Predicting Large Negative Stock Returns: The Trouble Score

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2589272

Predicting Large Negative Stock Returns: The Trouble Score

  1. Korcan AkUniversity of California, Berkeley – Haas School of Business
    April 6, 2015

Abstract: 
The purpose of this study is to predict large negative stock returns. I create an indicator variable, which takes the value of one when a company experiences a stock price decline of 50 percent or more over the subsequent year. Then, using both accounting-based and market-based variables, I predict this large change by using a logit model; the outcome of this prediction is the “Trouble Score”. The top three deciles of the T-Score correctly classify 63.00 percent of observations for the in-sample tests and 60.52 percent of observations for the out-of-sample period. Further, I document a significant and negative association between the out-of-sample T-Score and future stock returns even after controlling for well-known risk factors and control variables that are correlated with future stock returns.

Do Accounting Errors Breed Fraud?

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2590155

Do Accounting Errors Breed Fraud?

Vivian W. Fang University of Minnesota – Twin Cities – Department of Accounting

Allen Huang Hong Kong University of Science and Technology – Department of Accounting

Wenyu Wang Indiana University – Kelley School of Business – Department of Finance
April 5, 2015
Kelley School of Business Research Paper No. 15-29

Abstract: 
This paper links accounting errors to firms’ incentives for fraud. While errors discourage fraud by lowering the value relevance of reported earnings, they also incentivize fraud by providing camouflage. We analyze the two effects in the framework of Fischer and Verrecchia (2000) and generate hypotheses. Using intentional and unintentional misstatements as empirical proxies for fraud and errors, respectively, we document a hump-shaped relationship between an industry’s prevalence of fraud and that of errors. This result is robust to using SEC enforcement actions or the likelihood of meeting or marginally beating analyst consensus forecasts as alternative proxies for fraud. Motivated by three causes of errors (i.e., transaction complexity, regulation ambiguity, and staffing deficiency), we use firms’ number of items in their quarterly filings, rules-based characteristics of accounting standards, and state boards’ CPA requirements as alternative proxies for errors. These proxies are associated with fraud in a similar fashion as errors. Our results highlight an important economic implication of accounting errors and shed light on the recent debate on “principles-based” versus “rules-based” accounting systems.

Does Auditor Explanatory Language in Unqualified Audit Reports Indicate Increased Financial Misstatement Risk? “Emphasis of matter” language predicts restatements + China Environment’s Auditor Emphasis of Matter

Related posts: (1) China Environment: Auditor Emphasis of Matter raises more questions on potential accounting tunneling risk; (2) Open Letter to SGX/MAS: Reply to CFO of SGX-Listed China Environment (CENV SP) on report “Potential Accounting Tunneling Fraud at China Environment?” – Address the accounting and governance concerns in an SGX/MAS announcement

http://eds.a.ebscohost.com.libproxy.smu.edu.sg/ehost/pdfviewer/pdfviewer?sid=6a62a86d-f3c9-4fac-96bc-04ffe9ad6590%40sessionmgr4004&vid=0&hid=4113

Does Auditor Explanatory Language in Unqualified Audit Reports Indicate Increased Financial Misstatement Risk?

Czerney, Keith1 Schmidt, Jaime J.2 Thompson, Anne M.1

Accounting Review. Nov2014, Vol. 89 Issue 6, p2115-2149. 35p. 8 Charts.

Abstract:

According to auditing standards, explanatory language added at the auditor’s discretion to unqualified audit reports should not indicate increased financial misstatement risk. However, an auditor is unlikely to add language that would strain the auditor-client relationship absent concerns about the client’s financial statements. Using a sample of 30,825 financial statements issued with unqualified audit opinions during 2000-2009, we find that financial statements with audit reports containing explanatory language are significantly more likely to be subsequently restated than financial statements without such language. We find that this positive association is driven by language that references the division of responsibility for performance of the audit, adoption of new accounting principles, and previous restatements. In addition, we find that (1) ”emphasis of matter” language that discusses mergers, related-party transactions, and management’s use of estimates predicts restatements related to these matters, and that (2) the financial statement accounts noted in the explanatory language typically correspond to the accounts subsequently restated. In sum, our results suggest that present-day audit reports communicate some information about financial reporting quality.

The Ties that Bind: The Decision to Co-Offend in Fraud

http://onlinelibrary.wiley.com.libproxy.smu.edu.sg/doi/10.1111/1911-3846.12063/epdf

The Ties that Bind: The Decision to Co-Offend in Fraud

Clinton Free1 and Pamela R. Murphy2

Contemporary Accounting Research

Volume 32Issue 1pages 18–54March 2015

It is frequently observed that fraud has a greater economic impact on society than any other category of crime. Arguing that both research and practitioner frameworks in auditing and forensic accounting have tended to adopt an individualizing perspective predicated primarily on solo offending, this article adopts an inductive approach to consider why individuals co-offend in fraud. It reports the results of a set of interviews with 37 individuals convicted of a range of frauds including financial statement fraud, insider trading, credit card fraud, money laundering, and asset misappropriation. In each instance, the fraud was perpetrated by a group of two or more co-offenders. Based on inductive, exploratory case coding, we find that reasons for co-offending vary according to the type of bond that exists between co-offenders. Two dimensions of fraudulent co-offending are identified—the primary beneficiary of the fraud and the nature of group attachment—to derive three distinct archetypes of bonds between co-offenders: (1) individual-serving functional bonds, (2) organization-serving functional bonds, and (3) affective bonds. Key elements of each archetype as well as their impact on the decision to co-offend are examined. Our findings suggest that the social nature of fraud is not merely an incidental feature of the crime but is instead a potential key to understanding its etiology and some of its distinctive features. They also support the need for diagnostic tools to move beyond individualistic analyses of fraud toward a broader, group-sensitive assessment of fraud risk.

