
Contractual Motivations [9] External Agency Conflicts – Bond Covenants
Hypothesis: Managers select or change accounting methods to
avoid covenant violations – debt hypothesis Tries to explain accounting choices with closeness to debt
covenants Focuses on firms that have violated debt covenants
Investigated which firms are more likely to be adversely affected by mandated accounting changes by analyzing stock price reactions around the announcement of, or the lobbying behavior prior to, mandated accounting changes
Contractual Motivations [10] External Agency Conflicts – Bond Covenants
Debt covenant violation: Leverage ratio/Debt to equity ratio Firms that actually violated covenants
Previous reserachs Healy and Palepu (1990) – dividend constraint
in debt covenants: accounting changes vs. dividend reduction
Sweeney (1994) – mixed results & methodological problem
Contractual Motivations [11] External Agency Conflicts – Bond Covenants
Previous reserachs DeAngelo et al. (1994) - not statistically significant &
methodological problem DeFond and Jiambalvo (1994) – accrual manipulation vs.
accounting changes Haw et al. (1991) & Chase and Coffman (1994) – debt
covenants and specific accounting choice with real economic impact
Chung et al. (1993) and Malmquist (1990) – GAAP vs non GAAP
Francis (1990): cost of violation vs. cost of compliance
Contractual Motivations [12] External Agency Conflicts – Bond Covenants
Summary The evidence on whether accounting choices are
motivated by debt covenant concerns is inconclusive Consistent with the debt hypothesis and other
hypothesis Moving beyod the use of the debt to equity ratio as the
proxy for proximity to covenant violation Consider alternative hypothesis: efficient contracting vs.
opportunism Relation between accounting choice and violation of
debt covenants
Asset Pricing Motivations [1] Accounting choice and stock price or
returns (equity valuation or cost of capital) Forms:
Maximize earnings in a given period Smooth earnings over time Avoid losses Avoid earnings declines
Researchs: Association between earnings and share prices Market efficiency: accounting choices without direct cash
flow implication and changes in stock prices Alternative explanations: investor irrationality, manager
signaling, and contractual motivations
Asset Pricing Motivations [2]
Researchs: Earnings management and share prices –
specific situations DeAngleo (1986) and Perry & Williams
(1994) – MBO Erickson dan Wang (1999) – equity financed
acquisitions Kasznik (1999) – earnings forecasts
Asset Pricing Motivations [3]
Disclosure Policies Botosan (1997): level of disclosure
(accounting choice) and costs of capital Sengupta (1998): level of disclosure and cost
of debt Hayes & Lundholm (1996) and Harris (1998):
segment disclosures and firm value – level of competitiveness
Balakrishnan et al. (1990) and Boatsman et al. (1993): geographical segments and earnings quality/security valuation
Asset Pricing Motivations [4]
Disclosure Policies Barth & McNichols (1994): environmental
liability disclosures and market value of equity Forst & Kinney (1996): level of disclosure –
foreign vs. U.S. Firms – earnings and stock returns
Summary: Results on whether the level of disclosure affects the cost of
capital are mixed Evidence does not support an unequivocal decrease in cost of
capital as a results of increased disclosure More study is necessary to understand the relative costs and
benefits of increased disclosure
Asset Pricing Motivations [5]
Earnings Management Gaver et al. (1995) vs. Healy (1985): bonus plan
hypotheses DeFond & Park (1997): income smoothing hypotheses Burgstahler & Dichev (1997): avoi earnings decreases
and losses Barth et al. (1999): earnings management and stock
prices Hong et al. (1978) and Davis (1990): earnings
management (purchase vs. pooling) and abnormal returns
Asset Pricing Motivations [6]
Market Efficiency 1970s: support market efficiency 1980s – 1990s: assumes market efficiency and other
economic explanations (example: efficient contracting theory)
1990s: irrationality of investors – behavioral finance Beaver and Engel (1996): decomposition of allowance
for loan losses – nondiscretionary (negatively priced) and discretionary (positively priced)
Subramanyam (1996): value of discretionary accruals – income smoothing: persistency & predictability & communicate private information
Asset Pricing Motivations [7]
Market Efficiency Hand et al. (1990): stock (bond) prices and
insubstance defeasance Summary
There is neither clear evidence that markets are inefficient nor unequivocal evidence that they are not
Most research supporting both conclusions is subject to criticism that interpretation of the results is conditional on both the proper specification of the returns generating process and of the event under consideration
It is difficult to draw strong inferences about the implications of accounting choices for asset prices
Motivation Due to Impact on Third Parties [1]
Taxes Research question: whether firms choose
accounting methods to minimize the present value of taxes
Evidence: consistent with tax-minimizing choices or other offsetting considerations (presence of conflicting goals)
Structured around changes in tax rates Dhaliwal & Wang (1992): shifting permanent
and timing differences across periods to minimize the impact of the AMT
Motivation Due to Impact on Third Parties [2]
Taxes Structured around changes in tax rates
