Wayne B. Thomas

Harmonisation of Accounting Measurement Practices in the European Community

Abstract This study attempts to determine the level of accounting harmonisation in the European Community by examining selected measurement practices from the 1992/93 annual reports of companies from Belgium, Denmark. France, Germany, Ireland, the Netherlands. Portugal and the UK. Harmonisation is tested using the chi-square statistic and measured using the / index. The chi-square statistic tests for the equality of the proportions of accounting measurement methods across countries. The / index measures the extent of concentration around a particular accounting measurement method. The results reveal that accounting for foreign currency translation of assets and liabilities, treatment of translation differences, and inventory valuation are harmonised, while accounting for fixed asset valuation, depreciation, goodwill, research and development costs, inventory costing, and foreign currency translation of revenues and expenses are not harmonised. The results also demonstrate that the extent of harmonisation ...

Financial Reporting Quality of U.S. Private and Public Firms

Using a new database that contains accounting data for a large sample of U.S. private firms, we provide an investigation of financial reporting quality (FRQ) of U.S. private versus public firms. We find that in general public firms have higher accrual quality and are more conservative. The results are consistent with public firms’ reporting reflecting greater demand for financial information. However, these reporting qualities of public firms are mitigated or eliminated in settings where public firms are more likely to manage earnings or face reduced demand for their financial information. Our study contributes not only to the current debate on private versus public financial accounting but also to the broader literature attempting to understand the determinants of FRQ.

Information-processing demands and the multinational enterprise: a comparison of foreign and domestic earnings estimates

We examine the information-processing demands top managers of the multinational enterprise (MNE) deal with in their portfolio of international operations by comparing the accuracy of foreign and domestic earnings estimates. Results indicate that the increase in information-processing demands is due to the complexity of managing foreign operations of the MNE. We also find greater information processing demands in foreign operations for managers of smaller multinational firms, firms with relatively low performance, and firms with lower levels of intangible assets. We use these results to develop implications for information-processing theory and practice.

The Value-relevance of Geographic Segment Earnings Disclosures Under SFAS 14

This study examines whether geographic segment earnings as reported under the requirements of SFAS 14 provide value-relevant information. The FASB recently issued SFAS 131, which drastically changes the segment reporting requirements for US firms. Firms are required to disclose segment information by operating segment. For those firms that define operating segments along industry lines, disclosure of geographic segment earnings is no longer required. If geographic segment earnings provide value-relevant information, a potentially valuable source of information may be lost. In this study, geographic segment earnings coefficients are estimated by (1) regressing unexpected security returns on unexpected geographic segment earnings and (2) regressing leading-period returns on current geographic segment earnings. Leading period returns involve extending the return interval to include the returns for prior years. The results show that unexpected geographic segment earnings relate differentially to unexpected security returns. For the leading-period returns model, little significant evidence is found for the markets differential valuation of geographic segment earnings coefficients for one- and two-year return intervals. When the return intervals extend to three years or more, significant evidence is found that the market values geographic segment earnings differently, which suggests that such disclosures reflect information used by market participants in setting security prices. The FASB may want to reconsider or amend its segment reporting requirements.

Segment reporting in the European Union: Analyzing the effects of country, size, industry, and exchange listing

Abstract The purpose of this study is to provide an analysis of segment reporting practices of firms in the European Union and to identify factors which potentially influence the quality of disclosure. The quality of segment reporting is defined as the number of financial statement items (e.g., sales, profits, assets) disclosed per segment. Segment reporting by line of business and by geographic area are analyzed separately. The four variables hypothesized to influence the quality of segment reporting are country, firm size, industry, and exchange listing. The descriptive analysis individually examines the effect of each of these four variables on the quality of segment reporting. The multiple regression analysis measures the marginal effect of each variable while holding the effects of all other variables constant. The results indicate that the quality of segment reporting is significantly affected by country, firm size, and exchange listing. No evidence is found for an industry effect.

