This article examines whether a corporate disclosure practice is one of the reasons for the forecast dispersion anomaly—the negative relation between analyst forecast dispersion and future stock returns. Prior studies have shown that firms tend to delay the disclosure of bad news and that withholding of news leads to greater dispersion in analysts’ forecasts. Accordingly, we predict that firms with higher dispersion in analysts’ earnings forecasts are more likely to experience poor earnings in the subsequent quarter, and find evidence consistent with this prediction. After controlling for the relation between forecast dispersion and future earnings, we find that forecast dispersion is no longer significantly negatively related to future stock returns. These results suggest that temporary withholding of bad news by firms increases forecast dispersion among analysts and leads to low subsequent stock returns.

This study examines changes in CEOs? incentive to manage their firms? reported earnings during their tenure. Earnings overstatement is greater in the early years than in the later years of CEOs? service, and this relation is less pronounced for firms with greater external and internal monitoring. These results suggest that new CEOs try to favorably influence the market?s perception of their ability in their early years of service, when the market is more uncertain. Also, consistent with the horizon problem, earnings overstatement is greater in the CEOs? final year, but this result obtains only after controlling for earnings overstatement in their early years of service.

This study examines the association between U.S. Census industry concentration measures and the informativeness of corporate disclosure policy. We find that in more concentrated industries firms? management earnings forecasts are less frequent and have shorter horizons, their disclosure ratings by analysts are lower, and they have more opaque information environments, as measured by the properties of analysts? earnings forecasts. Also, when these firms raise funds they prefer private placements, which have minimal SEC-mandated disclosure requirements, over seasoned equity offerings. Overall, our findings suggest that firms in more concentrated industries disclose less and avoid certain financing decisions that have non-trivial disclosure implications, presumably due to proprietary costs of disclosure.

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 US GAAP requirement to expense R&D costs when incurred causes investors to underestimate the benefits of R&D.

We examine the relation between dividend increases and unexpected changes in future earnings. This issue has been the subject of numerous empirical studies. However, the extant evidence on this issue is inconclusive. We allow for the fact that investor demand for dividend paying stocks is time-varying and the market pays a premium for such stocks when the demand is high. Moreover, when the dividend premium (DP) is high, dividend increases could be due to managers catering to high demand for dividends by investors. We find that when the DP is low, there is a significant positive relation between dividend increases and unexpected future earnings changes, consistent with the signaling theory of dividends. However, when the DP is high, the relation between dividend increases and unexpected future earnings changes is insignificant. This finding suggests that when the DP is high, managers increase dividends primarily to cater to investors’ demand for dividends rather than to signal an increase in the future profitability of the firm. Finally, as is the case with prior studies, we find an insignificant relation between dividend increases and unexpected changes in future earnings when we constraint the relation to be constant over time.

Mutual funds experiencing large outflows (inflows) tend to decrease (expand) their positions, creating downward (upward) price pressure in the stocks held in common by them (Coval and Stafford [2007]). This study shows that corporate insiders exploit the resulting mispricing by buying (selling) their company's stock if it is subject to such fire sales (purchases) by funds. We also show that the likelihood of option grants is greater for stocks that are subject to mutual fund fire sales. Finally, we show that both the insider trading and the option granting activities help speed up the correction of the flow-driven mispricing. Overall, this study illustrates that insiders enhance personal benefits by trading on their personal account and influencing the timing of option grants in response to mispricing due to flow-driven fund trading. Moreover, these activities help improve the informational efficiency of stock price.

We examine the relation between dividend increases and unexpected changes in future earnings. This issue has been the subject of numerous empirical studies. However, the extant evidence on this issue is inconclusive. We allow for the fact that investor demand for dividend paying stocks is time-varying and the market pays a premium for such stocks when the demand is high. Moreover, when the dividend premium is high, dividend increases could be due to managers catering to high demand for dividends by investors (Baker and Wurgler, 2004a; and Li and Lie, 2006). We find that when the dividend premium is low, there is a significant positive relation between dividend increases and unexpected future earnings changes, consistent with the signaling theory of dividends. However, when the dividend premium is high, the relation between dividend increases and unexpected future earnings changes is insignificant. This finding suggests that when the dividend premium is high, managers increase dividends primarily to cater to investors’ demand for dividends rather that to signal an increase in the future profitability of the firm. Finally, as is the case with prior studies, we find an insignificant relation between dividend increases and unexpected changes in future earnings when we constraint the relation to be constant over time.