Boynton et al. (1992): smaller firms manipulating discretionary accruals to reduce the impact of AMT
Guenther (1994): firms shift net income from the higher to the lower taxed periods by means of current accruals
Motivation Due to Impact on Third Parties [3]
Taxes The effect of tax rate changes on the
accounting choices of MNCs Harris (1993), Klaessen et al. (1993), and
Collins et al. (1998): Tax Reform Act 1986 (tax rate changes) and income shifting in MNCs
Jacob (1996): transfer pricing
Motivation Due to Impact on Third Parties [4]
Taxes Accounting choice and tax effect
LIFO vs. FIFO and the marke reactions: Tse (1990); Hand (1993 & 1995); Jennings et al. (1996) – inconsistence results
Cloyed et al. (1996): firms choose a conforming financial reporting method when the tax savings apparently outweigh the estimated non-tax costs – tax accounting method
Guenther et al. (1997): cash to accrual basis (derived by TRA’86) significantly increased the level of deffered financial statement income
Motivation Due to Impact on Third Parties [5]
Taxes Tax vs. non-tax considerations
Tax costs to other contracting parties due to deferred revenue recognition and accelerated expense recognition (Scholes et al., 1992)
The impact on debt covenants of shifting income into net operating loss years (Maydew, 1997)
Increased cash flow and smoother earnings (Maydew et al., 1999)
The effect on earnings used for performance measurement and the effect on equity valuation (Klassen et al., 1993)
Motivation Due to Impact on Third Parties [5]
Taxes Tax vs. non-tax considerations
Tax costs to other contracting parties due to deferred revenue recognition and accelerated expense recognition (Scholes et al., 1992)
The impact on debt covenants of shifting income into net operating loss years (Maydew, 1997)
Increased cash flow and smoother earnings (Maydew et al., 1999)
The effect on earnings used for performance measurement and the effect on equity valuation (Klassen et al., 1993)
Motivation Due to Impact on Third Parties [5]
Taxes Tax vs. non-tax considerations
Dhaliwal et al. (1994): tax minization, earnings management, adn debt covenants all provide incetive to dip into LIFO layers
Klaessen (1997): trade off taxes and financial reporting goals in the context of the choice of the divestiture form chosen
Summary: Firms make accounting choices in order to reduce
theirtax burden The evidence with respect to the stock market effects of
these actions is mixed
Motivation Due to Impact on Third Parties [6]
Regulation Industry-specific regulations
Focuses on accounting responses to specific constraints
Considers more indirect effets: the political costs of appearing to be ‘overly’ profitable
Managers choose accounting methods and procedures to increase shareholder wealth
Motivation Due to Impact on Third Parties [7]
Regulation The regulatory costs imposed by capital
adequacy ratio guidelines in the banking industry Moyer (1990): adjusting loan loss
provisions, loan charge-offs, and securities gains and losses
Kim & Kross (1998): manipulating accruals Blacconiere et al. (1991): adopting
voluntary regulatory accounting principles
Motivation Due to Impact on Third Parties [8]
Regulation Insurance industry
Petroni (1992): insurers bias downward their loss reserves when they are close to receiving regulatory attention
Adiel (1996): insurers enter into costly financial reinsurance transactions to reduce regulatory costs
Motivation Due to Impact on Third Parties [9]
Regulation The regulation literature generally concludes
that managers select accounting methods to avoid regulatory intervention
There are information costs in the political process such that there is some probability that the regulators will not detect or adjust for the accounting manipulation
The cost of regulatroy interventions and the manner in which the regulation is enforced
Motivation Due to Impact on Third Parties [10]
Regulation Price-regulated industries
Managers select accounting numbers and procedures to increase cash flows to share-holders, even when this reduces earnngs and increases liabilities: Eldenbrug & Sodestrom (1996) and D’Souza (1998)
Motivation Due to Impact on Third Parties [11]
Regulation Non-regulated industries
Jones (1991) – income decreasing in the year of import relief investigations
Key (1997) – cable industry Hall & Stammerjohan (1997) and Han & Wang
(1998) – oil company Blacconiere & Patten (1994) – environmental
disclosure in chemical firms
Motivation Due to Impact on Third Parties [12]
Regulation Multiple incentives and multiple accounting
methods Beatty et al. (1995) – bank’s accounting accruals,
investment, and financing decisions are interdependent and cannot be studied effectively in isolation
Collins et al. (1995) – cross-sectional differences in bank’s responses to capital, earnings, and tax incentives
Summary: Consistent with expectations Third parties are either not willing or not able to undo
the accounting manipulations
Impediments to Progress [1]
Multiple Method Choices One choice vs. multiple accounting
choices to accomplish a specific goal Examine the net effect of all accounting
choices on the accruals of the firms for the period under consideration DeAngelo (1986) and Perry & Williamns
(1994) –discretionary accruals (MBO) Erickson & Wang (1999) – discretionary
accruals (stock-for-stock acquisition)
Impediments to Progress [2]
