Joanna Shuang Wu

Accounting standards, the institutional environment and issuer incentives: Effect on timely loss recognition in China

Abstract Accounting income of Chinese companies reporting under both domestic ASBE accounting standards and International Accounting Standards (“IAS”) is shown to lack timely incorporation of economic losses. This is less surprising for ASBE-compliant income, because although ASBE standards are based on IAS, they lack important asymmetric rules, such as lower-of-cost-or-market, and impairment of long-term assets. More striking is the absence of timely loss incorporation in financial statements certified by international auditors as IAS-compliant. IAS resemble common-law standards and are widely believed to increase financial reporting quality. The timely incorporation of losses has become perhaps the single most important feature of income reporting under common law (Basu (1997), Ball, Kothari and Robin (2000)). We attribute the result to the comparatively low incentive of managers and auditors to recognise economic losses in a timely fashion and, conversely, to comparatively high political and tax influences on financial reporting practices. Our results imply that financial reporting cannot be improved simply by governments mandating accounting standards that evolved endogenously in different economies. The most fruitful area for Chinese accounting reform lies not in simply adopting or imitating international accounting standards, but in reforming domestic institutions such as the legal system, corporate governance and auditor training and independence.

What Determine Financial Analysts' Career Outcomes During Mergers?

We investigate the effects of mergers on the career outcomes of financial analysts. We hypothesize and find that analysts with good earnings forecast performance experience higher turnover during mergers, target analysts are more likely to turnover and the existence of a competing analyst in a merger counter party also increases analyst turnover. We analyze the promotion of analysts to research executive positions and find that analysts with greater experience and especially experienced stars are more likely to be promoted. Finally, we document that analyst turnover is associated with decreases in research quality at the merged firms post-merger.

The Adoption of Internationally Recognized Accounting Standards Implications for the Credit Markets

We examine whether the adoption of internationally recognized accounting standards is associated with a greater sensitivity of credit ratings to accounting information. We find that credit ratings are significantly more sensitive to the accounting default factor post voluntary International Financial Reporting Standards (IFRS)/U.S. Generally Accepted Accounting Principle (GAAP) adoption. Similar evidence is also found post mandatory IFRS adoption in countries with strong rules of law. Collectively, the above evidence suggests that firms’ incentives to comply are important in determining the consequences of accounting standard changes.

Soft-Talk Management Cash Flow Forecasts: Bias, Quality, and Stock Price Effects

We exploit a novel feature of management cash flow forecasts (MCFFs) to investigate how managers’ discretion over forecast precision, clarity, and verifiability affects the bias, quality, and stock price effects of such forecasts. Many MCFFs are issued with an equivocal definition of the cash flow number being forecasted. We refer to such forecasts as “Soft-Talk” MCFFs and predict, due to their lower precision and clarity, potential for bias, and low ex-post verifiability, that they will have lower disclosure quality and lower credibility with investors when compared to “GAAP-Based” MCFFs. “GAAP-Based” MCFFs are those whose cash flow definition is associated with a GAAP cash flow measure (e.g., OCF or NCF), one that can be derived from GAAP cash flow measures (e.g., free cash flow, FCF), or one where management explicitly discloses the definition of cash flow. We find that “Soft-Talk” MCFFs are optimistically biased and that managers’ decision to issue “Soft-Talk” MCFFs is related to economic factors including litigation risk, actual cash flow performance, industry concentration, and the issuance of prior cash flow forecasts. As predicted, “Soft-Talk” MCFFs have lower disclosure quality than “GAAP-Based” MCFFs. Finally, while MCFFs in general affect stock prices, consistent with the low precision and clarity, and potential for optimistic bias in “Soft-Talk” MCFFs, they have no effect on stock prices. Our findings document how and why managers’ discretion over forecast precision, clarity, and verifiability affects the bias, quality, and stock price effects of such forecasts.

