So, does accounting information matter

1. So, does accounting information matter???? IF there are so many problems�we don�t know what assets are, there are some problems with trying to show liabilities at fair value, we have trouble distinguishing between liabilities and owners� equity, we have weak measurement tools and there are unrecorded assets, and all of these things affect the determination of net income�

2. Does accounting information have a purpose, and can it serve as a basis for business decisions????

3. Oh, the Robust Beauty of Improper Linear Models....

4. There was a research article published a number of years ago by Dawes and Corrigan with the above title.

5. Any idea what this means?

6. The thesis of the article was that a very simplified linear model could be used to make predictions that were quite efficient and effective, even if the underlying model was much more complex.

7. What would you expect the predicting variables�the drivers of success�to be for success in graduate school?

8. Possible variables: Undergraduate GPA Quality of undergraduate institution Undergraduate class rank GMAT motivation work experience interpersonal and group skills

9. All of these variables seem relevant, and there may be others. Further, the relationship might not be linear. The very highest UGPA and GMAT scores may be less predictive of success than high scores.

10. But you can use a simple linear model that combines GPA and GMAT and have a model that has a high ability to select candidates who will be successful in grad school.

11. The simplified model, which only considers a two of the variables we have discussed and assumes a linear relationship, can efficiently sort successful candidates even if all of the relevant measures aren�t included.

12. An efficient model is not the same thing as an accurate model. There will be mistakes�applications will be rejected for people who would be successful graduate students, and applications will be accepted for people who will not be successful graduate students.

13. BUT�the cost of improving the model so that it considers more variables, and the cost of using the more complex model, is thought to be less than the cost of errors caused by the imperfect model.

14. What does this mean for accounting and our financial reporting model?

15. Disclosure Reg FD

16. Usefulness of Accounting Information What does it mean for accounting information to be �useful�?

17. One component of �usefulness� is �capable of making a difference� One way of evaluating whether information makes a difference is to investigate the relation between publicly released accounting data and changes in a firm�s security prices.

18. If there is a significant association, then there is evidence that accounting information is useful with respect to firm valuation.

19. Efficient Market Hypothesis What is the efficient market hypothesis?

20. Market efficiency refers to the speed with which the market reacts to new information. The classic definition of market efficiency is that security prices reflect all available information. (Information is immediately impounded in security prices).

21. Information has value if there is evidence of a price response to new information.

22. How compelling is the efficient market hypothesis? Most believe that at least some form of the efficient market hypothesis is supported.

23. Why does the concept of market efficiency (with respect to information) have no necessary relation to the quality of accounting information?

24. --Market efficiency refers only to the speed with which new information is incorporated into security prices. It says nothing about the quality of the information.

25. If market efficiency is valid, there is no additional benefit to analysis of information as security prices reflect the information immediately.

26. Problems? Empirical studies are not powerful and may not be able to pick up subtle differences. It is difficult to isolate the variable of interest and to control all other variables!

27. The research to date presents conflicting results with respect to market efficiency and the information content of accounting information.

28. Fundamental Analysis Assumes markets are INEFFICIENT and that underpriced shares can be identified through financial statement analysis.

29. The market does respond to information about net income. Does it respond to balance sheet information and supplementary disclosure? Evidence of this is more difficult to find.

30. Some studies suggest that the market may wait until certain balance sheet information is reflected in future earnings or cash flows before reacting. (Of course, if this is a result of improving decision rules, the stronger than expected results of those who use the information earlier, rather than later, should precipitate additional decision makers who follow this solution strategy�)

31. Ou and Penman (1989) Studied financial ratios to determine if they could devise a strategy that �beat the market� It appeared, at least in their study, that this could be accomplished.

