Emerald | Review of Accounting and Finance | Table of Contents

Goodwill accounting and asymmetric timeliness of earnings

literatinetwork@emeraldinsight.com (Sohyung Kim, Cheol Lee, Sung Wook Yoon) — Thu, 09 May 2013 00:00:00 +0100

Abstract

Purpose – The purpose of this paper is to investigate how fair value reporting and increased managerial discretion under the new goodwill accounting affect the asymmetric timeliness of earnings;, i.e. accounting conservatism. Design/methodology/approach – Various empirical models are applied to a sample of 11,034 firms. To capture a cross-sectional variation in asymmetric timeliness of earnings, Kahn and Watts' C_Score is adopted. Findings – It is found that financial reporting for firms with purchased goodwill has become more conservative after the enactment of the new standard. However, once an increase in conservatism that is not attributable to new goodwill accounting is controlled for, it is found that accounting earnings for firms with purchased goodwill become less conservative. Research limitations/implications – The results should be interpreted with caution, because the effect of concurrent events other than the adoption of SFAS 142 on reported earnings is not perfectly controlled. Practical implications – The results of this paper support Watts' assertion that new goodwill accounting impairs accounting earnings' ability to reflect the economic earnings in a timely manner, but these results should be interpreted with caution, as the main objective of goodwill accounting is not to improve accounting conservatism. Originality/value – This paper makes a timely contribution to the debate of fair value accounting by focusing on the impact of SFAS 142 on the asymmetric timeliness of earnings. By employing all available firms with purchased goodwill balances rather than relying on firms that report impairment losses, our research design better captures the impact of SFAS 142 on financial reporting.

Customer value disclosure and cost of equity capital

literatinetwork@emeraldinsight.com (Raf Orens, Walter Aerts, Nadine Lybaert) — Thu, 09 May 2013 00:00:00 +0100

Abstract

Purpose – This paper seeks to examine the association between a firm's extent and precision of customer value disclosure and its implied cost of equity capital. In addition, it aims to investigate whether industry competition intensity attenuates this association. Design/methodology/approach – The content of corporate websites from four continental European countries is analysed on the presence and precision of customer value information and empirically test whether content and precision are associated with the firm's implied cost of equity capital measurement. Findings – The results show a negative association between cross-sectional differences in the extent of customer value disclosure and cross-sectional differences in a firm's cost of equity capital. In addition, the precision of the customer value information disclosed affects this association. It is observed that a negative relationship between quantitative (or hard) customer value disclosure and a firm's cost of equity capital, but not for qualitative (or soft) customer value disclosure. As expected, industry competition intensity attenuates the association between quantitative customer value disclosures and a firm's cost of equity capital. Research limitations/implications – The paper considers web placement of customer value disclosure although a firm might disclose such information through other information channels as well. Practical implications – A firm tends to benefit economically from more precise customer value disclosure. Originality/value – The paper extends existing evidence by considering the capital market implications of disclosing customer value information. In addition, it examines whether industry competition affects the association between customer value disclosure and the firm's cost of equity capital.

“6 and 1” option exchanges and stockholder wealth

literatinetwork@emeraldinsight.com (Atul Gupta) — Thu, 09 May 2013 00:00:00 +0100

Abstract

Purpose – Firms will, at times, replace employee holdings of out-of-the-money stock options with new ones that have lower exercise prices. This paper seeks to examine how stockholders view such actions. Design/methodology/approach – The stock price reaction to announcements of option exchange programs is used to establish how stockholders view option exchanges. Regression analysis is then used to get insight into firm and program characteristics that explain cross-sectional differences in the stock price response. Findings – A positive stock price response indicates that stockholders view such option exchanges as value enhancing. Regression analysis indicates that the price response increases with a firm's growth opportunities, the level of employee turnover, the extent to which employee option holdings are out-of-the-money, and the quality of corporate governance. Deals where only non-executive employees are allowed to participate are viewed more favourably. Originality/value – This is the first paper to document that stockholders regard resetting the terms of employee option holdings in a positive vein, confirming implications emerging from theoretical papers on this subject. The paper also documents firm and program characteristics that impact the extent of possible value creation.

Excess volatility and closed-end fund discounts

literatinetwork@emeraldinsight.com (Michael Bleaney, R. Todd Smith) — Thu, 09 May 2013 00:00:00 +0100

Abstract

Purpose – The purpose of this paper is to examine the conditions under which discount risk leads to closed-end funds trading at a discount. Design/methodology/approach – A model of investor portfolio choice is developed in which investors face proportional fees for holding managed funds but fixed transaction fees for purchasing other risky assets. The conditions under which investors will hold shares in closed-end funds are derived. Findings – It is shown that, with fixed transaction costs in the market for risky assets, investors with wealth below a certain threshold will hold pooled index funds that charge a proportional fee, rather than the market portfolio chosen by wealthier investors. If a portfolio of closed-end index funds yields greater volatility of returns to investors than open-end index funds (i.e. displays “excess volatility”), and charges the same fees, the closed-end funds need to trade at a discount in equilibrium to attract buyers. The same applies to actively managed funds if higher fees fully reflect extra expected returns from the managers' skill. Practical implications – A primary determinant of closed-end fund discounts is discount volatility and co-movement across funds. Originality/value – Until now it has been argued that discount risk needs to be systematic (correlated with market returns) to be priced. The evidence that discount risk is systematic is weak. There is strong empirical evidence of excess volatility and co-movement of discounts across closed-end funds, which in our model are a sufficient condition for funds to trade at a discount, under plausible assumptions. This model thus provides a stronger argument that discount risk explains why discounts exist.

Momentum profits and idiosyncratic volatility: the Korean evidence

literatinetwork@emeraldinsight.com (Unyong (Howard) Pyo, Yong Jae Shin) — Thu, 09 May 2013 00:00:00 +0100

Abstract

Purpose – This study aims to focus on the profitability of momentum trading in the Korean stock market. More specifically, it aims to conduct an examination of the relationship between momentum returns and idiosyncratic volatility (IVol) to determine whether momentum profits can be explained by IVol. Design/methodology/approach – Portfolios are formed based on their past performance and examine the momentum, or contrarian returns, as the difference between winning and losing portfolios. To confirm that the momentum strategy provides excess returns, the relationship between momentum returns and IVol is studied. The Fama and French three-factor model is also examined to see whether systematic risk affects momentum profits. Firm size, stock price, and turnover are controlled to determine robustness. Finally, a time-series relationship between aggregate IVol and momentum profits is investigated. Findings – The paper illustrates that excess returns are obtained from a momentum strategy, not a contrarian strategy, in the Korean stock market. Momentum returns are higher among high IVol stocks, especially high IVol winners. Examining the Fama and French three-factor model, it is found that momentum returns cannot be explained by systematic risk. The findings are robust after controlling for factors such as firm size, book-to-market ratio, and turnover. The paper confirms the effect of IVol on momentum returns by illustrating that a time-series relationship between momentum returns and aggregate IVol is positive. Originality/value – This paper is among the first, to the authors' knowledge, to examine the relationship between momentum profits and IVol in the Korean stock market, one of the mature financial markets. The findings in this study can be applied to better understand the sources of gains from the momentum strategy in international stock markets.