Research Papers

The working papers are in Adobe Acrobat format (.pdf). To view them, you will need Adobe Acrobat Reader. 

Earnings and Dividend Informativeness when Cash Flow Rights are Separated from Voting Rights
(with Jennifer Francis and Katherine Schipper)  
Journal of Accounting and Economics (Forthcoming, March 2005)

ABSTRACT:  In dual class firms, the unequal voting rights of the two classes of common stock separate cash flow rights from voting rights. Dual class firms also typically have concentrated managerial ownership. We argue that the combination of these features creates two effects (an entrenchment effect and an information effect) which reduce the credibility, and thereby also the informativeness, of dual class firms’ earnings. However, the incentive effects associated with concentrated managerial ownership should increase the credibility & therefore the informativeness of earnings. Our analysis is intended to discern which effects dominate. Controlling for other factors known to affect earnings informativeness, we find that the coefficient on earnings in returns-earnings regressions is significantly smaller for dual class stocks than for single class stocks, with the magnitude of the decrease increasing in the degree of separation between cash flow and voting rights. Results also indicate that dividends are generally more informative for dual class stocks than for single class stocks, consistent with the view that dividends are particularly salient for non-controlling shareholders when cash flow rights are separated from voting rights. Finally, within-sample tests show that while earnings are significantly more informative than dividends for single class stocks, the same is not true for dual class stocks; rather, earnings and dividends are equally informative by our measures. 

Valuation Effects of Debt and Equity Offerings by Real Estate Investment Trusts (REITs)
(with Jennifer Francis and Thomas Lys)  

ABSTRACT:  This paper provides new evidence on capital structure choice. By focusing on REITs, which have no tax advantages for debt and often face internal funds constraints, we identify a setting in which we expect managers to reveal their private information about their firm's growth and investment opportunities through offering decisions. Because REITs must pay out at least 95 percent of taxable income as dividends to shareholders to avoid payment of corporate income taxes, REITs with growth strategies access the capital markets on a more frequent basis than most non-REIT industrial firms. For our sample of 127 REITs during 1992-1997, the average REIT accessed external capital markets 8 times in 2.5 years. Prior research documents that investors, on average, react negatively to the announcement of seasoned equity offerings and either positively or not at all to the announcement of debt offerings. We find that the average market reaction to both equity and debt offerings by REITs is more favorable than that docuemnted for industrial firms in prior work. In addition,investors react more favorably to both debt and equity offerings made by REITs with with better investment opportunities relative to REITs with poorer investment opportunities, supporting the hypothesized signaling interpretation of the offerings. Our results to date support an asymmetric information explanation for investors' reactions to REIT offerings rather than the alternative explanation of agency costs. 

Financial Reporting for Defined Benefit Pension Plans
(with Patricia Ledesma Liebana)  

ABSTRACT:  This paper investigates how investors incorporate disclosures made under GAAP for defined benefit pension plans into equity security prices. We first explore whether investors perceive the pension obligation and the pension plan assets as liabilities and assets, respectively, of the firm. There has been considerable controversy in the literature about whether the property rights to the pension assets reside with the firm (its shareholders) or with the plan participants. Secondly, we explore whether components of the reported pension expense and the pension expenditure are value relevant for share prices. Thirdly, we examine which elements of the current pension disclosures are more highly associated with future cash flows and future earnings. Our results indicate that investors, on average, do not value the pension assets and obligation as similar to the sponsoring firm's other assets and liabilities. The recognized net periodic pension expense is value relevant but results are mixed on the value relevance of the contribution to the plan. Both the cash contribution and the pension expense have predictive ability for cash flows and earnings respectively. We infer that these mixed results might reflect lack of investor confidence in the reliability of the pension disclosures. 

Earnings Quality
(with Katherine Schipper) 
Accounting Horizons 17 (2003 Supplement: 97-110)

ABSTRACT:  This commentary discusses empirical measures used in academic research to assess earnings quality and relates these measures both to decision usefulness, from the Financial Accounting Standards Board's Conceptual Framework, and the economics-based definition of earnings developed by Hicks (1939). Hicksian income corresponds to the amount that can be consumed (that is, paid out as dividends) during a period, while leaving the firm equally well off at the beginning and the end of the period. We discuss several earnings quality constructs and measures that have been used in academic accounting research. We describe the approaches used to measure earnings quality, some of the tradeoffs inherent in choosing among the approaches, and some of the design choices inherent in empirical research related to earnings quality.  

The Relative and Incremental Information Content of Alternative (to Earnings) Performance Measures
(with Jennifer Francis and Katherine Schipper) 
Contemporary Accounting Research 20 (Spring 2003: 121-164)

ABSTRACT:  We analyze the ability of earnings and non-earnings performance metrics to explain the variability in annual stock returns for industries wher we identify, ex ante, an allegedly preferred (for valuation purposes) summary performance metirc. We identify three industries where earnings before interest, taxes, depreication, and amortizaiton (EBITDA) and cash from operations (CFO) are preferred, and three idustries where specific non-GAAP performance metrics are preferred. As a benchmark, we also examine the ability of EBITDA and CFO to explain returns for seven industries for which earnings is the preferred metric. Results for the benchmark earnings industries show that earnings dominates EBITDA and CFO in explaining returns. All other results are inconsistent with the view that perceptions of preferred metrics are reflected in actual aggregate investment behavior. 

Earnings Announcements and Competing Information
(with Jennifer Francis and Katherine Schipper) 
Journal of Accounting and Economics 33 (2002: 313-342)

ABSTRACT:  We investigate whether competing information, primarily analyst reports, reduces the usefulness of earnings announcements. Inconsistent with the view that the information in analyst reports substitutes for earnings annoucements, we find a positive relation between absolute abnormal returns to the two types of disclosures. This positive relation also characterizes subsequent period analyst reports relative to current period earnings announcements. We also find that aggregate absolute reactions to both types of disclosures increased over 1986-1995. As a whole, these results provide little support for the view that the informativeness of earnings announcements is eroded by competing information in the form of analyst reports. 

