Compliance, Detection, and Mergers and Acquisitions

Compliance, Detection, and Mergers and Acquisitions

Vivek Ghosal Georgia Institute of Technology; Center for Economic Studies and Ifo Institute for Economic Research (CESifo)

D. Daniel Sokol University of Florida – Levin College of Law; University of Minnesota School of Law; George Washington University Law School Competition Law Center

May 1, 2013
University of Minnesota Law School, Legal Studies Research Paper Series, Paper No. 13-21

Abstract: 
Firms operate under a wide range of rules and regulations. These include, for example, environmental regulations (in which some industries have increased regulatory exposure) and finance and accounting (where all industries have reporting requirements). In other areas, such as antitrust cartels, enforcement is unregulated and antitrust leaves the market as the default tool to police against anti-competitive behavior. In all of these areas, detection of non-compliance by a firm can result in significant penalties. This issue of non-compliance has implications in the merger and acquisitions (M&A) context. In a transaction between an acquiring firm (buyer) and a target firm (seller), there is asymmetric information about the target’s quality. In our framework, we link a target’s quality directly to the strength of its regulatory compliance. In an M&A transaction, an acquirer seeks information about the target’s compliance, as a compliance failure may result in substantial penalties and sanctions, post-acquisition. In the presence of quality (compliance) uncertainty about target firms, low quality targets can masquerade as high quality. This would tend to give rise to a M&A market with Lemons-like characteristics, resulting in low transactions prices and dampening of M&A activity. We examine how M&A transactions in such regulatory areas – environmental, finance and accounting, and antitrust compliance problems – might function to alleviate quality uncertainty.

Classification Shifting Using the ‘Corporate/Other’ Segment

Classification Shifting Using the ‘Corporate/Other’ Segment

Bradley E. Lail Baylor University

Wayne B. Thomas University of Oklahoma – Michael F. Price College of Business

Glyn J. Winterbotham Winthrop University

April 26, 2013
Accounting Horizons, Forthcoming

Abstract: 
In this paper, we examine management’s use of the “corporate/other” segment to mask the true performance of operating (or core) segments. The corporate/other segment represents firm-wide expenses not allocated to core segments. We find that managers take advantage of vague cost allocation requirements to shift expenses between the corporate/other segment and core segments. Specifically, in the presence of agency problems (i.e., transfer of resources to underperforming segments), our evidence is consistent with expenses being shifted from core segments to the corporate/other segment. This shifting increases the reported performance of underperforming core segments. In addition, when proprietary concerns are high (i.e., operations in less competitive industries), we find evidence consistent with corporate/other expenses being shifted to core segments. By shifting expenses to core segments, core profits are concealed when proprietary motives are present. Our research contributes to a growing literature on earnings manipulation through expense shifting (rather than accrual manipulation or real activities management).

An Analysis of Accounting Frauds and the Timing of Analyst Coverage Decisions and Recommendation Revisions: Evidence from the US

An Analysis of Accounting Frauds and the Timing of Analyst Coverage Decisions and Recommendation Revisions: Evidence from the US

Susan M. Young Fordham University

Emma Y. Peng Fordham University – Accounting Area

April/May 2013
Journal of Business Finance & Accounting, Vol. 40, Issue 3-4, pp. 399-437, 2013

Abstract: 
This paper provides a comprehensive exploration of the types of accounting fraud committed by firms over the period 1995–2009. Using detailed data from US SEC Accounting and Auditing Enforcement Releases (AAER), we examine the likelihood and timing of analyst coverage decisions and recommendation revisions related to fraud firms versus firms without accounting fraud. We find that analysts have a higher probability of taking the more severe action of dropping coverage rather than only revising down recommendations for firms with any type of accounting fraud and also for specific egregious types of accounting fraud. Through the use of competing hazards models, we also find that accounting frauds and their egregiousness are positively (negatively) associated with the timeliness of the analysts’ action to drop coverage (revise only). Overall, we find that analysts’ actions may be useful in determining the occurrence of accounting fraud prior to the public announcement of the fraud.

Is the Decline in the Information Content of Earnings Following Restatements Short-Lived?

Is the Decline in the Information Content of Earnings Following Restatements Short-Lived?

Xia Chen Singapore Management University

Qiang Cheng Singapore Management University

Alvis K. Lo Boston College

May 1, 2013
Singapore Management University School of Accountancy Research Paper No. 1

Abstract: 
Prior research finds that the decline in the information content of earnings after restatement announcements is short-lived and that the earnings response coefficient (ERC), the proxy for the information content of earnings, bounces back after three quarters. We re-examine the persistence of the drop in the ERC after restatement announcements using a more comprehensive and recent sample of restatements. We find that material restatement firms experience a significant decrease in the ERC over a prolonged period – close to three years after restatement announcements. In contrast, other restatement firms experience a decline in the ERC only for one quarter after restatement announcements. In cross-sectional analyses, we find that among material restatement firms, those that are subject to more credibility concerns and those that do not take prompt actions to improve reporting credibility are associated with a longer drop in the ERC than others. Lastly, we reconcile our findings with prior studies. Our analyses indicate that using a potentially more powerful proxy for material restatements and imposing less restrictive sampling requirement help increase the power of the tests to detect the long-run drop in the ERC.

Using MD&A to Improve Earnings Forecasts

Using MD&A to Improve Earnings Forecasts

Khrystyna Bochkay Rutgers, The State University of New Jersey – Rutgers Business School at Newark & New Brunswick

Carolyn B. Levine Rutgers, The State University of New Jersey – Rutgers Business School at Newark & New Brunswick

April 17, 2013

Abstract: 
We estimate and compare quantitative and text-enhanced earnings forecasting models to evaluate the extent to which MD&A disclosures improve earnings forecasts. Incorporating MD&A disclosures into forecasting models significantly improves forecasting accuracy. The gains in accuracy are much greater following regulatory reforms, providing some of the first large-sample empirical evidence on the success of recent MD&A regulatory actions. The MD&A section is less informative between 2007-2009, particularly for those firms hardest hit by the financial crisis (i.e., firms with low cash and large changes in performance). Further, we find that text improves forecast accuracy most for firms in the consumer staples sector, firms with low profit margins, large changes in performance, high political and/or legal costs and high complexity. Last, we find that models enhanced by MD&A disclosures are generally less accurate than analysts’ consensus forecasts for large and medium sized firms, but equally accurate for small firms.