John Forker

Earnings Management in English NHS Hospital Trusts

In this paper we review the financial reporting incentives associated with the requirement to breakeven for English NHS Trusts. We also investigate the distribution of reported income and estimate discretionary accruals thereby contributing to the limited literature on earnings management in not-for-profit hospitals. We find that Trust managers use discretion over accruals to report income within the target range around zero. The results are robust to recent challenges to earnings management explanations arising from the use of distributional and aggregate accruals methodologies. Our findings indicate that a precise and challenging financial breakeven target based on current cost residual income is associated with wide-spread use of discretionary accruals to an extent that weakens the accountability of NHS Trusts.

The Governance of CEO Incentives in English NHS Hospital Trusts

Institutional arrangements for the governance of CEO pay and turnover in English NHS Hospital Trusts replicate best practice for listed companies but with the additional feature of centrally imposed performance measurement. In this paper we investigate the impact of this unique combination of incentives on the relationship between CEO pay/turnover and Trust financial and operating performance in the period 1998–2005. We identify a strong association between poor Trust performance and CEO turnover but find little evidence that remuneration committees relate pay to performance in the best performing Trusts. Our findings raise questions about the economic rationale for remuneration committees in the governance of NHS Hospital Trusts.

A Comparison of Error Rates for EVA, Residual Income, GAAP-Earnings, and Other Metrics Using a Long-Window Valuation Approach

Predictability and variability are two measures commonly used in the empirical literature to gauge the quality of earnings and hence, decision usefulness to investors. We adopt both measures to investigate empirically the relative quality of Stern Stewarts measure of economic value added (EVA) compared to GAAP (generally accepted accounting principles) earnings, residual income, cash flows and other mandated metrics in the USA and UK. We proxy for accounting quality by applying a long-window methodology to obtain hindsight valuation errors based on the difference between ex ante market value and discounted ex post metrics. Decision usefulness, in terms of ease of forecasting, is proxied by differences in valuation errors between the benchmark and alternative accounting methods. Contrary to the Biddle et al. (Journal of Accounting and Economics, 24, pp. 301–336, 1997) finding that mandated earnings were superior to EVA and residual income, we find that EVA and other residual income metrics consistently give rise to lower average valuation errors and thus have higher predictability across a variety of windows and terminal dates. Further, on the basis of our second measure of accounting quality, the variability of valuation errors, EVA performs best in the USA and third in the UK. The results strongly indicate that differences between residual income constructs, including EVA, are generally small but that earnings quality will be improved by recognition of a cost of equity capital in measuring reported income.

European harmonization and the true and fair view

In all financial statements the amount of flexibility which can be exercised in presentation is limited by accounting regulations, one of the purposes of which is to ensure comparability across firms. This has given rise to a debate within the UK and the EU as to the optimum balance between flexibility and comparability. This study uses the evolution of UK accounting policy for long-term contracts as a vehicle for investigating the role of the true and fair view (TFV) in the develop-ment of this debate. Within the context of EU harmonization insight is also obtained into the consequences of using accounting bases for assessing tax liab-ilities. The role of TFV in UK accounting is assessed by analysis of the Accounting Standards Committee (ASC) Archive and the responses to ASC exposure drafts. Net costs of compliance with regulated requirements are identi-fied and the ranking obtained is used to test the sensitivity of compliance by com-panies during 1981-90 to changes in the costs of compliance, particularly with regard to differing interpretations of EU requirements by the ASC and the Department of Trade and Industry. The findings are that, contrary to a widely held view, the TFV plays a central role in shaping UK accounting policy by pre-serving the traditional flexibility in the application of accounting conventions. It is concluded that a shift to a narrow application of the TFV in exceptional cir-cumstances is now appropriate and that the task of accounting regulators, and the path towards harmonization, will be eased if accounting bases for recognition of income are not used for tax purposes.

Management Models and Priorities in Member Associations Is Credit Unions’ Community Involvement Crowded-Out?

Credit unions are membership-based cooperative financial services organizations that are run by and for their members. Historically, credit unions provided financial services for their members and encouraged community development through philanthropy and volunteering. The World Council of Credit Unions (WOCCU), the sector’s global trade association and development agency, encourages the adoption of a management model, coined “new model,” which encourages for-profit financial management practices. The “new model” approach is challenged by some practitioners and academics concerned that it will diminish the community involvement of credit unions. We explore the following research question: “Does the implementation of a management model that promotes for-profit-style financial management crowd out the community impact of credit unions?” We use a dataset extracted from 2,275 annual returns for 188 credit unions spanning 1996-2008, and find no evidence that community impact diminishes as a result of “new model” operating practices, suggesting a crowding-out effect is absent.

The market response to information quality shocks: the case of Enron

Relying on the market to provide incentives that would bring about optimal information quality is potentially a cost effective alternative to regulatory oversight. However, this depends on the ability of the market to recognize and price this attribute. In this article, we gain insights into the disciplinary role of the market by examining its response to Enron-related accounting scandals. We report evidence that information quality was in decline, leading upto the Enron-related scandals, but that the market was not sensitive to this decline. We confirm, however, that there was an abrupt decline in perceived information quality post-Enron. Furthermore, using an ex-ante methodology we provide strong evidence that auditor reputations were differentially affected by the scandals. We also find evidence that the Enron-related scandals adversely affected the market risk premium implying that information quality is part of systematic risk. Our results indicate that the market was operating effectively in recognizing lower quality information through an auditor reputation effect prior to the Sarbanes-Oxley Act. This calls into question the need for regulation to address the perceived deficit in information quality.