Research Opportunities in
Management Accounting
Journal of Management Accounting Research (1993)
Robert S. Kaplan
Research Opportunities in
Management Accounting (1)
 Limitations of statistical analysis to test emerging
theories
 The role for analytical research
 Role for design research vs. analysis research
 The new research agenda for management
accountants should encompass mode design and less
analysis
 The new research should like engineering and less
like science
 The new research should take basic principles and
apply them to the new environment in which
management accounting is being practiced
 The researchers have to learn how to perform and
evaluate research whose output is something new: a
prototype, a management accounting system that
seems to work, according to criteria they develop, in
an actual setting
Research Opportunities in
Management Accounting (2)
 Role for Field Research
 “What-is” research
 Tested theories that had been influential and in
existence long enough for company practice to
have change based on the theories
 “What’s new” research
 Observing and documenting the changes and
innovations now underway in organizations
 Researchers associate themselves with the
organization to become intimately familiar with
the circumstances of such experiments and the
process of implementation and change
Research Opportunities in
Management Accounting (3)
 Role for Field Research
 “What’s new” research
 The research output:
 Describe what practitioners believe and the
design principles that guided their action
 Document the historical circumstances that led
to the innovation, and the principles of learning
the practitioner used
 A priori predictions about the types of
resistances the design innovation will
encounter and its likelihood of success
 The researcher must identify
opportunistically innovating companies
Research Opportunities in
Management Accounting (4)
 Role for Field Research
 “What’s new” research
 Conduct in-dept observation and
documentation to describe the
management accounting innovation
 Describe practice
 Formulate theories that provide a
conceptual framework to explain the
successful innovations
 The theories can then be tested using normal
science investigative methods when
widespread adoption of the innovation begins
to pervade practice
Research Opportunities in
Management Accounting (5)
 Role for Field Research
 “To-be” research
 Active participants in the change process
 Required when adoption of new methods is
slow or unlikely
 The researcher becomes like the
practitioner, a part of the design and
implementation process, and hence come
closer to developing not only a more
complete theory of management
accounting, but contributing to a more
general theory of management
Research Opportunities in
Management Accounting (6)
 Role for Field Research
 “To-be” research
 Longitudinal action-oriented research
 Research on new settings
 A management accounting innovation has yet
to be tried in a particular setting
 Active role of researcher: extend and
customize the innovation to that setting
 Design research:
 Developing and evaluating new systems
 Attempting to identify some of the different
or unique features that arose in the new
settings
 Being sensitive to implementation concerns
Research Opportunities in
Management Accounting (7)
 Role for Field Research
 “To-be” research
 Research on implementation
 Explore the wide set of issues that arise when
attempting to implement new management
accounting concepts
 Research on integration
 Who does what?
 Situations still arise when normal science
methods can and should be productively
employed
 The longitudinal and action research methods
may require a greater maturity and knowledge
of individual and organizational behavior
Field Research Methods in
Management Accounting
Accounting Horizons (1999)
S. Mark Young
Introduction
 Sources disciplines: anthropology,
sociology and business
 Unique characteristics: people
interactions
 Major influence: Kaplan (1983)
The Range of Field Research
Methods (1)
 Depends on levels of observation,
interaction and participation with
organizational members
 Outsider vs. insider perception
 Adler and Adler (1987): based on the
degree of researcher involvement
 The Chicago School of Sociology
 Existential Sociology
 Ethnomethodology
The Range of Field Research
Methods (2)
 The Chicago School of Sociology
 Stages:
 Direct observation (observe members)
 Direct but detached interaction (interact with
members)
 Firsthand participation in member’s activities
(participate with members)
 Characters:
 Researcher attempt to remain objective
 Researcher adopt an overt role and
acknowledge to organizational members that
they are conducting a study
 Strive to not become emotionally involved as
organizational members to not risk influencing
the environment they are studying
The Range of Field Research
Methods (3)
 The Existential Sociology
 Investigates participation
 Fundamental assumption: people in
organizations tend to present (at least) two
sides of their behavior and activities
 Presented to outsiders (impression
management)
 Presented to insiders
 Researcher rules:
 Shed their objective detachment
 Become an insider to the organization
 Establish relationships with organization
members to gather information and tp drwa on
members’ subjective experiences
 Use combination of overt and covert roles
The Range of Field Research
Methods (4)
 Ethnomethodology
 The peripheral membership role
 Researchers seek an insider’s viewpoint and
take part in social activities
 Researchers do not assume leadership roles or
participate in the core activities of the group
 Researchers may decide to restrict their
involvement because they do not want to
participate in some of the group’s activities
 The Active Membership Role
 Researchers moves into a more central role in
the organization