Prior studies document that firms that increase research and development (R&D) expenditures experience positive abnormal returns in future years. The reasons for this association are unclear, however. This result may reflect an unidentified R&D correlated risk factor and/or it may reflect a systematic underestimation by market participants of future benefits from current increase in R&D. We show that future abnormal returns to R&D increases are concentrated around subsequent earnings announcements. We further show that market expectations, implied from stock prices, underestimate the future earnings benefits of increase in R&D. Finally, we document 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.

Industry concentration measures calculated with Compustat data, which cover only the public firms in an industry, are poor proxies for actual industry concentration. These measures have correlations of only 13% with the corresponding U.S. Census measures, which are based on all public and private firms in an industry. Also, only when U.S. Census measures are used is there evidence consistent with theoretical predictions that more-concentrated industries, which should be more oligopolistic, are populated by larger and fewer firms with higher price-cost margins. Further, the significant relations of Compustat-based industry concentration measures with the dependent variables of several important prior studies are not obtained when U.S. Census measures are used. One of the reasons for this occurrence is that Compustat-based measures proxy for industry decline. Overall, our results indicate that product markets research that uses Compustat-based industry concentration measures may lead to incorrect conclusions.

This study examines the effect of investor sentiment on the accruals anomaly. We find that for small stocks mispricing per unit of accruals is greater in high sentiment periods as compared with low sentiment periods. This result is consistent with the notion that in high sentiment periods individual investors pay less attention toward understanding the accruals and cash flow components of earnings. This effect is observed primarily for small stocks because these stocks are more likely to be followed by individual investors, who tend to have limited attention. We also find that for small stocks reported accruals are greater during high sentiment periods as compared with low sentiment periods, suggesting that managers exploit the greater overvaluation per unit of accruals during high sentiment periods.

Utama and Cready [Utama, S., Cready, W.M., 1997. Institutional ownership, differential predisclosure precision and trading volume at announcement dates. Journal of Accounting and Economics 24, 129–150] use total institutional ownership to proxy for the proportion of better-informed traders, an important determinant of trading around earnings announcements. We argue that institutions holding small stakes cannot justify the fixed cost of developing private predisclosure information. Also, institutions with large stakes generally do not trade around earnings announcements since they are dedicated investors or face regulations that make informed trading difficult. However, institutions holding medium stakes have incentives to develop private predisclosure information and trade on it; we show that their ownership is a finer proxy for the proportion of better-informed traders at earnings announcements.

Using data on both fund stockholdings and fund returns, we examine whether actively managed equity mutual funds trade on and profit from the accruals anomaly. We find that few, if any, mutual funds trade on the anomaly. The top 10% of mutual funds that have the highest portfolio weights in low-accruals stocks have a greater, but still relatively small, exposure to low-accruals stocks. Nonetheless, these funds make significant profit net of actual transaction costs, exhibiting an average Fama-French three-factor alpha of 2.83% per year. We also find that these funds are smaller, less divcisified, and exhibit higher fund return volatility and higher fund flow volatility.

Hu, Meng and Potter (2008) (hereafter HMP), analyze transaction level data on trading by professional investment managers and claim to provide the following evidence. First, when managers trade in the same direction (buying or selling), they do not earn abnormal returns in the future.HMPargue that this evidence suggests that professional investment managers do not possess superior information about stock value. Second, when professional investment managers trade against each other, subsequent returns are low, especially for stocks that are difficult to short. HMP argue that this relationship is consistent with the Miller (1977) hypothesis, which states that prices reflect the view of the more optimistic investors, because pessimistic investors cannot trade due to high short-sale costs. Moreover, such overvaluation would increase with the difference of opinion among investors. HMP use the extent to which investment managers trade against each other as the measure of divergence of opinion across investors. HMP make a useful contribution to our understanding of institutional investors’ stock picking ability. However, I do not believe that HMP contribute significantly towards validating the Miller (1977) hypothesis. In Section 1, I discuss prior studies and assess the incremental contribution of HMP. In Section 2, I discuss issues related to the methodology used in the study. Specifically, the omission of the main effects is likely to have biased the coefficients on the interaction variables in the regression models. Section 3 concludes the discussion.

Compared to non-family firms, family firms face less severe agency problems due to the separation of ownership and management, but more severe agency problems that arise between controlling and non-controlling shareholders. These characteristics of family firms affect their corporate disclosure practices. For S&P 500 firms, we show that family firms report better quality earnings, are more likely to warn for a given magnitude of bad news, but make fewer disclosures about their corporate governance practices. Consistent with family firms making better financial disclosures, we find that family firms have larger analyst following, more informative analysts’ forecasts, and smaller bid-ask spreads.

