Firms commonly define Free Cash Flow as operating cash flow minus capital expenditures. We examine the hypothesis that managers presenting Free Cash Flow in their earnings announcements are more myopically focused on maximizing Free Cash Flow. We find that firms presenting that metric in their earnings announcements engage in abnormally low capital expenditures. Firms reporting Free Cash Flow are also more likely to curtail their capital expenditures to achieve positive and increasing Free Cash Flow. Prior research suggests firms reporting EBITDA overinvest in capital assets. We find that emphasizing Free Cash Flow in addition to EBITDA neutralizes this overinvestment to zero, on average. This complimentary relationship between EBITDA and Free Cash Flow helps explain why firms tend to present these metrics together in their earnings announcements. Overall, our evidence supports the interpretation that managers present non-GAAP metrics that are consistent with the way they define and make decisions to maximize differing measures of operating performance.

The recent demise of Silicon Valley Bank, First Republic Bank, and Signature Bank are three of the four largest bank failures in U.S. history. To address the very real problems of recurring banking crises, the extant literature has focused on bank capital regulation. The corporate governance literature has focused extensively on executive compensation reform. We focus on the interaction among bank capital structure, bank capital requirements and bank executive incentive compensation, and related policy proposals.Specially, we recommend the following compensation structure for senior bank executives: Executive incentive compensation should only consist of restricted stock and restricted stock options – restricted in the sense that the executive cannot sell the shares or exercise the options for one to three years after their last day in office. This will more appropriately align the long-term incentives of the senior executives with the interests of the stockholders.Regarding bank capital reform - our bank capital proposal has two components: Bank capital should be calibrated using both balance sheet and market value of equity. Second, bank capital should be at least 20% of total assets (not risk-based assets per current regulatory requirement). Greater equity financing of banks coupled with the above compensation structure for bank managers will drastically diminish the likelihood of a bank falling into financial distress. This has policy implications for the federal deposit insurance.

SEC rules require managers to reconcile their non-GAAP earnings forecasts with the most directly comparable GAAP forecasts unless doing so would entail ‘unreasonable effort.’ A significant number of managers rely on the unreasonable efforts exception to justify the omission of comparable GAAP forecasts. We analyze firms that rely on the unreasonable efforts exception and find that their non-GAAP earnings forecasts are more likely to exclude significant recurring expenses that are not excluded by analysts. Our results suggest that almost a third of managers exploit the unreasonable efforts exception to exclude significant recurring expenses from their earnings guidance.

Goodwill impairment rules compel managers to convey their fair value assessments to investors. Several academic studies suggest that managers, on average, take advantage of discretion under these rules to opportunistically avoid or recognize smaller-than-expected goodwill impairments. We re-examine this conclusion and deliver three main findings. First, 44 percent of firms that avoid or record smaller-than-expected goodwill impairments are justified in doing so based on future stock price recovery. Second, the credibility of managers’ optimistic fair value assessments is positively associated with fundamental firm performance and strong external monitoring. Finally, a trading strategy long in firms that record smaller-than-expected impairments earns excess returns, suggesting that investors do not fully appreciate the signal embedded in these accounting decisions. We conclude that positive private information can be conveyed through smaller-than-expected goodwill impairments.

Since 2001, the number of financial statement line items forecasted by analysts and managers that I/B/E/S and FactSet capture in their data feeds has soared. Using this new data, we find that 13 item surprises—11 income statement-based and 2 cash flow statement-based analyst and management guidance surprises—reliably explain firms’ signed earnings announcement returns. No balance sheet or expense surprises are significant. The most important surprises are (i) one-quarter-ahead sales guidance surprise, (ii) analyst sales surprise, (iii) annual Street earnings guidance surprise, and (iv) analyst Street earnings surprise. We also find that the adjusted R2s of our multivariate regressions are three times higher than the adjusted R2s of univariate Street earnings surprise regressions, and that the four most important surprises account for approximately half of this increase in explanatory power.

Correction to this paper has been published: https://doi.org/10.1007/s11142-021-09616-6

Managers almost always define non-GAAP earnings to exclude the effects of acquisition and restructuring expenses, the amortization of intangibles, and impairments. I find that managers with a history of reporting non-GAAP earnings act as if they place lower weight on these excluded expenses when making real activities and accounting choices. They pursue more and larger acquisitions, have higher total capital investment, are more likely to restructure, and are more likely to recognize discretionary impairments. In a difference-in-differences setting, I find that non-GAAP reporting firms are less likely to alter their restructuring activities following a significant change in accounting rules for restructuring expense recognition. Finally, in supplementary analyses, I find that non-GAAP-reporting firms tend to repeat these real activities and accounting choices year-after-year, resulting in more persistent special-item expenses.

Since 2001, the number of financial statement line items forecasted by analysts and managers that I/B/E/S and FactSet capture in their data feeds has soared. Using this new data, we find that 13 item surprises—11 income statement-based and 2 cash flow statement-based analyst and management guidance surprises—reliably explain firms’ signed earnings announcement returns. No balance sheet or expense surprises are significant. The most important surprises are (i) one-quarter-ahead sales guidance surprise, (ii) analyst sales surprise, (iii) annual Street earnings guidance surprise, and (iv) analyst Street earnings surprise. We also find that the adjusted R2s of our multivariate regressions are three times higher than the adjusted R2s of univariate Street earnings surprise regressions, and that the four most important surprises account for approximately half of this increase in explanatory power.

Since 2001, the number of financial statement line items forecasted by analysts and managers that I/B/E/S and FactSet capture in their data feeds has soared. Using this new data, we find that 13 item surprises—11 income statement-based and 2 cash flow statement-based analyst and management guidance surprises—reliably explain firms’ signed earnings announcement returns. No balance sheet or expense surprises are significant. The most important surprises are (i) one-quarter-ahead sales guidance surprise, (ii) analyst sales surprise, (iii) annual Street earnings guidance surprise, and (iv) analyst Street earnings surprise. We also find that the adjusted R2s of our multivariate regressions are three times higher than the adjusted R2s of univariate Street earnings surprise regressions, and that the four most important surprises account for approximately half of this increase in explanatory power.

ABSTRACT We investigate the effects of audit partner rotation among U.S. publicly listed firms, utilizing the fact that audit partners are periodically copied by name in public correspondence between issuers and the Securities and Exchange Commission. Relative to non-rotation firms, we find no evidence of a change in the frequency of misstatements following the partner rotation; however, there is an increase in the frequency of restatement discoveries and announcements. We also find an increase in deferred tax valuation allowances. Overall, the results provide some evidence suggesting that U.S. partner rotations support a fresh look at the audit engagement. JEL Classifications: M41; M42; M48. Data Availability: Data are publicly available from sources identified in the article.

We revisit evidence that conditional conservatism aggregates up from the firm level causing corporate profit estimates in the National Income and Product Accounts (NIPA) to be more sensitive to negative relative to positive aggregate return news. Our study delivers three main messages. First, annual estimates of NIPA corporate profits are designed to provide neutral estimates of income from current production regardless of whether times are good or bad. Second, we find spurious evidence of asymmetric sensitivity to aggregate return news in placebo test variables that are void of conditional conservatism, clearly indicating that an alternative explanation is in order. Third, we find that the variance of aggregate returns decreases with the level of economic activity. Although this return variance effect is unlikely to be attributed to accounting, it has the potential to generate spurious evidence of conditional conservatism at the macro level. Overall, our study highlights the importance of construct validity tests in archival studies and contributes to research in the properties of NIPA corporate profits.

Managers can use the flexibility inherent in the accounting standards for segment reporting to delay or avoid goodwill write-downs. Goodwill is tested for impairment at the reporting unit level and the accounting standards define reporting units as operating segments or components of operating segments. Since operating segments are defined according to the management approach, or how the chief operating decision maker chooses to view the firm's operations, a firm can manage its segment boundaries to allocate acquired goodwill in a way that delays or avoids impairments. We find that in acquisition years, firms with higher book-to-market ratios are more likely to increase the number of reported segments, and that these high book-to-market, segment-increasing firms are associated with delayed goodwill impairments.