 Researchers ascend to a higher level of insider
status by interacting with members as
colleagues and co-participants in the groups’
core activities
The Range of Field Research
Methods (5)
 Ethnomethodology
 The complete membership role
 Researchers literally go native and become
bona fide members of a group with co-equal
status in all ways
 Type: opportunist vs. convert
 Management accounting
 Chicago school
 Field research in management accounting is still
its infancy and many researchers are in a
“learning-by-doing” phase of their own
development
 Many of researchers have been schooled in the
logical empiricist tradition
Contributions of Field Research to The
Management Accounting Literature
 Testing and developing theories with
data not obtainable using other
research methods
 Raising new research questions
 Informing other research methods
 Understanding the limitations of the
outsider’s view
Advancing Our Use of Field Methods
 Learning by doing
 Apprenticeships with field researchers
 Forge relation with managers and
business people involved with their
own institutions
 Joint the practitioner forums
 Formal coursework: field research,
training in specific techniques, and
study on philosophy of science
Directions in Accounting
Research: NEAR and FAR
Accounting Horizons (1996)
William H. Beaver
Factors Affecting Directions in
Accounting Research (1)
 Exogenous factors: arise “outside” of the
influence of the accounting academic
community
 Applications from other disciplines (Finance,
Information Economics, Behavioral Sciences)
 Greater data availability at lower cost (CRSP,
COMPUSTAT, I/B/E/S, GLOBAL VANTAGE,
OSIRIS)
 Changes in the financial reporting environment
(changes in event, transaction, and nature of
the regulatory oversight: changes in accounting
standards)
Factors Affecting Directions in
Accounting Research (2)
 Endogenous factors: are those that largely
lie within the influence of the academic
accounting community
 Journals (Journal of Accounting Research –
empirical accounting research; Journal of
Accounting and Economics – positive accounting
theory research)
 Annual conferences
 Sections of the profession association
 Promotion policies at colleges and universities
 Creative process of talented individuals
NEAR Directions
 Sources:
 Accounting doctoral seminar on security price
research at Stanford
 Research currently in progress
 See Figure 1 at page 116
 Features of NEAR:
 The number of nodes in which research is
actively taking place
 The proportion of research that is taking place in
nodes that are subcategories of subcategories
 There is an paucity of research that has opened
“new” nodes at a higher level in the hierarchy
(synthesis vs. fragmentation)
Personal Examples of NEAR (1)
 The Pricing of Discretionary Accruals
 “Accrual Management” node
 Test the relationship of security prices and
discretionary portion of loan loss
 Discretionary and non-discretionary
 Particular industry and particular accrual
 Findings: indicate that the nondiscretionary
portion is negatively priced and, as predicted,
the discretionary portion is significantly less
negative priced
Personal Examples of NEAR (2)
 The Value-Relevance of SFAS No. 107: Fair
Value Disclosures
 “Accounting Data as Measurement” node
 SFAS 107 vs. SFAS 33: similarities and
differences
 Dependent variable: the difference between
market value and the book value of equity;
Independent variable: the difference between
SFAS 107 fair value and the respective book
values of five categories, investment securities,
loans, deposits, long-term debt and off-balance
sheet items
 Selection of dependent variable: level vs. event
study
 Old vs. new passion of estimation technique
Personal Examples of NEAR (3)
 The price-earnings relation – A simultaneous equation
approach
 “Information Content of Prices” node and “Earnings
Response Coefficients” node
 New applications of econometrics tool: simultaneous
equation approach
 Relative Importance of Book Value and Earnings
 “Accounting Data as Measurement” node
 Initial findings: the importance of the balance sheet
in explaining valuation increases with financial
difficulty and is higher for industries where intangible
assets are less likely
 Conservatism and Delayed Recognition in Accrual
Accounting
Features of FAR
 Trends in accounting research
 Outstanding accounting research is likely to be a
blend of theory, empirical analysis and
institutional knowledge
 The emphasis on contextual rather than generic
research (need particular samples, specific
reporting issues, and the collection of distinctive
data bases)
 The “wild card” factors:
 Change in the financial reporting environment
 The creativity of individual researchers
 Syntheses
Perspectives on Recent
Capital Market Research
The Accounting Review (2002)
William H. Beaver
Introduction





Market efficiency
Feltham-Ohlson modeling
Value relevance
Analysts’ behavior
Discretionary behavior
Market Efficiency [1]
 Market efficiency and the regulation of financial
reporting
 Market efficiency and investment decisions –
resource allocation and production efficiency
 Market efficiency and researchers (set of
inference, variable measurement, and
interpretations)
 Earlier studies: confirmed the market efficiency
 Recent studies: post-earnings announcement
drift; market-to-book ratios and its
refinements; contextual accounting issues
Market Efficiency [2]
 Post-Earnings Announcement Drift
 Market-to-Book Ratios and Extensions
 Abnormal return associated with portfolio strategies
based on market-to-book ratios
 Extensions: (1) market-to-value ratios; and (2)
analysts’ biased forecasts
 Contextual Accounting Issues
 The price of accrual and cash flow information
 The IPO puzzle
 etc
Market Efficiency [3]
 How can widely disseminated and examined data used
with simple portfolio strategies that require no
knowledge of accounting be associated with abnormal
returns?
