Asher Curtis

The Disclosure of Non-GAAP Earnings Information in the Presence of Transitory Gains

We examine the disclosure of non-GAAP earnings information in quarters containing transitory gains to investigatewhether the primarymotivation for thesemanagers to disclose non-GAAP earnings is to inform or mislead. In this setting, non-GAAP earnings aremore informative thanGAAPearnings, even though they are lower thanGAAPearnings. Thus, managers motivated to inform stakeholders about sustainable earnings will disclose non-GAAP earnings information excluding the gain, whereas managers motivated to report higher earningswill obscure the transitory nature of the gain by focusing onGAAPearnings. We find evidence that managers’ disclosure choices vary widely across firms, and these choices affect investors’ perceptions of core operating earnings. We then contrast how the same firm discloses non-GAAP earnings in the presence of transitory losses to provide additional evidenceon themotivesof individual firms’disclosures.Weconclude that themost pervasivemotivation to disclose non-GAAP earnings in the presence of transitory gains is to inform. An economically significant proportion of firms, however, appear opportunistic in that they only disclose non-GAAP earnings information when it increases investors’ perceptions of core operating earnings.Our evidence is important becausewespeak to the influence that eachmotive has on the choice to disclose non-GAAP earnings and we provide evidence on the underlying motives behind specific firms’ disclosures.

Does Short Selling Amplify Price Declines or Align Stocks with Their Fundamental Values

Critics of short selling argue that short sellers amplify price declines by targeting firms with falling prices in an unwarranted manner. Contrary to this viewpoint, we find that increases in short interest for firms following a price decline are associated with measures of overpricing based on financial statement analysis. Our results extend to short-selling activity following marketwide declines. We also find evidence consistent with the profitability of short selling following price declines being driven by valuation-based positions. Overall, our findings suggest short sellers primarily undertake valuation-based strategies following price declines and have implications for regulators. Limiting short selling following price declines is likely to impede efficient price discovery. This paper was accepted by Mary Barth, accounting.

Historical Cost Measurement and the Use of DuPont Analysis by Market Participants

We investigate a possible weakness of measuring assets using historical cost. Our results suggest that an economically significant portion of the return on net operating assets reported by firms with older assets is an artifact of historical cost accounting rather than superior economic performance. We document that this feature of historical cost accounting lowers the comparability and value-relevance of accounting-based rates of return. Results are concentrated in firms with high proportions of PPE, and alternative explanations due to variation in the age of the firm, managerial ability and competitive advantages are not supported by the data. Our results have implications for the ongoing debate on the appropriate measurement techniques for assets.

Investor Attention and the Pricing of Earnings News

We investigate whether investor attention is associated with the pricing (and mispricing) of earnings news where investor attention is measured using social media activity. We find that high levels of investor attention are associated with greater sensitivity of earnings announcement returns to earnings surprises, with the effect being strongest for firms that beat analysts’ forecasts. This appears to be appropriate pricing, on average, as only firms with low levels of attention are associated with significant post-earnings-announcement drift. Our results are distinct from other information sources including traditional media outlets, financial blogs, and internet search engine activity. Our results are consistent with investor attention observed in social media activity having distinct effects on the pricing and mispricing of earnings news.

The Use of Adjusted Earnings in Performance Evaluation

We examine the use of adjusted earnings in CEO performance evaluation. We find that the majority of firms in the S&P 500 use adjusted earnings for performance evaluation, and that common exclusions such as interest, taxes, discontinued operations, and special items do not fully explain how firms calculate adjusted earnings. This suggests a widespread adoption of firm-specific adjustments to earnings for performance evaluation. Results of cross-sectional tests investigating the use of unadjusted earnings for performance evaluation are more consistent with the use of adjusted earnings improving incentive alignment between shareholders and managers than with managerial power over compensation.

The Changing Implications of Research and Development Expenditures for Future Profitability

Research and development (R&D) expenditures have grown dramatically over time. We examine how R&D profitability has changed as a result, hypothesizing that the sharp increase in spending might lead to diminishing marginal returns on R&D investments and thus a decline in average profitability. Consistent with this, we estimate that the profitability of R&D has declined by over 70 percent (on average) and 62 percent (in aggregate) between the early and later parts of our sample period. This decline does not appear limited to any particular subset of our sample and is robust to alternative model specifications. We provide evidence of diminishing marginal returns to R&D investments (as higher aggregate amounts of R&D spending are associated with lower profitability). We also provide evidence of a decline in R&D investment risk across time, which could contribute to the decline in profitability. Despite the pervasiveness of the decline, we provide evidence that analysts do not fully incorporate this decline into their growth forecasts and that investors appear to revise their long-run expectations when anticipated future profits are not realized. Our results inform market participants and researchers assessing the implications of R&D for future earnings.

Aggregate Margin Debt and the Divergence of Price from Accounting Fundamentals

We examine whether, in the aggregate, margin debt is associated with the divergence of price from accounting fundamentals. We find that investors increase their margin debt following upward price movements away from accounting fundamentals, consistent with these investors being extrapolative in aggregate. We also find evidence that margin debt appears to be linked to temporary overpricing in recent periods, as the aggregate ratio of margin debt-to- price is reliably associated with negative future returns since at least 1992. Our results are consistent with the theoretical literature which predicts extrapolative traders provide a destabilizing effect on market prices and help explain why prices diverge from accounting fundamentals.

Bulls and Bears: Disagreement and Trading Volume Around News Announcements

We examine the association between disagreement and trading volume around news events using a novel measure of disagreement that overcomes two challenges Bamber et al. (2011) identify as facing earlier measures. Specifically, we measure disagreement based on heterogenous opinions about firm value of StockTwits users. We find strong results that both pre-existing disagreement and the change in disagreement following the earnings announcement are both associated with trading volume. We next provide novel evidence on the differential effects of attention and disagreement by examining the impact of more influential users in the StockTwits network. We find that disagreement between influential investors is associated with incrementally higher trading volume. Our measure of disagreement generalizes to other news events, consistent with the measure capturing disagreement about firm value, not just the short-term earnings prospects of the firm. Our results provide evidence consistent with the importance of both pre-existing heterogeneity between users of financial statement information and preliminary evidence that disagreement between individuals about financial information can be affected by online social networks.

The Measurement of Speculative Investing Activities and Aggregate Economic Outcomes

We examine whether differences in the accounting measurement of investment activities help explain the negative association between aggregate investments and future returns. We decompose aggregate investment activity into investments in tangible and intangible assets. We find that the previously documented negative association between aggregate investment and future market returns is largely explained by investments in intangible assets, especially in goodwill. These effects are stronger in recent periods and in the technology sector. In contrast, we find investments in tangible assets explain less of the negative association and are generally limited to both earlier time periods and the non-technology sector. Our results suggest the recognition of speculative M&A activities on the balance sheet helps explain the negative association between aggregate investments and future returns.

Arbitrage Risk and the Timeliness of Stock Price Adjustments to Accounting Fundamentals

I examine the effect of arbitrage risk on the alignment between stock prices and accounting fundamentals, where arbitrage risk is measured as the lack of close substitutes that can be used as a hedge. I find evidence consistent with the disparity between value and price being positively associated with arbitrage risk. Consistent with short-positions being more sensitive to arbitrage risk, my results are more pronounced for strategies that require short positions. I then show that the timeliness of the alignment between stock prices and accounting fundamentals is negatively related to arbitrage risk. My results provide empirical support for the hypothesis that price requires time to reflect accounting information and has implications for research that assumes that prices are measured without error.