Discussion of The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition

Ball and Shivakumar (2005) augment existing models of expected accruals to incorporate conditional conservatism. They document a robust asymmetry in the relation between accruals and economic losses and gains, and demonstrate that accruals models that incorporate this asymmetry have increased explanatory power. This discussion of Ball and Shivakumar (2005) makes five main points: 1) incorporating asymmetry in gain and loss recognition is an important contribution to empirical models of expected accruals; 2) the economic underpinnings of asymmetry in loss and gain recognition remain open to considerable debate; 3) the extent to which accruals recognize gains in a timely manner remains an interesting but unanswered question; 4) non-working capital accruals are important to both the earnings process and accounting conservatism, yet modeling of nonworking capital accruals has received little attention in the literature; and 5) incorporating asymmetry into the accruals process has important implications for estimating discretionary accruals and for future research in this area

Discussion of Accounting Discretion, Corporate Governance, and Firm Performance

Bowen, Ragjopal, and Venkatachalam (2008) explore whether managers, on average, use accounting discretion for reporting objectives that are in the interests of shareholders (e.g., signaling, tax minimization, etc.), or alternatively whether managers use discretion opportunistically in the presence of governance structures that allow greater discretion. The authors find that although accounting discretion is positively related to governance structures that allow managers greater discretion in decision-making, there is no evidence that the portion of accounting discretion related to governance structures is negatively associated with firm performance. In this discussion, I emphasize the importance of decision rights allocation within widely held corporations, and how this allocation naturally leads to cross-sectional variation in the degree of discretion afforded managers. In contrast to much of the existing governance literature, I argue that governance structures that allow managers greater discretion in making decisions do not necessarily imply weak/poor governance. For example, it is difficult to see why a firm that allocates the least possible decision-making rights to their board or executives is necessarily the firm with highest quality governance. I also discuss why the observed relation between accounting discretion and firm performance may be uninformative about whether accounting discretion is used for opportunistic purposes. If shareholders/boards thoughtfully select an appropriate amount of overall decision-making discretion to allow managers, it will be difficult to determine whether specific types of discretion are used opportunistically

Conservative Financial Reporting, Debt Covenants, and the Agency Costs of Debt

Considerable research has documented the role of debt covenants and conservative financial accounting in addressing agency conflicts between lenders and borrowers. Beatty, A., Weber, J., and Yu, J. [2008. Conservatism and debt. Journal of Accounting and Economics, forthcoming] document interesting, but mixed, findings on the relation between debt covenants and conservative accounting, and the extent to which the two contracting mechanisms act as substitutes or complements. In this paper, I discuss the economic roles of financial reporting, debt covenants, and conservatism within the debt contracting environment, and attempt to fit BWY\u27s findings within this context

Are U.S. CEOs Paid More than U.K. CEOs? Inferences from Risk- Adjusted Pay (CRI 2009-003)

We compute and compare risk-adjusted pay for US and UK CEOs, where the adjustment is based on estimated risk premiums stemming from the equity incentives borne by CEOs. Controlling for firm and industry characteristics, we find that US CEOs have higher pay, but also bear much higher stock and option incentives than UK CEOs. Using reasonable estimates of risk premiums, we find that risk-adjusted US CEO pay does not appear large compared to that of UK CEOs. We also examine differences in pay and equity incentives between a sample of non-UK European CEOs and a matched sample of US CEOs, and find that risk-adjusting pay may explain about half of the apparent higher pay for US CEOs

The Cash-Flow Permanence and Information Content of Dividend Increases Versus Repurchases

We hypothesize that firms choose dividend increases to distribute relatively permanent cash-flow shocks and repurchases to distribute more transient shocks. As predicted, we find that post-shock cash flows of dividend increasing firms exhibit less reversion to pre-shock levels compared with repurchasing firms. We also examine whether the stock market uses the announcement of the payout method to update its beliefs about the permanence of cash-flow shocks. Controlling for payout size and the market\u27s expectation about the permanence of the cash-flow shock, the stock price reaction to dividend increases is more positive than the reaction to repurchases

Executive equity compensation and incentives: a survey

Stock and option compensation and the level of managerial equity incentives are aspects of corporate governance that are especially controversial to shareholders, institutional activists, and government regulators. Similar to much of the corporate finance and corporate governance literature, research on stock-based compensation and incentives has not only generated useful insights, but also produced many contradictory findings. Not surprisingly, many fundamental questions remain unanswered. In this study, the authors synthesize the broad literature on equity-based compensation and executive incentives and highlight topics that seem especially appropriate for future research.Executives ; Stockholders ; Corporate governance

The Use of Equity Grants to Manage Optimal Equity Incentive Levels

We predict and find that firms use annual grants of options and restricted stock to CEOs to manage the optimal level of equity incentives. We model optimal equity incentive levels for CEOs, and use the residuals from this model to measure deviations between CEOs’ holdings of equity incentives and optimal levels. We find that grants of new incentives from options and restricted stock are negatively related to these deviations. Overall, our evidence suggests that firms set optimal equity incentive levels and grant new equity incentives in a manner that is consistent with economic theory

Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility

The costs associated with compiling data on employee stock option portfolios is a substantial obstacle in investigating the impact of stock options on managerial incentives, accounting choice, financing decisions, and the valuation of equity. We present an accurate method of estimating option portfolio value and the sensitivities of option portfolio value to stock price and stock-return volatility that is easily implemented using data from only the current year’s proxy statement or annual report. This method can be applied to either executive stock option portfolios or to firm-wide option plans. In broad samples of actual and simulated CEO option portfolios, we show that these proxies capture more than 99% of the variation in option portfolio value and sensitivities. Sensitivity analysis indicates that the degree of bias in these proxies varies with option portfolio characteristics, and is most severe in samples of CEOs with a large proportion of out-of-the-money options. However, the proxies’ explanatory power remains above 95% in all subsamples

Stock Option Plans for Non-Executive Employees

We examine determinants of non-executive employee stock option holdings, grants, and exercises for 756 firms during 1994–1997. We find that firms use greater stock option compensation when facing capital requirements and financing constraints. Our results are also consistent with firms using options to attract and retain certain types of employees as well as to create incentives to increase firm value. After controlling for economic determinants and stock returns, option exercises are greater (less) when the firm\u27s stock price hits 52-week highs (lows), which confirms in a broad sample the psychological bias documented by Heath et al. (Quarterly Journal of Economics 114 (1999) 601–628)