 How can studies of arcane disclosure find that such
disclosures are apparently reflected in prices, yet more
visible variables, such as earnings and book value, are
not?
 How can studies of security return in the very short run
shwo evidence of relatively rapid response, and yet have
evidence of abnormal returns that appear to persist for
year after the portfolio formation date?
 How can the body of research in aggregate show that
prices both lead and lag accounting data?
Feltham-Ohlson Modeling [1]
 Key Feartures of F-O Modeling
 Parsimonious assumptions – the value of equity
= the present value of expected future
dividends, the clean surplus relation, and some
form of a linear information dynamic
 Provides a role for many importance features of
the accounting system: clean surplus, book
value, earnings, transitory components of
earnings, conservatism, delayed recognition
Feltham-Ohlson Modeling [2]
 Key Feartures of F-O Modeling
 Stimulated considerable empirical research
 Both book value and earnings are significant pricing factors
 The relative importance of book value is inversely related
to the financial health of the firm
 The coefficient on earnings is lower for firms with low
return on equity
 The coefficient on positive earnings is positive and
significant, while the coefficient on losses is insignificantly
different from zero
 Accrual vs. cash flow components of earnings are priced
significantly differently from one another. In general, the
accrual components are associated with a lower coefficient
Feltham-Ohlson Modeling [3]
 Criticisms of the F-O Approach
 The model has no endogenous demand for
accounting data vs. F-O models do not attempt to
derive a demand for accounting
 There is no information asymmetry and that hence
no strategic uses of accounting data arise within the
F-O framework
 Some aspects of the models are unsupported by the
empirical data
Value-Relevance Research [1]
 Examines the association between a security
price-based dependent variable and a set of
accounting variables
 What are the distinctive characteristics?
 Value-relevance research demands an in-depth
knowledge of accounting institutions, accounting
standards, and the specific features of the reported
numbers
 Timeliness of information is not an overrding issue
(event studies, level of stock prices and the
accounting data)
Value-Relevance Research [2]
 Why Is Timeliness Not the Key Issue?






Delayed recognition
Earnings announcements are largely preempted by the
disclosure of other information vs. the cost of obtaining
the prior information
Key role of financial statements is to summarize
relevant information parsimoniously and in a manner
consistent with the underlying concept
The financial statements are not intended to list only
those assets, liablities, revenues, and expenses not
preempted by other publicly available information
Timeliness is only one dimension
Implication for research: change vs. level
Value-Relevance Research [3]
 What Is the Conceptual Foundation of
Value-Relevance Research?
 Combination of a valuation theory plus
contextual accounting arguments that allow
researchers to predict how accounting variables
relate to the market value of equity
 Valuation models
 Earnings-only approach – MM (1996): present
value of permanent future earnings
 Balance-sheet approach
 F-O models: book value of equity and the present
value of expected future abnormal earnings
Value-Relevance Research [4]
 What Have We Learned?
 Is it priced?
 Is it priced consistently with some
theoretical value?
 Is a particular accounting number priced
equal to or differently from similar
accounting numbers?
 Addressess questions relating to footnote
information and nonfinancial intangle assets
Value-Relevance Research [5]
 The Role of Value-Relevance Research
 Help articulate the nature of the issues and provide a
paradigm or language with which to frame the
questions of interest
 Provide a theory
 Provide empirical evidence
 Unresolved Issues
 Market efficiency
 Econometric issues
 Other puposes of financial statements
Research on Analysts’ Behavior [1]
 Analysts are among the major
information intermediaries who use and
interpret accounting data
 Security prices reflect the results of their
analysis
 Analysts rely on a rich set of publicly
available data – assess the importance
of accounting data relative to the total
mix of information
Research on Analysts’ Behavior [2]
 What Have We Learned?
 Analysts’ forecasts are optimistics
 Analysts employed by investment firms that
are associated wth the underwriting of the
firm’s securities issue more optimistic
forecasts
 Analysts’ forecasts tend to be revised
downward during the year
 Analysts with better forecasting ability appear
to have a higher profitability of survival
Research on Analysts’ Behavior [3]
 What Have We Learned?





Analysts’ forecast outperform the best statistical models
Analysts’ forecast do not reflect all of the information in
the past earnings series (the forecast errors are serially
correlated and analysts underestimate the persistency
of earnings)
Capital markets appera to reflect naively analysts’
forecast in prices – abnormal returns associated with
MTB and MTV strategis
Analysts’ forecasts appear to be a parsimonious way to
capture “other information”
Analyst coverage is greater for firms with more
institutional investor and more intagible assets
Research on Analysts’ Behavior [4]
 Unresolved Issues
 Need a better understanding of the
incentives of analysts with respect to
forecasting
 Identification the other information besides
accounting data that influences analysts’
forecasts
Research on Discretionary
Accruals [1]
 Motives for Accrual Management
 Opportunistics vs. signaling
 Compensation contracts, debt covenants,
capital market pricing, taxes, litigation,
and regulatory behavior
 Multiple motives: opposing or
reinforcing?
