Financial Accounting & Auditing

This paper documents that the earnings yield and book-to-price combine to predict equity returns in a way that is consistent with the rational pricing of risk. It is well known that earnings yields predict returns in the cross-section, consistent with standard formulas that show that the earnings yield equals the required return when there is no expected earnings growth beyond that from retention. With growth, those same formulas show that the earnings yield is increasing in the required return but decreasing in the growth.

This paper, the second in CEASA's White Paper series on accounting issues, lays out principles under which fair value accounting satisfies the objective of reporting to shareholders. Its "principles-based" approach embraces broad economic concepts but is also pragmatic and specific enough to guide practice.

While empirical evidence alludes to the intertemporal nature of corporate voluntary disclosures, most of the existing theory analyzes firms' voluntary disclosure decisions within single-period settings. Introducing a repeated, multiperiod, disclosure setting, we study the extent to which firms' strategic disclosure behavior in the past affects their prosperity to provide voluntary disclosures in the future.

We examine whether a simple quantitative measure of language can be used to predict individual firms' accounting earnings and stock returns. Our three main findings are: (1) the fraction of negative words in firm-specific news stories forecasts low firm earnings; (2) firms' stock prices briefly underreact to the information embedded in negative words; and (3) the earnings and return predictability from negative words is largest for the stories that focus on fundamentals.

We examine the association between CEO reputation (proxied by the extent of press coverage) and the quality of the firm's earnings (proxied by two accruals-based measures). We test three explanations for an association between these constructs: the efficient contracting hypothesis suggests that reputed CEOs are associated with good earnings quality, while the rent extraction and matching explanations argue that reputed CEOs are associated with poor earnings quality.

The pressure to meet/beat analysts' expectations is often blamed for the recent onslaught of accounting scandals. We investigate changes in the meeting/beating phenomenon post-scandals and find that the stock market premium to meeting or just beating analyst estimates has disappeared while the premium to beating by a larger margin has diminished. In the post-scandals period, managers tend to meet or just beat analysts' forecasts less often. Further, managers rely less on income-increasing discretionary accruals and more on earnings guidance.

The Securities and Exchange Commission (SEC) recently issued a call for comment on a proposal to accept financial statements prepared in accordance with International Financial Reporting Standards (IFRS) without reconciliation to U.S. GAAP. Accounting researchers have attempted to assess the quality of IFRS using different methods and criteria. While we are skeptical of drawing direct conclusions about the SEC’s proposal based on this research, there is adequate evidence that both IFRS and U.S. GAAP provide useful information to investors and other users of financial statements.

Under U.S. GAAP, reported balance sheet and income statements are based on immediate expensing of R&D expenditures. We capitalize those expenditures and derive adjusted equity book values and earnings using simple amortization techniques (straight-line over assumed industry-specific useful lives). After confirming that such adjustments increase the association of book values/earnings with contemporaneous stock prices (and future earnings), we examine the relation between those adjustments and future returns.