Byung T. Ro

Self-serving behavior in managers' discretionary information disclosure decisions

Research has shown that managers display self-serving behavior with regard to a variety of discretionary information production decisions. We test here whether such behavior is also manifest in discretionary information disclosure decisions. Our particular focus is on the common stock return performance comparisons now required in corporate proxy statements under the SECs new executive compensation disclosure regulations. We find evidence which suggests that the industry and peer company stock return benchmarks and the broader market indices chosen by management for those comparisons are downward biased resulting in a pervasive overstatement of the relative performances of the reporting firms. Cross-sectionally the extent of the bias varies systematically with certain key attributes of the reporting firm. Among these are the level of its own performance and the degree of stock ownership by the firms senior management. We interpret our findings as indicative of self-serving behavior on the part of the firms management.

The association between deferred taxes and common stock risk

The nature of deferred taxes and their cash flow implications have long been debated, and accounting rule-making bodies have adopted different policies on deferred taxes in the past. Our study examines how the capital market perceives deferred taxes in assessing common stock risk. We document extensive evidence of a negative relation between deferred taxes and two measures of security risk, market beta and standard deviation of security returns, when the debt-equity ratio is adjusted for deferred taxes. The above associations between deferred taxes and risk are robust to controls for selected firm characteristics. Our findings are in accord with the hypothesis that in assessing common stock risk, the market views deferred taxes as a form of equity or a proxy for some firm attribute which is inversely related to risk, and suggest that the liability view of deferred taxes mandated by Financial Accounting Standards Board (FASB) Statement Nos. 96 (FASB 1987) and 109 (FASB 1992) may be an inappropriate basis for formulating accounting rules on deferred taxes.

The Association between LIFO Reserve and Equity Risk: An Empirical Assessment:

This study examines the association between a firms LIFO reserve and its equity risk. We hypothesize that LIFO reserve has favorable implications for equity risk as it confers tax benefits and represents unbooked profits, which prompt firms to lower their borrowings and effectively increase equity. Consistent with this hypothesis, we document a negative association between LIFO reserve and two measures of risk: standard deviation of stock returns and beta. We document a negative association between LIFO reserve and debt, consistent with the proposition that UFO reserve and debt are tax shield substitutes. However, the negative association between LIFO reserve and equity risk remains even when the level of debt of firms is controlled. Further tests show that adjusting the denominator of the debt-equity ratio for LIFO reserve improves its explanatory power with regard to risk, consistent with the notion that LIFO reserve is viewed as a component of equity in assessing risk. Additional tests indicate that LIFO reserve has explanatory power with regard to future risk. Also, variability of LIFO reserve is positively associated with equity risk, suggesting that firms with high temporal variability in their LIFO reserve may be unable to fully avail of the future benefits of LIFO accounting. Collectively, these results indicate that LIFO reserve is negatively associated with equity risk and conveys information that is potentially useful in assessing equity risk.

Differential market reactions to accounting changes away from versus towards common accounting practices

Abstract Our study examines whether the direction of voluntary accounting method changes for inventory, depreciation, and investment tax credit (ITC) has a stock price implication. The direction of accounting changes (ACs) in each area is defined relative to the most commonly-used accounting practices by industry. Our results show that the abnormal stock returns of the sample firms around the AC announcements are, on average, positive for the ACs away from the common accounting practices in the selected areas and negative for the ACs towards the practices. The relative abnormal return difference between the two types of ACs exists for the inventory ACs and the depreciation/ITC ACs, respectively. It also persists when selected firm characteristics are controlled. The evidence suggests that the direction of voluntary ACs relative to the common accounting practices has a stock price implications, and that the uniformity of accounting rules accross all firms may limit investors access to some firm-specific information.