A model of forecast precision using segment disclosures: implications for SFAS no. 131

Abstract This paper models the use of segment information in forecasting earnings. The model derives four conditions under which segment information is expected to increase earnings forecast precision. Forecast precision should increase with (1) greater differentiation across segment forecast factors (i.e., expected segment growth, expected inflation, political risk), (2) greater disaggregation of earnings, (3) greater predictive accuracy of segment forecast factors, and (4) greater accuracy in measuring the segment weights. The second half of the paper provides a practical analysis of the four conditions. The analysis of each condition includes an important implication regarding the potential contribution of the new standard for segment disclosures, SFAS No. 131, in improving the usefulness of segment information from a forecasting perspective. Two negative and two positive implications of SFAS No. 131 are discussed. Relating the new standard to conditions (1) and (2), forecast precision may have been hindered in certain situations by not defining segments according to risk, return, and growth characteristics and by the materiality guidelines (or lack thereof for enterprise-wide disclosures). Relating the new standard to conditions (3) and (4), forecast precision will likely improve due to the availability of interim segment information and the impact of the management approach increasing the measurement accuracy of individual segments.

International Evidence on Analyst Stock Recommendations, Valuations, and Returns

This is the first large study to examine the relation between analysts’ stock recommendations, earnings forecasts, and future excess stock returns in an international context. We first document that some of the peculiar findings established in the U.S. extend to other countries where individual investor participation in the stock market is high (especially when Japan is excluded from the sample). Specifically, we find that analysts’ recommendations relate positively to simple heuristics but negatively to more rigorous residual income valuation estimates (scaled by price). Furthermore, residual income valuation estimates relate positively to future returns, indicating their usefulness to investors, while analysts’ recommendations and heuristics relate negatively to future stock returns. In contrast, in countries with low investor participation rates, these peculiar findings are less observable. In these countries, analysts appear to rely relatively more on residual income valuation estimates in setting their recommendations, and these recommendations relate positively to future returns. The overall results are consistent with analysts’ recommendations being influenced by economic incentives other than identifying mispriced stocks in countries with high investor participation rates, substantiating puzzling results in the U.S.

Geographic segment disclosures: Theories, findings, and implications

Abstract This article discusses both the relevant theories and the research findings on geographic segment disclosures under SFAS 14 and relates implications of these findings to the FASB/AcSBs exposure draft. Research studies on geographic segment disclosures are divided into three broad categories: predictive ability, security pricing, and risk assessment. For each category, we provide a theoretical analysis of the importance of geographic segment information and the related empirical findings. Finally, we relate potential implications for the usefulness of geographic segment disclosures to the FASB/AcSBs exposure draft, discussing both weaknesses and improvements.

Abnormal Accrual Estimates and Evidence of Mispricing

To estimate abnormal accruals, prior research employs a wide variety of models and estimation procedures. We evaluate the performance of three representative models – modified Jones model (MJ), MJ with operating cash flows (MJOCF), and MJ with return on assets (MJROA) – and two estimation procedures – industry-specific and firm-specific regressions. In evaluating the performance of various models, we use mispricing tests (i.e. relating current accruals to future returns) as our main test. We find that the best performing model is the firm-specific MJOCF model followed by the industry-specific MJROA model. However, when we use the recursive firm-specific procedure (i.e. based on current and previous years’ information only), we do not find the firm-specific MJOCF model outperforms the industry-specific MJROA model. We recommend that researchers use the industry-specific MJROA model to estimate abnormal accruals when investigating earnings management. For evaluating earnings quality that can include management estimation error, the firm-specific MJOCF remains clearly the best model from the perspective of abnormal accrual mispricing.

The Torpedo Effect: Myth or Reality?

General evidence indicates that managers manage earnings at three common earnings thresholds: analyst forecasts, prior period earnings, and zero earnings. We examine one market-based motivation suggested for this behavior. If managers perceive the market penalty for barely missing an earnings threshold to be disproportionately high (i.e., a torpedo effect), they may use discretion to manage earnings upward to meet the earnings threshold. This market-based incentive would explain the evidence in favor of earnings management at earnings thresholds. To test the existence of a torpedo effect, we employ a comprehensive model that measures the market’s reaction to reported earnings that barely miss earnings thresholds. This model controls for the level of unexpected earnings and several other firm characteristics known to affect the relation between returns and earnings. Overall, we conclude that there is little evidence of a torpedo effect. This conclusion holds for both low-growth and high-growth firms and is unaffected by the firm’s history of meeting the threshold. Our paper dispels some commonly held beliefs about the market’s response to earnings thresholds.