Research on Discretionary
Accruals [2]
 What Have We Learned?
 Earnings management identification:
 Generic models of discretionary accruals
 Tests based on discontonuities in the
reported earnings distribution
 Account-specific models of discretionary
behavior
 Combination
Research on Discretionary
Accruals [3]
 What Have We Learned?
 Earnings management motivation:




Avoid a loss
Avoid an eanrings decline
Avoid falling below analysts’ forecasts
Meeting the earnings forecasts
 EM appears to be widespread and
relatively easy to detect, at least as
estimated by extant techniques
Research on Discretionary
Accruals [4]
 What Have We Learned?
 EM:
 Accrual management
 Hedging activities
 Altering research and development
expenditures
 Combination
 Capital markets appear to price
differently the nondiscretionary and
discretionary components of an accrual
Research on Discretionary
Accruals [5]
 Estimation of Discretionary and
Nondiscretionary accruals
 Jones (1991) model: parsimonious model
 Use sector-specific variables for investigating sectorspecific accruals
 Unresolved Issues
 Identification of discretionary accruals
 The nature of the discretion may be known but not
contractible
 Incentives and costs to eliminate discretionary
behavior are unclear, and discretionary behavior may
be an equilibrium outcome, albeit not a “first best”
solution
Empirical Research on
Accounting Choice
Journal of Accounting and Economics
(2001)
Thomas D. Fields
Thomas Z. Lys
Linda Vincent
Introduction [1]
 Market imperfections and accounting
choice
 Definition of accounting choice
 The motives behind the accounting
choice decision
 Accounting research: the determinants
and implication of accounting choice
 Literature review
Introduction [2]
 Structure of review:
 Review and summarize the results of research
bearing on accounting choice (focusing on the
1990s)
 Assess the extent to which knowledge of the
importance of accounting choice has increased
beyond that of the 1970s and 1980s
 Conclusions about the importance and
implications of accounting choice research
 Suggestions for future avenues of research into
accounting choice
Introduction [3]
 Organization of review:
 Agency costs: contractual issues – mitigate
agency costs
 Information asymmetric: informed vs. less
infromed parties – disseminate privately
held information
 Externalities: third-party contractual and
non-contractual relations – quality and
quantity of financial disclosures, which in
turn have welfare and policy implications in
the presence of externalities
Introduction [4]
 Brief conclusions:
 Accounting research has made modest progress in
advancing the state of knowledge beyond what was
known in the 1970s and 1980s
 Researchers generally focus on refinaing knowledge
of specific accounting choice or on narrow problems
that accounting choices are presumed to address
 Accounting research generally fail to distinguish
appropriately between what is endogenous and
exogenous
 A comprehensive theory is currently unavailable and
possibly unattainable: limit to use of accounting
choice and ignore the major role of accounting in
normal, day-to-day situations
Introduction [5]
 Opportunities
 Evidence be gathered on whether the alleged
attempts to manage financial disclosures by selfinterested managers are successful; that is, what are
the economic implications of the accounting choices”
 More emphasis on the costs and benefits of
addressing the three types of market imperfections
driving accounting choice
 Reseachers develop better theoretical models and
more refined economectric techniques with the
explicit goal of guiding empirical research and
articulating expected results from such empirical
research
Reasons for Accounting Choices [1]
 Accounting choices in accounting
principles
 Accounting choices and information
asymmetries
 Accounting choices and issues of
consistency and comparability
 Accounting choices and efficient
contracting
Reasons for Accounting Choices [2]
 Accounting choices and mixed
motives
 Accounting choices: cost vs. benefit –
optimal level of discretion
 Accounting choices and earnings
management: intention and
opportunity
Reasons for Accounting Choices [3]
 Zero accounting choices:
Disputes over interpretation of the code
Detail rules for all facts and circumtances
New situations required new accounting rules
Accounting flexibility mitigates manager’s attempt to
obtain desired accounting results by means of real
decisions
 Accounting choices as part of an optimal solution to
an agency problem
 Accounting choices made can be informative




 Accounting choices: cost (?) vs.
benefits (?)
