Senyo Y. Tse

A Nonlinear Model Of Security Price Responses To Unexpected Earnings

This study presents evidence that the marginal response of stock price to unexpected earnings declines as the absolute magnitude of unexpected earnings increases. Most previous studies assume a linear relation between unexpected returns (UR) and unexpected earnings (UE). The constant marginal response of prices to earnings in linear models is typically referred to as the earnings response coefficient (ERC) and estimated as the slope coefficient from simple linear regression of UR on UE. Relative to the linear model, a nonlinear approach provides both significantly higher explanatory power and a richer explanation for differences between ERCs and price-earnings ratios. The nonlinear relation described in this paper rests on the premise that the absolute value of unexpected earnings is negatively correlated with earnings persistence. Valuation theory suggests that analysts and investors should place greater emphasis on forecasting high-persistence earnings than low-persistence earnings, because a given amount of the former has a greater valuation impact than the same amount of the

The Multiperiod Information-Content Of Accounting Earnings - Confirmations And Contradictions Of Previous Earnings Reports

In this study, we propose and test the hypothesis that investors reevaluate earnings announcements in the light of postannouncement information.1 Our argument for multiperiod price reactions to earnings news is motivated by the literature linking price responses to earnings persistence.2 When earnings are announced, we assume that investors are unable to determine with certainty the persistence of an earnings

An earnings prediction approach to examining intercompany information transfers

Abstract We assess potential information transfers by examining the association between the earnings announcements of early and late announcers in an industry. Our earnings prediction models are statistically significant much more frequently than would be expected by chance. The models suggest potential positive information transfers on average, but there is substantial cross-industry variation in the strength of this relation. We find that the greatest price reactions by nonannouncers to same-industry earnings announcements occur in industries with the greatest earnings comovement

Audit Quality, Alternative Monitoring Mechanisms, and Cost of Capital: An Empirical Analysis

Prior studies document that firms using a Big 4 auditor have a lower cost of capital than other firms. We extend this literature by examining whether using an industry specialist auditor reduces cost of capital for clients of Big 4 audit firms. We document that firms that use Big 4 auditors that are industry specialists have significantly lower cost of both equity and debt than firms that use non-specialist Big 4 auditors. We further investigate whether the benefits of using an industry specialist auditor vary with the strength of alternative monitoring mechanisms. We show that using an industry specialist auditor is especially important when alternative monitoring mechanisms, such as boards of directors or institutional shareholders, are relatively weak. In other words, the benefits of using an industry specialist auditor dissipate when alternative monitoring mechanisms are strong. This evidence suggests some degree of substitutability between audit quality and alternative monitoring mechanisms.

Market Reaction to Earnings Surprise Warnings: The Incremental Effect of Shareholder Litigation Risk on the Warning Effect

We examine the incremental effect of shareholder litigation risk on market reaction to earnings surprise warnings, that is, the warning effect. Prior research examines earnings warnings by firms reporting large earnings news (at least 1% of share price), and finds a negative warning effect for bad news firms but no warning effect for good news firms. We find similar results for a larger sample of firms. In addition, we find negative and positive warning effects, respectively, for firms reporting small bad and good earnings news, suggesting that the insignificant warning effect for good news firms is restricted to large earnings news. More importantly, we find that litigation risk magnifies the warning effect—for bad news firms, the warning effect is more negative for high-litigation-risk firms than for low-litigation-risk firms, but for good news firms, the warning effect is more positive for high-litigation-risk firms than for low-litigation-risk firms.

The Effects of a Mixed Approach toward Management Earnings Forecasts: Evidence from China

Chinese regulators mandate management earnings forecasts when managers’ earnings expectations meet bright-line thresholds and allow voluntary forecasts in other circumstances. We examine the effects of this mixed approach. We find that Chinese mandatory forecasts have significant information content. Moreover, we observe a learning effect: mandatory forecasts appear to stimulate voluntary forecasts in subsequent periods as managers become familiar with the forecasting and disclosing procedures through forced experience. We find one negative consequence of the mixed approach, however: managers appear to manipulate earnings to avoid the forecast threshold of large earnings decreases. Overall, we document the pros and cons of a mixed approach toward management earnings forecasts in a major emerging market.

The Contribution of Delayed Gain Recognition to Trends in Conservatism: A Re-Examination Using a New Approach to Measuring Accounting Conservatism

Firms can increase their level of conservatism by recognizing adverse economic events more promptly or by delaying the recognition of positive economic events, that is, by increasing their loss or gains conservatism, respectively. We extend prior research by examining the independent contribution of loss and gains conservatism to overall trends in conservatism. Stakeholders such as shareholders and creditors rely on accounting information for investment, monitoring, and contracting purposes, and have conflicting interests in loss and gains conservatism (Guay 2006, Guay and Verrecchia 2006). Our analysis provides insights on how trends in conservatism serve some stakeholders’ interests while disadvantaging others. We build on Ball and Shivakumar’s (2005) model of the relation between positive versus negative cash flows and contemporaneous accruals and design a new measure of conservatism based on the association between current positive versus negative accruals and future cash flows. Thus, we link managers’ current accruals with the future cash flows that they presumably anticipate when they record the accruals. We interpret the coefficients for positive and negative accruals as indicators of gains and loss conservatism, respectively, and measure overall conservatism as the difference in positive- and negative-accrual coefficients. We find that gains conservatism contributes at least as much as loss conservatism to the overall trend in conservatism. We also find that conservatism in high-tech industries has increased at a faster rate than in other industries, primarily due to increases in gains conservatism. Our findings suggest that trends in conservatism have tilted towards creditors’ interests, increasing shareholders’ reliance on non-earnings information for investment decisions and for contracting.

Does Forecast Bias Affect Financial Analysts’ Market Influence?:

Prior studies find that analysts tend to bias their forecasts upward in poor information environments and downward in rich information environments, consistent with attempts to curry favor with management. We find that investors anticipate this behavior by reducing their response to upward forecasts in poor information environments and downward forecasts in rich information environments. Using Hugon and Muslu’s measure of analyst conservatism as an ex ante indicator of individual analysts’ forecast bias tendencies, we show that the stronger return response they find to conservative analysts’ forecast revisions is restricted to poor information environments, where optimistic analyst bias is prevalent. Our results suggest that analysts pay a price in market influence when their forecasts reinforce analysts’ typical forecast bias for the firm’s information environment. Conversely, analysts whose forecasts conflict with the typical bias for the firm are rewarded with larger than average return responses.

Why Are Successive Cohorts of Listed Firms Persistently Riskier

Prior studies show that the risk level of each new cohort of listed firms is higher than its predecessor’s. We find that these risk differences are persistent and investigate two potential explanations: (1) Each cohort adopts and retains operating innovations that are associated with higher risks and (2) increasing numbers of younger and less-experienced firms are represented in each new cohort. Our results support the first explanation. Each new cohort uses riskier production technologies and operates in more competitive product markets than its predecessor.

Why Are Successive Cohorts of Listed Firms Persistently Riskier?: Why Are Successive Cohorts of Listed Firms Persistently Riskier?

Prior studies show that the risk level of each new cohort of listed firms is higher than its predecessors. We find that these risk differences are persistent and investigate two potential explanations: (1) Each cohort adopts and retains operating innovations that are associated with higher risks, and (2) increasing numbers of younger and less‐experienced firms are represented in each new cohort. Our results support the first explanation. Each new cohort uses riskier production technologies and operates in more competitive product markets than its predecessor.