Edward Jones

Profit Measurement and UK Accounting Standards: A Case of Increasing Disharmony in Relation to US GAAP and IASs

UK accounting practice differs from International Accounting Standards (IASs) particularly with regard to amortisation of goodwill, provision for deferred taxation and the accounting treatment of pension costs. Under the core standards programme of the IASC the IASs have emerged closer to US practice. This paper evaluates the profit of those UK companies reporting to the Securities and Exchange Commission (SEC) in 1988 and 1994, spanning a period which saw the establishment of the ASB and the implementation of the IASCs comparability project. An increasing gap was found between the reported profit under UK accounting principles and that restated under US GAAP. The difference lay most frequently in accounting for goodwill, provision for deferred tax, and the accounting treatment of pension costs, with accounting for goodwill showing a particularly significant impact in 1994. Notwithstanding the introduction of FRS 10, an overall impression of increasing disharmony could continue to cause reconciliations to be required of UK companies seeking full listing on a US stock exchange, with consequent disadvantage relative to companies in other European countries seeking international capital in the US.

Measuring Growth Opportunities

Although the impact of growth opportunities on company value has been recognized since Miller and Modigliani (1961), relatively little empirical work has been undertaken to value growth opportunities. In this study the validity of the KBM model (Kester (1984) and Brealey and Myers (1981)) is tested on a sample of 278 large UK companies for 1987–1995. Applying standard assumptions, the value of growth opportunities is found to account for a larger proportion of market values than assets-in-place. However, tests of the KBM model cast doubt on the credibility of these results and the validity of the model. The KBM model is highly sensitive to the inclusion of inflation in the risk free interest rate, and with a real interest rate (which on theoretical grounds is preferable), the model ceases to provide credible results. The model also fails to provide results consistent with expectations derived from option pricing theory regarding the relationship between the value of growth opportunities and the value of assets-in-place. These limitations of the KBM model indicate a need for a reappraisal of the method of measuring the value of growth opportunities.

Empirical evidence on the determinants of the stock market reaction to product and market diversification announcements

The announcement of product and market diversification projects lead to significant abnormal returns of 1.1%. However, the gains are higher for new products than for new markets, and for companies with high price-earnings ratios and low (or zero) dividend yields.

R&D Project Announcements and the Impact of Ownership Structure

This paper examines the stock market reaction to research and development (R&D) announcements made by listed UK companies. R&D projects on average are found to be associated with significant positive abnormal returns. However, the level of these abnormal returns varies significantly with the ownership structure of the firm. In particular, it is found that the level of abnormal returns are significantly lower for companies with large institutional investors. This negative relationship may be associated with short-term pressures on the performance of institutional investors.

Disclosure by Indian companies following corporate governance reform

Purpose - – The purpose of this paper is to investigate Indian companies’ compliance with the mandatory and voluntary corporate governance disclosure requirements of the Stock Exchange Board of India’s Clause 49. Design/methodology/approach - – The authors develop a corporate governance disclosure index and sub-indices based on Clause 49. Annual reports of listed Indian companies are scored according to their disclosures in two periods – pre and post amendments to Clause 49. Findings - – Indian companies are highly compliant with corporate governance disclosure requirements of Clause 49. Disclosure increases significantly after amendments to Clause 49 as the penalties for non-compliance increase in severity. Government controlled firms disclose significantly less than privately owned firms. Research limitations/implications - – The findings are consistent with bonding theory and the authors note that the presence of an independent regulator (with powers to take action against violators) provides corporate India with additional incentives to comply with corporate governance reform. Practical implications - – These findings have important implications for policy makers and regulators as they contribute to the debate on the choice between formal corporate governance regulation versus informal self-regulation. The study also has implications for understanding factors associated with the adoption of disclosure practices in general. Originality/value - – This is the first study to examine disclosure compliance in a major developing country pre and post amendments to mandatory corporate governance requirements. Prior evidence indicates a low level of disclosure in India but our results demonstrate an improvement in line with our theoretical predictions that suggests, India is converging towards an Anglo-Saxon model of corporate governance.