Classification of Accounting Choice [1]
 The presence of agency costs and the
absence of complete markets
 Accounting choice and contractual
arrangements: efficient contracting
perspective
 Examples: executive compensation
agreements and debt covenants – ex ante
vs. ex post setting
 There are potential conflicts among multiple
goals in the choice of accounting methods
Classification of Accounting Choice [2]
 The presence of information
asymmetries: attempts to influence
asset prices
 Ex ante: information transfer from wellinformed to less-informed
 Ex post: self-interest motives
 Influence external parties other than
actual and potential owners of the
firm
Classification of Accounting Choice [3]
 Literature review:


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

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
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Research on accounting choices
Period: 1990s
Sources: (1) Journal of Accounting and Economics; (2)
Accounting Review; and (3) Journal of Accounting Research
Major categories of choice-based research
US GAAP
Exclude managerial choices about eanrings announcemenet
and other kinds of announcements involving accounting
numers
Behavioral, experimental, analytical, and empirical
Rely on market imperfections and assume individual
decision makers are rational
Prior Literature Reviews [1]
 Late 1960s and 1970s
 Assume that market are efficient
 Examines the association between stock returns
and accounting information
 Research question: whether investors could ‘see
through’ alternative accounting practices to the
underlying firm economics
 Hypothesis: absent effects on the firm’s cash
flows, investors do not alter their assessment of
share prices based on alternative accounting
methods
 Methodology limitation
Prior Literature Reviews [2]
 Late 1970s
 Research on Manager’s motives for the choice of
accounting techniques
 Investigation of the effects of accounting choice on
contractual arrangements
 Bernards (1989): economic consequences of
mandated accounting changes – little or no evidence
of associated stock price effects
 Holthausen and Leftwich (1983): fim size and
leverages are the only two significant variables
explaining choices of accounting techniques
 Watts and Zimmerman (1990): ex ante vs. ex post
and mixed motives
Contractual Motivations [1]
 Contractual arrangements and financial
accounting numbers:
 management compensation contracts
 bond covenants
 Contractual arrangements and accounting
choice
 The results in general suggest that:
managers select accounting methods to
increase their compensation and to reduce
the likelihood of bond covenant violations
Contractual Motivations [2]
 Internal Agency Conflicts – Executive
Compensation
 Background:
 Reporting flexibility and the associated
increased compensation are a relatively low
cost compromise
 Manipulating accruals may results in lower
wealth losses to principals that
manipulating real activity
 Interest alignment
 Market rationality and anticipation
Contractual Motivations [3]
 Internal Agency Conflicts – Executive
Compensation
 Evidence of managerial opportunism:
 Healy (1985) – lower and upper bound
 Clinch and Magliolo (1993) – absence of cash
flow effects
 Gaver et al (1995) vs. Healy (1985) - income
smoothing
 Holthausen et al (1995) vs. Healy (1985):
methodology
 Chen and Lee (1995) support Healy (1985) –
big bath behavior
Contractual Motivations [4]
 Internal Agency Conflicts – Executive
Compensation
 Evidence of managerial opportunism:
 Ittner et al (1997) expand Healy (1985): nonfinancial measures
 Gaver and Gaver (1998) support Healy (1985):
asymmetric function
 Guidry et al (1999) support Healy (1985) –
different business units within a singel corp
 Other several studies
Contractual Motivations [5]
 Internal Agency Conflicts – Executive
Compensation
 Problem with endogeneity:
 The contract itself is endogenous (the obvious
opportunities for self-serving behavior should
have been anticipated and priced
 Other checks and balances exist
 The models use to detect accrual management
are not very powerful and may not be able to
differentiate between accruals management and
real performance
Contractual Motivations [6]
 Internal Agency Conflicts – Executive
Compensation
 Problem with endogeneity:
 The studies implicitly take the conditioning event as
exogenous
 Only part of the compensation function, usually the
cash bonus is analyzed, without condisering the
effect on total compensation (includin stock
ownership)
 Managerial opportunism is usually defined as
maximizing the current period’s net income whereas
there are different forms of managerial opportunism
 Alternative explanations are not explored
Contractual Motivations [7]
 Internal Agency Conflicts – Executive
Compensation
 Managerial opportunism vs. value
maximization
 Summary:
 Managers exploit their accounting discretion to
take advantage of the incentives provide by
bonus plans
 However, little is known about whether such
manipulations actually result in higher payouts,
or about the impanct of earnings management
on other corporate goals
Contractual Motivations [8]
 External Agency Conflicts – Bond
Covenants
 Research questions:
 Why lending agreements rely on reported accounting
numbers
 Why these contracts allow companies discretion to
select and change accounting methods subsequent
to the debt issuance
 Assumption: Floating GAAP
 Less costly to monitor
 The difficulty in specifying frozen GAAP
 Impposes fewer restrictions on corporate activities,
particularly investments
Contractual Motivations [9]
 External Agency Conflicts – Bond
Covenants
 Hypothesis:
 Managers select or change accounting methods to
avoid covenant violations – debt hypothesis


Tries to explain accounting choices with closeness to debt
covenants
Focuses on firms that have violated debt covenants
 Investigated which firms are more likely to be
adversely affected by mandated accounting changes
by analyzing stock price reactions around the
announcement of, or the lobbying behavior prior to,
mandated accounting changes
Contractual Motivations [10]
 External Agency Conflicts – Bond
Covenants
 Debt covenant violation:


Leverage ratio/Debt to equity ratio
Firms that actually violated covenants
 Previous reserachs
 Healy and Palepu (1990) – dividend constraint
in debt covenants: accounting changes vs.