Trading Behavior Prior to Public Release of Analyst Reports: Evidence from Korea

http://onlinelibrary.wiley.com.libproxy.smu.edu.sg/doi/10.1111/1911-3846.12090/epdf

Trading Behavior Prior to Public Release of Analyst Reports: Evidence from Korea

Bobae Choi1, Kooyul Jung2 and Doowon Lee1

Contemporary Accounting Research

Volume 32Issue 1pages 105–138March 2015

Abstract

This paper investigates information leakage from analyst reports prior to their public release. Previous studies document abnormal trading by institutions or short selling before announcement of recommendation changes. Such prerelease abnormal trading is interpreted as evidence of information leakage from analyst reports. However, if sophisticated investors obtain information similar to what analysts have from other sources, abnormal prerelease trading patterns would be observed even if there were no information leakage from analyst reports. This paper, using a unique data set from Korea, aims to determine whether a direct causal link between recommendation changes and prerelease trading exists, by comparing trading behavior of client investors with non-client investors. We find that abnormal prerelease trading by client investors, especially client institutions, is earlier in timing and greater in magnitude than that of other investor groups, supporting the information leakage hypothesis. We further find that net buying by client institutions and client large individuals is positively associated with firm, analyst, and earnings forecast change variables that influence formulation of recommendation changes and their impacts.

Helping Other CEOs Avoid Bad Press: Social Exchange and Impression Management Support among CEOs in Communications with Journalists

http://eds.b.ebscohost.com.libproxy.smu.edu.sg/ehost/pdfviewer/pdfviewer?sid=15ab420f-3178-4768-9e96-d928d0e8a6d8%40sessionmgr198&vid=1&hid=117

http://ejournals.ebsco.com.libproxy.smu.edu.sg/Direct.asp?AccessToken=95JIDIM8XZ949K5QDZM4KJQME5MP8XQM4I&Show=Object

Helping Other CEOs Avoid Bad Press: Social Exchange and Impression Management Support among CEOs in Communications with Journalists

Westphal, James D.1 Park, Sun Hyun2 McDonald, Michael L.3 Hayward, Mathew L. A.4

Administrative Science Quarterly. Jun2012, Vol. 57 Issue 2, p217-268. 52p. 1 Diagram, 6 Charts.

Abstract:

In this study, we examine the determinants and consequences of impression management (IM) support in communications between CEOs and journalists, whereby CEOs of other firms provide positive statements about a focal CEO’s leadership and strategy and/or external attributions for low performance at the focal CEO’s firm. Drawing from social exchange theory, our theoretical perspective suggests how IM support may result from norms of reciprocity among corporate leaders. We consider the potential for direct and generalized reciprocity in the provision of IM support, including generalized reciprocity in which CEOs who received IM support previously pay the support forward to another third-party CEO, and a second form of generalized reciprocity in which CEOs reciprocate IM support to fellow CEOs whom they believe have given similar support to other CEOs in the past. We also draw from the social psychological literature on persuasion to suggest why IM support for another CEO may have a more positive influence on the tenor of journalists’ coverage about the firm’s leadership than impression management by the CEO about his or her own leadership and strategy. We test our hypotheses with data from large and mid-sized public U.S. companies from 1999 to 2007, including original survey data from a large sample of CEOs and journalists. The results supported our hypotheses, and additional findings suggested that the apparent effects of impression management by leaders and staff about their own firms following a negative earnings surprise may be partially attributable to the effects of IM support.

Avoiding Bad Press: Interpersonal Influence in Relations Between CEOs and Journalists and the Consequences for Press Reporting About Firms and Their Leadership

Westphal, James D.1 westjd@umich.edu Deephouse, David L.2 david.deephouse@ualberta.ca

Organization Science. Jul/Aug2011, Vol. 22 Issue 4, p1061-1086. 26p. 3 Charts, 2 Graphs.

