This study examines whether the smoothing of GAAP effective tax rates (ETRs) using tax accruals informs or obscures financial reporting quality. We develop a GAAP ETR smoothing measure that isolates variation in tax accruals from underlying variation in cash tax planning and performance reflected in GAAP ETRs. We find that smoothing ETRs through tax accruals is beneficial to financial statement users. Our tests show that GAAP ETR smoothing is associated with (1) greater ability of current-period ETRs to predict future cash ETRs, (2) analysts producing more accurate ETR forecasts, and (3) lower incidence of restatements and tax-related financial reporting fraud. We also find some evidence consistent with managers using their discretion to achieve these benefits, rather than our results being solely an artifact of GAAP rules. Our results suggest that accrual-based GAAP ETR smoothing informs financial statement users about tax outcomes and indicates enhanced financial reporting quality.

Job vacancy duration reflects the time a firm spends searching, selecting, and hiring for a job opening. Capturing vacancy duration using the creation and deletion dates of job postings by US public firms, we examine the informativeness of vacancy duration for future firm profitability. We find that while firms that quickly fill low-skill job vacancies exhibit higher future profitability, firms that take more time to fill high-skill jobs exhibit higher future profitability. Our cross-sectional analyses across the benefits and costs of candidate selection and performance expectations suggest that the informativeness of vacancy duration comes from its reflection of firms’ hiring strategies. That is, firms expecting higher profitability recruit more intensively to avoid the opportunity cost associated with vacancies for low-skill jobs and to ensure the selection of high-quality workers for high-skill jobs. Further analyses show that the implication of job vacancy duration for future profitability is not incorporated timely in the capital markets, as evidenced by pessimistic analyst forecasts and positive earnings announcement returns in future quarters for firms with short (long) durations for low-skill (high-skill) jobs. These results demonstrate the informativeness of job vacancy duration for firm profitability and advance the understanding of firms’ hiring strategies.

ABSTRACT We empirically examine the impact of operating cash flows on future earnings targets in CEOs' annual cash bonus plans. Using target and actual compensation earnings-per-share disclosed in proxy statements of large U.S. public firms, we find operating cash flows have no significant incremental effects on the revision of future earnings targets in the presence of current earnings. We observe a positive association between future target achievability and current operating cash flows, indicating that firms with higher operating cash flows set significantly easier future earnings targets for CEOs. These findings suggest that the higher persistence of operating cash flows in predicting future earnings is not fully incorporated into target setting. Further analyses reveal that the positive association between future target achievability and current operating cash flows is attributable to both expectation bias and contractual considerations to reward CEOs who deliver greater cash flows and to limit activities that sacrifice cash flows. Data Availability: Data are publicly available from sources identified in the article. JEL Classifications: M41; J33.

This study provides the first large-sample archival evidence on the impact of three commonly used accounting performance goals (thresholds, targets, and maximums) in CEO compensation contracts on corporate risk taking. Using proxy statement disclosure on performance goals for CEOs of U.S. public companies, we find that lower thresholds and higher maximums are associated with greater corporate risk taking, and these results are more pronounced when CEOs have greater incentives to achieve accounting performance goals or have lower innate risk aversion. In addition, we find that target difficulty is not significantly associated with corporate risk taking after controlling for thresholds and maximums. Finally, we find that CEO compensation contracts are more likely to have lower thresholds and higher maximums when risk taking is more value-enhancing or when R&D investment is more profitable, consistent with boards setting performance goals to induce an appropriate amount of corporate risk taking. Our study contributes to the accounting literature on target setting and corporate risk taking by identifying accounting performance goals as a tool in executive compensation contract design to influence risk taking. This paper was accepted by Suraj Srinivasan, accounting.

Relative performance evaluation (RPE) compensates managers on their relative performance against a peer group. Since observing more peers’ performance allows managers to better estimate the performance level required to achieve RPE targets, we conjecture that releasing earnings later than peers facilitates managers to achieve targets by exploiting last-minute reporting discretion. Empirical evidence is consistent with our conjecture. Further, managers tend to select peers that release earnings more timely and delay own firms’ earnings releases to be later than peers’ after RPE adoption. Our evidence suggests strategic timing of earnings release and discretionary reporting in response to relative performance evaluation.