dividend reduction
 Sweeney (1994) – mixed results &
methodological problem
Contractual Motivations [11]
 External Agency Conflicts – Bond
Covenants
 Previous reserachs
 DeAngelo et al. (1994) - not statistically significant &
methodological problem
 DeFond and Jiambalvo (1994) – accrual manipulation
vs. accounting changes
 Haw et al. (1991) & Chase and Coffman (1994) – debt
covenants and specific accounting choice with real
economic impact
 Chung et al. (1993) and Malmquist (1990) – GAAP vs
non GAAP
 Francis (1990): cost of violation vs. cost of compliance
Contractual Motivations [12]
 External Agency Conflicts – Bond
Covenants
 Summary
 The evidence on whether accounting choices are
motivated by debt covenant concerns is inconclusive
 Consistent with the debt hypothesis and other
hypothesis
 Moving beyod the use of the debt to equity ratio as the
proxy for proximity to covenant violation
 Consider alternative hypothesis: efficient contracting vs.
opportunism
 Relation between accounting choice and violation of
debt covenants
Asset Pricing Motivations [1]
 Accounting choice and stock price or
returns (equity valuation or cost of capital)
 Forms:




Maximize earnings in a given period
Smooth earnings over time
Avoid losses
Avoid earnings declines
 Researchs:



Association between earnings and share prices
Market efficiency: accounting choices without direct cash
flow implication and changes in stock prices
Alternative explanations: investor irrationality, manager
signaling, and contractual motivations
Asset Pricing Motivations [2]
 Researchs:
 Earnings management and share prices
– specific situations
 DeAngleo (1986) and Perry & Williams
(1994) – MBO
 Erickson dan Wang (1999) – equity
financed acquisitions
 Kasznik (1999) – earnings forecasts
Asset Pricing Motivations [3]
 Disclosure Policies
 Botosan (1997): level of disclosure
(accounting choice) and costs of capital
 Sengupta (1998): level of disclosure and cost
of debt
 Hayes & Lundholm (1996) and Harris (1998):
segment disclosures and firm value – level of
competitiveness
 Balakrishnan et al. (1990) and Boatsman et
al. (1993): geographical segments and
earnings quality/security valuation
Asset Pricing Motivations [4]
 Disclosure Policies
 Barth & McNichols (1994): environmental
liability disclosures and market value of equity
 Forst & Kinney (1996): level of disclosure –
foreign vs. U.S. Firms – earnings and stock
returns
 Summary:



Results on whether the level of disclosure affects the cost of
capital are mixed
Evidence does not support an unequivocal decrease in cost of
capital as a results of increased disclosure
More study is necessary to understand the relative costs and
benefits of increased disclosure
Asset Pricing Motivations [5]
 Earnings Management





Gaver et al. (1995) vs. Healy (1985): bonus plan
hypotheses
DeFond & Park (1997): income smoothing hypotheses
Burgstahler & Dichev (1997): avoi earnings decreases
and losses
Barth et al. (1999): earnings management and stock
prices
Hong et al. (1978) and Davis (1990): earnings
management (purchase vs. pooling) and abnormal
returns
Asset Pricing Motivations [6]
 Market Efficiency





1970s: support market efficiency
1980s – 1990s: assumes market efficiency and other
economic explanations (example: efficient contracting
theory)
1990s: irrationality of investors – behavioral finance
Beaver and Engel (1996): decomposition of allowance
for loan losses – nondiscretionary (negatively priced)
and discretionary (positively priced)
Subramanyam (1996): value of discretionary accruals –
income smoothing: persistency & predictability &
communicate private information
Asset Pricing Motivations [7]
 Market Efficiency
 Hand et al. (1990): stock (bond) prices and
insubstance defeasance
 Summary
 There is neither clear evidence that markets are
inefficient nor unequivocal evidence that they are not
 Most research supporting both conclusions is subject
to criticism that interpretation of the results is
conditional on both the proper specification of the
returns generating process and of the event under
consideration
 It is difficult to draw strong inferences about the
implications of accounting choices for asset prices
Motivation Due to Impact on
Third Parties [1]
 Taxes
 Research question: whether firms choose
accounting methods to minimize the present
value of taxes
 Evidence: consistent with tax-minimizing
choices or other offsetting considerations
(presence of conflicting goals)
 Structured around changes in tax rates
 Dhaliwal & Wang (1992): shifting permanent
and timing differences across periods to
minimize the impact of the AMT
Motivation Due to Impact on
Third Parties [2]
 Taxes
 Structured around changes in tax rates
 Boynton et al. (1992): smaller firms
manipulating discretionary accruals to reduce
the impact of AMT
 Guenther (1994): firms shift net income from
the higher to the lower taxed periods by
means of current accruals
Motivation Due to Impact on
Third Parties [3]
 Taxes
 The effect of tax rate changes on the
accounting choices of MNCs
 Harris (1993), Klaessen et al. (1993), and
Collins et al. (1998): Tax Reform Act 1986
(tax rate changes) and income shifting in
MNCs
 Jacob (1996): transfer pricing
Motivation Due to Impact on
Third Parties [4]
 Taxes
 Accounting choice and tax effect
 LIFO vs. FIFO and the marke reactions: Tse
(1990); Hand (1993 & 1995); Jennings et al.
