Bradley E. Lail

The Role of Non-Financial Measures in Management Forecasts

This study examines how the interplay between financial and non-financial measures affects management forecasting behavior. Building on the knowledge that NFMs are typically aligned with actual earnings and are likely incorporated into earnings forecasts, we investigate if the level of divergence between changes in NFMs and contemporaneous changes in earnings influences management forecasting behavior. We hand-collect company-specific NFMs (e.g., number of retail outlets, square footage of facilities, patents) disclosed in 10-K filings and describe how a greater divergence between NFMs and earnings (i.e., NFM changes substantially outpacing earnings growth, or vice versa) renders NFMs less useful for forecasting. As such, in more divergent settings, we observe that management is less likely to issue guidance. Consistent with our theory, for managers that do provide guidance in more divergent settings, management forecast errors increase. Last, we provide evidence that external stakeholders can use the level of divergence between NFMs and earnings to predict future management forecasting behavior. Our evidence demonstrates that NFMs and their relation with financial information play an important role in explaining management forecasting behavior.

Are Entrenched Managers’ Accounting Choices More Predictive of Future Cash Flows?

We examine the role manager entrenchment has on firms’ financial reporting quality. More specifically, we test whether entrenched managers’ reported accruals deviate from industry norms and whether entrenched managers’ abnormal accruals are more (or less) predictive of future cash flows. Consistent with implications from prior research, we find that firms with entrenched managers generally report lower levels of abnormal accruals (in an absolute sense), but the abnormal accruals utilized by entrenched managers are more predictive of future cash flows. Contrary to a more traditional view of manager entrenchment, our evidence suggests that entrenched managers report higher quality abnormal accruals. While prior research provides evidence that manager entrenchment is associated with negative economic outcomes, we argue that attempts to limit entrenchment are unlikely to improve financial reporting quality and may actually lower quality. Future corporate governance should consider not only the level but also the quality of the association between accounting choices and manager entrenchment.

The Influence of Strong Shareholders on Earnings Management

Presumably, shareholder rights aim to better align the actions of managers with the interests of shareholders; however, it is not clear from prior research whether such alignment mitigates or exacerbates managers’ propensity to manage earnings. We document that when shareholder rights are stronger, managers are more likely to manage earnings upward to meet analyst expectations or last year’s EPS. The greater propensity of firms with strong shareholder rights to manage earnings to meet earnings benchmarks is not consistent with the traditional expectation that shareholder rights serve as a governance mechanism to reduce what could be opportunistic reporting behavior. We further highlight the unique impact of shareholder rights for our sample by demonstrating that other traditional governance mechanisms (audit quality, institutional ownership, and board’s financial expertise) have the expected effect of reducing earnings management. Given recent demands to enhance shareholder rights, our study highlights an interesting and perhaps unexpected financial reporting consequence.

Manipulation of Internal Performance Measures: Evidence from SFAS No. 131 Disclosures

Existing evidence indicates a propensity by managers to report GAAP net income to external parties that meets or beats performance thresholds. An unanswered question is whether managers also beat thresholds with internal performance measures. Due to the implementation of SFAS No. 131, researchers can now access internal measures that are most prominently reviewed by top decision makers. Adopting the methodology used by Burgstahler and Dichev (1997) to detect earnings management, I examine the sum of a companys segment performance measures and find that companies avoid reporting losses for these consolidated internal performance measures. Additional tests rule out several alternative explanations.