This study provides the first large-sample archival evidence on the impact of three commonly used accounting performance goals (thresholds, targets, and maximums) in CEO compensation contracts on corporate risk taking. Using proxy statement disclosure on performance goals for CEOs of U.S. public companies, we find that lower thresholds and higher maximums are associated with greater corporate risk taking, and these results are more pronounced when CEOs have greater incentives to achieve accounting performance goals or have lower innate risk aversion. In addition, we find that target difficulty is not significantly associated with corporate risk taking after controlling for thresholds and maximums. Finally, we find that CEO compensation contracts are more likely to have lower thresholds and higher maximums when risk taking is more value-enhancing or when R&D investment is more profitable, consistent with boards setting performance goals to induce an appropriate amount of corporate risk taking. Our study contributes to the accounting literature on target setting and corporate risk taking by identifying accounting performance goals as a tool in executive compensation contract design to influence risk taking.

We examine the extent to which current operating cash flows are incorporated in future earnings targets in executive compensation. Using target and actual compensation earnings per share (EPS) disclosed in proxy statements for large U.S. public companies, we find that revision of the following year’s EPS target is unrelated to current operating cash flows. Because of the positive association of operating cash flows with future earnings incremental to current earnings, failing to incorporate operating cash flows in target revision results in more achievable earnings targets for firms with higher operating cash flows. Interestingly, we find that the positive relationship between target achievability and operating cash flows is attributable to both expectation bias related to operating cash flows and contractual considerations designed to reward CEOs who deliver greater cash flows and to limit activities that sacrifice cash flows.

Prior literature is mixed as to whether smoothing through accruals indicates higher or lower financial reporting quality (Tucker and Zarowin 2006; Jayaraman 2008; Dechow et al. 2010). Motivated by the unique inter-temporal features and reporting incentives of tax expense, we provide new evidence on this debate by examining the link between smoothing of GAAP effective tax rates (ETRs) and the likelihood of financial restatements. Different from earnings smoothing’s insignificant relation with restatements, we find that ETR smoothing through tax accruals is strongly associated with a lower likelihood of financial restatement and tax-related financial reporting fraud. Further investigation reveals that these associations are stronger in firms with a higher level of discretion in tax reporting and when the demand for transparent reporting is higher. We also document corroborating evidence that smoothing through tax accruals increases the informativeness of GAAP ETRs for predicting future cash ETRs. Collectively, our results contribute to the financial reporting and tax literatures by providing evidence that smoothing activities pertaining to tax accruals are consistent with higher financial reporting quality.

Earnings non-synchronicity reflects the extent to which firm-specific factors determine a firm's earnings. Prior research suggests that high earnings non-synchronicity impedes corporate outsiders' ability to process information. This study examines the impact of earnings non-synchronicity on managers' decisions to provide earnings forecasts. We propose that high earnings non-synchronicity motivates managers to issue earnings forecasts to reduce information asymmetry between managers and investors and to preempt costly information acquisition by outsiders. Consistently, we find a positive relation between earnings non-synchronicity and managers' propensity to issue earnings forecasts, particularly long-horizon forecasts. This positive relation is weaker when earnings are easier to predict based on the firm's earnings history and is stronger when the firm has higher institutional ownership and greater analyst following. We also find that the market's reaction to management forecasts increases with earnings non-synchronicity. Overall, the evidence suggests that managers voluntarily provide earnings forecasts to alleviate the adverse consequences of earnings non-synchronicity. These findings provide a more complete picture about the impact of earnings non-synchronicity on a firm's information environment, and highlight the effect of the nature of information asymmetry on voluntary disclosures.

