Current Trend in Empirical Accounting Research

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Current Trend in Empirical Accounting Research

• Prof Kevin Chen
• Hong Kong University of Science Technology
• December 28, 2006

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I. Valuation Use of Accounting

• Y stock price (P) or return (R)
• Accounting data as measurement of P study P
• Study how accounting data are reflected in stock
  prices
• Value relevance research see if an accounting
  item (e.g., MV of stock investment) is reflected
  in stock price

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• Accounting data as information (change
  beliefs) study R
• Study how accounting data affect stock prices
• Ball and Brown (1968)
• Windows of R (annual, quarter, months, days,
  hours)
• Properties of R (mean, variance)
• Magnitude of corr(E, R) ERC

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Two Perspectives in Valuation Use of Accounting

• Y Rt (or Pt) Assume EMH, test how accounting
  information is used by investors ? standard
  setting implications
• Marginal contribution difficult to find now
• New avenue EBO model
• Y Rt1 (or Pt1) Test EMH ? securities
  analysis implications
• Whether market is efficient ? Why market is not
  efficient (arbitrage costs)? ? How managers react
  to overvaluation or undervaluation?

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II. Contracting Use of Accounting

• Y accounting decision variables
• Start from positive accounting research Y
  accounting choice or change
• 3 factors lending agreements, compensation, and
  political costs
• ?Earnings management
• Y abnormal accruals
• Broader measure of accounting choice in a
  specific setting when EM is likely
• ?Voluntary disclosure
• Y disclosed items (management earnings
  forecasts, specific items, or survey)

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• ? Earnings quality (EQ, or attributes)
• Meanings persistent, free of EM, closer to
  underlying cash flow, conservatism, timeliness,
  etc.
• One of firm characteristics
• EQ can be
• Y study determinants of EQ
• X use EQ to explain corporate behavior
  (ownership and board structures, disclosure,
  investment decisions, etc.) or its effects on
  pricing or cost of capital
• ? Corporate governance

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Current Topic 1 EBO Model

• Ohlson (CAR 1995)
• Valuation function of BV of equity and earnings
• Applications
• Test of the model
• Valuation relevance research
• Relation between returns and earnings
• Relative weights on book value and earnings
• Test of EMH (use valuation model to estimate
  intrinsic value)
• Estimation of cost of capital

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• Estimation of cost of capital
• Botosan (AR, 1997)
• Use Ohlsons model to estimate COC
• Examine relation between disclosure and COC
• Claus and Thomas (JF 2001)
• Estimate aggregate COC
• Risk premium is much lower than that estimated
  from realized returns

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• Gebhardt, Lee, and Swaminathan (JAR 2001)
• COC from EBO is correlated with many firm-risk
  characteristics, e.g., leverage, analyst
  following, liquidity, earnings volatility
• COC from realized returns is not
• Easton, Taylor, Shroff, and Sougiannis (JAR 2002)
• Simultaneous estimation of COC and growth rate
• Hail and Leuz (JAR 2006)
• International difference in securities and
  disclosure regulation and cost of capital
• Hail and Leuz (WP 2006)
• Cross-listing and cost of capital

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Current Topic 2 Why market is not efficient?

• Take an anomaly and explain it
• Common explanation arbitrage costs
• Well known anomalies
• Post-earnings announcement drifts (Bernard and
  Thomas, JAR 1989)
• Accruals anomaly (Sloan, AR 1996)
• V/P anomaly (Frankel and Lee, JAE 1998)

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• Example
• Mashruwalaa, Rajgopala and Shevlin (JAE 2006)
  abnormal returns from accruals are concentrated
  in stocks with
• high idiosyncratic (non-systematic) volatility ?
  risky for arbitrageurs to take positions in
  stocks with extreme accruals.
• low-price and low-volume stocks ? high
  transaction costs

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Current Topic 3 How managers react to
overvaluation or undervaluation?

