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Publications and Working Papers
All of my working papers are available from SSRN. You can access my papers on the
Social Science Research Network (SSRN) through the following url: http://ssrn.com/author=292475.
VALUATIONS. 1
What determines residual income?. 1
The role of analysts’ forecasts in
accounting-based valuation: A critical evaluation. 1
FINANCIAL ANALYSTS. 2
Institutional holdings and analysts’ stock recommendations. 2
Analyst coverage and the cost of raising capital:
Evidence from underpricing of seasoned equity offerings. 2
Are analyst research and corporate disclosures
complements or substitutes?. 3
On the association of analysts’ forecast errors
with past stock returns: A re-examination. 3
Issuing stock recommendations: Theory and evidence. 3
EARNINGS MANAGEMENT AND VOLUNTARY DISCLOSURES. 4
Equity incentives and earnings management 4
Insider trading and voluntary disclosure. 4
Earnings restatement, change in CEO compensation,
and firm performance. 4
Abnormal accrual-based anomaly and managers’
motivations to record abnormal accruals. 5
(The Accounting Review January 2005, 80 (1): 85-112)
[Download the
working paper version before publication]
This paper investigates determinants of residual
income scaled by beginning-of-period book value of equity, i.e., abnormal
return on equity (ROE), by analyzing the impact of value-creation (economic
rents) and value-recording (conservative accounting) processes on abnormal
ROE. I rely on economic theories to characterize economic rents and develop
an empirical measure – the conservative accounting factor – to capture the
effect of conservative accounting. As expected, both the permanent level
and the persistence of industry abnormal ROE increase with industry
concentration, industry level barriers to entry, and industry conservative
accounting factors. Also as expected, the permanent level and the
persistence of the difference between firm and industry abnormal ROE
increase with market share, firm size, firm level barriers to entry, and
firm conservative accounting factors. Integrating determinants of abnormal
ROE into the residual income valuation model can double its explanatory
power for the variation in the market-to-book ratio.
(Review of Accounting Studies March
2005 10 (1): 5-31)
[Download the
working paper version before publication]
Prior research has used explicitly identified other
information items and analysts’ forecasts separately to proxy for other
information when implementing the residual income valuation model. The
former approach is explicit about the information it incorporates, but not
parsimonious. In contrast, the latter approach incorporates more timely
information in a parsimonious way, but it is subject to the bias and
inefficiency in analysts’ forecasts. This paper compares the usefulness of
explicitly identified other information items with that of other
information derived from analysts’ forecasts in predicting future abnormal
return on equity and in explaining the market-to-book ratio. The results
indicate that when used separately, explicitly identified other information
items have higher explanatory power than other information derived from
analysts’ forecasts. The results also indicate that when used jointly, the
two sources of other information complement each other. Additional analyses
suggest that explicitly identified other information items are especially
important for firms with bad news, firms in high-tech industries, firms
with high R&D capital, or firms with high accruals, where the
explanatory power of abnormal return on equity is relatively low.
(with
Xia Chen, UBC)
(Journal of Accounting, Auditing, and Finance 21 (4): 399-440)
[Download
paper]
There is mixed evidence regarding the investment value
of analysts’ stock recommendations. On one hand, prior research, such as
Womack (1996), documents significant abnormal returns around stock
recommendations. On the other hand, Barber et al. (2001) find that
investors cannot benefit from trading on stock recommendations. In this
paper, we investigate whether institutional investors, who acquire stock
recommendations under soft dollar arrangements, benefit from these
recommendations by allocating their assets accordingly. Based on quarterly
institutional holding data, we find that institutional investors increase
holdings of firms with favorable recommendations and decrease holdings of
firms with unfavorable recommendations. Results from intraday analyses
confirm that institutional investors adjust their holdings in response to
stock recommendations. There are more buyer-initiated than seller-initiated
large trades (proxy for institutional tradings) around favorable
recommendations, and more seller-initiated than buyer-initiated large
trades around unfavorable recommendations. These results are consistent
with the proposition in Grossman and Stiglitz (1980) that informed traders
should benefit from costly information acquisition.
(with
Bob Bowen, University of Washington, and Xia Chen, UBC)
(Contemporary Accounting Research Forthcoming)
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paper]
There is little direct evidence that analyst coverage
benefits the firms they follow. In this paper, we hypothesize that analyst
coverage can reduce information asymmetry and thus lower the cost of
raising equity capital. We investigate the effect of analyst coverage on
the underpricing of seasoned equity offerings (SEOs), which increases with
information asymmetry and is a substantial cost of issuing new shares.
Based on 4,766 SEOs in the period 1984-2000, our overall results suggest
that analyst coverage significantly reduces SEO underpricing. Firms with
high sell-side analyst coverage (over eight analysts following) have lower
SEO underpricing by an average of 2.27% of total proceeds, compared with
firms with low analyst coverage (one to three analysts). This effect is
economically significant given that average SEO underpricing across the
entire sample is 2.38%, and is robust to controlling for other factors
affecting SEO underpricing. Next, we examine additional attributes of
analyst coverage and find that firms followed by analysts working for the
lead underwriter or by analysts with a reputation for superior ability have
incrementally lower SEO underpricing. Finally, we use institutional
ownership to proxy for buy-side analyst coverage and find that
institutional ownership is associated with incrementally lower SEO
underpricing.
