Earnings-quality-Evidence-from-the-field

Earningsquality:Evidencefromthefield$articleinfoJELclassification:G30M14M41Keywords:EarningsqualityFASBEarningsmanagementabstractWeprovideinsightsintoearningsqualityfromasurveyof169CFOsofpubliccompaniesandin-depthinterviewsof12CFOsandtwostandardsetters.CFOsbelievethat(i)aboveall,high-qualityearningsaresustainableandrepeatable;specificcharacteristicsincludeconsistentreportingchoices,backingbyactualcashflows,andabsenceofone-timeitemsandlong-termestimates;(ii)about50%ofearningsqualityisdrivenbynon-discretionaryfactorssuchasindustryandmacro-economicconditions;(iii)inanygivenperiod,about20%offirmsmanageearningstomisrepresenteconomicperformance,andforsuchfirms10%ofEPSistypicallymanaged;(iv)earningsmanipulationishardtounravelfromtheoutsidebutpeercomparisonsandlackofcorrespondencebetweenearningsandcashflowsprovidehelpfulredflags.Inaddition,CFOsdisagreewithcurrentstandardsettingonanumberofissuesincludingthesheernumberofpromulgatedrules,thetop-downapproachtorule-making,theneglectofthematchingprinciple,andtheemphasisonfairvalueaccounting.Theyindicatethatarules-basedculturemakestheauditfunctioncentralizedandmechanical,andhindersthedevelopmentofauditprofessionals.AsummaryimpressionfromourworkisthatCFOsviewearningsqualityasmoreofasingleandunconditionalcharacteristic,incontrasttocurrentresearchwheremeasuresofearningsqualityarestronglyconditionalonthedecisionsetting.ThisCFOviewisrelatedtotheirideaof“onenumber”–asingleearningsmetricthatshapesboththeirinteractionswithexternalstakeholdersandinternaldecision-making.1.IntroductionTheconceptofearningsqualityisfundamentalinaccountingandfinancialeconomics.Yet,therearebroaddisagree-mentsabouthowtodefineandmeasureit.Thelistofcandidatemeasuresislong:earningspersistence,predictability,asymmetriclossrecognition,variousformsofbenchmarkbeating,smoothearnings,magnitudeofaccruals,income-increasingaccruals,absolutevalueofdiscretionaryorabnormalaccruals,andtheextenttowhichaccrualsmapintocashflows.Complicatingthemeasurementofearningsquality,archivalresearchcannotsatisfactorilyparseouttheportionofmanagedearningsfromtheportionresultingfromthefundamentalearningsprocess(Dechowetal.,2010).Thus,anumberofvexingquestionshavebeendifficulttoaddresswitharchivalworkbecauseanswersoftenrelyonunobservablemanagerialintent.Examplesofsuchquestionsincludethefollowing:Whatopportunitiesandconstraintsdomanagerstradeofftochooseonesetofearningsattributesovertheother?Whataccountingpoliciespromotehigherqualityearnings?Howprevalentisearningsmanagement?Whatisthetypicalmagnitudeofearningsmanagement?HowcananoutsideContentslistsavailableatSciVerseScienceDirectjournalhomepage:://dx.doi.org/10.1016/j.jacceco.2013.05.004☆WeacknowledgeexcellentresearchassistancebyMengyaoCheng,JivasChakravarthyandStephenDeason.WeappreciatewrittencommentsonanearlierversionofthepaperfromMarkNelsonandDougSkinner(discussants),VicAnand,SudiptaBasu,PaulHealy,UrtonAndersonandespeciallyPatO'Brien,TerryShevlin,MichelleHanlon(editor),andJerryZimmerman.WethankworkshopparticipantsatTexasA&MUniversity,CornellUniversity,HarvardBusinessSchool,Wharton,UniversityofTechnology–Sydney,UniversityofMelbourne,CassBusinessSchool,LondonSchoolofEconomics,VirginiaCommonwealthUniversity,StanfordSummerCamp,TempleUniversity,OhioStateUniversity,RotmanSchoolofBusiness,TuckSchoolatDartmouth,IndianSchoolofBusiness,MinnesotaFinancialAccountingConferenceandthe2012AAADoctoralConsortium.WeacknowledgehelpfulcommentsonapreliminaryversionofthesurveyinstrumentfromworkshopparticipantsatEmoryUniversityandfromBobBowen,DaveBurgstahler,BrianBushee,DanCollins,JohnCore,PattyDechow,MarkDeFond,JenniferFrancis,WeiliGe,JeffHales,MichelleHanlon,GaryHecht,KathrynKadous,MarkLang,RussLundholm,MarkNelson,StephenPenman,KathyPetroni,GracePownall,CathySchrand,TerryShevlin,ShyamSunder,TerryWarfield,RossWatts,GregWaymire,JoeWeberandJerryZimmerman,andtwoanonymousstandard-setters.WethankLarryBenvenisteandTrevorHarrisforarranginginterviews.WearegratefulforCFOmagazine'shelpinthisproject,thoughtheviewsexpressedheredonotnecessarilyreflectthoseofCFO.Finally,wethankDavidWalonickandStatpac,Inc.fordedicatedworkincodinganddeliveringthesurvey.JournalofAccountingandEconomics](]]]])]]]–]]]investigatortellwhetherex-anteearningsqualityispoorbeforeobservingex-postoutcomessuchasrestatementsandSECenforcementactions?Thesearethetypesofquestionsweendeavortoanswer.Inthispaper,weprovideinsightsaboutearningsqualityfromanewdatasource:alargesurveyandadozeninterviewswithtopfinancialexecutives,primarilyChiefFinancialOfficers(CFOs).WhyCFOs?First,CFOsarethedirectproducersofearningsquality,whoalsointimatelyknowandpotentiallycatertoconsumersofearningsinformationsuchasinvestmentmanagersandanalysts.CFOsmakethekeydecisionsonhowtoapplyaccountingstandardsintheircompany,andwhethertouseorabusediscretioninfinancialreporting.Second,CFOscommonlyhaveaformalbackgroundinaccounting,whichprovidesthemwithkeeninsightintothedeterminantsofearningsquality,includingtheadvantagesandlimitationsofGAAP