• Managers take advantage of mispricing
• Sell shares or takeover other firms with shares
  when stock is overvalued
• Buy back shares when stock is undervalued
• Examples
• Shleifer and Vishny (JFE 2001) mergers
• Baker and Wurgler (JF 2002) equity issuance
• Bradshaw, Richardson, and Sloan (JAE 2006)
  measure of equity issuance

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• Why overvalued?
• Theoretical (Bolton, Scheinkman, Xiong, Journal
  of Corporate Law, 2005)
• Divergent opinions
• Short-sales constraints
• Empirical (La Porta, JF 1996 Frankel and Lee,
  JAE 1998)
• Analysts are over-optimistic in forecasting
  earnings

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• Agency cost of overvaluation
• Jensen (FM 2005)
• When a stock is overvalued, managers dont try to
  reduce it rather they have pressure to sustain
  overvaluation ? major corporate scandals (Enron,
  Worldcom, etc.)
• Efendi, Srivastava and Swanson (WP 2004)
• Stock options and earnings restatements
• Chen, Hui, and Wei (WP 2006)
• When overvalued, managers have incentives to use
  earnings forecast to reduce overvaluation,
• But reduced by executive options, short horizon,
  and more short-selling

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Current Topic 4 Corporate governance

• Adding more incentive factors to PAT research
• Finance links
• Tobins Q
• ROA
• Corporate behavior (investment, financing,
  dividends)

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• Accounting links
• Earnings quality or attributes
• Disclosure
• Auditing (quality, fees, non-audit fees,
  opinions, audit committees, auditors
  relationship with firm, etc.)
• Executive compensation
• Cost of capital

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• CG variables
• Legal environment (cross-country studies)
• LLSV (La Porta et al.)
• Ownership structure
• Concentration of ownership
• Institutional shareholders
• Family ownership
• Control-enhancement mechanisms (e.g.,
  dual-class stock in US, pyramidal or
  cross-holding structure in emerging markets)

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• Shareholder rights
• Anti-takeover provisions related to takeover
  market (Gompers et al. QJE 2003)
• Board structure
• CEO/chair duality
• Independent directors
• Board size
• Generally weak or no relation

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How to Publish in International Accounting
Journals?

• How to do accounting research and write up in
  English?

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Unique Situation in Accounting Publications

• Few SSCI journals
• SSCI coverage citations by covered journals
• Accounting is an applied area cite others but
  dont get cited
• SSCI ranking will kill accounting discipline
• University or business school ranking
• SSCI not widely used except in Taiwan

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Unique Situation in Accounting Publications

• Dominance of US
• Accounting functions in capital market and
  business environment
• Context is crucial in accounting issues are
  different in different capital markets and
  business environments
• US has by far the most mature market and business
  environment
• Because of proximity to setting and competitive
  academic system, US has by far the most rigorous
  group of accounting scholars
• Bias from US editors and reviewers
• Other countries issues are backward phenomena
  ? changed somewhat after Enron, but still exists

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Likely Targets for Taiwanese Authors

• Why top 3 are not realistic
• In writing and handling review process, need
  coauthoring with established researchers
• In Taiwan, no incentives for established
  researchers to emerge and continue
• Difficult to identify publishable Taiwanese
  issues
• Issues need to be unique and interesting to
  readers in other countries

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• Likely targets
• Below top 3, especially non-US (e.g., CAR)
• International journals (sample)
• The International Journal of Accounting (TIJA) U
  of Illinois (A-)
• Journal of International Accounting Research
  (JIAR) AAAs sectional journal (B)
• 25 acceptance rate, but only 40 submissions a
  year ? 2 issues a year, 4 papers each
• Journal of Business, Finance and Accounting UK
  (A)
• Journal of Banking and Finance (A, UK)
• Pacific-Basin Finance Journal (A-, US-HK)

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What it Takes to Publish in International Journals

• Two criteria
• Relevance of issue is it interesting
• Rigorous methodology
• One more for non-English speakers
• Reasonable writing

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Example International Accounting Topic 1

• Pick an issue and compare practices in two or
  more countries.
• Example article Pro Forma Earnings Disclosures
  A Sample of U.S. and Canadian Firms.
• Compare the practice in the two countries and
  explaining how institutional differences drove
  the disclosures.

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Example International Accounting Topic 2

• Look at the impact on the financial statements of
  foreign operations.
• Example article
• An event study to examine the value relevance of
  voluntarily disclosed quarterly sales data of the
  foreign operations of U.S. MNCs (included in
  quarterly earnings announcements).

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Example International Accounting Topic 3

• Examine a particular issue in a specific country.
  
• Example article
• Do Investors Reward Bank Disclosure
  Transparency Evidence from India.
• Show how the institutional environment of the
  country drives accounting practice and how the
  experience of that country might contradict
  results from other countries.
• Need to explain how the results have implications
  to the rest of the world.
• Cannot simply replicating a US study in a foreign
  setting without showing the relevance to the rest
  of the world