Abstracts‎ > ‎

Volume 18

The Numbers Game: How Do Managers Compensated with Stock Options Meet Analysts' Earnings Forecasts?

Mark P. Bauman, Mike Braswell and Kenneth W. Shaw
University of Northern Iowa

Existing research documents those firms employing relatively high levels of stock option-based compensation more frequently report quarterly earnings that meet or exceed analysts’ forecasts. This paper examines the roles of income-increasing accounting choices and management guidance to analysts in this “numbers game.” Our analysis is motivated by increased capital market and Securities and Exchange Commission scrutiny of the effects of both stock option-based compensation and financial analysts in capital markets. Using a sample of S&P 1500 firms over 1992-2002, we find that firms that compensate top managers more heavily with stock options employ expectations-reducing guidance to financial analysts, not income-increasing abnormal accounting accruals, to enable them to more frequently meet analysts’ earnings targets. The results suggest that rule-making and enforcement aimed at curbing managements’ guidance to analysts, rather than narrowing accounting flexibility, might be more effective in tempering the “numbers game.”

Pro Forma Adjustments to GAAP Earnings:
An Analysis of Specific Adjustments, Materiality and SEC Action

Nancy B. Nichols
James Madison University
 Sidney J. Gray
University of Sydney
Donna L. Street
University of Dayton

The Securities and Exchange Commission (SEC) issued Regulation G (implementing Section 401 (b) of the Sarbanes-Oxley Act of 2002) in 2003 subsequent to its warning in December 2001 about reporting misleading non-GAAP or pro forma results. This research provides a longitudinal analysis of the earnings releases of a sample of companies reporting pro forma results from 1999 through 2004, especially in the context of recent SEC action. The research examines (1) the specific items included in pro forma adjustments and their frequency, (2) the extent of materiality or magnitude of the adjustments compared to GAAP, and (3) the stated rationale for the adjustments.
The research also specifically addresses the impact of the SEC’s recent guidance and the extent to which Regulation G has modified pro forma reporting behavior. Our findings indicate pro forma adjustments have continued to be systematically biased in recent years to show significantly higher earnings compared to GAAP earnings and that the magnitude of such differences is highly material. While SEC action, particularly Regulation G, appears to have greatly reduced the number of companies disclosing non-GAAP financial measures and has improved transparency, a significant number of companies continue to make adjustments that are likely of concern to the SEC.

Federal Securities Litigation Update

Jimmy W. Martin
University of Montevallo
Marvin Narz
University of Montevallo

This paper reports on a review of recent federal securities court decisions that relate to accountant’s liability issues. The review covers litigation arising under the Securities Act of 1933 as well as the Securities and Exchange Act of 1934 with heavy emphasis on the Private Securities Litigation Reform Act (PSLRA) of 1995 which amended both the 1933 and 1934 Acts. Regarding the 1933 Act, emphasis is given to the question of whether aftermarket purchasers can sue under Section 11. The issue was apparently settled when the Eighth Circuit Court of Appeals ruled that aftermarket purchasers can sue if they can “directly trace” their securities to the deficient registration statement. Regarding the 1934 Act, the paper analyzes recent court interpretations of the PSLRA and their potential impact on accountants. The paper stresses two important trends resulting from the PSLRA: 1) that plaintiff allegations of the defendant’s motive and opportunity alone are usually not enough to allow a suit to survive the pleading stage, and 2) that plaintiffs must avoid generalized charges and cite particular facts that support a strong inference of the defendant’s scienter.

Existing Disclosure Challenges of IPO Allocations

Denise A. Jones
College of William and Mary
Wanda A. Wallace
College of William and Mary

IPO allocations have been a topic of regulatory and legal attention. Prudent economics may explain the use of friends and family shares by private company owners going public, as well as underwriters' allotments of shares of initial public offerings (IPOs). However, systematic inquiry into potential abuses and conflicts of interest in preferential IPO allocations requires information on allocation practices. This paper explores whether existing disclosure within the regulatory infrastructure of section 144 stock facilitated detection of the extent of use of friends and family shares. Likewise, newspaper accounts of allegations and lawsuits are used to explore whether the nature of conflicts of interest in allotments of IPO shares could be discerned using available public information. Our results suggest that these preferential allocations are not transparent ex ante nor are they discernible ex post. These disclosure challenges could be addressed through business practices and regulatory policy that build upon the potential power of information markets as envisioned in the Full Disclosure (FD) approach. However, political visibility, proprietary concerns, and the sensitivity of information regarding purchasers' privacy may combine to deter such practices.

Antecedents and Expected Outcomes of the New Accounting Regulation in the European Union

Sylwia Gornik-Tomaszewski
St. John's University

Considering the growing importance of capital markets for corporate financing and operating in the common currency environment, the European Commission developed an ambitious action plan integrating the financial services markets within the European Union (EU). In the area of financial reporting, the action plan proposed an unprecedented approach that all EU listed companies report under the same accounting framework. Consequently, a new Regulation was approved requiring EU listed companies to prepare consolidated financial statements in accordance with International Financial Reporting Standards (IFRS) for years beginning on or after January 1, 2005. The objective of this paper is to look back at the accounting

harmonization process in the EU leading to this Regulation. The reasons behind the decision to make IFRS compulsory are explored in the broader context of the EU market reforms. The paper also presents a forward look into the implementation issues and implications of the new accounting strategy for the European Union and beyond.

