Eli Bartov

Private Information, Earnings Manipulations, and Executive Stock Option Exercises

This paper investigates the decision by top-level executives of more than 1,200public corporations to exercise large stock option awards in the period 1992-2001. Wehypothesize and find that abnormally large option exercises predict stock return futureperformance. We then hypothesize that this predictive ability represents private information about disappointing earnings in the post-exercise period. Consistent with this hypothesis we find that abnormally positive earnings performance in the pre-exercise period turns to disappointingearnings performance in the post-exercise period, and that this pattern comes as a surprise to even sophisticated market participants (financial analysts). We also hypothesize and find that the disappointing earnings in the post-exercise period represent a reversal of inflated earnings in the pre-exercise period. Collectively, these findings suggest that the private information used by top-level executives to time abnormally large exercises follows from earnings management so as to increase the cash payout of exercises.

Exchange Rate Variability and the Riskiness of U.S. Multinational Firms: Evidence from the Breakdown of the Bretton Woods System

This study assesses the impact of exchange rate variability on the riskiness of U.S. multinational firms by examining the relation between exchange rate variability and stock return volatility and by decomposing this relation into components of systematic and diversifiable risk. Focusing on two periods around the 1973 switch from fixed to floating exchange rates, we find a significant increase in the volatility of U.S. multinational monthly stock returns corresponding to the period of increased exchange rate variability. This increase in stock return volatility is also significant relative to the increase in stock return volatility for firms in three control samples. Using a single factor market model, we show this increase in total volatility led to a significant increase in market risk (beta) for the multinational firms relative to the control samples between the two periods. Collectively, these results suggest that the increase in exchange rate variability after 1973 was perceived by investors to be associated with an increase in the riskiness of cash flows of multinational firms that required compensation in terms of higher expected returns.

The 'Numbers Game' in The Pre-and Post-Sarbanes-Oxley Eras

We document a decline in the frequency of just meeting/beating analysts’ earnings expectations in the aftermath of the 2001-2002 accounting scandals and the passage of the 2002 Sarbanes-Oxley Act (SOX). The primary purpose of this study is to explain this observed pattern. We hypothesize and provide empirical evidence that the drop in the frequency of just meeting/beating is associated with both (1) a decline in the use of downward earnings expectations management and upward accrual-based earning management in the Post-SOX period relative to the preceding seven-year period and (2) an increase in upward real earnings management activities.

The Valuation‐relevance of Earnings and Cash Flows: an International Perspective

We investigate which variable, earnings or cash flows, provides greater information for equity valuation within the United States, the United Kingdom, Canada, Germany, and Japan. We regress returns on earnings and cash flow metrics. We generally find earnings developed in three Anglo-Saxon countries—where capital is traditionally raised in public markets and reporting rules are unencumbered by taxation requirements—to have greater explanatory power for stock returns than cash flow metrics. Conversely, in two non-Anglo-Saxon countries—where capital is traditionally raised from private sources—earnings are generally not superior to cash flows for equity valuation, except in Japan, non-consolidated sample. While sensitivity analyses generally support the conclusions of our primary tests, in some of the additional analyses, earnings were superior to cash flows for samples from all countries. As expected, in all countries earnings have incremental information content over cash flows in explaining returns. Collectively, our findings provide two contributions. First, we generalize the findings of prior US research by showing that earnings are more important than cash flows for equity valuation in other Anglo-Saxon countries. Second and more importantly, our findings demonstrate that the superiority of earnings over cash flows is not universal. Rather, it depends on the national reporting regime and attendant institutional factors.

The cheek-to-cheek diameter in the ultrasonographic assessment of fetal growth.