We show that stock characteristics identified by D'Avolio (2002) provide a reliable index of the mostly unobservable short sales constraints. Specifically, we find that this index is positively related to the level of short interest and to short selling costs implied by the disparity in prices in the options and stock markets, and is negatively related to future returns. Using this index, we show that the magnitude of momentum returns for the period 1984 to 2001 is positively related to short sales constraints, and loser stocks rather than winner stocks drive this result. We conclude that short sales constraints are important in preventing arbitrage of momentum in stock returns.

This study documents an association between changes in institutional ownership during a calendar quarter and abnormal returns at the time of subsequent announcements of quarterly earnings. The result is driven by the portfolio returns of the extreme deciles of changes in institutional ownership, suggesting that institutions trade based on information about future earnings, but that such trading is not widespread. We also find that the difference between earnings announcement returns of the extreme deciles of change in institutional ownership is much greater when change in institutional ownership of a stock is driven by relatively few institutions. measured using the skewness of the distribution of change in institutional ownership of the stock. This result suggests that when fewer differentially informed investors make disproportionately large purchases or sales of stocks, a greater amount of the information on which they base their trades is not impounded in prices until the subsequent earnings announcement. Finally, we show that our results obtain for institutional investors with short-term focus, such as independent advisors, investment companies and insurance companies, but not for institutional investors with long-term focus, such as internally managed pension funds, educational institutions, and private foundations. This result further supports our conclusions regarding informed trading by institutions based on information about forthcoming earnings.

This paper shows that the book-to-market (B/M) effect is greater for stocks with higher idiosyncratic return volatility, higher transaction costs, and lower investor sophistication, consistent with the market-mispricing explanation for the anomaly. The B/M effect for high volatility stocks exceeds that for the low volatility stocks in 20 of the 22 sample years. Also, volatility exhibits significant incremental power beyond transaction costs and investor sophistication measures in explaining cross-sectional variation in the B/M effect. These findings are consistent with the Shleifer and Vishny (1997) thesis that risk associated with the volatility of arbitrage returns deters arbitrage activity and is an important reason why the B/M effect exists.

Frankel and Lee (1998) show that the value-to-price ratio (V[subf]/P) predicts future abnormal returns for up to three years, where V[subf] is an estimate of fundamental value based on a residual income valuation framework operationalized using analyst earnings forecasts. In this study, we examine whether the V[subf]/P effect is due to market mispricing or omitted risk factors. We find that the V[subf]/P effect is partially concentrated around the future earnings announcements, consistent with the mispricing explanation. On using an extensive set of risk proxies, suggested by Gebhardt et al. (2001) and Gode and Mohanram (2001), we also find that V[subf]/P is significantly related to some risk proxies. However, after controlling for these risk factors, V[subf]/P continues to exhibit a significant positive association with future returns suggesting that these risk factors are not responsible for the V[subf]/P effect. Overall, the results seem consistent with the mispricing explanation for the V[subf]/P effect.

The Private Securities Litigation Reform Act (PSLRA) increases restrictions on private litigation for securities fraud. We examine stock price reactions on legislative-event-related days of firms in four high-litigation-risk industries. Two other studies on this issue, Spiess and Tkac (1997) (ST) and Johnson et al. (2000) (JKN), conclude that shareholders considered PSLRA beneficial. While we find largely similar daily abnormal returns for event-related days that they examine, we present evidence that the timing of multiple confounding events makes the interpretation of these daily returns ambiguous. Results from additional analyses beyond those conducted by ST and JKN (market price reversal tests, analysis of additional legislative-event-related days, cumulative abnormal returns over the legislative period, and analysis of other events affecting investors' ability to bring securities-related lawsuits), are largely inconsistent with their interpretation, suggesting instead that share- holders in the four high-litigation-risk industries react negatively on average to PSLRA's restrictions on their ability to bring securities-related lawsuits.

We explore whether the association between accruals and future returns documented by Sloan (1996) is due to fixation by naive investors on the total amount of reported earnings without regard for the relative magnitude of the accrual and cash flow components. Contrary to the predictions of the naïve investor hypothesis, we find that the predictive ability of accruals for subsequent annual returns and for quarterly earnings announcement stock returns is not lower for large firms or for firms followed more by analysts or held more by institutions. Further, we find that the ability of accruals to predict future returns does not seem to depend on stock price or transaction volume, measures of transaction costs, also contrary to predictions of the naïve investor hypothesis. These results are robust to regression and hedge portfolio tests. We conclude that the predictive ability of accruals for subsequent returns does not seem to be due to the inability of market participants to understand value-relevant information.

