Review of Accounting Studies

Abstract Research suggests that the standard model used to detect opportunistic shifting of core expenses to special items is potentially biased. Such bias has been attributed to the use of accruals, including special item related accruals, as a control for the impact of performance on core earnings in this model. This paper provides an improved classification shifting model which both tests for such accruals-related bias and controls for other sources of error in the measurement of shifting. The paper also modifies conventional market rationality tests in accounting research to examine new dimensions of rationality in relation to measurement and valuation of shifting. The main empirical findings are as follows. First, the improved classification shifting model provides strong evidence of shifting and rejects the hypothesis that inclusion of accruals in the model causes bias. Second, estimates of shifted core expenses generated by the improved model exhibit forecasting properties of shifted earnings. Third, rationality test results are broadly consistent with rationality in relation to shifted core expenses but indicate possible partial (ir)rationality in relation to adjusted special items (i.e., special items excluding shifted core expenses). Further analysis of the latter findings, however, suggests they are more likely related to risk than irrationality. Overall, the paper contributes to improved measurement of shifting and highlights the importance of considering rational expectations when examining stock returns associated with shifting.

Abstract We offer several suggestions for researchers using corporate bond return data. First, despite clear instructions from older papers (e.g., Bessembinder et al., The Review of Financial Studies 22:4219–4258, 2009) about ways to compute credit excess returns, a lot of recent research simply subtracts a Treasury Bill return. We show that this imprecision is likely to contaminate inferences, as the rate component of returns is negatively correlated to the spread component. This is a problem for all research looking at corporate bond returns, especially time series analysis and safer corporate bonds (e.g., investment grade). We provide a simple approach using Wharton Research Data Services (WRDS) data to remove the interest rate component of corporate bond returns. Second, we note significant differences in the coverage of corporate bonds across the Trade Reporting and Compliance Engine (TRACE) platform and typical corporate bond indices. We provide some simple rules for researchers who are using TRACE to select a subset of bonds closest to those contained inside corporate bond indices used by institutional investors. Third, we note differential quality in the prices and hence returns between TRACE and typical corporate bond indices. Corporate bond returns provided by corporate bond indices (i) correctly estimate credit excess returns, (ii) are synchronous for the entire set of bonds, allowing for consistent cross-sectional comparability, and (iii) suffer less from stale pricing issues. Due to these coverage and data quality issues, researchers should try, where possible, to source return data from multiple sources to ensure the robustness of their results.

Abstract Should employers disclose their assessments of their employees? Popular managerial advice suggests that telling employees that they are assessed to have high potential leads to greater effort and engagement, boosting firm profits. However, some employers still choose to withhold employee assessments. What explains this paradoxical observation? We show that disclosing a positive assessment to an employee increases his incentive to appear successful. Success can be achieved by working hard or by misreporting. If the internal controls are sufficiently weak, the employee excessively substitutes misreporting for effort, thereby decreasing firm profits. Consequently, our model predicts that employers withhold assessments when internal controls are weak. Other predictions are that, all else equal, employers with an experienced human resources (HR) function will be more likely to disclose assessments, and employers who hire from “prestigious” target schools will be less likely to disclose assessments.

Abstract We use the year-end adjustments to the provisions for student loan losses of state and provincial governments in the United States and Canada to study government accounting conservatism and how it varies between these adjacent and highly integrated countries. Building on Canada’s more conservative cultural attributes, we hypothesize and find that Canadian provincial governments report more conservative provisions for student loan losses than U.S. state governments. Moreover, the year-end adjustments to the provisions in Canada are excessively conservative; they are larger than the audit materiality threshold. We further find that the political ideology of the government, government reporting incentives, government debt, and political competition are important determinants of government accounting conservatism. Finally, we find a negative association between the year-end adjustment to the provision and future student lending. This result suggests that government accounting conservatism leads to credit rationing and significant societal consequences for students. Overall, our study highlights important aspects of the determinants and consequences of government accounting conservatism. To the best of our knowledge, this study is the first to examine government unconditional accounting conservatism.