32. Return on total assets gross margin ratio percentage of change in current assets as a predictor of future income 20 accounting measures 68 financial ratios approximately 23000 observations

33. Investigated how well each ratio predicted the subsequent year�s net income Some did better than others. Took the 16 best predictors and developed a model and a solution strategy for investment decisions. And, over a multi-year investment protocol, they �beat� the market

34. Were predictors capturing information that was not already reflected in security prices and thus would result in �abnormal� security returns if investment were based on the earnings prediction of their model? Apparently..(but returns may have been attributable to risk factors...) And results may have been specific to the time period studied, or to firm-specific variables such as size.

35. Ou and Penman indicate that �better� accounting standards might improve the predictive ability of accounting information

36. Over time and within years, the correlation between earnings numbers and stock returns has been exceedingly low. Earnings have very little explanatory power (as measured by R-SQ) relative to changes in stock prices Lev believes that one of the principal reasons for this situation lies with low quality of reported income numbers...

37. Baruch Lev �Research on the quality of earnings shifts the focus to an explicit consideration of accounting issues by calling for a systematic examination of the extent to which the specific underlying accounting measurements and valuations, as well as managerial manipulations, detracts from the usefulness of earnings and other financial variables.

38. Such research has the potential both to further our understanding of the role of financial information in asset valuation and to contribute meaningfully to accounting policy making.�

39. So Ou and Penman find a low explanatory relationship between earnings and stock returns, while Lev sees a predictive role for accounting data in a market that may be less efficient than previously thought. Lev is particularly concerned with improving accounting measurement, and one focus of his work is intangible asset valuation

40. Post Earnings Announcement Drift While markets do react immediately to earnings announcements, research seems to indicate that it can take up to 60 days for security prices to fully reflect the information in the earnings announcement.

41. Abarbanell and Bushee found that financial analysts underreact to very fundamental signals, which leads to forecast errors, which lead to incomplete security price adjustments. Shareholders do not distinguish well between cash flow and accrual earnings measurements.

42. Cost/benefit...would the cost of additional effort exceed the benefit from higher returns?

43. Efficient Markets? Fundamental Analysis? What do you think?

44. Different views of information Accounting as an historical record.. implies feedback value, and the traditional role of accounting information to evaluate the stewardship function.

45. Accounting as a mirror of economic income implies a proprietary theory with the focus on the change in wealth (in real terms) of the owners; net income as a change in net asses

46. Accounting as an information system seems to focus on the predictive nature of accounting information (similar to CON 1 and CON 2)

47. Commodity metaphor external investor who invests in information as well as in the firm itself.

48. FASB seems to concentrate on accounting as an information system, although they also seem to be focusing on the measurement of economic wealth..

49. Economics of Financial Reporting Regulation Should Financial Reporting be regulated? Or will market forces lead to optimal information disclosure? (What are the penalties for inadequate or misleading disclosure? In what time frame are these penalties imposed? Who benefits or is hurt?)

50. Theories that encourage unregulated financial information

51. Agency Theory Agency theory: explains why incentives exist for voluntary reporting to owners.

52. Management is an agent for the owner (stewardship function). Because the owner is not part of management, management has private information about the performance of the company. Owners and managers do not have perfectly correlated goals.

53. Management wants to maximize compensation, performance evaluation, and job satisfaction; owners want to maximize return on investment.

54. Owners are motivated to contract with managers in such a way as to maximize the correlation between the goals of the two groups. Costs are incurred in monitoring the activities of management. Minimizing monitoring costs provides more resources for both management and for owners.

55. Routine financial reporting is one means by which owners can monitor performance of management. The audit adds credibility to the financial reports. (The audit team should be hired by, and report to, owners...you even vote on the auditors at the annual meeting..and the role of the Board of Directors is receiving more attention)

56. Do OWNERS really have much to do with contracts between the firm and management? What is the role of the Board of Directors? Does the Board really represent management, investors, both, or neither?

57. Signaling Theory Even if there were no mandatory reporting requirements, firms compete with one another for scare risk capital. Voluntary disclosure is a necessary component of competing for capital. (This may also be related to the supply of capital at any given time.)

