09 Financial: Fair Value Accounting/Intangible Assets/Innovations
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ItemFair Value, Historical Cost model, and Audit Fees: Evidence from Investment Properties( 2019-08-31)This study examines the effect of fair value model versus historical cost model for investment property on audit fees. Using China’s real state firms data from 2007-2014, controlling for other determinants of audit fees, this study finds that audit fees are higher for firms reporting investment property at the fair value model relative to those reporting investment property at the cost model. This study also finds that firm reporting investment properties at the fair value located in the cities with active markets leads to lower audit fees than those located in the remote areas with less active markets. This study does not find that investment property valued under the fair value model audited by industry specialist leads to higher audit fees than investment property audited by non-industry specialist. Finally, this study provides evidence that firms use external appraisers to monitor the fair value estimates of investment properties leads low audit fees. Overall, our result suggests that fair value measurements leads to lower audit fees in the developed regions relative to less developed regions.
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ItemProfitability of Corporate Acquisitions and the Acquisition Premium and Goodwill( 2019-08-31)We examine the unresolved questions of whether corporate acquisitions create synergistic gains in the form of post-merger abnormal operating performance and whether the accounting goodwill is associated with post-merger operating performance. By disentangling the purchase accounting effect, we propose an adjusted cash flow performance measure to be used consistently over the pre- and post-merger periods. Using the adjusted performance measure and difference-in-difference approach, we reconcile the conflicting results from prior studies (Healy, Palepu, and Ruback, 1992; Ghosh, 2001). We document evidence that post-merger operating cash flow performance of the merged firms increases in comparison with the control firms matched by pre-merger performance and size. We also find that the size of the accounting goodwill and acquisition premium varies directly with post-merger operating performance. Such evidence suggests that acquiring firms which pay higher acquisition premium experience a corresponding higher cash flow return following the corporate acquisition and that the accounting goodwill represents future benefits.
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ItemDoes Writing Down Goodwill Imperil a CEO's Job?( 2019-08-30)We find that accounting charges for goodwill impairment provide meaningful signals to corporate boards concerning CEO performance in selecting and conducting acquisitions. We examine 5,990 firms that completed acquisitions and investigate the relation between CEO turnover and goodwill impairment during 2002–2016. The results show that the amount of goodwill impairment recognized prior to the departure is positively associated with forced, but not voluntary, CEO turnovers. Pre-turnover goodwill impairment is higher for firms with forced CEO turnovers than for firms with voluntary turnover. This implies that goodwill impairment provides information before CEO changes occur. We find only the unexpected component of goodwill impairment is informative and associated with forced CEO turnover. Results also show that the association between goodwill impairment and forced CEO turnover varies as the audit quality changes, suggesting the reliability of accounting information influences the board’s CEO retention decision.
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ItemNarrative R&D Disclosure and the R&D Anomaly( 2019-08-30)Prior research documents that investors underreact to R&D expense because they have difficulty valuing innovation (Chan et al 2001; Eberhart et al. 2004; Cohen et al. 2013). This phenomenon is commonly referred to as the R&D anomaly. We extend prior research by examining how narrative R&D disclosure in 10-K filings impacts market participants’ understanding of the value of innovation. We first show that narrative R&D disclosure is positively related with future R&D outcome. Despite such value-relevance, we find that R&D anomaly is magnified in intense narrative R&D disclosure firms, as reflected in larger future returns associated with current R&D expense. We further find that the impact of R&D disclosure on the R&D anomaly is more pronounced when the number of investors’ 10-K views is low and when 10-K reports are less readable. Overall, our findings suggest that narrative R&D disclosure does not necessarily help investors’ ability to impound information about R&D into stock prices on a timely basis. Our study has implications for regulators in that users of financial statements have difficulty processing on a timely basis the information contained not only in R&D, but also in R&D narrative disclosure.
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ItemDifferences in the Value Relevance of Identifiable Intangible Assets Acquired in Business Combinations( 2019-08-29)Some investors assert there are weaknesses in the current accounting model for business combinations that limit the usefulness of information reported for acquired identifiable intangibles. Organically replaced intangible assets require future ongoing expenditures to maintain or enhance their value, creating uncertainty about the amount and timing of future cash flows. Wasting intangible assets have identifiable revenue streams that do not require future investment and often have definite lives that are legally or contractually determined. The current accounting model for business combinations also requires recognition of identifiable intangibles that are not strategically important sources of economic benefits from the acquisition. Motivated by these claims, we develop testable hypotheses and examine differences in the associations between post-acquisition equity prices and different types of acquired intangibles. We predict and find that both wasting and organically replaced intangibles are positively associated with post-acquisition equity prices. However, we predict and find that the association is less positive for organically replaced intangibles than wasting intangibles. In addition, we predict and find that organically replaced intangibles exhibit a similar association with equity prices to goodwill. We also predict and find that strategically important intangibles are positively associated with post-acquisition equity prices, but find no association for other intangibles. Our findings highlight how differences in the underlying economic characteristics of acquired intangibles are reflected in the usefulness of financial reporting information for business combinations.
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ItemLoan Portfolio Risk and Capital Adequacy: A New Approach to Evaluating the Riskiness of Banks( 2019-08-28)We develop a Loan Portfolio Risk (LPR) variable that measures time-varying volatility in default risk for a portfolio of bank loans. An Equity-to-LPR ratio (ELPR) is incrementally important in predicting bank failure up to five years in advance, even after controlling for all the CAMELS variables. Publicly-listed banks with higher ELPR have lower market implied costs-of-capital. ELPR also strongly predicts cross-sectional stock returns under stress conditions. During the financial crisis (7/2007-6/2011), a cash-neutral strategy that longs high-ELPR and shorts low-ELPR banks yields a monthly alpha of 3.3% to 4.2%. We conclude LPR captures key aspects of bank risk missed by a risk-weighted-asset approach.