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5. CONCLUSIONS AND DISCUSSIONS
Firms may adopt voluntary accounting changes to better reflect the firms’
activities or economic reality (Holthausen and Leftwich 1983; Healy and Palepu 1993), but several papers claims that VACs arise from managerial opportunism (Pincus and Wasley 1994; Fields et al. 2001). It is possible that VACs let external financial report users spend more efforts when processing the earnings-related information of VAC firms. Moreover, post-earnings announcement drift is among the most persistent market anomalies. Two possible causes of the drift are transaction costs that dissuade investors from trading on earnings information immediately, and the market’s inability to fully interpret the implications of earnings information. To investigate how VAC influence the speed of earnings-related information incorporated into stock price, this study examines the relation between voluntary accounting changes (VACs) and post-earnings announcement drift. In addition, this study further examines how accounting choice heterogeneity (different from the VAC firms’ peers) before and after VACs is associated with post-earnings announcement drift.
In order to address my research question, this study collects VAC firms in the period from 1994 to 2008 and identifies the heterogeneity of accounting choices between VAC and non-VAC firms. The results demonstrate that, overall, VACs have a positive effect on the three-day market reactions to 10-Q filings, which means that VACs may influence the external users’ comprehension of earnings information and result in 10-Q filing drift. In addition, after taking into account the accounting choice heterogeneity, the relation between VACs and post-earnings announcement drift is much
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clear. This study observes that VACs are positively related to the market reactions around 10-Q filing date and negatively related to the post-filing drift when VACs are similar as their industry peers after VACs. Moreover, VACs are positively associated with the post-filing period drift when VACs are different from their industry peers after VACs. Thus, when VAC firms’ post-change accounting method similar as their industry peers, VACs-related information is easier for external users to comprehend, which results in more market reaction around 10-Q filing date and less stock price reaction in the following window. In contrast, VAC firms adopting different post-change accounting method from non-VAC firms may make external users harder to digest related earnings information and lead to delayed market reaction, thus, more of stock price drift occur in post-filing window. In conclusion, though VACs may enhance market participants’ understanding of firms’ activities, the results demonstrate that market participants may spend more time to comprehend and digest VACs information disclosed by VAC firms compared to non-VAC firms, which leads to post-earnings announcement drift.
In addition, firms have discretionary power to choose the accounting method itself and VACs are managerial decision of firms, which may result in an endogenous problem in this study. It seems that the models in this study without considering the problem of endogeneity are likely not so significant than models with endogeneity.
There are some methods to solve this problem but it needs more tests and assumptions.
Therefore, the study doesn’t consider the endogeneity in above models.
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This paper contributes to the literature by showing VAC may be one factor that affects post-earnings announcement drift. Specifically, compared to prior studies demonstrating that the market largely reflects accounting changes in the years these changes are made, this study empirically finds that voluntary accounting changes positively affect the market’s responses to 10-Q filings around filing dates. And the impact of VACs to the market’s responses become much clearer when considering whether VAC firms adopt different accounting practices compared to the VAC firm’s major competitors. Furthermore, this study demonstrates that, given the change with heterogeneity requires more time to process, VACs are related to post-filing announcement drift. The results have implication for regulators and VAC firms that voluntary accounting changes may not play the role of better reflecting a firm’s activities.
Instead, VACs, especially when deviate from industry peers, require more time for market participants to process and may not achieve the expected objective.
There are limitations in this study. First, sample size of this research is relatively smaller compared to prior studies though this study has collected the VACs that can be identified. Second, many VAC firms do not disclose detailed information of VACs in the 10-Q reports, which limit the investigation in more details. Last, given that both VAC and non-VAC firms do not clearly disclose their accounting policies, accounting choice heterogeneity also limit my analyses.
Several possible of future research avenues. First, future research can take into account the details of VACs, e.g., LIFO to FIFO or income-increasing VACs to
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income-decreasing VACs. Second, some prior studies measure earnings surprise in different way, e.g., Livnat and Mendenhall (2006) use time series predictions based on historical earnings information. How different measurement of earnings surprise may influence the empirical results is deserving of investigation. Third, the post-filing drift window is set to begin from two trading days after the filing date and end on sixty trading days with respect to the earnings announcement date as prior studies. The market reaction drift in different period of time within sixty trading days after earnings announcement date can also be examined, e.g., the post-filing drift window is set to end on twenty or thirty trading days after earnings announcement date. Last, the longitudinal tests in prior studies about market reactions to accounting changes are unclear. The moderating effect of accounting choice heterogeneity on the relation between VACs and long-term market performance is worth exploring.
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Variable Definition Data Source
SAR
F Equally weighted cumulative abnormal returns over the10-Q filing window. CRSP
SAR
FD Equally weighted cumulative abnormal returns over the10-Q post-filing window. CRSP
SURPRISE
Earnings surprise, calculated by earnings per share minus the most recent analyst forecast consensus for the quarter divided by the stock price at the end of the quarter.
IBES
VAC
A dummy variable, which equals one if the firm hasVACs, 0 otherwise. 10-Q
POST
A dummy variable indicating whether a firm-quarter observation is after VACs, which equals 1 if a
firm-quarter observation is after the VAC, 0 otherwise.
SIZE
Size of a firm, which is the market capitalization of afirm at the end of the quarter. Compustat
NUMBER
Number of analysts following a firm at the end of thequarter. IBES
SGROWTH
Sales growth of firms at the end of the quarter. CompustatLEVERAGE
Leverage ratio of a firm at the end of the quarter, whichequals total liabilities divided by total assets. Compustat
DVOLUME
Dollar trading volume, which is scaled by the firm’smarket value at the end of the quarters. CRSP