William M. Cready

Information Value And Investor Wealth - The Case Of Earnings Announcements

This paper empirically investigates the relation between investor wealth and the value of annual and quarterly earnings announcements as implied by (1) the behavior of mean stock trade transaction sizes at announcement dates, and (2) transaction size-stratified trading activity in postannouncement time periods. Announcement-period mean transaction sizes are found to exceed expected mean transactions sizes estimated from trading activity occurring in nonannouncement periods. This result is attributed to a greater relative trading response to earnings announcements by wealthier investors, consistent with Ohlsons [1975] proposition that information value increases with investor wealth in a security market setting. Further evidence of a positive relation between value and wealth is found when postearnings announcement stock transactions are stratified by share size into three strata, where the first stratum (small stratum) is transactions of 100 and 200 shares, the second stratum (large stratum) is transactions of 300 to 900 shares, and the third stratum (institutional

Institutional stock ownership, accrual management, and information environment

This study examines the empirical relationship between institutional percentage shareholding and accounting discretion exercised by firms to manage accruals over a period of time. It also evaluates the effects of firm size and information environment on such relationship. By employing a firm-specific abnormal accrual estimation design to measure accounting flexibility/discretion used to adjust abnormal accruals in financial reporting, the study documents that institutional stock ownership is inversely related to such accounting discretion exercised to manage abnormal current accruals. This inverse relationship is, however, found to be dependent on firm size and richness of information environment. Specifically, the inverse relationship strongly holds for smaller firms that are deemed to have an impoverished information environment compared with larger firms having information-rich environment. Furthermore, by using a two-stage least-squares approach, the study addresses the endogeneity-driven ambiguity which is inherent in the simple identification of a negative relation between institutional stock ownership and accrual management. The analysis demonstrates that the overall negative relationship is partly attributed to institutional shareholder monitoring that constrains managements ability to opportunistically manage abnormal accruals. The evidence is consistent with the view that active monitoring of institutional shareholders mitigates opportunistic reporting behavior of corporate managers and improves the quality of governance in the financial reporting process.

Market Underestimation of the Implications of R&D Increases for Future Earnings: The US Evidence

This study shows that future abnormal returns to R&D increases are concentrated around subsequent earnings announcements. It further shows that market expectations, implied from stock prices, underestimate the future earnings benefits of increase in R&D. Finally, it documents that in their forecasts of future earnings, security analysts also underestimate the effect of increase in R&D spending. These results suggest that future abnormal returns following R&D increases are at least in part due to the market’s underestimation of the earnings benefits of R&D increases. The finding in this study contributes to the longstanding debate in accounting on whether the U.S GAAP requirement to expense R&D costs when incurred causes investors to underestimate the benefits of R&D.

Classification Shifting and Special Items: Evidence of Earnings Management or a Research Design Consequence?

McVay (2006, 2008) report compelling evidence that firms reclassify ordinary expense items as special item in order to boost benchmark core earnings numbers. We show that another far more innocuous explanation exists for this evidence. The effects that McVay attributes to classification shifting activities can arise as an artifact of the approaches used in deriving expected core earnings values. This can happen because expected core earnings and expected change in core earnings values are determined, in part, by special item accruals. When we focus on either subsamples where this special item accrual effect on the expected core earnings values is a priori expected to be small or incorporate controls for it into the analysis, there is no reliable evidence of widespread classification shifting activities by managers.

Bonus Rigidity and Future Performance: Theory and Evidence

Drawing on the extensive economics literature on wage rigidity, we examine CEO bonus rigidity and, in particular, the implications of downward bonus rigidity for future performance. We first document distributional support for downward rigidity in bonus payments. More importantly, we find that bonus cuts have distinct negative implications for future firm performance. Indeed, our evidence indicates that bonus rigidity is the primary driver of the positive relation between unexpected cash compensation and future performance documented by Hayes and Schaefer (2000). Our evidence is also broadly consistent with morale theories of pay rigidity (Bewley, 1995, 2002; Yellen, 1984) which posit that employers avoid reducing nominal wages due to the adverse impact that such cuts have on employee morale. This relation in turn suggests that morale consequences are an important factor in management compensation committee decisions to shield pay from adverse performance outcomes such as losses (Dechow et al., 1994; Gaver and Gaver, 1998).