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The valuation consequences of voluntary accounting changes

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  • James Linck

    ()

  • Thomas Lopez

    ()

  • Lynn Rees

    ()

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    Abstract

    Firm management typically claims that voluntary accounting method changes (VACs) are made to enhance the informativeness of earnings by better matching accounting practices with economic reality. In contrast, skeptics argue that managers adopt new accounting procedures to opportunistically manage earnings and influence their firm’s stock price. In this paper, we investigate these alternative motives for VACs. Specifically, we investigate whether VACs cause equity prices to deviate from their fundamental values in the short-term by studying the long-run stock-price performance for a sample of firms that voluntarily change accounting methods. In addition, we investigate changes in earnings informativeness by examining the behavior of earning response coefficients and the relationship between earnings and future cash flows in years surrounding the VAC event. In contrast to prior research, we find little evidence that a strategy based solely on the earnings effect of a VAC can generate abnormal returns. While we find weak evidence of post-VAC abnormal returns for extreme VACs, this result appears to be driven by the accruals anomaly documented in Sloan [Sloan, R. G. (1996). The Accounting Review, 71, 289–315]. Our evidence further suggests that earnings informativeness is not significantly altered by voluntary changes in accounting methods. Taken together, our evidence suggests the market recognizes the financial statement effects of alternative acceptable accounting methods and efficiently processes the valuation implications of VACs. Copyright Springer Science+Business Media, LLC 2007

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    Bibliographic Info

    Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

    Volume (Year): 28 (2007)
    Issue (Month): 4 (May)
    Pages: 327-352

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    Handle: RePEc:kap:rqfnac:v:28:y:2007:i:4:p:327-352

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    Web page: http://springerlink.metapress.com/link.asp?id=102990

    Related research

    Keywords: Accounting changes; Accruals anomaly; Market efficiency; Earnings management; Earnings fixation; Earnings informativeness; Earnings quality; G14; M41;

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    References

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    1. Nelson, Karen K. & Barth, Mary E. & Cram, Donald, 2001. "Accruals and the Prediction of Future Cash Flows," Research Papers 1594r, Stanford University, Graduate School of Business.
    2. Mitchell, Mark L & Stafford, Erik, 2000. "Managerial Decisions and Long-Term Stock Price Performance," The Journal of Business, University of Chicago Press, vol. 73(3), pages 287-329, July.
    3. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 33(1), pages 3-56, February.
    4. Dimson, Elroy & Marsh, Paul, 1986. "Event study methodologies and the size effect : The case of UK press recommendations," Journal of Financial Economics, Elsevier, Elsevier, vol. 17(1), pages 113-142, September.
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    8. Kormendi, Roger & Lipe, Robert, 1987. "Earnings Innovations, Earnings Persistence, and Stock Returns," The Journal of Business, University of Chicago Press, vol. 60(3), pages 323-45, July.
    9. Collins, Daniel W. & Kothari, S. P. & Shanken, Jay & Sloan, Richard G., 1994. "Lack of timeliness and noise as explanations for the low contemporaneuos return-earnings association," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 18(3), pages 289-324, November.
    10. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, American Finance Association, vol. 52(1), pages 57-82, March.
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    12. Kothari, S. P., 2001. "Capital markets research in accounting," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 31(1-3), pages 105-231, September.
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