Multiple Method Choices Discretionary accual estimation model:
Dechow et al. (1995) – low power Guay et al. (1996) – mixed results Kang & Sivaramakrishnan (1995) – instrumental
variabels approach
The importance of ability to detect earnings management Premise: the interested parties are unable (or possibly
unwilling) to detect the effect of accounting method choice, accounting procedures, and accounting estimates on the reported numbers
Impediments to Progress [3]
Multiple Method Choices The importance of ability to detect
earnings management The difficulty using statistical techniques to detect
earnings management
Three approaches: Continue using the discretionary accruals method Continue to develop and test more powerful techniques
for the detection of earnings management Measure multi-dimensional accounting choice directly
via the financial statements – Hagerman & Zmijewski (1979) and Zmijewki & Hagerman (1981)
Impediments to Progress [4]
Multiple Motivations Mutilple and potentially conflicting motivations
for the accounting choices: interaction between and trade-offs among goals
Adding control variables Researchers often rely on coarse of inappropriate
proxies to measure the role of the omitted determinants of accounting choice
Inference problems are likely to arise when analyzing multiple motivations using proxies with differing amounts of measurement error, particularly when the underlying effects are correlated
The absence of linearity
Impediments to Progress [5]
Multiple Motivations Evidence of progress
Hand & Skantz (1998) Accounting choice of SAB 51 is a function of a
linear combination of different motives: political, debt-covenants, earnings management, and information signaling)
Francis et al. (1996) Discretionary asset write-offs is a function of
managerial incentives to increase compensation and to smooth earnings
Impediments to Progress [6]
Multiple Motivations Evidence of progress
Robinson and Shane (1990): the cost and benefits associated with accounting choice of purchase or pooling
Balsam et al. (1995): effect of earnings management and debt covenants on the timing of adoption of new FASB regulations
Bartov (1993): earnings smoothing and debt-to-equity considerations for corporate management of accounting earnings through asset sales
Impediments to Progress [7]
Multiple Motivations Evidence of progress
Guenther et al. (1997) – effect of tax motive, compensation contract, debt contract, and asset pricing, to accounting choice
Multiple methods and motivations Hunt et al. (1996) – simultaneous equation
approach: multiple choice (inventory management, depreciation, and other current accruals) vs. multiple objectives (income smoothing, minimizing debt-related costs, and minimizing taxes)
Impediments to Progress [8]
Multiple Motivations Multiple methods and motivations
Christie (1990) – multiple motivations vs. multiple choice
Further progress: Continue to consider the existence of multiple
motivations (Bartov, 1993) Exploring the underlying relations among
different motivations Refining and expanding the methodology
Impediments to Progress [9]
Methodological Issues Standard econometric problems:
simultaneity, errors-in-variables, omitted variables, etc – low power and unreliable tests
Inherent endogeneity of the choices that are made (accounting methods, firm financial structure, organizational structure, contracts, etc)
Impediments to Progress [10]
Methodological Issues Example of endogeneity problem:
Skinner (1993) Investment opportunities set, compensation and
debt contracts, and firms characteristics (including accounting choices)
IOS influence the structure of its compensation plans and debt contracts, and thus indirectly influences its accounting choices
There is an association between IOS and accounting choices
Interrelationship among variables affecting accounting choices
Impediments to Progress [11]
Methodological Issues Example of endogeneity problem:
Begley and Feltham (1999) Control for the endogeneity of both incentive
variables and debt covenants Changes in accounting policy choices of differences
in choices across firms may be driven by underlying economic differences in the firms, either cross-sectionally or through time
The self-selection bias inherent in the sample
Crude proxies vs. actual measurement
Impediments to Progress [12]
Methodological Issues Appropriate research question:
the driven of the accounting choice vs. consistency with one or more posited incentives
Distinguishing between managerial opportunism, shareholder wealth maximization, and information motivation
Impediments to Progress [13]
Narrow Scope of The Research on The Costs and Benefits of Accounting Choice Empirical tests of the benefits of
accounting choice yield mixed results There is little convincing research and
non consensus that the benefits of increased disclosure outweigh the costs
Impediments to Progress [14]
Lack of Theoritical Guidance The environment in which choices are
made and the mechanism by which thet have an impact are not well articulated – the need of analytical research
The limitation of analytical research – focuses on disclosure policy
Recommendations for Future Research
Compelling evidence of the implications of alternative accounting methods
Considering multiple choices and multiple motivations
Develop more powerfull statistical techniques and improve research design
Use the expertise as accountants – small sample and fields studies