58. The ability of a firm to raise capital will be improved if the firm has a good reputation with respect to financial reporting. The cost of capital is likely to be lower if there is less uncertainty about the quality of financial reporting. More extensive, more reliable, financial reports lead to less risk and less risk leads to a lower required rate of return.

59. Failure to report is often assumed to be bad information because there are incentives to report good information. IF no information is interpreted to be bad information, there are incentives to disclose the bad information to remove the uncertainty (and the risk).

60. Do the demands for information vary with the sources of finance? I.e., creditors vs. lenders?

61. Private Contracting Anyone who wanted to obtain more information about a company could contract for it, directly or indirectly (i.e., through analysts). And this does happen...investor newsletters, investment advisors, commissions...

62. The demand for information may be met when market forces determine the production and supply of accounting information. And this maybe an efficient method for disclosure. Who should bear the costs of information disclosure? How high are the costs? (What are the costs???)

63. Regulated Market for Information Are there incentives for regulation? To what extent should disclosure be mandated, and why?

64. Possibility of a failure within the free market system: market failure suboptimal allocation of resources Natural monopolies, such as utilities, are an example of market failures requiring regulatory intervention to prevent under supply and monopoly pricing

65. Possibility that free markets are contrary to social goals. For example, it can be argued that free markets do no communicate enough information to the security markets resulting in managers and other insiders having information that is not available to shareholders (owners)

66. Information in unregulated markets might not provide adequate comparability among firms.

67. Differential access to information may create �winners� and �losers� in the market economy. Companies may have incentives to provide differential information to different user groups.

68. Regulation FD Reg FD took effect October 23, 2000.

69. Regulation FD is the relatively new SEC rule that prohibits executives from feeding market-moving information to select individuals. A pet project of former SEC chairman Arthur Levitt, Reg FD was a response to his concern that executives would freely tip off analysts about the company�s earnings prospects without disclosing the news publicly (WHY?)

70. Fans and Critics... Who do you suppose are the fans? The critics?

71. The FD Effect: The SEC�s new corporate disclosure rule has CFOs saying more and talking less. CFO Magazine, April 1, 2001.

72. According to the CFO of the company, Diebold, Inc. is giving The Street more information than ever before. The company has disclosed additional performance data in its quarterly earnings releases and conference calls...

73. The company has been providing explicit forward-looking guidance, spelling out management expectations in bullet points, providing an earnings range for the upcoming quarter and full year, and/or estimating a revenue growth rate

74. The CFO notes that the company refuses to review analysts� models, comment on estimates, or indicate whether the company is on track to meet its targets, except in a public forum��Let�s guide The Street, rather than let the Street guide us.� (Note: The SEC, in implementation guidelines, states that reviewing analyst models does NOT violate FD...)

75. FD has had the curious effect of making Diebold more open and more tightlipped at the same time...giving more information, but to different people (public disclosure) and at defined times (rather than when an analyst calls up...)

76. CFO.com spoke with a dozen CFOs and IR officers and found they are responding to FD in similar ways. �There�s no question that Reg FD has spurred companies to issue more press releases, file more 8Ks, and increase Web-casting of earnings conference calls.�

77. CRITICS: Skeptical about the quality of information. �More transparency but less meaningful information.� (Meaningful to whom?) Others blame FD for a record number of negative preannouncements of earnings. And some claim that FD adds to market volatility. (Is this good or bad?)

78. (Are there incentives for preannouncements when we think about strike suits?)

79. Analysts claim that companies are less forthcoming.

80. Analysts are less likely to be told on the QT to shade their estimates; companies must make the announcements public. Some claim that such surprises tend to make stocks move more dramatically.

81. Reg FD has reshaped the disclosure landscape in ways that will likely be permanent regardless of changes in the regulations.

82. Guidance Finance chiefs and IR specialists have found FD to be strangely liberating. �Before, analysts would ask us if we were comfortable with their range on earnings. Now we give them our range.�

83. Private Meetings Still occur, but the attempt is made to not disclose new information (FD gives company 24 hours to put out a public statement).

