When managers anticipate synergy gains from an acquisition, they may pay more for target firm assets than their fair value, creating goodwill on an acquiring firm’s balance sheet. If synergy is not subsequently realized and the fair value of goodwill falls below its book value, goodwill write-downs result from annual impairment tests. Managers and investors may be able to avoid value destroying acquisitions if goodwill write-downs can be predicted from information at acquisition completion. We use purchase price allocation information from SEC 10-K filings to evaluate goodwill write-downs of prior acquisitions. For a sample of 421 U.S. acquisitions with a subset of 49 that experienced deal-specific goodwill write-downs, we find that firms acquiring target firms with larger relative size are more likely to experience goodwill write-downs. However, this effect is mitigated when a target firm’s value resides in identifiable intangible assets (e.g., brands and patents), suggesting acquirers may have private information about intangible asset combinations. Implications for management research and practice, as well as government policy are discussed.

We complement and extend the literature on real options and behavioral agency by identifying and documenting three drivers of asymmetry in the value-earnings convexity. Observing that financial reporting and disclosure play a feedback role in corporate investment decisions, the real options valuation models show that the equity value is increasing in the regions of profitability and investment growth, as reflected by the value-earnings convexity. We predict and find that value-earnings convexity also depends on the level of earnings management, the source of investment growth, and the Chief Executive Officer (CEO) personality traits. Specifically, we find that the value-earnings relation is less convex when the managed portion of earnings is high, or when off-balance-sheet intangibles support the capital investment growth. The value-earnings is more convex when CEOs are more extraverted or more open to learn.

Does pre-existing financial reporting quality play a role in mitigating market-driven takeover bids and enhancing investment efficiency? An exogenous buying pressure from mutual funds with extreme capital inflows affords us a quasi-experimental setting for testing the real effects of acquirers’ financial reporting quality. We find that financial reporting quality disciplines acquiring firm managers at the front-end of the acquisition process and averts value-destroying takeover stock bids. Our findings suggest that managers discipline themselves and offer takeover bids less frequently as a reaction to equity overvaluation when high-quality financial reporting facilitates an effective board oversight and managers rationally anticipate that the board will reject their market-driven stock bids. If managers inflate earnings proactively to prop up the stock price for their upcoming M&As, we will also observe an inverse relation between financial reporting quality and the likelihood of M&As. Our identification strategy on exogenous equity overvaluation helps in ruling out the reverse causality explanation of our findings. We contribute to the literature by investigating the effects of transparent financial reporting on mitigating managers’ sub-optimal investment decisions and unraveling the mechanisms underlying the real effects of financial reporting quality. Our falsification test result suggests the presence of tensions in our hypothesis.

This paper provides empirical evidence that the squared correlation coefficient between order imbalance and earnings surprise (COE) measures market underreaction and predicts the post-earnings announcement drift. We find strong evidence that COE during the announcement period predicts price movements (returns) during the post-announcement period in the expected direction. We find qualitatively similar results using risk-adjusted returns (i.e., Fama-French, Carhart, and Pastor-Stambaugh factor alphas), suggesting that well-known risk factors do not explain the profitability of trading strategy based on COE.

With intangible assets representing at least one third of U.S. corporate assets and one half of annual investment, it is important to understand to what extent intangible assets support debt. Some characteristics of intangible assets, such as high valuation risk and poor collateralizability, can discourage debt financing. Yet, intangible assets can generate cash flows just as reliably as tangible assets and may therefore support debt like tangible assets do. The empirical capital structure research has struggled to quantify the effects of intangible assets on leverage because most intangible assets are not reflected in financial statements. We take advantage of a recent accounting rule change that has made it possible to observe market-based valuations of a large part of intangible assets that beforehand where largely unobservable. With this novel dataset, we find a strong positive relation between intangible assets and financial leverage. The strength of this relation depends on the type of firm. In firms with ample tangible assets, the tangible assets can support the desired debt and intangible assets do not affect leverage. In firms with limited tangible assets, intangible assets strongly affect leverage and are the primary support of debt. On a per dollar basis across all firms, intangible assets support roughly three quarters as much debt financing as tangible assets. We also observe that the type of debt financing differs for firms whose assets are predominantly intangible. Firms with higher proportions of intangible assets utilize more unsecured and convertible debt, debt types that fit an intangible asset base well.

We show that strategic informed trading that arises from information asymmetry (i.e., the difference in the precision of information) between the liquidity demander and the liquidity provider results in underreaction to earnings announcements. The price impact of a trade increases with the precision of the information used exclusively by the liquidity demander, but decreases with the precision of the information used by the liquidity demander and provider. The post-earnings announcement drift increases with both the price impact of a trade and the squared correlation coefficient between order imbalance and earnings surprise. We discuss several testable implications of our analytical results.

We investigate whether earnings comparability is associated with the probability of informed trading ( PIN ) as a proxy for information asymmetry in the equity market. We measure earnings comparability in three different ways to account for idiosyncratic variation in firm-specific components of earnings using GAAP earnings, special item-adjusted GAAP earnings, and Street earnings. We find that earnings comparability is inversely associated with PIN . The inverse relation between earnings comparability and information asymmetry is pronounced for large and high-analyst coverage firms. Overall, this paper adds to the literature by demonstrating economic benefits of cross-firm properties of accounting information. © 2016 Elsevier Inc. All rights reserved.

