Hayn (1995) and Burgstahler and Dichev (1997) find evidence that there is a ‘point of discontinuity’ in the cross-sectional distribution of earnings around zero with an unusually low concentration of firms just below zero and an unusually high concentration of firms just above zero earnings (earnings level threshold). Burgstahler and Dichev (1997) find similar breaks in the distribution for small positive and small negative earnings changes (earnings changes threshold). Degeorge, Patel, and Zeckhauser (1999) find similar results for the cross sectional distribution of analyst forecast errors (analyst forecast threshold). These studies interpret the breaks in the distributions as circumstantial evidence that earnings are managed to beat these thresholds.
Firms have incentives to beat earnings thresholds. Graham, Harvey, and Rajgopal (2005) survey 312 financial executives from public companies. They ask executives which earnings benchmarks are important to them and find that roughly two thirds or more (depending on the benchmark) of the respondents agree that all three benchmarks are important (Graham et al. 2005, Table 3). Over 80% of the executives surveyed agreed that meeting earnings benchmarks helped them to ‘build credibility with the capital market’ and ‘maintain or increase stock price’ (Graham et al. 2005, Table 4). There has developed a large literature that documents firms’ capital market incentives for beating one of the benchmarks (e.g. Barth, Elliot, and Finn 1999, Myers et al. 2007, Bartov et al. 2002, Kasznik and McNichols 2003, Brown and Caylor 2005). Matsunaga and Park (2001) suggest that CEO bonus payments give CEOs an economic incentive to beat the analyst forecast benchmark and the earnings changes benchmark. If firms have incentives to beat a threshold, then why do so many firms miss a threshold? What prevents firms just below a threshold from managing earnings to beat a threshold? I examine the characteristics of firms just above and firms just below thresholds. I focus on two specific characteristics—market sensitivity to earnings announcements and a firm’s flexibility to manage earnings.
According to a global CEO study performed by IBM, where over 750 business leaders all over the world participated, over 65% of the asked people replied that they thought business model innovation would be the most important innovation for the future. Furthermore, fully 61% of CEO’s who have a primary focus on business model innovation fear that changes in the business model of a competitor could likely result in a radical change to the entire landscape of their industry.
Rapid advances in information and communication technologies have facilitated new types of technology-mediated interactions between economic agents (Geoffrion and Krishnan, 2003). This has enabled firms to change fundamentally the way they organize and transact both within and across firm and industry boundaries (Mendelson, 2000). Thus, the focus of organization design has shifted from the administrative structure of the firm to the structural organization, or architecture, of its exchanges (Amit and Zott, 2004). Echoing this shift, researchers have observed that the locus of value creation increasingly extends traditional firm boundaries (Dyer and Singh,1998; Gulati, et al., 2000; Normann, 2001), and that they have called for broader conceptualization of organizational boundaries beyond the legally relevant demarcation of the firm from its environment (Santos and Eisenhard, 2006). The world is getting more and more like a global village. Globalization is bringing tougher competition and stronger market forces with it. And when the competition gets stronger, companies constantly needs to find new ways of doing business to sustain in the fierce competition. External market factors force companies to rethink the way they do business.
We study the association between conditional accounting conservatism and firm investment efficiency. Classic agency theory shows that managers have superior information about the expected profitability and the timing of the payoffs of undertaken projects and investments (Lambert 2001) and can therefore make investment or operating decisions that are harmful to the interests of the providers of finance (Jensen and Meckling 1976). Accounting research argues that increased disclosure and higher quality financial reporting mitigates information asymmetry problems and agency costs (Healy and Palepu 2001).