We examine whether management earnings forecast errors exhibit serial correlation and how analysts understand the serial correlation property of management forecast errors. Management forecast errors should not exhibit serial correlation if managers efficiently process information in prior forecast errors and truthfully convey their earnings expectations through management forecasts. However, for long-horizon management forecasts of annual earnings, we find significantly positive serial correlation in management forecast errors, and sample self-selection does not seem to drive this phenomenon. Further analyses suggest that managers’ unintentional information processing bias contributes to this positive serial correlation. Analysts anticipate the inter-temporal persistence of management forecast errors but underestimate the persistence level when reacting to management forecasts. Our findings have implications for market participants who rely on management forecasts to form earnings expectations, and also shed light on the efficiency of managerial decision making.

Based upon the premise that peer performance captures common exogenous shocks, relative performance evaluation (RPE) entails the use of peer performance in evaluating the performance of executives. In this paper we examine the use of RPE and related peer groups using disclosures collected from S&P 1500 firms’ first proxies filed under the SEC’s new disclosure rules on executive compensation. We find that 27.34 percent of our sample firms use RPE in determining executive compensation. The use of RPE varies with industry, firm, and executive characteristics as predicted by economic theories. Further, we find evidence supporting both efficient contracting and rent extraction in the peer selection choice. Consistent with efficient contracting, firms exhibiting a higher ability to remove common risk are more likely to be chosen as peers. However, we also find a selection bias in forming RPE peer groups as evidenced by a negative relation between firm performance and the likelihood of being selected as a peer. Finally, we find that CEOs in RPE firms receive greater compensation after controlling for a comprehensive set of economic and governance-related determinants of executive pay. Further investigation shows that the higher level of CEO compensation in RPE firms is at least partly attributable to the selection bias in forming RPE peer groups.

We investigate the association between errors in management forecasts of subsequent year earnings and current year accruals. In an uncertain operating environment, managers' assessments of their firms' business prospects are imperfect. Since managers' imperfect business assessments influence both accruals generation and earnings projection, we hypothesize that management earnings forecasts exhibit greater optimism (pessimism) when accruals are relatively high (low). Consistent with this hypothesis, we find a positive association between management earnings forecast errors and accruals. This positive association is stronger for firms operating in a more uncertain business environment and for firms in industries exhibiting greater covariation between accruals and growth-related activities. Moreover, this positive association is significant when accruals likely reflect managers' true beliefs about firms' business prospects, but is nonexistent when accruals are likely manipulated to boost managers' trading gains. Supplementary analysis reveals that the presence of management earnings forecasts does not significantly reduce accrual mispricing.

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In recent years, a substantial percentage of managers voluntarily choose to provide disaggregated earnings forecasts, i.e., earnings forecasts supplemented with additional numerical forecasts for other line items on the income statement. We examine whether such disaggregation yields higher-quality (i.e., more accurate and less biased) management earnings forecasts, and whether market reactions to disaggregated vs. aggregated forecasts are consistent with the quality of these forecasts. We find that: (1) for good news forecasts, earnings forecasts with disaggregated information are no different from aggregated earnings forecasts in either bias or accuracy; (2) for bad news forecasts, earnings forecasts with disaggregated information are significantly less accurate and, on average, more optimistic than aggregated earnings forecasts; 3) stock market reactions to disaggregated good news forecasts are no different from stock market reactions to aggregated good news forecasts, but stock market reactions to disaggregated bad news forecasts are more negative than stock market reactions to aggregated bad news forecasts. Taken together, our results suggest that disaggregated earnings forecasts are no better than and sometimes even worse than aggregated earnings forecasts and that investors anticipate and adjust for the biases associated with disaggregation in management earnings forecast.

We study the relationship between the amount of managed earnings and firms’ earnings performance and expected growth in a reporting model, where managers manipulate earnings to influence the valuation of firms’ equity while bearing a cost that is increasing and convex in the amount of managed earnings. In the unique revealing equilibrium to the model, firms with higher performance and growth over-report earnings by a larger amount because price responsiveness increases with earnings performance and growth. And earnings quality, defined as the proportion of true economic earnings in total reported earnings, increases with earnings performance but decreases with earnings growth. We conduct empirical tests on a large sample and a restatement sample using different proxies for earnings management. Results from the large sample tests support our predictions while results from the restatement sample tests are mixed. Our study provides an alternative explanation to the positive relationship between discretionary accruals estimated from the Jones model and firms’ performance and growth.