Joint Venture Investments and the Market Value of the Firm

The impact of Joint Venture announcements on the market value of UK listed companies is examined. Based on a sample of 158 announcements of either joint venture formation or joint venture activities, significant positive market-adjusted abnormal returns of 0.5% on the announcement date are observed. Cross-sectional analysis reveals that abnormal returns are significantly lower when undertaken by large companies, or where the project is located in Asia. On the other hand, market-adjusted returns are found to be significantly higher when the project is large compared to the size of the company undertaking the investment, and where the project is either domestic or located within the European Union.

The growth companies puzzle: can growth opportunities measures predict firm growth?

While numerous empirical studies include proxies for growth opportunities in their analyses, there is limited evidence as to the validity of the various growth proxies used. Based on a sample of 1942 firm-years for listed UK companies over the 1990–2004 period, we assess the performance of eight growth opportunities measures. Our results show that while all the growth measures show some ability to predict growth in company sales, total assets, or equity, there are substantial differences between the various models. In particular, Tobins Q performs poorly while dividend-based measures generally perform best. However, none of the measures has any success in predicting earnings per share growth, even when controlling for mean reversion and other time-series patterns in earnings. We term this the ‘growth companies puzzle’. Growth companies do grow, but they do not grow in the key dimension (earnings) theory predicts. Whether the failure of ‘growth companies’ to deliver superior earnings growth is attributable to increased competition, poor investments, or behavioural biases, it is still a puzzle why growth companies on average fail to deliver superior earnings growth.

The Stock Market Reaction to Changes to Credit Ratings of US-Listed Banks

In this paper we provide empirical evidence of abnormal returns associated with credit rating changes for a sample of 264 credit ratings announcements by 43 international and US banks between 2000 and 2012. The banks in the sample have either a primary or secondary US listing. We provide evidence using four models for estimating expected returns including the Fama-French Three-Factor model (1992). We find short-term negative abnormal returns are exhibited to downgrades and positive post-announcement abnormal returns are exhibited to both upgrades and downgrades. Cumulative abnormal returns exhibit a positive trajectory following an upgrade announcement whilst cumulative average abnormal returns to downgrades return almost to zero over our event window. In contrast to previous studies, we identify that concurrent announcements impact significantly on reported abnormal returns using our four models and hence we present our results after removal of contaminating effects. Whilst we are hampered by small subsamples in our test data, we are able to identify a significant difference between our subsamples for unanticipated and anticipated ratings announcements. We also provide evidence that US domestic banks experience significantly larger negative abnormal returns to downgrades than international banks listed in the US, which we attribute to the greater impact of a rating change of a US bank on the rest of the local economy. Finally, we report abnormal returns and significance for pre- and post- financial crisis samples, simultaneous and long-term only rating announcements, ratings within and across investment classes, and ratings which cross the investment grade line.

Shareholders and managers as principal-agent hierarchies and cooperative teams

Purpose - Shareholders and managers can work in a hierarchy in which principals attempt to control the actions of agents to achieve the wealth objective. Alternatively, shareholders and managers can work together as a cooperative team in which shareholders provide financial capital and managers provide human capital. We examine the different implications for value creation provided by the two approaches. Design/methodology/approach - By comparing the literature on the value implications of the incomplete contracting framework and control arrangements in principal-agent hierarchies, we identify deviations from optimal outcomes and suggest solutions. Findings - Our review indicates that a cooperative framework has some advantages over the hierarchical model. The stability of human capital and the relationship between managers and shareholders can be enhanced when shareholders provide capital in increments which vest over time, and latitude for renegotiation of agreements is built into contracts. Practical implications - By surrendering control using stock options programmes, managers are free to invest in relationship-specific assets. Shareholders can control the provision of capital by withdrawing investment if insufficient returns are realised i.e. if stock options do not meet vesting requirements. The market can then be left to do its work. Originality/value - This paper provides an original review of literature on cooperation and hierarchies in the shareholder-manager relationship and proposes solutions to identified deviations from optimal outcomes.

Wealth effects to bidding companies from regulatory interventions in the UK

Using a sample of 186 referrals between 1965 and 2006, we analyse the abnormal returns experienced by UK bidding companies when a decision is made by UK regulators to refer a merger or acquisition for inquiry and when the decision is published by the regulator. We find evidence of disagreement between the regulator and stock valuations as to the expected outcome of the merger or acquisition.