Mechanisms to Meet/Beat Analyst Earnings Expectations in the Pre- and Post-Sarbanes-Oxley Eras

This paper asks two questions. First, has the prevalence of expectations management to meet/beat analyst expectations changed in the aftermath of the 2001-2002 accounting scandals and the passage of the 2002 Sarbanes-Oxley Act (SOX)? Second, has the mix among the three mechanisms used for meeting earnings targets: accrual earnings management, real earnings management, and earnings expectations management shifted in the Post-SOX Period? We document that the propensity to meet/beat analyst expectations has declined significantly in the Post-SOX Period. Our primary findings explain this pattern. In particular, we find a decline in the use of expectations management and accrual management, and no change in real earnings management in the Post-SOX Period relative to the preceding seven-year period. Our results are robust to controlling for varying macro economic conditions. These findings contribute to the academic literature, investors, and regulators

Mechanisms to Meet/Beat Analyst Earnings Expectations in the Pre- and Post-Sarbanes-Oxley Eras

This paper asks two questions. First, has the prevalence of expectations management to meet/beat analyst expectations changed in the aftermath of the 2001-2002 accounting scandals and the passage of the 2002 Sarbanes-Oxley Act (SOX)? Second, has the mix among the three mechanisms used for meeting earnings targets: accrual earnings management, real earnings management, and earnings expectations management shifted in the Post-SOX Period? We document that the propensity to meet/beat analyst expectations has declined significantly in the Post-SOX Period. Our primary findings explain this pattern. In particular, we find a decline in the use of expectations management and accrual management, and no change in real earnings management in the Post-SOX Period relative to the preceding seven-year period. Our results are robust to controlling for varying macro economic conditions. These findings contribute to the academic literature, investors, and regulators

Post Loss/:Profit Announcement Drift

We document a market failure to fully respond to loss/profit quarterly announcements. The annualized post portfolio formation return spread between two portfolios formed on extreme losses and extreme profits is approximately 21 percent. This loss/profit anomaly is incremental to previously documented accounting-related anomalies, and is robust to alternative risk adjustments, distress risk, firm size, short sales constraints, transaction costs, and sample periods. In an effort to explain this finding, we show that this mispricing is related to differences between conditional and unconditional probabilities of losses/profits, as if stock prices do not fully reflect conditional probabilities in a timely fashion

Stock Option Expense, Forward-Looking Information, and Implied Volatilities of Traded Options

Prior research generally finds that firms underreport option expense by managing assumptions underlying option valuation (e.g. they shorten the expected option lives), but it fails to document management of a key assumption, the one concerning expected stock-price volatility. Using a new methodology, we address two questions: (1) To what extent do companies follow the guidance in FAS 123 and use forward looking information in addition to the readily available historical volatility in estimating expected volatility? (2) What determines the cross-sectional variation in the reliance on forward looking information? We find that firms use both historical and forward-looking information in deriving expected volatility. We also find, however, that the reliance on forward-looking information is limited to situations where this reliance results in reduced expected volatility and thus smaller option expense. We interpret this finding as managers opportunistically use the discretion in estimating expected volatility afforded by FAS 123. In support of this interpretation, we also find that managerial incentives play a key role in this opportunism

Exchange Rate Variability and the Riskiness of U.S. Multinational Firms:Evidence from the Breakdown of the Bretton Woods System

This study assesses the impact of exchange rate variability on the riskiness of U.S. multinational firms by examining the relation between exchange rate variability and stock return volatility and by decomposing this relation into components of systematic and diversifiable risk. Focusing on two periods around the 1973 switch from fixed to floating exchange rates, we find a significant increase in the volatility of U.S. multinational monthly stock returns corresponding to the period of increased exchange rate variability. This increase in stock return volatility is also significant relative to the increase in stock return volatility for firms in three control samples. Using a single factor market model, we show this increase in total volatility led to a significant increase in market risk (beta) for the multinational firms relative to the control samples between the two periods. Collectively, these results suggest that the increase in exchange rate variability after 1973 was perceived by investors to be associated with an increase in the riskiness of cash flows of multinational firms that required compensation in terms of higher expected returns.

Mechanisms to Meet/Beat Analyst Earnings Expectations in the Pre- and Post-Sarbanes-Oxley Eras

This paper asks two questions. First, has the prevalence of expectations management to meet/beat analyst expectations changed in the aftermath of the 2001-2002 accounting scandals and the passage of the 2002 Sarbanes-Oxley Act (SOX)? Second, has the mix among the three mechanisms used for meeting earnings targets: accrual earnings management, real earnings management, and earnings expectations management shifted in the Post-SOX Period? We document that the propensity to meet/beat analyst expectations has declined significantly in the Post-SOX Period. Our primary findings explain this pattern. In particular, we find a decline in the use of expectations management and accrual management, and no change in real earnings management in the Post-SOX Period relative to the preceding seven-year period. Our results are robust to controlling for varying macro economic conditions. These findings contribute to the academic literature, investors, and regulators

Mechanisms to Meet/Beat Analyst Earnings Expectations in the Pre- and Post-Sarbanes-Oxley Eras

This paper asks two questions. First, has the prevalence of expectations management to meet/beat analyst expectations changed in the aftermath of the 2001-2002 accounting scandals and the passage of the 2002 Sarbanes-Oxley Act (SOX)? Second, has the mix among the three mechanisms used for meeting earnings targets: accrual earnings management, real earnings management, and earnings expectations management shifted in the Post-SOX Period? We document that the propensity to meet/beat analyst expectations has declined significantly in the Post-SOX Period. Our primary findings explain this pattern. In particular, we find a decline in the use of expectations management and accrual management, and no change in real earnings management in the Post-SOX Period relative to the preceding seven-year period. Our results are robust to controlling for varying macro economic conditions. These findings contribute to the academic literature, investors, and regulators

Stock Option Expense, Forward-Looking Information, and Implied Volatilities of Traded Options

Prior research generally finds that firms underreport option expense by managing assumptions underlying option valuation (e.g. they shorten the expected option lives), but it fails to document management of a key assumption, the one concerning expected stock-price volatility. Using a new methodology, we address two questions: (1) To what extent do companies follow the guidance in FAS 123 and use forward looking information in addition to the readily available historical volatility in estimating expected volatility? (2) What determines the cross-sectional variation in the reliance on forward looking information? We find that firms use both historical and forward-looking information in deriving expected volatility. We also find, however, that the reliance on forward-looking information is limited to situations where this reliance results in reduced expected volatility and thus smaller option expense. We interpret this finding as managers opportunistically use the discretion in estimating expected volatility afforded by FAS 123. In support of this interpretation, we also find that managerial incentives play a key role in this opportunism

Corporate financial policies and performance around currency crises

Using data from 17 countries that have suffered a currency crisis, this paper studies firm-level leverage and performance measures before and after a crisis has occurred. We show that in the years preceding a currency crisis, companies that are expected to benefit from currency depreciations increase their leverage more than companies that are expected to be harmed by currency depreciations. The evidence regarding the profitability and financial fragility ratios is consistent with the leverage results, since companies that are expected to benefit from depreciations fare worse than other companies before a crisis. We also provide evidence that the Asian crisis is different from the previous European and Latin American ones: in Asia firms become more fragile after the crisis and their profitability declines and leverage increases further, whereas in Europe and Latin America there are clear signs of recovery after a crisis has occurred, especially for firms that are ex-ante expected to benefit from depreciations