Does Investors' Sophistication Affect Persistence and Pricing of Discretionary Accruals?

Review of Pacific Basin Financial Markets and Policies 03/2007; 10(01):33-50. DOI: 10.1142/S0219091507000945
Source: RePEc

ABSTRACT This paper examines whether the sophistication of market investors influences management's strategy on discretionary accounting choice, and thus changes the persistence of discretionary accruals. The results show that the persistence of discretionary accruals for firms face with naive investors is lower than that for firms face with sophisticated investors. The results also demonstrate that sophisticated investors indeed incorporate the implications of current earnings components into future earnings in a more sufficient manner than naïve investors do.

  • [Show abstract] [Hide abstract]
    ABSTRACT: This study refines the accrual decomposition approach in Richardson et al. (Account Rev 81:713–743, 2006) and introduces a growth measure that is free from accounting distortions. My evidence indicates that the lower persistence of accruals extends to accruals that are unrelated to accounting distortions. I, however, find that the growth and accounting distortion components of accruals are not isolated. Growth may provide a context where firms have more incentives to manipulate earnings. I provide evidence that the persistence of both the growth and accounting distortion components of accruals is affected by firm growth and agency cost factors, such as free cash flows, leverage, and overvalued equity. I also document high accounting distortions for relatively high-growth firms that are close to reporting positive earnings, and negative accounting distortions for relatively low-growth firms that are far from the potential to report positive earnings.
    Review of Quantitative Finance and Accounting 01/2014; 42(1).
  • [Show abstract] [Hide abstract]
    ABSTRACT: We posit that the effect of non-audit fees on audit quality is conditional on the extent of institutional monitoring. We suggest that institutional investors have incentives and the ability to monitor financial reporting quality. Because of the reputation concerns and potential litigation exposure, auditors are likely to provide high audit quality, when they also provide non-audit services to clients, particularly when clients are subject to high institutional monitoring. We find evidence that, as non-audit fees increase, audit quality (measured by performance-adjusted discretionary current accruals and earnings-response coefficients) reduces only for clients with low institutional ownership but not for clients with high institutional ownership. Our results are robust after controlling for auditor industry specialization, firms’ operating volatility, size effect, and potential endogeneity between institutional ownership and audit quality.
    Review of Quantitative Finance and Accounting 08/2012; 41(2).
  • Source
    [Show abstract] [Hide abstract]
    ABSTRACT: In this unique empirical investigation investors need to decide whether or not to allow their fund manager to receive a portion of their managed portfolio transaction fees. This arrangement can cause the manager to increase the volume of trade thus increase his income and lower investor's return. Though common-sense and financial literature suggest investors should not agree evidence show most of the investors in the sample (88.7%) agreed. We differentiate between sophisticated and unsophisticated investors using two different proxies: professional occupations vs. non-professionals and firms vs. private clients. We find consenting investors to underperform 4% in the year following the decision. Under the two definitions sophisticated investors tend not to agree relative to other investors.


Available from