Abstract:

In this study we consider how and when interpersonal relations between chief executive officers (CEOs) and journalists can influence the content of journalists’ reporting about corporate leaders and their firms. Specifically, we draw from the social psychological literature on interpersonal influence and social exchange to suggest (i) how the disclosure of relatively low corporate earnings may prompt the CEO to engage in ingratiatory behavior toward journalists, and (ii) how such behavior may be effective in prompting journalists to issue relatively positive reports about the CEO’s firm. We also extend our theory to consider how relatively negative journalist reports may prompt CEOs to retaliate against individual journalists by limiting or cutting off communication with the offending journalist, and how such retaliation may deter other journalists from issuing negative reports about the firm in the future. We find support for our hypotheses in a unique data set that includes large-sample survey data on CEO-journalist relations. We discuss how our research contributes to the growing literature in organization theory and strategy on the social processes by which corporate leaders influence the behavior of information intermediaries and other external constituents toward their firms. Moreover, we suggest that an implication of our findings is that top executives can actively influence the reputation of their firms, as well as their own reputations as corporate leaders, by engaging in interpersonal influence processes toward journalists.

Earnings Management To Tunnel: Evidence from China’s Listed Companies

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.197.6710&rep=rep1&type=pdf

Posted by Hannah YAP Qing, Year 4 undergrad at the School of Accountancy, Singapore Management University

Earnings Management To Tunnel: Evidence from China’s Listed Companies

Qiao Liu Zhou (Joe) Lu

This Draft: April 2004

Abstract

This paper conducts a two-stage analysis to demonstrate that earnings management in China’s listed companies is mainly induced by the controlling owners’ tunnelling incentive. In the first stage, we relate our analysis to previous research on the Chinese listed companies which has documented their strong incentives to manage earnings in order to meet certain return on equity (ROE) thresholds. We identify tunnelling evidence in two situations where such practice has been the most conspicuous. In the second stage, we examine systematic differences in earnings management across the universe of China’s listed companies during 1999-2001. We provide cross-sectional and time-series evidence showing that firms with higher corporate governance levels tend to have less earnings management. Our empirical findings although not being able to completely exclude other explanations, strongly suggest that agency conflicts between controlling shareholders and outside investors are the main stimuli of earnings management in China’s listed companies.

Pamela Meyer: How to spot a liar

Posted by Padma LAU Heng Ee, Year 4 undergrad at the School of Business, Singapore Management University

On any given day we’re lied to from 10 to 200 times, and the clues to detect those lie can be subtle and counter-intuitive. Pamela Meyer, author of Liespotting, shows the manners and “hotspots” used by those trained to recognize deception — and she argues honesty is a value worth preserving.

Independent Directors’ Dissent on Boards: Evidence from Listed Companies in China

Posted by Eugene SAY Gui Hua, Year 4 undergrad at the School of Business, Singapore Management University

Eugene: As we ask ourselves this week whether whistleblowing works in Asia, research has found that even at a supervisory board level (equivalent to Board of Directors) in China, directors are not as ‘independent’ as they are deemed to be.  The research has found that directors are more likely to dissent when the board chair (most commonly, the dual-role CEO and Chairman of the company) has left the board. There is a 27% occurrence of dissent among departing directors who are due to leave the board in their last 60-days. Also, while directors with foreign experience are more likely to dissent, it is inconclusive that academics, accountants and lawyers are significantly more active in voicing dissent. Even in a situation of dissent, findings show that they dissenting directors tend to offer mild, subjective justifications and overt criticism of the management is rare. Lastly, while current literature suggests that dissent might be reflective of diverse viewpoints, which is beneficial to the firm, it has been found that  dissent is consequential to both the director and the firm.  For directors, dissent significantly increases one’s likelihood of exiting the director labor market, translating to a more-than-10% estimated loss of annual income. For firms, there is an economically and statistically significant cumulative abnormal return of -0.97% around announcement of dissent.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2252200&download=yes

Independent Directors’ Dissent on Boards: Evidence from Listed Companies in China

Juan Ma, Harvard Business School

Tarun Khanna, Harvard University – Strategy Unit

October 24, 2013

Harvard Business School Strategy Unit Working Paper No. 13-089

Abstract:

In this paper, we examine the circumstances under which so-called “independent” directors voice their independent views on public boards in a sample of Chinese firms. First, we ask why independent directors dissent, i.e. how they justify such dissent to public investors. We find that when independent directors dissent, they tend to offer mild, subjective justifications. Overt criticism of the management is rare. Next, we ask when an independent director is more likely to dissent and who is more likely to dissent. Controlling for firm and board characteristics, we find that dissent is significantly correlated with breakdown of social ties between the independent director and the board chair who locates at the center of the board bureaucracy in China. Dissent is more likely to occur when the board chair who appointed the independent director has left the board. Dissent also tends to occur at the end of board “games”, defined as a 60-day window prior to departure of the board chair or departure of the independent director herself. The endgame effect is particularly strong, seeing 27% of the dissent issued at board “endgames” which represents only 4% of independent directors’ average tenure. While directors with foreign experience are more likely to dissent, we do not find that academics, accountants and lawyers are significantly more active in voicing dissent. Lastly, we show that dissent is consequential to both the director and the firm. For directors, dissent significantly increases one’s likelihood of exiting the director labor market, which translates to a more-than-10% estimated loss of annual income. For firms, we document an economically and statistically significant cumulative abnormal return of -0.97% around announcement of dissent. Although the literature has suggested that dissent might be reflective of diverse viewpoints, and perhaps beneficial in and of itself through reduction of firm variability, we do not find this offsetting beneficial effect to be strong.