(1996) – inconsistence results
 Cloyed et al. (1996): firms choose a conforming
financial reporting method when the tax savings
apparently outweigh the estimated non-tax costs
– tax accounting method
 Guenther et al. (1997): cash to accrual basis
(derived by TRA’86) significantly increased the
level of deffered financial statement income
Motivation Due to Impact on
Third Parties [5]
 Taxes
 Tax vs. non-tax considerations
 Tax costs to other contracting parties due to
deferred revenue recognition and accelerated
expense recognition (Scholes et al., 1992)
 The impact on debt covenants of shifting income
into net operating loss years (Maydew, 1997)
 Increased cash flow and smoother earnings
(Maydew et al., 1999)
 The effect on earnings used for performance
measurement and the effect on equity valuation
(Klassen et al., 1993)
Motivation Due to Impact on
Third Parties [5]
 Taxes
 Tax vs. non-tax considerations
 Tax costs to other contracting parties due to
deferred revenue recognition and accelerated
expense recognition (Scholes et al., 1992)
 The impact on debt covenants of shifting income
into net operating loss years (Maydew, 1997)
 Increased cash flow and smoother earnings
(Maydew et al., 1999)
 The effect on earnings used for performance
measurement and the effect on equity valuation
(Klassen et al., 1993)
Motivation Due to Impact on
Third Parties [5]
 Taxes
 Tax vs. non-tax considerations
 Dhaliwal et al. (1994): tax minization, earnings
management, adn debt covenants all provide incetive to
dip into LIFO layers
 Klaessen (1997): trade off taxes and financial reporting
goals in the context of the choice of the divestiture form
chosen
 Summary:
 Firms make accounting choices in order to reduce
theirtax burden
 The evidence with respect to the stock market effects of
these actions is mixed
Motivation Due to Impact on
Third Parties [6]
 Regulation
 Industry-specific regulations
 Focuses on accounting responses to specific
constraints
 Considers more indirect effets: the political
costs of appearing to be ‘overly’ profitable
 Managers choose accounting methods and
procedures to increase shareholder wealth
Motivation Due to Impact on
Third Parties [7]
 Regulation
 The regulatory costs imposed by capital
adequacy ratio guidelines in the banking
industry
 Moyer (1990): adjusting loan loss
provisions, loan charge-offs, and securities
gains and losses
 Kim & Kross (1998): manipulating accruals
 Blacconiere et al. (1991): adopting
voluntary regulatory accounting principles
Motivation Due to Impact on
Third Parties [8]
 Regulation
 Insurance industry
 Petroni (1992): insurers bias downward
their loss reserves when they are close to
receiving regulatory attention
 Adiel (1996): insurers enter into costly
financial reinsurance transactions to reduce
regulatory costs
Motivation Due to Impact on
Third Parties [9]
 Regulation
 The regulation literature generally concludes
that managers select accounting methods to
avoid regulatory intervention
 There are information costs in the political
process such that there is some probability
that the regulators will not detect or adjust
for the accounting manipulation
 The cost of regulatroy interventions and the
manner in which the regulation is enforced
Motivation Due to Impact on
Third Parties [10]
 Regulation
 Price-regulated industries
 Managers select accounting numbers and
procedures to increase cash flows to shareholders, even when this reduces earnngs and
increases liabilities: Eldenbrug & Sodestrom
(1996) and D’Souza (1998)
Motivation Due to Impact on
Third Parties [11]
 Regulation
 Non-regulated industries
 Jones (1991) – income decreasing in the year
of import relief investigations
 Key (1997) – cable industry
 Hall & Stammerjohan (1997) and Han & Wang
(1998) – oil company
 Blacconiere & Patten (1994) – environmental
disclosure in chemical firms
Motivation Due to Impact on
Third Parties [12]
 Regulation
 Multiple incentives and multiple accounting
methods
 Beatty et al. (1995) – bank’s accounting accruals,
investment, and financing decisions are interdependent
and cannot be studied effectively in isolation
 Collins et al. (1995) – cross-sectional differences in
bank’s responses to capital, earnings, and tax
incentives
 Summary:
 Consistent with expectations
 Third parties are either not willing or not able to undo
the accounting manipulations
Impediments to Progress [1]
 Multiple Method Choices
 One choice vs. multiple accounting
choices to accomplish a specific goal
 Examine the net effect of all accounting
choices on the accruals of the firms for
the period under consideration
 DeAngelo (1986) and Perry & Williamns
(1994) –discretionary accruals (MBO)
 Erickson & Wang (1999) – discretionary
accruals (stock-for-stock acquisition)
Impediments to Progress [2]
 Multiple Method Choices
 Discretionary accual estimation model:
 Dechow et al. (1995) – low power
 Guay et al. (1996) – mixed results
 Kang & Sivaramakrishnan (1995) – instrumental
variabels approach
 The importance of ability to detect
earnings management
 Premise: the interested parties are unable (or possibly
unwilling) to detect the effect of accounting method
