Accounting

The nature of deferred taxes and their cash flow implications have long been debated, and accounting rule-making bodies have adopted different policies on deferred taxes in the past. Our study examines how the capital market perceives deferred taxes in assessing common stock risk. We document extensive evidence of a negative relation between deferred taxes and two measures of security risk, market beta and standard deviation of security returns, when the debt-equity ratio is adjusted for deferred taxes. The above associations between deferred taxes and risk are robust to controls for selected firm characteristics. Our findings are in accord with the hypothesis that in assessing common stock risk, the market views deferred taxes as a form of equity or a proxy for some firm attribute which is inversely related to risk, and suggest that the liability view of deferred taxes mandated by Financial Accounting Standards Board (FASB) Statement Nos. 96 (FASB 1987) and 109 (FASB 1992) may be an inappropriate basis for formulating accounting rules on deferred taxes.

Private placements of straight nonbank debt by publicly traded firms elicit a positive stock price reaction on average, consistent with a market perception that they confer significant certification and monitoring benefits on borrowers. However, long-run stock returns following the debt issues are significantly lower than benchmarks. Our results are consistent with the view that firms issue private debt prior to a decline in operating performance, and they disclose overly optimistic information in the pre-issue period which prevents information on the upcoming downturn from reaching the market in a timely manner. Lenders have private information on the post-issue performance decline prior to their lending decision, and take steps to protect their investment which do not benefit equity investors. Our results are inconsistent with certification and monitoring benefits accruing to equity investors from private nonbank debt.

This study examines the association between a firm's LIFO reserve and its equity risk. We hypothesize that LIFO reserve has favorable implications for equity risk as it confers tax benefits and represents unbooked profits, which prompt firms to lower their borrowings and effectively increase equity. Consistent with this hypothesis, we document a negative association between LIFO reserve and two measures of risk: standard deviation of stock returns and beta. We document a negative association between LIFO reserve and debt, consistent with the proposition that LIFO reserve and debt are tax shield substitutes. However, the negative association between LIFO reserve and equity risk remains even when the level of debt of firms is controlled. Further tests show that adjusting the denominator of the debt-equity ratio for LIFO reserve improves its explanatory power with regard to risk, consistent with the notion that LIFO reserve is viewed as a component of equity in assessing risk. Additional tests indicate that LIFO reserve has explanatory power with regard to future risk. Also, variability of LIFO reserve is positively associated with equity risk, suggesting that firms with high temporal variability in their LIFO reserve may be unable to fully avail of the future benefits of LIFO accounting. Collectively, these results indicate that LIFO reserve is negatively associated with equity risk and conveys information that is potentially useful in assessing equity risk.

In this paper, we study the association between commercial paper rating downgrades and expectations of the level and variability of future earnings. Our examination shows that such rating downgrades are associated with a significant reduction in analyst forecasts of near-term earnings. We document a tendency by financial analysts at the Value Line Investment Survey to progressively revise their estimates of quarterly earnings downward on average and implement two methods to control for the resulting bias. The reduction in earnings estimates is robust to these controls. In addition, we observe an increase in systematic risk for a subset of firms for which the downgrade implies exit from the commercial paper market. Analysis of stock price changes around the downgrade announcement dates shows that although the information on lower future earnings reflected in mild rating downgrades merely confirms market beliefs, the information on lower level and/or higher variability of future earni...

Prior analytical research suggests that competitive firms within an industry may not voluntarily share their private market information through a trade association. Given legal restrictions which preclude trade associations from compelling participation or accurate reporting by firms or revealing their proprietary data, it is uncertain whether trade associations can design and implement systems to collect and transmit useful market information. This paper documents significant stock price movements on release dates of aggregate industry data on new orders and shipments by the Semiconductor Industry Association (SIA) each month which are positively associated with changes in the numbers disclosed. The industry information released is positively correlated with earnings changes in the subsequent quarterly earnings announcements of firms within the industry. Additional tests indicate that semiconductor firms' stock prices respond significantly to their quarterly earnings announcements, and that the prior disclosure of aggregate industry information does not materially reduce the valuation relevance of earnings reports of semiconductor firms. Overall, these findings support the hypothesis that trade associations are able to obtain reliable data from firms, aggregate it into statistics that do not reveal a specific company's information, and then distribute aggregate statistics back to participating firms in a timely manner. Our analysis further suggests that while the aggregate industry data are informative for investors in high-tech stocks, they do not reduce the valuation impact of semiconductor firms' quarterly earnings. * Significant at the .05 level, one-tailed test. ** Significant at the .01 level, one-tailed test. * Mean coefficient is significantly different from zero at the .05 level (one-tailed: t-test applied to mean and sign rank test applied to percentage of positive cases). ** Mean coefficient is significantly different from zero at the .01 level (one-tailed: t-test applied to mean and sign rank test applied to percentage of positive cases). *** Mean coefficient is significantly different from zero at the .001 level (one-tailed: t-test applied to mean and sign rank test applied to percentage of positive cases).

SYNOPSIS: This study examines the role of revenue in valuing firms beyond earnings and investigates whether this (1) is pervasive or limited to certain situations in which earnings may be less informative, (2) is sensitive to nonlinearity in the relation between returns and earnings, and (3) has changed over time. Our analysis indicates that revenue is useful both as a summary measure for valuation purposes and in conveying new information to the market, after controlling for earnings information. These results are not driven by technology firms, extreme earnings news or loss situations, or by model misspecification because of nonlinearities. The role of revenue in firm valuation is greater, and the role of earnings is smaller, in extreme earnings situations. We also find that revenue is more useful in summarizing the performance of technology firms and for profit observations. While the combined ability of revenue and earnings to summarize contemporaneous value-relevant information...

Prior research documents a large downward drift in stock prices following issuances of debt and equity by US firms. We conduct tests based on both stock price and trading volume to provide evidence on the reasons for this apparent market anomaly. We document evidence of earnings management through accruals prior to external financing and lower operating performance afterward that is associated with the amount of capital raised. The earnings management that precedes external financing and the amount of capital raised are associated with both the post-financing decline in stock price and trading volume around earnings announcements that follow for a period of three years. This evidence is consistent with the proposition that firms raise external capital prior to predictable declines in their operating performance and they release upward biased earnings before these events to manage investor expectations. The failure of many investors to incorporate this information into their trading decisions in a timely manner consistent with limited attention and over-confidence appears to drive stock mispricing. Our evidence does not support the conjecture that the financing anomaly is primarily a statistical artifact or that it is a manifestation of the accrual anomaly.