Expanded Disclosures and the Increased Usefulness of Earnings Announcement
(with Jennifer Francis and Katherine Schipper) 
The Accounting Review 77 (3) (2002: 515-546)

ABSTRACT:  We investigate three explanations for prior studies' finding that the usefulness of earnings announcements, as measured by their absolute market responses, has increased over time. We confirm this increase for a sample of 426 relatively large, stable firms over 1980-1989. We find no evidence that this over-time increase in the magnitude of the market reaction to our sample firms' earnings announcements is attributable to increases in the absolute amount of unexpected earnings conveyed in the announcements or to incrases in the intensity of investors' average reaction to unexpected earnings. To test the third explanation - an over-time expansion in the amount of concurrent (with bottom line earnings) information in earnings announcement press releases - we analyze and code the contents of 2,190 earnings announcment press releases made by 30 of our sample firms over 1980-1989. Concurrent disclosures increased significantly over this period and we find that these concurrent disclosures, especially the inclusion of detailed income statements, explain increases in the absolute market reacitons to earnings announcements for our sample firms. 

Empirical Research on Accounting Choice
(with Thomas Fields and Thomas Lys) 
Journal of Accounting and Economics 31 (2001: 255-308)

ABSTRACT:  We review research from the 1990s that examines the determinants and consequences of accounting chicoe, structuring our analysis around the three types of market imperfections that influence managers' choices: agency costs, information asymmetries, and externalities affecting non-contracintg parties. We conclude that research in the 1990s made limited progress in expanding our understanding of accounting choice because of limitations in resarch design and a focus on replication rather than extension of current knowledge. We discuss opportunities for future research, recommending the exploration of the economic implications of accounting choice by addressing the three different reasons why accounting matters. 

The Impact of Taxes on the Choice of Divestiture Method
(with Edward Maydew and Katherine Schipper) 
Journal of Accounting and Economics 28 (1999: 117-150)

ABSTRACT:  This paper estimates the magnitude of tax costs and their impact on the decision to divest asets via a taxable sale rather than a tax-free spin-off. We find that the tax costs are substantial, averaging 8% of market value of the divested assets, and that cross-sectional variation in tax costs has a large impact on managers' choice of divestiture method. Our results are consistent with two explanation. First, managers are willing to incur avoidable tax costs to gain earnings and cash flow benefits. Second, managers choose taxable sales because the acquisition premia on the sales esceed the avoidable tax costs.  

The Information Content of Funds from Operations (FFO) for Real Estate Investment Trusts (REITs)
Journal of Accounting and Economics 26 (1999: 69-104)

ABSTRACT:  This paper examines the information content of alternative summary performance measures, using stock returns as the benchmark, for 138 REITs during 1994-1996. This paper tests for both incremental and relative information content of FFO (a voluntarily disclosed, accounting-based performance measure that is the industry standard for REITs) compared to GAAP net income (EPS), cash from operations, and earnings before interest, taxes, depreciation, and amortization. Results indicate that both FFO and EPS consistently provide incremental information content with onely weak evidence that EPS has greater relative information content and no evidence for the other summary performance measures.  

Equity Valuation Implications of Purchase versus Pooling Accounting
Journal of Financial Statement Analysis (1997: 5-19)

ABSTRACT:  This paper uses an equity valuation model based on Ohlson (1995) and Feltham and Ohlson (1995) to examine whether investors value firms using different accounting methods for business combinations differently. I convert the accounting for both sets of firms to a common basis; that is, all purchase firms are converted to an "as if" pooling basis and all pooling firms are converted to an "as if" purchase accounting basis for the purposes of these tests. I test for different valuation effects at the time of the business combination and for five years after the combination. The results are also checked using common valuation ratios (market to book and price to earnings). Results indicate that firms using the pooling method enjoy some equity valuation advantage over firms using the purchase method. However, this advantage is not related to the differences in accounting. The results may be due to the self-selection bias inherent in such accounting choice studies.  

Causes and Effects of Discretionary Asset Write-offs
(with Jennifer Francis and Douglas Hanna)  
Journal of Accounting Research 34 (1996: 117-134)

ABSTRACT:  This paper examines whether management incentives or economic impairment drives discretionary write-off decisions and whether investor reactions to the announced write-offs are conditional on the perceived motivation for the write-off. For the full sample of write-offs, we find that both factors are important determinants of the write-off decision. However, when we analyze write-offs by type (inventory; goodwill; property, plant, and equipment; restructuring charges) we find that incentives play little or no role in determining inventory and PP&E write-offs but play a substantial role in explaining other, more discretionary, items such as goodwill write-offs and restructuring charges. Investor reaction to the write-offs also differs by type of write-off and is consistent with predictions based on whether economics or management incentives drive the write-off decision.  

An Analysis of Value Destruction in AT&T's Acquisition of NCR
(with Thomas Lys)  
Journal of Financial Economics 39 (1995: 353-378)

ABSTRACT:  AT&T's $7.5 billion acquisition of NCR decreased the wealth of AT&T shareholders by between $3.9 billion and $6.5 billion and resulted in negative synergies of $1.3 to $3.0 billion. We find that AT&T paid a documented $50 million and possibly as much as $500 million to satisfy pooling accounting requirements, thus boosting EPS by roughly 17% but leaving chas flows unchanged. We conclude that AT&T's decision to acquire NCR what the market perceived as a value-destroying transaction was related at least in part to the 1984 consent decree with the Department of Justice that led to the break-up of AT&T.