Dan S. Dhaliwal

Is comprehensive income superior to net income as a measure of firm performance?1

Abstract With the exception of financial firms, we find no evidence that comprehensive income is more strongly associated with returns/market value or better predicts future cash flows/income than net income. Moreover, the only component of comprehensive income that improves the association between income and returns is the marketable securities adjustment. Our results do not support the claim that comprehensive income is a better measure of firm performance than net income. Our results also raise questions about the appropriateness of items included in SFAS 130 comprehensive income as well as the need for mandating uniform comprehensive income disclosures for all industries.

Last Chance Earnings Management: Using the Tax Expense to Meet Analysts' Forecasts

We assert that the tax expense is a powerful context in which to study earnings management, because it is one of the last accounts closed prior to earnings announcements. Although many pre-tax accruals must be posted in the year-end general ledger, managers estimate and negotiate tax expense with their auditors immediately prior to earnings announcements. We hypothesize that changes from third- to fourth-quarter effective tax rates (ETRs) are negatively related to whether and how much a firm’s earnings absent tax expense management miss analysts’ consensus forecast, a proxy for target earnings. We measure earnings absent tax expense management as actual pre-tax earnings adjusted for the annual ETR reported at the third quarter. We provide robust evidence that firms lower their projected ETRs when they miss the consensus forecast, which is consistent with firms decreasing their tax expense if non-tax sources of earnings management are insufficient to achieve targets. We also find that firms that exceed earnings targets increase their ETR, but this effect is less significant. By studying the tax expense in total, rather than narrow components of deferred tax expense, our results provide general evidence that reported taxes are used to manage earnings.

The effect of owner versus management control on the choice of accounting methods

Abstract This paper examines the relationship between the ownership control status of firms and the accounting methods they adopt. The arguments of Watts and Zimmermans positive theory are integrated with those of managerial economists to generate the prediction that management controlled firms are more likely than owner controlled firms to adopt accounting methods which increase reported earnings. This prediction is inconsistent with Famas hypothesis that the market for managerial talent will prevent management controlled firms from acting differently than owner controlled firms. This paper compares the depreciation methods used by a sample of management and owner controlled firms for financial reporting purposes. The comparison considers and controls for the factors of firm size, leverage, and the depreciation method used for tax reporting purposes. The comparison reveals that there is a significant difference in the depreciation methods adopted by management controlled and owner controlled firms for financial reporting purposes.

Audit Committee Financial Expertise, Corporate Governance and Accruals Quality: An Empirical Analysis

Following the enactment of the Sarbanes Oxley Act 2002, US stock exchanges strongly advocate the presence of financial experts on audit committees. However, the ideal definition of financial expertise proves to be a controversial issue culminating with the stock exchanges adopting a wide scoped definition of financial expertise. Using this definition, prior studies have not provided consistent evidence of financial expertise positively influencing audit committee effectiveness. We investigate the association between three types of audit committee financial expertise (accounting, finance and supervisory expertise) and accruals quality. We find significant positive relation between accounting expertise and accruals quality, which is more pronounced in the presence of strong audit committee governance. The findings indicate that the current definition of financial expertise is too broad and any future refinements must focus on accounting expertise of the audit committee members.

Is a dividend tax penalty incorporated into the return on a firm's common stock?

We find that a firms dividend yield has a positive impact on its common stock return that is decreasing in the level of institutional and corporate ownership, our indicator of whether the marginal investor in a firms common stock is more likely to be a low-tax or a high-tax investor. These results suggest that 1) a dividend tax penalty is incorporated into the return on a firms common stock and 2) both a firms dividend policy and its ownership structure impact the size of the dividend tax penalty.

The effect of book income adjustment in the 1986 alternative minimum tax on corporate financial reporting

Abstract This study examines the effect of the book income adjustment provision in the 1986 alternative minimum tax ( AMT ) on financial accounting practices. A model is developed to identify firms that are more susceptible to the book income adjustment. The changes in financial accounting practices for firms affected by the AMT are then examined. Our results indicate that firms that are likely to be affected by the book income adjustment shift timing and permanent differences across years to reduce the impact of the AMT .

The Taxable And Book Income Motivations For A Lifo Layer Liquidation

This study examines the potential determinants of LIFO liquidations using a multivariate tobit model.1 Unlike the univariate analysis used in prior LIFO liquidation studies (e.g., Davis, Kahn, and Rozen [1984] and Tse [1990]), our multivariate analysis takes into account both the correlations among these potential determinants and the magnitude of LIFO liquidations. Simple correlation analysis indicates that the sales changes and earnings changes of LIFO liquidation firms are highly correlated. Thus, while univariate support for both the declining-sales and declining-earnings explanations of LIFO liquidations could indicate that both explanations are correct, it could also be the case that support for either explanation stems from the high correlation between sales changes and earnings changes. Our multivariate approach helps avoid such ambiguities in interpretation and supports two conclusions. First,

Demand for Audit Quality: The Case of Laventhol and Horwath’s Auditees

This study investigates the demand for audit quality for the firms being audited by Laventhol and Horwath (LH) at the time LH declared bankruptcy. The demand for audit quality by the former LH clients is inferred from their decisions to select Big Six or non–Big Six auditors. Because the change in auditors was involuntary, the sample avoids self-selection issues associated with voluntary auditor switches. LH clients that selected Big Six auditors tended to be more highly leveraged, have less management ownership, and issue more securities in the year after selecting the new auditor than LH clients that selected non–Big Six auditors.

The Impact of Operating Leases on Firm Financial and Operating Risk

This study uses ex ante cost-of-equity capital measures based on accounting valuation models to assess the risk relevance of off-balance sheet operating leases. We investigate whether off-balance sheet operating leases have the same risk-relevance for explaining ex ante measures of risk as a firm’s on-balance sheet capital leases. We also investigate how investors’ risk perception of operating leases has changed in recent years when off-balance sheet transactions in general and operating leases in particular have been facing increased regulatory and investor scrutiny. This study finds that a firm’s ex ante cost-of-equity capital is positively associated with adjustments in its financial leverage (financial risk) and operating leverage (operating risk) resulting from capitalized off-balance sheet operating leases and that the positive association between the ex ante cost of capital and the impact of operating leases on a firm’s financial leverage is weaker for the operating leases compared with the capital leases. This study also finds that the positive association between the ex ante cost of capital and the impact of operating leases on a firm’s financial leverage has decreased considerably in recent years, since regulators issued interpretation letters clarifying controversial lease accounting issues.

Management Influence on Auditor Selection and Subsequent Impairments of Auditor Independence During the Post-SOX Period

This study investigates the influence of management over auditor selection decisions during a period in which audit committees have “direct responsibility” for auditor selection. We find that contrary to the intent of SOX, management continues to have significant influence over auditor selection and this is not mitigated by the presence of an apparently higher quality audit committee. As SOX presumes that management influence over auditor selection leads to negative outcomes, we also examine the impact that management influence has on proxies for subsequent auditor independence during the post-SOX period. We find that companies whose managers influence auditor selection are significantly less likely to receive going concern opinions, but no evidence of an impact on earnings management. We also find mixed evidence as to whether the relationship between management influence over auditor selection and subsequent audit quality is influenced by audit committee quality.