We investigate whether earnings comparability is associated with the probability of informed trading (PIN) as a proxy for information asymmetry in the equity market. We measure earnings comparability in three different ways to account for idiosyncratic variation in firm-specific components of earnings using GAAP earnings, special item-adjusted GAAP earnings, and Street earnings. We find that earnings comparability is inversely associated with PIN. The inverse relation between earnings comparability and information asymmetry is pronounced for large and high-analyst coverage firms. Overall, this paper adds to the literature by demonstrating economic benefits of cross-firm properties of accounting information.

This paper investigates whether sell-side equity analysts fully incorporate the future earnings implications of really dirty surplus (RDS) into their earnings forecasts. RDS refers to gains or losses from contingent equity transactions settled at prices other than the fair value. We find that analysts’ earnings forecasts are over-optimistic for firms with large RDS losses, RDS over-optimism is lower for firms with higher analyst following, and the over-optimism carries over to stock recommendations. Our findings suggest that the lack of fair value information in accounting records about the off-market settlement drives the RDS-related analyst over-optimism.

We show that strategic informed trading that arises from information asymmetry (i.e., the difference in the precision of information) between the liquidity demander and the liquidity provider results in underreaction to earnings announcements. The price impact of a trade increases with the precision of the information used exclusively by the liquidity demander, but decreases with the precision of the information used by the liquidity demander and provider. The post-earnings announcement drift increases with both the price impact of a trade and the squared correlation coefficient between order imbalance and earnings surprise. We discuss several testable implications of our analytical results.

This paper reports two empirical regularities regarding trading volume prior to earnings announcements. The literature suggests that discretionary liquidity traders postpone their equity trading until firms publicly announce earnings due to high information asymmetry before anticipated information events. Our first finding is that pre-announcement trading volume increases for firms with high analyst coverage. Our second finding is that trading volume prior to bad news is lower than good news earnings announcements for firms with low analyst coverage. Our findings suggest that the intensity of analyst activity and the nature of mandatory earnings news jointly determine the direction and magnitude of pre-announcement trading volume. We contribute to the literature by showing that analysts' information discovery (temporarily pushed back trading demand) prior to earnings announcements may understate (overstate) the magnitude of a short-window trading volume reaction to earnings announcements as measures of information content for firms with high (low) analyst coverage.

ABSTRACT This paper examines the effect of tax-related material weakness in internal controls (MWIC) over financial reporting investors' valuation of unrecognized tax benefits (UTBs). Firms are required to record a UTB when their uncertain tax positions are unlikely to be sustained upon tax return audit. While Koester (2012) finds that investors positively value UTBs, we posit that a tax-related MWIC represents information risk in the tax account, reducing the value-relevance of UTBs. We predict that the positive relation between market value of equity and UTBs is attenuated when firms report a tax-related MWIC, and our empirical tests reveal that the relation is completely mitigated in the presence of a tax-related MWIC. Falsification tests confirm that non-tax-related MWICs do not attenuate the positive relation between market value of equity and UTBs, consistent with tax-related MWICs capturing low information quality specific to the tax account.

We investigate whether the change in accounting treatment of in-process research and development cost (IPRD) from expensing to capitalization affects the frequency of acquiring target firms with IPRD and the purchase price allocated to IPRD. We examine 1490 acquisitions in high-technology industries using a unique data set of purchase price allocations. For our sample as a whole, we find that the accounting rule change does not reduce the number of acquisitions with IPRD or the purchase price allocated to IPRD, but our results vary by industry. We provide evidence that the frequency of acquisitions with IPRD decreased for two of the four industry groups and IPRD intensity (IPRD/Assets Acquired) decreased for two industry groups. Our study contributes to research that examines whether mandatory accounting changes affect company economic decisions and research on managing earnings using IPRD.

How accounting information affects corporate investments is an important question, and prior studies suggest that managers tend to overinvest when their interests do not align with those of shareholders in order to reap perks, build large empires, and entrench their corporate positions. We explore whether high-quality financial reporting helps mitigate the agency conflicts created by overvalued equity in the context of M&A. To address the endogenous nature of the relation between accounting quality and overvalued equity, we identify overvalued equity based on the price pressure caused by relatively exogenous capital flows of mutual funds. We predict and find that high-quality financial reporting attenuates the tendency of managers to bid for acquisitions while the stock of an acquiring firm is overpriced in the equity market. We contribute to the literature by demonstrating a specific mechanism through which high-quality financial reporting moderates value destruction by self-interested managers.

This paper reports three empirical findings on the differential information content of the components of accounting profitability. First, the paper finds that the shareholder profitability driven by operating activities has a stronger association with annual stock returns than the shareholder profitability driven by financing activities. The finding provides empirical support for the FASB Financial Statement Presentation project, and the project suggests disaggregating accounting profitability into operating and financing activities. Second, the paper finds that the sustainable portion of operating profitability has a stronger association with annual stock returns than the unsustainable portion. This finding contributes to the literature by extending the two popular methods of breaking down operating profitability (DuPont analysis and operating liability leverage) into sustainable versus unsustainable operating income. Penman (Financial statement analysis and security valuation. McGraw-Hill, New York, NY, 2010) suggests disaggregating operating income into sustainable versus unsustainable operating income. Finally, the paper identifies the conditional persistence in Amir et al. (Rev Acc Stud 16:302–327, 2011) as one of the empirical attributes that affects the valuation usefulness of disaggregated accounting profitability. The conditional persistence measures the marginal contribution of disaggregated profitability to the persistence of aggregate profitability. This paper reports that the disaggregation is more useful in firms with significant differences in the conditional persistence of disaggregated components than in other firms. Test results are robust to controls for cross-sectional and time-series dependence in error terms.