choice, accounting procedures, and accounting
estimates on the reported numbers
Impediments to Progress [3]
 Multiple Method Choices
 The importance of ability to detect
earnings management
 The difficulty using statistical techniques to detect
earnings management
 Three approaches:
 Continue using the discretionary accruals method
 Continue to develop and test more powerful techniques
for the detection of earnings management
 Measure multi-dimensional accounting choice directly
via the financial statements – Hagerman & Zmijewski
(1979) and Zmijewki & Hagerman (1981)
Impediments to Progress [4]
 Multiple Motivations
 Mutilple and potentially conflicting motivations
for the accounting choices: interaction between
and trade-offs among goals
 Adding control variables
 Researchers often rely on coarse of inappropriate
proxies to measure the role of the omitted determinants
of accounting choice
 Inference problems are likely to arise when analyzing
multiple motivations using proxies with differing
amounts of measurement error, particularly when the
underlying effects are correlated
 The absence of linearity
Impediments to Progress [5]
 Multiple Motivations
 Evidence of progress
 Hand & Skantz (1998)
 Accounting choice of SAB 51 is a function of a
linear combination of different motives:
political, debt-covenants, earnings
management, and information signaling)
 Francis et al. (1996)
 Discretionary asset write-offs is a function of
managerial incentives to increase
compensation and to smooth earnings
Impediments to Progress [6]
 Multiple Motivations
 Evidence of progress
 Robinson and Shane (1990): the cost and
benefits associated with accounting choice of
purchase or pooling
 Balsam et al. (1995): effect of earnings
management and debt covenants on the timing
of adoption of new FASB regulations
 Bartov (1993): earnings smoothing and debtto-equity considerations for corporate
management of accounting earnings through
asset sales
Impediments to Progress [7]
 Multiple Motivations
 Evidence of progress
 Guenther et al. (1997) – effect of tax motive,
compensation contract, debt contract, and asset
pricing, to accounting choice
 Multiple methods and motivations
 Hunt et al. (1996) – simultaneous equation
approach: multiple choice (inventory
management, depreciation, and other current
accruals) vs. multiple objectives (income
smoothing, minimizing debt-related costs, and
minimizing taxes)
Impediments to Progress [8]
 Multiple Motivations
 Multiple methods and motivations
 Christie (1990) – multiple motivations vs.
multiple choice
 Further progress:
 Continue to consider the existence of multiple
motivations (Bartov, 1993)
 Exploring the underlying relations among
different motivations
 Refining and expanding the methodology
Impediments to Progress [9]
 Methodological Issues
 Standard econometric problems:
simultaneity, errors-in-variables, omitted
variables, etc – low power and unreliable
tests
 Inherent endogeneity of the choices that
are made (accounting methods, firm
financial structure, organizational
structure, contracts, etc)
Impediments to Progress [10]
 Methodological Issues
 Example of endogeneity problem:
 Skinner (1993)
 Investment opportunities set, compensation and
debt contracts, and firms characteristics (including
accounting choices)
 IOS influence the structure of its compensation
plans and debt contracts, and thus indirectly
influences its accounting choices
 There is an association between IOS and accounting
choices
 Interrelationship among variables affecting
accounting choices
Impediments to Progress [11]
 Methodological Issues
 Example of endogeneity problem:
 Begley and Feltham (1999)
 Control for the endogeneity of both incentive
variables and debt covenants
 Changes in accounting policy choices of differences
in choices across firms may be driven by underlying
economic differences in the firms, either crosssectionally or through time
 The self-selection bias inherent in the
sample
 Crude proxies vs. actual measurement
Impediments to Progress [12]
 Methodological Issues
 Appropriate research question:
 the driven of the accounting choice vs.
consistency with one or more posited incentives
 Distinguishing between managerial
opportunism, shareholder wealth maximization,
and information motivation
Impediments to Progress [13]
 Narrow Scope of The Research on The
Costs and Benefits of Accounting
Choice
 Empirical tests of the benefits of
accounting choice yield mixed results
 There is little convincing research and
non consensus that the benefits of
increased disclosure outweigh the costs
Impediments to Progress [14]
 Lack of Theoritical Guidance
 The environment in which choices are
made and the mechanism by which thet
have an impact are not well articulated –
the need of analytical research
 The limitation of analytical research –
focuses on disclosure policy
Recommendations for Future
Research
 Compelling evidence of the implications
of alternative accounting methods
 Considering multiple choices and
multiple motivations
 Develop more powerfull statistical
techniques and improve research design
 Use the expertise as accountants –
small sample and fields studies