(With Xia Chen and Kin Lo from UBC)
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This paper examines the relation between
analyst research and corporate disclosures. While prior theoretical studies
suggest that analyst research substitutes for corporate disclosures, recent
empirical studies find that the two complement each other – the aggregate
market impact of analyst research and that of earnings announcements are
positively correlated. In this paper, we hypothesize that the role of
analyst research depends on the timing of analyst reports relative to
earnings announcements. We predict that before firms announce earnings,
analyst research contains information that substitutes for earnings
announcements while after firms announce earnings, analysts help to
interpret the announced earnings information and thus their research serves
a complementary role. Our empirical evidence is consistent with both
predictions. We find that the information content of an earnings
announcement is negatively correlated with that of analyst research in the
week prior to the earnings announcement, and positively correlated with
that of analyst research in the week afterwards. In addition, we predict
and find that the complementary role of analyst research is more important for
firms with financial accounting information that is difficult to interpret.
(with Xia Chen, UBC)
[Download paper]
Prior studies (e.g., Lys and Sohn 1990;
Ali, Klein and Rosenfeld 1992) have documented a positive association
between analysts’ forecast errors and past stock returns and suggested
cognitive bias on the part of analysts as a possible explanation. In this
paper, we separately analyze the association between forecast errors and
past negative returns and that between forecast errors and past positive
returns. We find that forecast errors are only positively associated with
past negative returns and are not associated with past positive returns.
These results are robust to a series of sensitivity tests. They are
inconsistent with analysts being subject to cognitive bias; instead, they
are consistent with several explanations related to accounting conservatism
or analysts’ incentives: analysts having difficulty in forecasting
discretionary charges associated with past negative returns, analysts not
exerting effort in forecasting earnings of firms with poor performance, or
analysts ignoring bad news in order to please managers.
(with
Xia Chen, UBC)
[Download
paper]
In this paper, we investigate determinants of the
market impact of stock recommendations issued by sell-side financial
analysts. We propose a simple framework for understanding the process that
financial analysts use to issue stock recommendations. The framework yields
three testable predictions: The market impact of stock recommendations
increases with analysts' perceived ability and investors' uncertainty about
firm value, and decreases with analyst experience after controlling for
analysts' innate ability. We empirically test these predictions and find
consistent results. Using Institutional Investor All-American analyst
status to proxy for high perceived ability and return volatility for
uncertainty about firm value, we find that the market impact of
recommendations increases with analysts' perceived ability and return
volatility. Using the number of quarters an analyst has been issuing
recommendations or earnings forecasts to proxy for experience, we find that
the market impact of recommendations decreases with analyst experience
after controlling for analyst-company specific effects. These results hold
when we control for other characteristics of financial analysts and
brokerage firms that might affect the market impact of stock
recommendations. The results hold for recommendation revisions as well.
(with
Terry Warfield, University of Wisconsin - Madison)
(The Accounting Review April 2005 80 (2): 441-476)
[Download the
working paper version before publication]
In this paper, we develop the link from stock-based compensation
to future insider trading and then examine whether this link provides
incentives for earnings management. Based on all firm-year observations
with data available over the 1993-2000 time period, we provide empirical
evidence that managers with high stock-based compensation are more likely
to sell shares in subsequent periods. We then document a significantly
higher incidence of meeting or just beating analysts' forecasts for
managers with high stock-based compensation. Additional analyses indicate
that high stock-based compensation managers are also more likely to report
income increasing abnormal accruals. Collectively, these results indicate
that stock-based compensation leads to incentives for earnings management.
(with Kin Lo, UBC)
(Journal of Accounting Research 44
(4): 815-848)
[Download paper]
We hypothesize that insiders strategically
choose disclosure policies and the timing of their equity trades to
maximize trading profits. We find that managers provide more good news
forecasts in periods when they sell more and buy fewer shares. Managers
also increase the number of bad news forecasts when they purchase more and
sell less equity. These relations are stronger for trades of the chief
executive officer than for other executives. Consistent with Noe (1999), we
also find that managers are successful in timing their trades both before
and after management forecasts depending on whether the news is good or
bad.
(with David Farber, U. Missouri-Columbia)
[Download paper]
Prior research finds that earnings
restatements are linked to CEOs’ excessive option-based compensation and
equity holdings. In this paper, we
investigate whether firms that experience earnings restatements recontract
with their CEOs to reduce their option-based compensation and if so,
whether this leads to improved firm performance. Based on 289 restatement firms over the
period 1997-2001, we find that the proportion of CEOs’ compensation in the
form of options declines significantly in the two years following the
restatement. Furthermore, we
document that this reduction is accompanied by a decrease in the riskiness
of investments, as reflected in lower stock return volatility, and subsequent
improvements in operating performance.
Our results suggest that a decrease in option-based compensation
reduces CEOs’ incentives to take excessively risky investments, resulting
in improved profitability. Overall,
our findings provide insights into the design and efficacy of CEO compensation
contracts.
(with Xia Chen, UBC)
[Download
paper]
Prior research (e.g., Xie 2001) documents that future
stock returns are negatively correlated with abnormal accruals (referred to
as the abnormal accrual-based anomaly), but the underlying reason is not
clear. In this paper, we investigate the impacts of managers’ motivations
to record abnormal accruals on this anomaly. We hypothesize and find that
the abnormal accrual-based anomaly is systematically associated with
managers’ motivations to record abnormal accruals. Future returns are
negatively (positively) associated with abnormal accruals recorded for
opportunistic earnings management (performance / signaling) purposes. These
results suggest that investors’ failure to detect managers’ motivations to
record abnormal accruals provides a potential explanation for the abnormal
accrual-based anomaly. This failure provides managers with an opportunity
to engage in opportunistic earnings management, and thus hinders managers’
ability to communicate private information to the stock market via abnormal
accruals.
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