This article explores relations between measures of the value relevance of financial accounting data and several country-specific factors suggested in prior research. It is explained that the article uses data taken between 1986-1995 from manufacturing firms from 16 countries. The research found that value relevance is specified primarily in terms of explanatory power of accounting variables for security returns, relative to explanatory power for comparable U.S. firms. The article also reveals that the value relevance of financial reports is lower for countries where the financial systems are bank orientated rather than market orientated, and where private-sector bodies are not involved in the standard-setting process.

The article examines the incremental information content of earnings, funds flow from operations and cash flow from operations. Economists J.L.G. Board and J.F.S. Day examined the incremental information content of earnings, funds flow from operations (hereafter, funds flow) and cash flow from operations (hereafter, cash flow) by employing a methodology that was equivalent to estimating a multivariate regression model that assumes linear relationships between abnormal returns and unexpected components of earnings, funds flow and cash flow. Their evidence suggested that earnings contain incremental information beyond the other two performance measures. However, they concluded that their evidence is not consistent with the existence of incremental information content of funds flow or cash flow beyond earnings. The authors' approach differs from Board and Day by incorporating some recent innovations in the specifications of earnings-returns models for the purposes of assessing incremental information content.

This study examines information disclosures about non-announcing firms' following the earnings release by another firm in the same industry. It provides indirect evidence (through stock price changes) that the information disclosed about non-announcing firms is significant only when announcing firms convey bad news through their earnings releases and when non-announcing firms are large. This finding provides support to Verrecchia's (1983) theory which predicts that in the presence of disclosure related costs, full revelation of managers' private information (as shown in the Grossman [1981]-Milgrom [1981] world) does not obtain. Instead, managers use discretion in disclosing their private information.

We examine the accounting choice decision in the context of the timing of adoption of SFAS 87. Unlike most prior studies, we consider interactions between firm characteristics and the magnitudes of the financial statement effects of an accounting decision. We expect that including interactions will both enhance the ability to explain accounting choice, and facilitate distinction between omitted variables (Ball and Foster, 1982) and hypothesized relations. Results are consistent with these expectations.

The article discusses the incremental information content of the performance variables: earnings, working capital from operations (WCFO), and cash flows, allowing for nonlinear associations. The multivariate model used to analyze the incremental information in earnings, WCFO, and cash flows shows the marginal price response declines with absolute value. The persistence of earnings, WCFO, and cash flows vary along with the absolute value off changes in these performance variables. The beginning-of-period market value of equity is used as a deflator for the explanatory variables with raw returns used as the dependent variable.

This study presents evidence indicating a greater influence of accounting incentives on reported pension cost under the current pension accounting standard, Statement of Financial Accounting Standards Number 87 (SFAS 87), relative to the preceding standard, Accounting Principles Board Opinion Number 8 (APB 8). Accounting incentives refer to managerial incentives arising from income smoothing and contractual arrangements that use accounting numbers. This study uses the difference between the income reported under SFAS 87 and APB 8 in the adoption year as a measure that incorporates the difference between the discretionary components of pension cost under the two regimes and shows that this difference is associated with proxies for managers' accounting incentives. This finding has important implications for accounting regulatory agencies. Even though SFAS 87 appears to have been successful in moving pension accounting away from cash basis and toward accrual basis, the increased influence of accounting incentives may have hampered the comparability across firms of the reported pension numbers and hence their usefulness.

This article examines the changes in earnings levels as they relate to annual earnings. The authors show that the estimated earnings response coefficient will rise when the earnings level variable is included. They estimate the unexpected earnings-abnormal returns regression model with both earnings changes and levels, based on beginning-of-period earnings-price ratios. The research suggests that using the earnings level as a regressor indicates that measurement error in unexpected earnings is responsible for low ERCs.

Previous research has generally estimated unexpected earnings as the change relative to the previous year, assuming that shocks to annual earnings are purely permanent. In the presence of transitory components of annual earnings, we predict that using earnings changes as a proxy for unexpected earnings causes earnings response coefficients to be understated and the estimation error to be negatively cross-sectionally correlated with persistence. The negative correlation causes the association between earnings response coefficients and persistence to be overstated. We use the IMA (1,1) model to capture transitory components of annual earnings and obtain results that are consistent with our predictions.

Examines whether analysts properly recognize the time-series properties of annual earnings when setting their estimates of future earnings. Method of study; Apparent inability of market and analysts to properly recognize the time-series properties of quarterly earnings shocks; View that analysts do not utilize available information efficiently when setting forecasts.