Arthur G. Kraft

Regression-Based Tests of the Market Pricing of Accounting Numbers: The Mishkin Test and Ordinary Least Squares

The test developed in Mishkin [1983] (hereafter, MT) is widely used to test the rational pricing of accounting numbers. However, contrary to the perception in the accounting literature, the exclusion of variables from the MTs forecasting and pricing equations leads to an omitted variables problem that affects inferences about the rational pricing of accounting variables. Only if the omitted variables are rationally priced is their exclusion irrelevant. Failure to recognize this issue leads accounting researchers to employ the MT without appreciating how omitted variables affect the inferences they draw. We demonstrate that when additional explanatory variables are included in the MT, the rational pricing of accruals is not rejected. That is, the accrual anomaly documented in Sloan [1996] vanishes when additional explanatory variables are incorporated into the MT. We also show that in accounting research settings, where samples are large, ordinary least squares (OLS) is equivalent to the MT. As a result, accounting researchers should consider using OLS or be more explicit about the exact advantages of the MT over OLS in their research setting.

Asymmetric Persistence and the Market Pricing of Accruals and Cash Flows

We investigate whether stock prices reflect the asymmetric persistence of accruals and cash flows resulting from conditional conservatism. Using the Mishkin (1983) test (MT), we provide further evidence on the earnings fixation explanation for the accrual anomaly. We also apply panel estimation techniques that significantly affect market efficiency inferences. Our results suggest that over our sample period (1) investors seem to partially anticipate asymmetric persistence in accruals and cash flows; (2) the accrual anomaly originates in the mispricing of accruals in years of economic gains, even though the differential persistence between accruals and cash flows is greatest in years of economic losses; (3) investors respond differently to accrual and cash flow surprises and therefore they do not naively fixate on earnings surprises; and (4) after clustering standard errors in the MT by firm and year dimensions, there is no longer evidence of cash flow mispricing, while the statistical significance of accrual mispricing falls. All our findings contradict the earnings fixation explanation for the accrual anomaly. Our study has implications for understanding the accrual anomaly in relation to accrual dynamics, as well as for researchers interested in using the MT framework to test the rationality of investor expectations more generally.

Voluntary vs. Mandatory Management Earnings Forecasts in IPOs

Until 2001 companies making initial public offerings in Greece were obliged to include a forecast of next year’s profit in the new issue prospectuses; however in 2001 the regulations changed and made the inclusion of earnings forecasts in the prospectuses voluntary. This study takes advantage of these two regulatory regimes and compares the accuracy of earnings forecasts under both mandatory and voluntary disclosure environments. Findings indicate a change in the properties of the earnings forecasts, as pessimistic earnings forecasts during the mandatory era turn optimistic in the voluntary period. The comparison of these two regimes suggests that mandatory earnings forecasts may force firms to forecast that have neither the incentives nor the ability to do so. Furthermore, the results imply that regulations penalizing IPOs for providing highly inaccurate forecasts appear to be a more appropriate regulatory strategy. Accuracy of earnings improves after the introduction of voluntary disclosures where firms that provide forecasts are characterized as mature, with high demand multiple and low retained ownership.