Panos N. Patatoukas

Revisiting Conditional Conservatism

Basu (1997) proposes a measure of financial reporting conservatism based on asymmetry in the conditional earnings/returns relation. Patatoukas and Thomas (2011) show upward bias in this measure, because a placebo — lagged earnings — also exhibits similar asymmetry. Ball, Kothari, and Nikolaev (2013a) and Collins, Hribar, and Tian (2014) propose alternative explanations for the bias and offer revised measures to overcome the bias. We find, however, that both revised measures remain substantially upward biased. In particular, a placebo based on lagged share price mimics time-series and cross-sectional variation observed for the revised measures. More generally, we find biases in the asymmetric timeliness specification because earnings, accruals, and other measures of performance are often related to second and higher moments of the distribution of returns. In addition to suggesting the asymmetric timeliness specification be used with caution, our study illustrates the useful role placebos can play in archival studies.

Short-Sales Constraints and Aftermarket IPO Pricing

It is well established that initial public offerings (IPOs) tend to be characterized by positive first trading day returns followed by subsequent underperformance, especially around lockup agreement expirations. Miller (1977) provides a unified explanation for these phenomena based on divergence of investor opinions about fundamental value combined with short-sales constraints. We provide a direct test of Miller’s explanation by analyzing a new and comprehensive database from the securities lending market. Our evidence suggests that divergence of investor opinions coupled with short-sales constraints are key to explaining aftermarket IPO pricing.

Identifying Conditional Conservatism in Accounting Data: Theory and Evidence

Using a financial reporting and valuation model, we show that the asymmetric timeliness (AT) coefficient based on Basu’s (1997) regression model varies not only with the degree of conditional conservatism but also with economic factors, such as expected returns, asymmetry in the distribution of cash flow news, and cash flow persistence. Our theoretical analysis predicts that (i) the AT coefficient will be positive even if accounting is entirely symmetric, and (ii) the AT coefficient will vary with the economic factors identified even if the degree of conditional conservatism is held constant. Our empirical analysis shows that AT estimates vary with the economic factors identified and in the direction predicted by our theory. AT estimates increase with expected returns and asymmetry in the distribution of return news, while they decrease with cash flow persistence. When we control for the confounding effects of variation in the economic factors, we find that AT estimates of conditional conservatism become substantially weakened, especially when we remove spurious evidence of asymmetric timeliness due to either the expected component of earnings—as recommended by Ball et al. (2013a)—or the cash flow component of earnings—as recommended by Collins et al. (2014). We introduce and validate asymmetry in the distribution of the accrual component of earnings as an alternative measure of conditional conservatism. Consistent with a key implication of conditional conservatism, we find that the variance of bad news accruals is significantly higher than the variance of good news accruals. Our analysis of “placebo” test variables provides evidence in support of the construct validity of our measure.

Comment On 'On Estimating Conditional Conservatism' by Ball, Kothari, and Nikolaev

Ball, Kothari, and Nikolaev (2011) make two major claims in their recent working paper titled “On estimating conditional conservatism.” While they agree that the effect documented in Patatoukas and Thomas (2011) biases the conditional conservatism estimate proposed in Basu (1997), they claim that the source of bias is not scale effects but a non-linear relation between expected returns and expected earnings. Second, they propose revised measures of conditional conservatism, which they claim are unbiased. Our evidence contradicts both claims.

Dissecting the Association between Stock Returns and GDP Growth Forecast Surprises: An Implied Cost of Capital Approach

Using consensus forecasts from the Philadelphia Fed’s Survey of Professional Forecasters, I find that the univariate association between stock returns and GDP growth forecast surprises is indistinguishable from zero. I consider two non-mutually exclusive hypotheses for this phenomenon. The first hypothesis is that GDP growth forecast surprises are correlated with offsetting cash flow news and discount rate news. The second hypothesis is that GDP growth forecast surprises measure news about economic growth with noise. Using Easton’s et al. (2002) implied cost of capital procedure along with Li and Mohanram’s (2014) cross-sectional earnings forecasts, I extract a measure of discount rate news at the stock market level and find evidence consistent with offsetting value-relevant news in GDP growth forecast surprises. A key implication is that researchers interested in the valuation of news about economic growth need to account for the impact of contemporaneous movements in the discount rate. From an implementation standpoint, my study shows that changes in implied cost of capital estimates offer a comprehensive measure of discount rate news capturing not only procyclical variation in the long-term nominal interest rate but also countercyclical variation in the otherwise unobservable equity risk premium.

Short-Sales Constraints and Aftermarket IPO Pricing: Evidence on Short Sellers as De Facto Gatekeepers

It is well established that initial public offerings (IPOs) tend to be characterized by positive first trading day returns followed by subsequent underperformance, especially around lockup agreement expirations. Miller (1977) provides a unified explanation for these phenomena based on divergence of investor opinions about fundamental value combined with short-sales constraints. We provide a direct test of Miller’s explanation by analyzing a new and comprehensive database from the securities lending market. Our evidence suggests that divergence of investor opinions coupled with short-sales constraints are key to explaining aftermarket IPO pricing.

From Micro to Macro: Making Sense of Accounting Data in the National Income and Product Accounts

We revisit evidence that conditional conservatism aggregates up from the firm level causing corporate profit estimates in the National Income and Product Accounts (NIPA) to be more sensitive to negative relative to positive aggregate return news. Our study delivers three main messages. First, annual estimates of NIPA corporate profits are designed to provide neutral estimates of income from current production regardless of whether times are good or bad. Second, we find spurious evidence of asymmetric sensitivity to aggregate return news in placebo test variables that are void of conditional conservatism, clearly indicating that an alternative explanation is in order. Third, we find that the variance of aggregate returns decreases with the level of economic activity. Although this return variance effect is unlikely to be attributed to accounting, it has the potential to generate spurious evidence of conditional conservatism at the macro level. Overall, our study highlights the importance of construct validity tests in archival studies and contributes to research in the properties of NIPA corporate profits.

On the Association between Stock Returns and GDP Growth Forecast Surprises

Using consensus forecasts from the Philadelphia Fed’s Survey of Professional Forecasters, I find that the univariate association between stock returns and GDP growth forecast surprises is indistinguishable from zero. I consider two non-mutually exclusive hypotheses for this phenomenon. The first hypothesis is that GDP growth forecast surprises are correlated with offsetting cash flow news and discount rate news. The second hypothesis is that GDP growth forecast surprises measure news about economic growth with noise. Using Easton’s et al. (2002) implied cost of capital procedure along with Li and Mohanram’s (2014) cross-sectional earnings forecasts, I extract a measure of discount rate news at the stock market level and find evidence consistent with offsetting value-relevant news in GDP growth forecast surprises. A key implication is that researchers interested in the valuation of news about economic growth need to account for the impact of contemporaneous movements in the discount rate. From an implementation standpoint, my study shows that changes in implied cost of capital estimates offer a comprehensive measure of discount rate news capturing not only procyclical variation in the long-term nominal interest rate but also countercyclical variation in the otherwise unobservable equity risk premium.

Short-Sales Constraints and IPO Pricing

It is well established that initial public offerings (IPOs) tend to be characterized by positive first trading day returns followed by subsequent underperformance, especially around lockup agreement expirations. Miller (1977) provides a unified explanation for these phenomena based on divergence of investor opinions about fundamental value combined with short-sales constraints. We provide a direct test of Miller’s explanation by analyzing a new and comprehensive database from the securities lending market. Our evidence suggests that divergence of investor opinions coupled with short-sales constraints are key to explaining aftermarket IPO pricing.