K.R. Subramanyam

The Pricing of Discretionary Accruals

This paper examines if the market attaches value to discretionary accounting choices. Discretionary accruals are computed by using a cross-sectional variation of the Jones [1991] technique. The results of return association tests and tests using P/E ratios indicate that under the maintained hypothesis that the Jones technique is able to correctly decompose accruals into the discretionary and non- discretionary components the market attaches value to discretionary accruals. This is consistent with two alternative scenarios: (1) discretionary accounting choices arise from managerial opportunism and are value irrelevant and the pricing of discretionary accruals connotes market mispricing arising either because of functional fixation or information asymmetry (2) managers convey private information through discretionary accruals and the market properly prices them. Further tests are undertaken to investigate if management uses its discretion to improve the value relevance of earnings. There is evidence of pervasive income smoothing which improves the ability of reported earnings to approximate the long-term trend in profitability. There is also evidence that discretionary accruals predict future earnings/cash-flows individually and collectively with other components of income.

Do Non-audit Service Fees Impair Auditor Independence? Evidence from Going-concern Audit Opinions

We find no significant association between non–audit service fees and impaired auditor independence, where auditor independence is surrogated by auditors’ propensity to issue going concern audit opinions. We also find no association between going concern opinions and either total fees or audit fees. In addition, our findings are robust to controlling for unexpected fees, to controlling for endogeneity among our variables, and to several alternative research design specifications. Our results are consistent with market–based incentives, such as loss of reputation and litigation costs, dominating the expected benefits from compromising auditor independence.

Auditor changes and discretionary accruals

This paper examines accounting choice as reflected in the behavior of discretionary accruals for a sample of auditor change firms. Discretionary accruals are estimated around the time of the auditor change using a variation of the Jones (1991) technique. After controlling for several potentially confounding factors associated with auditor changes the paper finds that discretionary accruals are significantly income-decreasing during the last year with the predecessor auditor and not significantly different from zero during the first year with the successor auditor. In addition the difference in discretionary accruals between the last year with the predecessor and the first year with the successor is significantly income-increasing. The results also indicate there is no significant difference across sample partitions based on prior year audit opinions or Big Six membership of the predecessor and successor auditors.

Is comprehensive income superior to net income as a measure of firm performance?1

Abstract With the exception of financial firms, we find no evidence that comprehensive income is more strongly associated with returns/market value or better predicts future cash flows/income than net income. Moreover, the only component of comprehensive income that improves the association between income and returns is the marketable securities adjustment. Our results do not support the claim that comprehensive income is a better measure of firm performance than net income. Our results also raise questions about the appropriateness of items included in SFAS 130 comprehensive income as well as the need for mandating uniform comprehensive income disclosures for all industries.

Do Options Price Predictable Patterns in Future Stock Returns? Evidence from Accounting Anomalies

We examine whether option prices correct for predictable bias in stock prices associated with accounting anomalies. Evidence from put-call parity violations suggests that they do not. Rather, option prices accurately track contemporaneous stock prices. Further analysis suggests that high costs of trading options — implied volatility premiums and transaction costs — could prevent traders from exploiting these profit opportunities. However, we find some evidence of unexploited profit opportunities of significant magnitudes, even after transaction costs, for trading strategies that sell options. Our results suggest that option prices mechanically incorporate contemporaneous stock prices, and therefore reflect the exact forms of mispricing present in stock prices.