Auditors' Reporting Options and Client Disclosure Quality

Joseph V. Carcello
University of Tennessee
 Jing Lin
University of Tennessee
Kannan Raghunandan
Florida International University

Auditors, legislators, and others have recently suggested that audit reporting options be expanded so as to provide better information about expected future events. However, the last action by the Auditing Standards Board (ASB) related to auditor reporting was to reduce the reporting options available to the auditor. In this paper, we examine if the quality of footnote disclosures about pending litigation related loss contingencies deteriorated after SAS No. 79 removed the option available to auditors to issue a modified audit report for uncertainties. We find that there is no difference in the quality of disclosures in periods before and after SAS No. 79 became effective. Our results indicate that reducing reporting options did not have an adverse effect on the quality of financial statement disclosures.

The Analysis of SFAS No. 109's Usefulness in Predicting Future Cash Flows from a Conceptual Framework Perspective

Joseph Legoria 
Louisiana State University
 Keith F. Sellers
Fort Lewis College

Abstract: This paper empirically tests whether the various SFAS No. 109 reporting and disclosure requirements provide information that is consistent with the FASB’s Conceptual Framework. To address this question, we examine whether information required by SFAS No. 109 provides any incremental ability to predict future operating cash flows. Our findings suggest that separate recognition of deferred tax assets, liabilities and valuation allowance provides useful information to predict future cash flows. To determine whether SFAS No. 109 data provides incremental useful information when predicting future cash flow, we develop a model (restricted) using financial statement information available in 1994. Next, we add the separate SFAS No. 109 components to the restricted model and test whether the full model is more appropriate. The results indicate that the SFAS No. 109 reporting requirements provide information useful for predicting future cash flows. These findings support the FASB’s position that SFAS No. 109 information is consistent with the conceptual framework of accounting. In addition, we find that separate recognition of deferred tax amounts required by SFAS No. 109 is a better predictor of future cash flows than reporting net deferred tax information as required by APB No. 11.

Do CEO/CFO Certifications Provide a Signal
of Credible Financial Reporting?

Thomas Vermeer
University of Baltimore

Over the last thirty years, numerous parties have discussed whether CEOs and CFOs should certify the appropriateness of their financial statements. Despite the interest in this issue, there is limited empirical research on whether a voluntary disclosure system for CEO\CFO certifications provides a signal of the credibility of financial reporting. In this study, I examine whether a voluntary disclosure system for CEO\CFO certifications provides a signal of the credibility of their financial reporting. I use the level of earnings management as the measure of the level of credible financial reporting.
I find that firms that include a voluntary CEO\CFO certification on the appropriateness of the financial statements are less likely to practice income increasing earnings management. Section 302 of the Sarbanes-Oxley Act requires that CEOs and CFOs certify the appropriateness of their financial statements. The findings of this study suggest that Section 302 may provide value by enhancing the credibility of those companies that did not provide certifications under a voluntary system.

Does Income Tax Regulation Apply Downward Pressure to CEO Compensation?

Toni Smith
Merrimack College

This paper addresses the question of whether Internal Revenue Code §162(m) was effective in decreasing the compensation of chief executive officers of publicly held US corporations. Section 162(m) limited the annual deduction of nonperformance-based executive compensation to $1 million. The stated goal of this section was to limit the compensation paid to corporate executives. This study utilizes the CEO compensation of a sample of 340 publicly traded US corporations for the years 1992-1997. Results indicate that §162(m) was not effective; compensation did not decrease. The most highly paid CEOs, whose salaries were subject to a limited deduction, however, realized smaller increases than their lower-paid peers (whose salaries were fully deductible).

A Note on Pre-Sarbanes-Oxley Act Users’ and Auditors’ Perceptions of a Limitations Paragraph in the Auditor’s Internal Control Report

Benjamin P. Foster
University of Louisville
Willie E. Gist
Ohio University
 Guy McClain 
Rhodes College
 Trimbak Shastri
University of Louisville

The auditor’s internal control report format prescribed by the Auditing Standards Board (ASB) and the Public Company Accounting Oversight Board (PCAOB) includes a “limitations paragraph.” This study examines the impact of a “limitations paragraph” on users’ and auditors’ perceptions about readability of the report, reliability provided by the report over financial reporting, and the auditors’ exposure to liability. The study uses data obtained from a field experiment conducted (with 122 audit partners and managers, and 123 professionals from the financial community) in 1991 in connection with auditors’ internal control reporting. This data set should provide input for regulators to evaluate the PCAOB prescribed internal control report format, because many of the expectations gap issues experienced in the 1970s and 1980s parallel those currently faced. Analyses indicate that the “limitations paragraph” may be perceived by users as providing less than a reasonable degree of assurance, and that the internal control report format without the “limitations paragraph” (structured along the lines of the SAS 58 auditors’ standard report) would significantly enhance users’ perceptions about the report’s readability, without increasing the liability as perceived by auditors. Policy-making bodies may find the results and approach taken in this study useful to evaluate report formats for assurance services that will strike a balance between user needs and auditors’ exposure to liability.