84. Preannouncements First Call, negative preannouncements were up 85% in the 4th quarter of 2000. Weakening economy, or sudden unwillingness on the part of executives to walk The Street down to an earnings expectation that could be met? Or both? (Negative preannouncements are dependent in part on the current expectation of earnings based on current estimates by analysts.)

85. Many companies that now give more explicit guidance on earnings also have a stated policy that they will issue a public disclosure as soon as that outlook changes. This may lead to more preannouncements. Management is more in control of the information flow rather than in a position of having to curry favor with analysts.

86. Information Updates Many companies are now using the Internet to provide broader and more frequent disclosures that go beyond earnings guidance and include key nonfinancial performance metrics.

87. �We are now releasing more timely and useful information so investors can build their models and make reasonable judgments about the company (CFO, Frontier Airlines) Similar statements from Chevron, Xilinx

88. Expeditors International of Washington, Inc.: Any questions about the company must be submitted in writing; the written responses to inquiries about the quarterly results are available on the company�s Web site within 48 hours, while answers to other business questions are posted on the first business day after the 15th of the month.

89. �Rather than give ad hoc responses in a conference call, we are able to do research and put out substantive answers to everybody at the same time,� says Expeditors CFO Jordon Gates.

90. In January, topics for questions submitted to Expiditors included derivatives accounting, competitive pressures, and the impact on the business of normalized trade relations with China. �Our goal is not to be more talkative, but to provide more meaningful information.�

91. Volatility NONE of the CFOs or IR directors we contacted attributed any volatility in their stocks to Reg FD.

92. Critics insist that it has been a factor in recent market swings. �It�s creating considerably more volatility in share prices, because management cannot give guidance on earnings estimates as it did in the past.

93. We don�t have less access, but executives are much more cautious with the information they provide.� James D. Parker, a growth -airline analyst at Raymond James and Associates in Atlanta.

94. Imperative to Communication For the most part, CFOs find it hard to dispute the notion of fairness that�s at the heart of the new SEC rule. �Talking the Street up or down was always unethical,� says Ken Goldman, CFO of Siebel Systems.

95. For many, it puts an enhanced premium on communication. �It�s in our best interest to be visible,� says Thomas Ryan of Allied Waste Industries, Inc. �We�re driven by the premise that our securities will trade better if people have more information.�

96. Thomson Financial survey What changes have you made due to Reg FD: Instituted formal disclosure policy 23.2% Provide more information in earnings release 21.1% No longer giving earnings guidance 21.1% Web-cast conference calls 15.8%

97. Provide more information in conference calls 7.4% Post more information on Web site 6.3% Issue more press releases 5.3%

98. How has Reg FD affected your relationship with Buy-Side and Sell-Side Analysts? Limited flow of information 32.5% More cautious in discussing models 22.5% More focus on public documents 8.8% No more one-on-one discussion 8.8%

99. More structured analyst meetings 7.5% IR monitors all discussion with analysts 2.5%

100. Have you added information to your quarterly earnings releases, such as guidance? Yes 53.4% No 46.4%

101.  A look at Reg FD from the Corporate Side. David D. Miller, NymbleInvestor.com

102. Gwen Rosenberg, VP of Corporate Communications, Alliance pharmaceutical (honored by Investor Relations Magazine for Best Communications with Retail Investors, 2000)

103. �Good IR people already understood the rules of uniform disclosure of material information. However, pressure from lazy or unscrupulous research analysts often forced companies to selectively disclose information in order to gain or retain coverage by major analyst firms. The fewer analysts a company had, the more pressure to �play the game.�

104. In general, there is more caution when talking with the financial analysts�.It has put a �block� between the company and the analysts because of the need to be more careful in the type of information we are giving.

105. Companies are taking this to heart. They really want to make sure they are giving the same information and level of information to everyone. On one hand, there should be more information available to the general public.

