Martin Walker

Incentives or Standards: What Determines Accounting Quality Changes around IFRS Adoption?

Abstract We examine the impact of managerial financial reporting incentives on accounting quality changes around International Financial Reporting Standards (IFRS) adoption. A novel feature of our single-country setting based on Germany is that voluntary IFRS adoption was allowed and common before IFRS became mandatory. We exploit the revealed preferences in the choice to (not) adopt IFRS voluntarily to determine whether the management of individual firms had incentives to adopt IFRS. For comparability with previous studies, we assess accounting quality through multiple constructs such as earnings management, timely loss recognition, and value relevance. While most existing literature documents accounting quality improvements following IFRS adoption, we find that improvements are confined to firms with incentives to adopt, that is, voluntary adopters. We also find that firms that resist IFRS adoption have closer connections with banks and inside shareholders, consistent with lower incentives for more comprehensive accounting standards. The overall results indicate that reporting incentives dominate accounting standards in determining accounting quality. We conclude that it is unwarranted to infer from evidence on accounting quality changes around voluntary adoption that IFRS per se improves accounting quality.

The implications of research on accounting conservatism for accounting standard setting

This paper provides a commentary on the academic literature on accounting conservatism with a view to highlighting the insights of that literature that are potentially useful for accounting standard setters. We begin by introducing the basic concepts of conservatism focusing on the distinction between conditional and unconditional conservatism. We then briefly discuss the objectives of financial reporting and the economics of information, paying particular attention to the role of stewardship in the Conceptual Framework, and the economic concepts of adverse selection and moral hazard. The two middle sections of the paper provide overviews of, respectively, the theoretical and empirical literatures on accounting conservatism. Having summarised the theoretical and empirical literatures, we then try to synthesis the implications of the literature for standard setters, paying particular attention to understanding the costs and benefits of conservatism, implications for the Conceptual Framework, highlighting the particular demands of public debt markets for conservatism, and explaining how accounting standards might be adapted to allow some degree of flexibility in conservative accounting choice. The final section discusses the limitations of the academic literature from the practical point of view of standard setters, and highlights areas for new research that may be of more direct value for policy-making.

Strategic distortions in analyst forecasts in the presence of short-term institutional investors

We document that analysts cater to short-term investors by issuing optimistic target prices. Catering dominates among analysts at brokers without an investment banking arm as they face lower reputational cost. The market does not see through the analyst catering activity and their forecasts lead to temporary stock overpricing that short-term institutional investors exploit to offload their holdings to retail traders. We also report evidence consistent with catering brokers being rewarded with more future trades channelled through them. Our study identifies a new source of conflicts of interest in analyst research originating from the ownership composition of a stock.

Earnings: Concepts vs. Reported

The paper examines three benchmark earnings concepts: (i) permanent earnings with the cost-of-equity determining the capitalization, (ii) permanent earnings with the risk-free rate determining the capitalization, and (iii) economic earnings (Hicks’s concept). The concepts can be measured empirically using stock prices. The study explains how the three concepts differ in terms of reflecting risk and growth. Critically, (i) and (ii) highlight two cases along a continuum. Case (i) renders growth irrelevant so that risk alone, as reflected by the cost-of-equity, determines the E/P yield ratio. By contrast, for (ii) the risk-free rate determines the E/P ratio because growth cancels out risk. The case is referred to as full cancelling out, FCO for short. The empirical part of the paper compares the earnings concepts to reported earnings using US data, for the period 1976 to 2015. These evaluations split firms into two categories, industrial and financial. Main findings show that for industrial firms, as an overall average, reported earnings relate closer to (ii) - that is, FCO - than to (i). Though the result is robust across methods, for distinct sub-periods (i) provides the better benchmark. As to reported earnings of financial firms, we hypothesize and find that reported earnings relate closer to (i) than (ii). This conclusion should be expected insofar financial firms rely on approximate fair value accounting, in which case earnings come close to economic earnings, (iii), and such earnings imply an average of (ii).

Modelling analysts’ target price revisions following good and bad news?

We study the relation between analysts’ target price revisions and recent market returns, excess stock returns, and other analysts’ target price revisions. Empirical results show that, after controlling for earnings forecast and recommendation revisions, target price revisions are associated with each of these information sources. We also find that target price revisions are more sensitive to negative than to positive excess stock returns. We conjecture that firms’ tendency to withhold bad news, while releasing good news promptly, drives this effect and, using proxies for firms’ withholding of bad news, we report evidence supporting this hypothesis.

Are interim management statements redundant

In 2004 the Transparency Directive increased the reporting frequency by mandating the Interim Management Statement (IMS). However, only nine years later, the EU announced that it was making quarterly reporting voluntary again, arguing that IMSs are redundant as they are unlikely to contain any additional information not already required by the Market Abuse Directive (MAD). The current paper tests this argument empirically. For that it collects data on trading statements from a post-MAD pre-IMS year and uses these statements to predict which IMSs are genuinely incremental firm announcements (‘incremental IMSs’) and not simply substitutes for otherwise disclosed trading statements (‘non-incremental IMSs’). It then calculates three-day abnormal return variability and abnormal trading volume associated with incremental and non-incremental IMSs and it makes three observations. First, the introduction of IMSs coincided with a substantial reduction in other trading statements consistent with a large substitution effect between IMSs and non-periodic trading statements. Second, incremental third-quarter IMSs, but not incremental first-quarter IMSs, exhibit significantly positive abnormal return variability and abnormal trading volume, suggesting that the withdrawal of IMSs will involve the loss of some relevant information. Third, higher abnormal return variability and trading volume for non-incremental IMSs, relative to incremental IMSs, are consistent with the argument that a MAD-only regime will ensure the release of most relevant information.