We investigate whether ineffective internal control over financial reporting has implications for firm operations by examining the association between inventory-related material weaknesses in ...internal control over financial reporting and firms' inventory management. We find that firms with inventory-related material weaknesses have systematically lower inventory turnover ratios and are more likely to report inventory impairments relative to firms with effective internal control over financial reporting. We also find that inventory turnover rates increase for firms that remediate material weaknesses related to inventory tracking. Remediating firms also experience increases in sales, gross profit, and operating cash flows. Finally, we assess the generalizability of our findings by examining all material weaknesses in internal control over financial reporting, regardless of type, and provide evidence that firms' returns on assets are associated with both their existence and remediation. Collectively, our findings support the general hypothesis that internal control over financial reporting has an economically significant effect on firm operations.
Managerial Ability and Earnings Quality Demerjian, Peter R.; Lev, Baruch; Lewis, Melissa F. ...
The Accounting review,
03/2013, Letnik:
88, Številka:
2
Journal Article
Recenzirano
We examine the relation between managerial ability and earnings quality. We find that earnings quality is positively associated with managerial ability. Specifically, more able managers are ...associated with fewer subsequent restatements, higher earnings and accruals persistence, lower errors in the bad debt provision, and higher quality accrual estimations. The results are consistent with the premise that managers can and do impact the quality of the judgments and estimates used to form earnings.
We propose a measure of managerial ability, based on managers' efficiency in generating revenues, which is available for a large sample of firms and outperforms existing ability measures. We find ...that our measure is strongly associated with manager fixed effects and that the stock price reactions to chief executive officer (CEO) turnovers are positive (negative) when we assess the outgoing CEO as low (high) ability. We also find that replacing CEOs with more (less) able CEOs is associated with improvements (declines) in subsequent firm performance. We conclude with a demonstration of the potential of the measure. We find that the negative relation between equity financing and future abnormal returns documented in prior research is mitigated by managerial ability. Specifically, more able managers appear to utilize equity issuance proceeds more effectively, illustrating that our more precise measure of managerial ability will allow researchers to pursue studies that were previously difficult to conduct.
This paper was accepted by Mary E. Barth, accounting.
We examine the disclosure of non-GAAP earnings information in quarters containing transitory gains to investigate whether the primary motivation for these managers to disclose non-GAAP earnings is to ...inform or mislead. In this setting, non-GAAP earnings are more informative than GAAP earnings, even though they are lower than GAAP earnings. Thus, managers motivated to inform stakeholders about sustainable earnings will disclose non-GAAP earnings information excluding the gain, whereas managers motivated to report higher earnings will obscure the transitory nature of the gain by focusing on GAAP earnings. We find evidence that managers' disclosure choices vary widely across firms, and these choices affect investors' perceptions of core operating earnings. We then contrast how the same firm discloses non-GAAP earnings in the presence of transitory losses to provide additional evidence on the motives of individual firms' disclosures. We conclude that the most pervasive motivation to disclose non-GAAP earnings in the presence of transitory gains is to inform. An economically significant proportion of firms, however, appear opportunistic in that they only disclose non-GAAP earnings information when it increases investors' perceptions of core operating earnings. Our evidence is important because we speak to the influence that each motive has on the choice to disclose non-GAAP earnings and we provide evidence on the underlying motives behind specific firms' disclosures.
We examine the relation between accruals quality and internal controls using 705 firms that disclosed at least one material weakness from August 2002 to November 2005 and find that weaknesses are ...generally associated with poorly estimated accruals that are not realized as cash flows. Further, we find that this relation between weak internal controls and lower accruals quality is driven by weakness disclosures that relate to overall company-level controls, which may be more difficult to "audit around." We find no such relation for more auditable, account-specific weaknesses. We find similar results using four additional measures of accruals quality: discretionary accruals, average accruals quality, historical accounting restatements, and earnings persistence. Our results are robust to the inclusion of firm characteristics that proxy for difficulty in accrual estimation, known determinants of material weaknesses, and corrections for self-selection bias.