106. On the other hand, some companies are taking the route of giving less information to everyone. In a sense it is becoming a more even playing field, but whether that results in more information remains to be seen.

107. Opponents... The opponents of Reg FD were of the opinion many (most?) individual shareholders would not have the skill level or intelligence to interpret �raw guidance� from the company.

108. Old scenario: Companies were able to have detailed conversations with analysts with no real fear of disclosing material information inappropriately. In a perfect world, highly trained analysts would take this information and add it to their own original research to determine the company�s prospects for success..

109. They would then issue a research report explaining in layperson�s terms the company, its products, and its prospects going forward. Ideally, this would be done objectively to best serve the analysts clients and the investing public

110. The ideal scenario might exist in one firm out of 200. Most analysts are rarely, if ever, objective. Those analysts who work with firms with investment banking operations bias their reports to the positive side in the hopes the company they are covering will choose their firm as investment bankers.

111. Some analysts are really PR firms in disguise, charging the company directly for issuing a research report. Still other firms issue reports in the hopes they will affect the share price according to the position they previously accumulated in the subject company�s stock.

112. �We have long believed IR professionals and especially research analysts far underestimate the intelligence and ability of the average independent investor. Sure, there are stupid investors out there, but we�ve met our fair share of stupid analysts, stupid institutional investors, and stupid management teams.�

113. Earnings Guidance There is one area where disclosure seems to be uniformly more conservative: Earnings guidance. The hypothesis is that company management wants to avoid a shareholder lawsuit at all costs.

114. If a company does not meet an independent analyst�s forecasts, that isn�t as important in the eyes of the court as if a company does not meet their OWN forecasts. It is our opinion that in order to avoid exposing themselves to strike suits, companies are lowballing earnings and revenue forecasts across the board.

115. Press to CFOs: Lighten up on Reg FD: CFO.com, April 25, 2001, Jennifer Caplan

116. The SEC sponsored forum on Reg FD. Participants included several members of the news media and some financial information providers who said that compliance with the rule could be a lot easier if CFOs and other corporate officials relied upon the press more often to distribute financial information.

117. ALL SEVEN MEMBERS OF THE PRESS PANEL (Isana, CNBC, Norris NYT, Armon, PR Newswire) agreed that Reg FD has leveled the investment playing field. The panelists praised the regulation�s role in prompting companies to distribute material information via a wider range of channels.

118. COO of Business Wire: percentage of people listening to conference calls has increased 300% in the last six months, and the number of Web-casts has risen by 54% in the same period.

119. Members of the press stressed that Reg FD has made their jobs easier and improved the quality of their financial coverage. It has also forced securities analysts to improve the quality of their reports.

120. Floyd Norris, New York Times: Although analysts have been hurt by the rule in the short run, it is forcing them to spend more time evaluating company fundamentals and tracking market trends, and less schmoozing with CEOs and working on investment banking deals. The general feeling was that this trend has improved the quality of sell-side research coming from Wall Street.

121. The impact of Reg FD transcends borders and will ripple across the globe as capital markets compete for investors� confidence, (Best Calls.com Mark Coker).

122. The Political Arena Regulation FD has a lot of people howling, and as might be expected, the political process is kicking in...

123. Laura Unger, former acting Chairman of the SEC (who held the post until Pitt was confirmed) was the single commissioner to vote AGAINST FD.

124. CFO.com Reg FD under Congressional Scrutiny. May 16, 2001, Ed Zwirn

125. Rep. Richard Baker and his Capital Markets subcommittee of the House Financial Services Committee will hear testimony from friends and foes of the rule.

126. �It�s fundamental that the $200 investors be treated with the same care as the $2 million investor, and that a select few not be given unfair advantage over the many when it comes to crucial, market-sensitive information

127. The practical question for our hearing, however, will be to gauge whether Reg FD actually accomplishes these goals or has instead had unintended consequences of reducing disclosure across the board.�

128. NYSSCPA. ORG April 25, 2001

129. Though regulation fair disclosure has not greatly affected corporate American according to company executives participating in a Securities and Exchange Commission roundtable Tuesday, the Commission needs to provide better guidance on the law that became effective last October.

