David S. Jenkins

Earnings Conservatism and Value Relevance Across the Business Cycle

Prior research has demonstrated higher value relevance of current earnings during economic expansions relative to contractions. We largely attribute such a result to expected growth prospects being captured in the current earnings coefficient when a direct proxy for expected future earnings is omitted from the returns-earnings model. We demonstrate that the conservatism and value relevance of current earnings is actually higher during economic contractions when including a proxy for future earnings expectations. We further demonstrate that the value-relevance of expected future earnings is higher during expansions, when the association between historical accounting information and future growth opportunities likely weakens. Copyright (c) 2009 The Authors Journal compilation (c) 2009 Blackwell Publishing Ltd.

Audit firm rotation and audit quality: evidence from academic research

Purpose - The purpose of this paper is to provide a succinct overview of academic research that has examined audit firm rotation both in the USA and in other countries. Design/methodology/approach - The authors outline the unresolved nature of academic research on audit firm rotation, review recent literature, discuss why academics have been unable to resolve this issue and offer suggestions for improving subsequent research in the area. Findings - Overall, the collective evidence is inconclusive at best; with earlier studies generally finding mixed results and more recent studies indicating that audit quality generally goes through two distinct phases during the auditor-client relationship, the “auditor learning” and “auditor closeness” phases. Originality/value - Given the importance of the issue, this article provides an overview of academic research that has examined audit firm rotation, discusses why academics have been unable to resolve this issue, and provides suggestions on how academics and practitioners can work together to enhance the quality of future research.

The Impact of Arbitrage Costs on Intertemporal Changes in the Earnings Response Coefficient

In this paper, we present a market-based explanation to the documented decline in the value relevance of earnings. Specifically, we argue that an increase in arbitrage costs in the markets has arguably caused an increased departure of stock price from fundamental value and in turn a decline in the returns-earnings relation over time. We first test and document that the presence of arbitrage costs indeed dampens the returns-earnings relation. Next, we find that, consistent with prior research, there has been a decline in the Earnings Response Coefficient (ERC) over time, however, the decline is insignificant after controlling for arbitrage costs.

THE EFFECT OF INSTITUTIONAL OWNERSHIP ON THE INFORMATIVENESS OF DISCRETIONARY ACCRUALS

We examine whether the pricing of discretionary accruals is associated with the level of institutional ownership. We posit that if institutional investors monitor their investment actively, then managers would be discouraged from using the discretion in U.S. GAAP to manage earnings and would be encouraged to convey private information which would translate into greater information content. As a sensitivity test, we also examine the relation between discretionary earnings and future earnings. We find that this association is positively related to the level of institutional ownership. Our results collectively support the notion that institutional investors actively monitor their investments and encourage managers to report informative accruals. Keyword: Institutional ownership, discretionary accruals, earnings management * University of Delaware, Department of Accounting and Management Information Systems, Newark, Delaware 19716 (302) 831-6823, e-mail: jenkinsd@lerner.udel.edu ** Corresponding Author: University of Delaware, Department of Accounting and Management Information Systems, Newark, Delaware 19716, (302) 831-1764, e-mail: veluryu@lerner.udel.edu

THE EFFECT OF INSTITUTIONAL OWNERSHIP ON THE REPORTING OF CONSERVATIVE EARNINGS

Given the spate of financial reporting scandals and enactment of the Sarbanes-Oxley Act of 2002 following the stock market crash of 1999, we examine the role of institutional monitoring as it pertains to reporting conservatism. Using the Basu (1997) asymmetric timeliness models, we examine the relation between institutional ownership and the conservatism of reported earnings, as defined by the asymmetric timeliness measures. Our results indicate that larger institutional holdings are associated with a decrease in earnings conservatism. We attribute these findings in part to the incentives of large institutional investors to capitalize on private information obtained through their role as corporate monitors. As such, it may be unlikely that large investors would not encourage the timely reporting of bad news.