Deviations from normal growth modify the amounts of adipose tissue and muscle mass in the adult and the fetus. As an index of the amount of adipose tissue in the fetus, the cheek-to-cheek diameter obtained on an ultrasonographic coronal view of the face at the level of the nostrils and lips was evaluated. Two hundred thirty-four singleton uncomplicated, well-dated pregnancies ranging from 20 to 41 weeks were studied. Two hundred fetuses with biometric measurements or estimated weights between the 10th and 90th percentile for gestational age were included in obtaining a nomogram. Cheek-to-cheek diameter as a function of gestational age was expressed by the regression equation: Cheek-to-cheek diameter (centimeters) = -0.908 + 0.195 Gestational age (gestational age greater than or equal to 20 weeks), with a Pearson correlation coefficient of R2 = 0.806. The cheek-to-cheek diameter/biparietal diameter ratio was almost constant, independent of gestational age, and ranged from 0.6 at 20 weeks to 0.7 at 41 weeks. Fetuses with intrauterine growth retardation tended to have lower ratios. Macrosomic fetuses of diabetic mothers had larger cheek-to-cheek diameters and elevated ratios, whereas large-for-gestational-age fetuses of nondiabetic mothers had normal ratios.

Risk, Mispricing, and Value Investing

We evaluate the stock return performance of a modified version of the book-to-market strategy and its implications for market efficiency. If the previously documented superior stock return of the book-to-market strategy represents mispricing, its performance should be improved by excluding fairly valued firms with extreme book-to-market ratios. To attain this, we classify stocks as value or glamour on book-to-market ratios and accounting accruals jointly. This joint classification is likely to exclude stocks with extreme book-to-market ratios due to mismeasured accounting book values reflecting limitations underlying the accounting system. Using both 12-month buy-and-hold returns and earnings announcement returns, our results show that this joint classification generates substantially higher portfolio returns in the post-portfolio-formation year than the book-to-market classification alone with no evidence of increased risk. In addition, this superior stock return performance is more pronounced among firms held primarily by small (unsophisticated) investors and followed less closely by market participants (stock price <

The Earnings Event-Time Seasonal and the Calendar-Time Seasonal in Stock Returns: Naive Use of Earnings Information or Announcement Timing Effect?

10). Finally, and most importantly, financial analysts are overly optimistic (pessimistic) about earnings of glamour (value) stock, and for a subset of firms identified as overvalued by our strategy, the earnings announcement raw return, as well as abnormal return, is negative. These last results are particularly important because it is hard to envision a model consistent with rational investors holding risky stocks with predictable negative raw returns for a long period of time rather than holding fT-bills and with financial analysts systematically overestimating the earnings of these stocks while underestimating earnings of stocks that outperform the stock market.

Overbidding in Mergers and Acquisitions: The Unintended Accounting Effect

We document a pattern in the day-of-the-week timing of future earnings announcements that is predictable from knowledge of the current quarters earnings. The pattern mimics the predictable (+, +,0, -) dependence previously reported in both seasonally differenced quarterly earnings themselves and in estimated abnormal returns at future quarterly earnings announcement dates (the “SUE effect”; see Rendleman, Jones, and Latané [1987]; Bernard and Thomas [1990]). The predictability of abnormal returns at future earnings announcement dates therefore is not independent of the well-documented day-of-the-week seasonal in stock returns (the “DOW effect”; see Osborne [1962]; Cross [1973]; French [1980]; Gibbons and Hess [1981]). Although the DOW effect is too small to fully explain the SUE effect, it appears to contribute to it, since both past SUE and current earnings announcement DOW are incremental in explaining announcement-day estimated abnormal returns. The unclear role of size and the presence of errors in estimating both unexpected earnings and its announcement day suggest caution in interpreting these results.

The rewards to meeting or beating earnings expectations

Does accounting regime play a role in the well-documented phenomenon of overbidding in M&As? The 2001 regulatory change from a goodwill amortization to a non-amortization regime (SFAS 142) affords us a quasi-experimental setting for testing the consequences of M&A accounting rules for acquirers’ bidding decisions. Relying on a novel approach to modeling optimal bidding, our primary finding indicates a significant increase in overbidding in the post-2001 period, suggesting that M&A accounting has real consequences for bidding decisions, and that this result is robust to a battery of sensitivity tests. In addition, supplementary tests show that overbidding is more pronounced in pooling versus purchase transactions, and that the accounting regime’s implications for overbidding and acquisition premium are distinct. Overall, our findings shed light on the role accounting plays in shaping managerial decisions—and ultimately shareholder wealth—in an important corporate setting. They may thus inform researchers, corporate boards, and standards setters.