Weili Ge

The Persistence of Earnings and Cash Flows and the Role of Special Items: Implications for the Accrual Anomaly

We argue that high accruals are likely to be the outcome of rules with an income statement perspective, while low accruals are likely to be the outcome of rules with a balance sheet perspective, and that this has implications for the properties of earnings. Specifically, earnings persistence is affected both by the magnitude and sign of the accruals. Accruals improve the persistence of earnings relative to cash flows in high accrual firms, but reduce earnings persistence in low accrual firms. We show that the low persistence of earnings in low accrual firms is primarily driven by special items. We then show that special item-low accrual firms have higher future stock returns than other low accrual firms. This is consistent with investors misunderstanding the transitory nature of special items. Further analysis reveals that special item-low accrual firms have poor past performance and declines in investor recognition (analyst coverage and institutional holdings). Special items continue to explain future returns after controlling for these factors.

The Effect of Manager-Specific Optimism on the Tone of Earnings Conference Calls

The use of more or less positive language in corporate disclosures has been the subject of increased interest in the academic literature. We add to this stream of research by examining whether there is a manager-specific component in the tone of earnings-announcement related conference calls. We find that the tone of conference calls that is not explained by current performance, future performance, and strategic incentives has a significant manager-specific component. We also find that tone is significantly associated with manager-specific factors such as early career experiences and involvement in charitable organizations. Taken together, our findings indicate that, in addition to reflecting current and future performance, the tone of conference calls is significantly influenced by a manager-specific tendency to be optimistic or pessimistic. We also find some evidence of a manager-specific component to conference call returns, which is consistent with manager-specific optimism impacting investors’ interpretation of disclosures made in conference calls.

When Does Internal Control Over Financial Reporting Curb Resource Extraction? Evidence from China

We examine whether internal control over financial reporting (internal control) reduces the expropriation of resources from the firm by managers and controlling shareholders. Although we have ample evidence from prior literature that internal controls reduce errors in financial reports, it is less clear that they can curb resource extraction, as management may simply override these controls. We exploit a rich Chinese dataset to distinguish between the design and implementation of internal controls. On average we find some evidence that internal controls curb resource extraction, but further investigation reveals that many firms with documented internal controls fail to implement these controls, or simply override them (i.e., form over substance), and these firms’ controls do not curb resource extraction. We find that internal controls are most likely to be form over substance when they are policy-driven instead of voluntarily adopted, and also when there are more severe agency problems (and thus an increased likelihood of control override). Although the analysis is conducted with Chinese data, the spirit of our findings should generalize to all settings. In particular, our findings suggest that management can use the “form” of internal control procedures while still engaging in the undesirable behavior.