130. The primary issue that needs clarification is materiality.

131. And the Business Press...

132. Forbes, January 22, 2001: Foul Disclosures. Before you join the Reg FD bashers, consider the facts. Many Wall Street analysts, especially the highly paid superstars, have been so busy finding and promoting corporate finance deals that they spend little time on serious company analysis.

133. Instead, they lamely rely on their good relations with corporate managements to feed them information. The analysts end up as shills for the companies they cover, doubly so when their firms have corporate finance relationships.

134. Despite corporate guidance, Wall Street analysts were still bagged often. If analysts are already blind, how can Reg FD hurt them more?

135. Business Week, January 8, 2001 News: Analysis and Commentary. Commentary Give �Fair Disclosure� Time to Work. Investors will eventually learn not to panic at a little bad news.

136. �The quality of information is poorer and it�s coming out slower and that is going to make the market react more,� argues Stuart J. Kaswell, general counsel of the Securities Industry Association.

137. Critics are saying managements are delaying or withholding market-sensitive information they once readily shared with Wall Street and big stockholders.

138. Moreover, they�re confusing the markets by packaging all the good and bad news at once in conference calls or in periodic releases, and they�re denying analysts private guidance once freely given on their quarterly earnings estimates, leading to lots of missed earnings targets.

139. Admittedly, there are short term consequences. Since Reg FD was enacted, stocks have been apt to plunge as everyone grapples with troubling news at the same time . . in pre-fd days, such slides may have been more gradual, as those in the know quietly sold before the news got out.

140. �In the old regime, certain investors and brokerage houses would be able to get out of the stock at better prices, and the rest of the investing public would get robbed,� argues Russell J. Lundholm, an accounting professor at the University of Michigan�s business school.

141. Contrary to what critics allege, though, many companies are actually chattier than ever. Most now Webcast quarterly conference calls previously open only to analysts.

142. June 30, 2004 Siebel in Reg FD Trouble Again -- What Were They Thinking? http://www.bynoother.com/2004/06/siebel_in_reg_f.html

143. January 21, 2005 Reg FD Unfair, Says Chamber of Commerce The business group maintains that ''in punishing companies for selectively disclosing 'material and nonpublic' information, Regulation FD impairs fundamental First Amendment values.'' http://www.cfo.com/article.cfm/3594674/c_3594684?f=TodayInFinance_Inside

144. Worst Fears Over Reg FD Unrealized By Jane Tisdale, CFA, Director of Product Engineering, U.S. Active Equity ��� On its fourth anniversary, the U.S. Security and Exchange Commission�s Regulation Fair Disclosure (Reg FD) has not realized its critics� worst fears of information shutdown or greater stock price volatility, but it has forced analysts to work harder for their insights. Supporters of Reg FD and other reforms to the analyst industry say investors will ultimately benefit from the changes through more thorough and unbiased research. http://www.ssga.com/library/povw/janetisdaleworstfearsover20041001/page.html

145. Earnings Estimates Before and After Regulation FD Our research suggests that both the critics and supporters of Reg FD vastly overstated the initial impact of these new rules. In fact, Reg FD seems to have had little noticeable effect on the accuracy and dispersion of analyst earnings forecasts.

146. Analyst earnings estimates still provide a useful guide for investors post-Reg FD. There has not been a significant decrease in forecast accuracy since the issuance of the new rules. In addition, recent consensus forecasts are dramatically better than the forecasts of ten and 15 years ago. http://www.ssga.com/library/resh/rthomasearningsestimatesFD20040225/page.html

147. Who Is Afraid of Reg FD? The Behavior and Performance of Supply-side analysts Following the SEC�s Fair Disclosure Rules, by Agrawal and Chadha, University of Alabama, Feb. 2004 http://www.cba.ua.edu/pdf/WP04-10-03.pdf