Another recent study is Gaio 2010 which attempts to assess the firm and country

Another recent study is gaio 2010 which attempts to

This preview shows page 31 - 32 out of 38 pages.

Another recent study is Gaio (2010) which attempts to assess the firm and country character- istics that cause earnings quality to vary around the world. She uses seven measures of earnings quality: accruals quality (using the DD measure), persistence, predictability, smoothness, value rel- evance, timeliness and conservatism). She ranks firms on a 100-point scale for all seven factors, and then derives an overall rank for the firm by taking the average of the seven ranks. She concludes: Our main results suggest that firm characteristics have incremental explanatory power over the overall country unobserved heterogeneity, and are the major determinant of firm-level earnings quality world- wide. Even though a country’s characteristics matter, they are not the primary source of variation. 9. Implications for investors, companies, policy-makers, and auditors It is difficult to draw normative conclusions from the EM literature for any particular user group. The literature is not designed to inform the actions of any particular user group. Rather, it is designed to tell us something about how the earnings reporting system is currently operating. To some extent, the appropriate policy response depends on the intended users of financial reporting. Sophisticated investors seem to be able to see through and price EM risk. Ordinary investors seem to be the capital market stakeholder group that loses out the most from EM. If policy-makers care about these investors, then they should be doing more to warn ordinary inves- tors about potential EM issues. Ordinary investors need to be aware that they are potentially exposed to EM risk. They should think about the opportunities for EM by the firm, and the incentives managers have to manage earnings in the current year. Perhaps more could be done to provide tools to enable ordinary inves- tors to calculate measures of accounting quality for the firms in which they invest, and to bench- mark these accounting quality indicators against other firms. Ordinary investors need to be informed that firms that just meet or beat earnings benchmarks, especially the analyst consensus, may be playing games with the numbers. More could be done to inform ordinary investors about how the earnings game is played between firms and analysts. Companies could give more information on their web sites about the analysts that follow the firm, and their forecasts. The accruals anomaly literature indicates that some stocks may be mis-priced due to investors being fooled by abnormal accruals. However the most recent research suggests that the abnormal returns to accruals-based trading strategies now seem much smaller (see Richardson et al . 2010). The cost of capital literature suggests that firms pay a price, in terms of increased costs of capital, if their EM choices make it difficult for investors to understand the relation between earn- ings and operating cash flows. This literature implicitly indicates that firms have a cost of capital incentive to curb opportunistic EM and to signal that their earnings figures can be relied upon.

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture