Jeff Zeyun Chen

Changes in Cash: Persistence and Pricing Implications

This paper decomposes the cash component of earnings and analyzes persistence characteristics and pricing implications of various subcomponents, with particular attention on changes in cash. Changes in underlying fundamentals might dictate changes in cash to new optimal levels. Alternatively, suboptimal changes in cash might result from agency costs allowing managers’ actions to diverge from the best interests of shareholders. We predict and find that both suboptimal increases and decreases in cash bode poorly for future earnings. In fact, we find that suboptimal increases (decreases) in cash have less (greater) persistence than any of the earnings components we study, including accruals and net distributions to both shareholders and debt holders. Market efficiency tests indicate that the market severely punishes firms with suboptimal decreases in cash, but we find no evidence to support the hubris hypothesis that the market overreacts to the earnings implications of unwarranted increases in cash.

Changes in Cash: Persistence and Pricing Implications: CHANGES IN CASH

This paper decomposes the cash component of earnings and analyzes persistence characteristics and pricing implications of various subcomponents, with particular attention to changes in cash. Changes in underlying fundamentals might dictate changes in cash to new optimal levels. Alternatively, suboptimal changes in cash might result from agency costs allowing managers’ actions to diverge from the best interests of shareholders. We predict and find that both suboptimal increases and decreases in cash bode poorly for future earnings. In fact, we find that suboptimal increases (decreases) in cash have less (greater) persistence than any of the earnings components we study, including accruals and net distributions to both shareholders and debt holders. Market efficiency tests indicate that the market severely punishes firms with suboptimal decreases in cash, but we find no evidence to support the hubris hypothesis that the market overreacts to the earnings implications of unwarranted increases in cash.

Approaching Research Broadly, Not Just Deeply: The Case of Real Activities Manipulation

Abstract This commentary discusses how self-identification of accounting researchers by specific subfields (e.g., financial, managerial, audit, tax, systems, and non-profit/governmental) and further, by research method (e.g., archival, experimental, and analytical), limits the scope and potential insights that we can glean from our research. Using the example of research in Real Activities Management (RAM), we illustrate how extending enquiry beyond the boundaries of a narrow research identity can broaden the types of research questions we ask and what we learn from conducting our research. We start with financial accounting research that has documented the existence of RAM and its relation to accrual-based earnings management and then summarize research on the consequences of RAM. We next explore studies outside of the traditional financial accounting setting that have examined similar issues and discuss how incorporating insights from these studies can broaden the enquiry and enhance the contribution of this stream of literature. We conclude by providing an example of where this broader approach has been successfully applied, resulting in new and interesting insights into managerial behavior.

When Are Outside Directors More Effective Monitors? Evidence From Real Activities Manipulation:

A large body of the corporate governance literature examines the disciplinary role of outside directors in overseeing the CEO. Although it is certainly a critical factor in effective monitoring, independence alone is not sufficient. Fulfilling the monitoring role also requires a skilled and knowledgeable board (Acharya, Myers, & Rajan, 2011; Adams & Ferreira 2007; Raheja, 2005). The skills and knowledge needed for monitoring vary with the type of CEO activity being monitored. For certain managerial actions that require sufficient firm-specific knowledge and expertise to exercise discipline, board informedness could be at least as critical as board independence. Given the trade-off between informedness and independence, outside directors are not necessarily better monitors than inside directors due to information disadvantages. In this study, we examine whether and to what extent an independent board constrains the CEO from taking real actions to manage financial performance. We refer to real earnings management as the CEO’s purposeful intervention in normal business practice in an effort to influence the output of the accounting system (Gunny, 2010; Roychowdhury, 2006). Relative to accrual-based earnings management, real earnings management is inherently more difficult to detect and requires more firm-specific information to understand because it can involve any real decision that deviates from normal business practice (Cohen, Dey, & Lys, 2008; Lo, 2008). Lo (2008) compares the two earnings management methods and concludes that

Accounting Quality, Liquidity Risk, and Post-Earnings-Announcement Drift

Recent microstructure research finds that liquidity risk, in particular its information component, plays an important role in explaining the post-earnings-announcement drift (PEAD). We decompose liquidity risk into an accounting-associated component and a nonaccounting-associated component and examine their relative importance in explaining PEAD. Our research is motivated by recent findings that liquidity risk is a systematic risk and earnings quality is negatively associated with liquidity risk. We find that the accounting-associated component is more strongly related to PEAD returns than is its nonaccounting-associated counterpart. Further analyses reveal that the relation between accounting-associated liquidity risk and PEAD returns is weaker for firms with greater analyst following. We also find that in a significant market downturn, the relation between accounting-associated liquidity risk and PEAD returns becomes more pronounced. Our study is the first to document a liquidity risk-based role of accounting quality in explaining the PEAD phenomenon. It parses out the PEAD risk premia associated with accounting versus nonaccounting sources and, by so doing, sheds light on the role of accounting quality in shaping the liquidity risk-PEAD returns relation. This article is protected by copyright. All rights reserved.

Information Processing Costs and Corporate Tax Aggressiveness: Evidence from the SEC's XBRL Mandate

Using the SEC’s XBRL mandate as a natural experiment, this study investigates the causal impact of XBRL-induced reduction in information processing costs on corporate tax avoidance. Motivated by the recent debate in the U.S. Congress over the cost-benefit of mandatory XBRL adoption for small-cap firms, our analysis focuses on small firms with relatively high information frictions. We predict and find that XBRL adoption leads to a significant decrease in tax avoidance in the post-adoption period for our sample of small firms. We also predict and find that the effect of XBRL reporting on tax avoidance is more pronounced for firms with higher information asymmetries and with less competition over information among outside stakeholders. Overall, our results suggest that XBRL-induced reduction in information processing costs to outside stakeholders leads to a significant change in the cost and benefit of tax avoidance and this change differs across firms with different information environments.

Financial Analysts’ Long-Term Growth Forecasts and Market Efficiency with Respect to Firms’ Innovative Efficiency

Prior research finds that investors have difficulty pricing corporate innovation. This paper investigates the role of long-term growth forecasting financial analysts in the efficiency of stock prices and consensus sell-side analyst forecasts, with respect to information about firms’ innovative efficiency (IE). We find that, on average, like stock prices, financial analysts’ consensus earnings and target price forecasts reflect underreaction to IE-related information. We also find that evidence of analyst and investor underreaction is limited to R&D-intensive firms not followed by long-term growth forecasting analysts. We investigate two alternative perspectives on the mechanism underlying these results. The underreaction-mitigation perspective argues that long-term growth forecasting analysts cultivate increased analyst and investor attention to IE-related information and its implications for research-intensive firms’ near- and long-term prospects; thereby, mitigating underreaction in stock prices and in consensus analysts’ earnings and target price forecasts. The offsetting-bias perspective argues that optimistically biased long-term growth forecasts beget optimism in stock prices and consensus analysts’ forecasts, which, in turn, offsets investor and analyst underreaction giving the appearance of underreaction dissipation for firms followed by long-term growth forecasting analysts. Overall, the weight of the evidence from a battery of tests favors the underreaction-mitigation perspective.