Financial Accounting & Auditing

The comprehensive survey reported here allowed analysis of how senior U.S. financial executives make decisions related to performance measurement and voluntary disclosure. Chief financial officers were asked what earnings benchmarks they cared about and which factors motivated executives to exercise discretion — even sacrifice economic value — to deliver earnings. These issues are crucially linked to stock market performance. The results show that the destruction of shareholder value through legal means is pervasive, perhaps even a routine way of doing business.

The conference paper by Johnson (2006, Review of Accounting Studies, forthcoming) develops an incomplete-contracting transfer pricing model with a number of novel features: taxation, sequential investments, and intangible assets being transferred. This discussion aims to disentangle these features so as to highlight those that are the key drivers of the results. Moreover, I show that some of the results can be generalized to settings involving a greater level of technological interdependency between the divisions.

When a boom ends, the downturn is generally sharp and short. When growth resumes, the boom is more gradual. Our explanation rests on learning about productivity. When agents believe productivity is high, they work, invest, and produce more. More production generates higher precision information. When the boom ends, precise estimates of the slowdown prompt decisive reactions: Investment and labor fall sharply. When growth resumes, low production yields noisy estimates of recovery. Noise impedes learning, slows recovery, and makes booms more gradual than downturns.

This paper yields a summary score that informs about the sustainability (or persistence) of earnings and about the trailing P/E ratio. The score is delivered from a model that identifies unsustainable earnings from the financial statements by exploiting accounting relations that require that unsustainable earnings leave a trail in the accounts. The paper also builds a P/E model that recognizes that investors buy future earnings, so should pay less for current earnings if those earnings cannot be sustained in the future.

Multidivisional firms frequently rely on external market prices in order to value internal transactions across profit centers. This paper examines the transfer pricing problem in a setting in which an upstream division has monopoly power in selling a proprietary component both to a downstream division within the same firm and to external customers. When internal transfers are valued at the prevailing market price, the resulting transactions are distorted by double marginalization.

The 1993 Japanese financial system reform allowed banks to enter the underwriting market for corporate bonds through bank-owned security subsidiaries. This paper examines empirically whether underwriting commissions and yield spreads on corporate straight bonds issued domestically fell as a result of this bank entry. The empirical results show that bank entry significantly lowers both underwriting commissions and yield spreads. Commissions charged by banks are significantly lower than those charged by investment houses.

The accruals anomaly—the negative relationship between accounting accruals and subsequent stock returns—has been well documented in the academic and practitioner literatures for almost a decade. To the extent that this anomaly represents market inefficiency, one would expect sophisticated investors to learn about it and arbitrage the anomaly away. Yet, we show that the accruals anomaly still persists and its magnitude has not declined over time.

Vertical integration is often proposed as a way to resolve hold-up problems, ignoring the empirical fact that division managers tend to maximize divisional (not firmwide) profit when investing. This paper develops a model with asymmetric information at the bargaining stage and investment returns taking the form of cash and "empire benefits." Owners of a vertically integrated firm then will provide division managers with low-powered incentives so as to induce them to bargain "more cooperatively," resulting in higher investments and overall profit as compared with non-integration.

This 2005 roundtable addressed stock market valuation and its implications for a number of important corporate financial management functions, including internal performance evaluation and capital budgeting. Panelists included Tom Copeland of MIT, Bennett Stewart of Stern Stewart, Trevor Harris of Morgan Stanley, Stephen O'Byrne of Shareholder Value Advisors, Justin Pettit of UBS, David Wessels of University of Pennsylvania, and Don Chew of Morgan Stanley. John Martin of Baylor University and Sheridan Titman of University of Texas at Austin moderated.