SIMS 2.0 Includes Controls for NYSE Special Closings, Small Firm Effects and Liquidity

Anthony J. Cataldo, II
Oakland University

This article updates Cataldo (1998 and 1999) and provides for descriptive measures of New York Stock Exchange (NYSE) special closings, the Russell 2000® Index, and 30-day commercial paper rates. NYSE special closings produce stock index behavioral patterns comparable to weekend and holiday effects. The Russell 2000® Index (1987-) provides a control measure for small firm effects. The 30-day commercial paper rates (1972-) provide a control measure for interest rates and liquidity. The significance of these control variables for small firm effects and liquidity is applied to all seasonal categories in this description of the expanded SIMS 2.0.


Stephen Moehrle
University of Missouri-St. Louis
 Jennifer Reynolds-Moehrle
University of Missouri - St. Louis

In this article, we synthesize in annotated bibliography form, recent regulation-related findings and commentaries published in the academic literature. This annotated bibliography is the first in a planned series of bibliographies that will summarize regulation-related academic research for at least the period 1990 forward. We reviewed academic outlets such as The Accounting Review, The Journal of Accounting Research, The Journal of Accounting and Economics, Accounting Horizons, The Journal of Accounting, Auditing & Finance, The Journal of Accounting and Public Policy, The Journal of Business, Finance & Accounting, Research in Accounting Regulation, and the Social Science Research Network. We annotate results of regulation-related research studies and key points from regulation-related commentaries.

FASB and the IASB versus J.R. Hicks
Joel Jameson
Silicon Economics, Inc.

FASB and the IASB, in asserting their preference for the “asset and liability view” of income over the “revenue and expense view”, have mistakenly invoked J.R. Hicks as grounding their position. In fact, Hicks argues that income based upon the “asset and liability view” is irrelevant when windfalls are present and that non-objective analysis is required to remove such windfalls to obtain an income measurement suitable for decision making. Hicks’ objective is actually aligned with the intention of the “revenue and expense view.” Given that both FASB and the IASB hold Hicks as a foundational authority, it is incumbent upon both of them to pursue accounting standards that remove windfalls as he suggested.

How FASB and LASB Should Apply
Hicksian Theory to Calculate Income

Joel Jameson
Silicon Economics, Inc.

Both FASB and the IASB inappropriately justify their “asset and liability view” of income determination based upon the published work of Nobel laureate economist J.R. Hicks. Hicks actually rejects the “asset and liability view” because the resulting income includes windfall gains. In this paper, Hicks’ conception of income is expressed as a mathematical formula that yields an income estimate for individual assets and liabilities, ultimately to yield net income reflective of the “earnings power view” as espoused by Hicks and others.

The Profession’s Core Values: Connecting our Past to our Future

S. Scott Voynich
American Institute of Certified Public Accountants

During this conference we are celebrating the 10th Congress that brings together the most renowned accounting historians from throughout the globe. We are also celebrating another event further back in our history. This program began in St. Louis in order to commemorate the 100th anniversary of the first truly international gathering of accounting professionals.

What brought those individuals together in 1904 and what bring us together in 2004 is a shared sense of purpose and a belief in a set of core values that holds true now as it did then. These values hold whether the individual accounting professional works for a small firm, a large corporation, or any type of enterprise in between.

These core values of integrity, competence and objectivity are the time tested building blocks for what has been a truly successful and honored profession. They are the basis upon which our individual clients and employers come to see the unique value that a CPA brings to the effort at hand. They are the basis of any opportunities our profession has had to expand the range of services offered beyond traditional auditing and tax compliance work.

Over the course of its history, the AICPA developed the world's largest and most prestigious accounting library. Now brought together in one place are an extensive photograph collection and approximately 190 rare volumes documenting the history of accounting.

Just as studying what the pioneers of the accounting profession believed and how they acted on those beliefs can serve each and every one of us today, future generations of the profession will surely look back at our beliefs and actions. If we hold true to our core values, even as we adapt to the ever-changing environment in which we practice, we can ensure that we can be looked upon as fondly as we look upon those who built our profession 100 years ago

Standing at the Crossroads

Peter R. Bible
General Motors Corporation

Today the accounting profession is standing at the crossroads. The corporate world recently closed two decades of unprecedented greed and corruption. As accountants, we presently find ourselves with an overly complex rules-based, mixed-attribute accounting model, the future of which could reside in the public sector. We will be faced with numerous problems as we attempt to converge U.S standards with international accounting standards.