We examine determinants of weaknesses in internal control for 779 firms disclosing material weaknesses from August 2002 to 2005. We find that these firms tend to be smaller, younger, financially ...weaker, more complex, growing rapidly, or undergoing restructuring. Firms with more serious entity-wide control problems are smaller, younger and weaker financially, while firms with less severe, account-specific problems are healthy financially but have complex, diversified, and rapidly changing operations. Finally, we find that the determinants also vary based on the specific reason for the material weakness, consistent with each firm facing their own unique set of internal control challenges.
ABSTRACT
Although the increase in non-GAAP earnings metrics has drawn unfavorable attention from regulators and standard setters, it can provide valuable experience for investors. We investigate ...whether experience with non-GAAP earnings metrics influences investors’ pricing of non-GAAP exclusions. We measure experience as the frequency with which managers or analysts provide non-GAAP earnings over the prior eight quarters and find that experience aids in the pricing of non-GAAP exclusions. Absent prior experience with non-GAAP earnings metrics, investors appear to overestimate the persistence of exclusions at the earnings announcement, which corrects in the following months. Cross-sectional tests suggest that experience facilitates investors’ pricing of non-GAAP exclusions by reducing their information processing costs.
JEL Classifications: M40.
This paper focuses on a sample of 261 companies that disclosed at least one material weakness in internal control in their SEC filings after the effective date of the Sarbanes-Oxley Act of 2002. ...Based on the descriptive material weakness disclosures provided by management, we find that poor internal control is usually related to an insufficient commitment of resources for accounting controls. Material weaknesses in internal control tend to be related to deficient revenue-recognition policies, lack of segregation of duties, deficiencies in the period-end reporting process and accounting policies, and inappropriate account reconciliation. The most common account-specific material weaknesses occur in the current accrual accounts, such as the accounts receivable and inventory accounts. Material weakness disclosures by management also frequently describe internal control problems in complex accounts, such as the derivative and income tax accounts. In our statistical analysis, we find that disclosing a material weakness is positively associated with business complexity (e.g., multiple segments and foreign currency), negatively associated with firm size (e.g., market capitalization), and negatively associated with firm profitability (e.g., return on assets).
Financial statements derive much of their usefulness from the association between the disclosed current period data and future economic outcomes. While the current period results in isolation may be ...useful for some purposes, the bulk of financial statement users are interested in predicting future outcomes that map into the value of equity or debt claims on the firm. Research in financial statement analysis examines how the mappings from current period data to future outcomes should be made. In this paper we model one of the most important mappings-- the relation between the firm's current period disclosures and future sales--and examine how well our model works in the retail industry. While forecasting retail sales may seem like a rather narrow exercise, it is a direct test of the usefulness of the disclosures these firms make about their sales activity. In addition, we show that the relation between current period sales data and a logical forecast of future sales is significantly more complicated than one might think. By thinking carefully about how the mapping should be modeled and then estimating the model parameters and making forecasts, we illustrate a process that can be used for many financial statement items beyond just sales and across most industries.
We empirically examine the effects of intensified scrutiny over non-GAAP reporting on the quality of non-GAAP earnings exclusions. We find that, on average, exclusions are of higher quality (i.e., ...more transitory) following intervention by the Securities and Exchange Commission (SEC) into non-GAAP reporting. We further find that firms that stopped releasing non-GAAP earnings numbers after the SEC intervention had lower quality exclusions in the pre-intervention period. These results are consistent with the SEC's objectives of improving the quality of non-GAAP earnings figures. However, when we decompose total exclusions into special items and other exclusions, we find evidence that the quality of special items has decreased in the post-intervention period, which suggests that managers adapted to the new disclosure environment by shifting more recurring expenses into special items. This suggests that there may be unintended consequences arising from the heightened scrutiny over non-GAAP reporting.