Heterogeneity in Firm Underlying Economics and Abnormal Accrual Models

Basic economics challenge the specification of discretionary accrual models. Since rent seeking firms pursue differentiated business strategies, firms in the same industry have heterogeneous accrual generating processes. Moreover, technological innovation, regulatory changes, and entry of new firms force existing firms to revise their extant business models. We present evidence that such business model shocks are widespread, propagate through several years of financial statements, reduce accrual models’ goodness of fit, and result in unrealistically large unsigned “abnormal” accruals. Further, there is a spillover effect among firms in the same industry in that one firm’s abnormal accrual is affected by business model shocks experienced by the other firms in the industry. We show that business model shocks not only add noise to abnormal accruals, but can also introduce biases into both unsigned and signed discretionary accruals. Our results suggest that removing observations contaminated by business model shocks leads to better specified accrual models, and reduces both Type I and Type II errors in tests of earnings management. We gratefully acknowledge the financial support provided by the Simon School at the University of Rochester and the comments from Dan Amiram, Dan Collins, Mark Evans, Wayne Guay, Shane Heitzman, Robert Resutek, Jerry Warner, Charles Wasley and seminar participants at Dartmouth University, University of Rochester, the MIT Asia Conference in Accounting, and Penn State Accounting Research Conference.Economics challenge the specification of discretionary accrual models. Since rent-seeking firms pursue differentiated business strategies, firms in the same industry have heterogeneous economic fundamentals and hence different accrual generating processes. Business model shocks amplify a firm’s underlying economic heterogeneity and thereby exacerbate accrual model misspecification. We present evidence that business model shocks are widespread, propagate through multiple years of financial statements, and reduce accrual models’ goodness of fit. This not only affects abnormal accrual estimates for the firm experiencing shocks, but also affects measurement of abnormal accruals for other firms in the industry. We show that underlying economic heterogeneity not only adds noise to abnormal accruals, but can also exacerbate bias in both unsigned and signed abnormal accruals. We propose ways to reduce accrual model misspecification.

Voluntary IAS and U.S. GAAP Adoption by Continental European Firms: The Role of Labor Relations

We investigate the decision by a sample of Continental European firms to voluntarily adopt the International Accounting Standards (IAS) or U.S. GAAP. The strong employment protection laws in Continental Europe lead to labor practices that lack responsiveness to firm underlying economic performance. We argue that by switching to IAS/U.S. GAAP, a Continental European company can more credibly communicate with its labor force, and/or a potential third party (e.g. a government labor office, an arbitrator, or a labor court judge in the case of labor disputes), the true economic conditions of the firm and potentially reduce the costs associated with labor force adjustments. We expect the costs of rigid labor practices, thus the potential benefits of switching to IAS/U.S. GAAP, to be particularly high for firms with low labor productivity. Therefore, we predict that 1) firms with low labor productivity are more likely to adopt IAS/U.S. GAAP after controlling for other factors potentially affecting the adoption decision; 2) firms adopting IAS/U.S. GAAP and with low labor productivity report lower earnings than before the adoption and the earnings change is more negative than for similar non-adopting firms; 3) firms adopting IAS/U.S. GAAP and with low labor productivity are more likely to reduce labor forces than before the adoption and the reduction in labor forces is more pronounced than for similar non-adopting firms. Our results are consistent with these predictions.

Discussion of “Will Harmonizing Accounting Standards Really Harmonize Accounting? Evidence from Non-U.S. Firms Adopting U.S. GAAP”

Bradshaw and Miller (2007) study a sample of non-U.S. firms that voluntarily adopted U.S. Generally Accepted Accounting Principles (GAAP) during the period from 1980 to 2001. They document that the voluntary U.S. GAAP adopters move significantly closer to U.S. firms in terms of compliance with U.S. GAAP and various accounting earnings properties, although they have not fully converged with U.S. firms. This paper is an interesting and comprehensive study of voluntary U.S. GAAP adopters. The papers research setting, however, limits its ability to address the question raised in its title.

Is Silence Golden? Real Effects of Mandatory Disclosure

Mandatory disclosure provides benefits, but it also entails costs. One cost concerns managerial learning: by discouraging informed trading, disclosure could reduce managers’ ability to glean decision-relevant information from prices. Using mandatory segment reporting in the United States, we uncover a reduction in investment-

Good Buffer, Bad Buffer

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Earnings Forecast Performance and Financial Analyst Turnover During Mergers

sensitivity, indicating lower investment efficiency after regulation. Consistent with learning, lower sensitivity is concentrated in firms with more informed trading and lower financing constraints. Constrained firms exhibit no change in investment-