Instructions Select an article of a high-profile event that discusses how the failure of ethical leadership impacted the company. Select an article that discusses corporate culture and gover
Instructions
Select an article of a high-profile event that discusses how the failure of ethical leadership impacted the company. Select an article that discusses corporate culture and governance of the company or business organization.
Use the Unit II Template , and include the following information.
- Explain the corporate culture and/or governance of the company or business organization.
- Explain the failure(s) of ethical leadership in the company that lead to the event.
- Discuss ways the failure might have been avoided.
You are required to use at least one source from the CSU Online Library. Please adhere to APA Style when creating citations and references for this assignment. APA formatting, however, is not necessary.
Unit II Template
Log into the Columbia Southern University Online Library, and select an article of a high-profile event that discusses how the failure of ethical leadership impacted the company. Use this two-page template to complete the assignment. Be sure to complete all tasks outlined on both pages below.
Provide the following information.
1. Name of the article |
[ Write response here…] |
2. URL of the article |
[ Write response here…] |
3. Name of company involved in the article |
[ Write response here…] |
Briefly explain each of the following regarding the article (one paragraph for each).
Explain the corporate culture and/or governance of the company or business organization. |
[ Write response here…] |
Explain the failure(s) of ethical leadership in the company that led to the event. |
[ Write response here…] |
Discuss how the failure might have been avoided. |
[ Write response here…] |
,
Meeting or Beating Analyst Expectations in the Post-Scandals World: Changes in Stock Market
Rewards and Managerial Actions*
KEVIN KOH, Nanyang Technological University
DAWN A. MATSUMOTO, University of Washington
SHIVARAM RAJGOPAL, University of Washington
1. Introduction
This paper investigates (a) whether the stock market rewards meeting or beating analyst expectations following the accounting scandals of the early 2000s (post- scandals period); and (b) whether earnings management and/or expectations management have changed from the pre-scandals period. The Enron accounting scandal, which broke in October 2001, and subsequent accounting scandals led to a loss of investor trust in the integrity of financial statements, passage of the Sarbanes-Oxley Act (SOX) 2002, and likely changed both investor reactions to fineincial disclosures as well as managers' disclosure decisions.
However, chief financial officers (CFOs) interviewed by Graham, Harvey, and Rajgopal (GHR) 2005 opine that in the post-scandals period, capital markets con- tinue to be obsessed with meeting and beating analysts' earnings per share (EPS) targets, and CFOs take potentially value-destroying actions to meet such expecta- tions. Jensen, JVIurphy, and Wruck (2004) argue that (a) the pressure to meet analyst expectations was the driver behind the accounting shenanigans of the early 2000s; and (b) SOX cannot effectively improve financial reporting transparency unless managers de-emphasize earnings guidance to equity analysts, as pressure to meet such guidance leads to earnings management.
We provide evidence of changes, post-scandals, (1) in the stock market's reac- tion to firms' meeting or beating analyst earnings forecasts; and (2) on firms' reliance on earnings and expectations management to beat these targets. For esti- mation purposes, we isolate the period during which the majority of the scandals (including Enron) broke and SOX passed and focus on a comparison between the
, periods before Q3:2001 ("the pre-scandals period") and after Q4:2002 ("the post- scandals period").
* Accepted by Gordon Richardson. We thank Thomson Financial I/B/E/S for providing the analyst forecast data used in this study. We acknowledge helpful comments from two anonymous review- ers, Gordon Richardson (editor). Bob Bowen, Angela Davis, Dan Dhaliwal, Mahendra Gupta, Frank Hodge, Jim Jiambalvo, Terry Shevlin, D. Shores, Matt Wieland, and workshop participants at the University of Washington, Washington University (St. Louis), and the American Accounting Association 2006 Annual Meeting.
Contemporary Accounting Research Vol. 25 No. 4 (Winter 2008) pp. 1067-98 © CAAA
doi:10.1506/car.25.4.5
1068 Contemporary Accounting Research
We find that the stock market premium assigned to meeting analyst estimates of quarterly earnings or beating by less than one cent per share ("small beaters") has disappeared in the post-scandals period while the premium assigned to beating expectations by more than a cent per share ("big beaters") has diminished. These results suggest that the market has become more skeptical of firms that meet or beat expectations after the accounting scandals.
We also examine the extent to which the scandals and subsequent regulatory changes have affected managers' actions to avoid missing analysts' expectations. We find that the proportion of firms that beat expectations by one cent or less has decreased post-scandals, after controlling for macroeconomic variables and the temporal trend in meeting or beating forecasts. Moreover, the mix of mechanisms employed to meet or beat earnings benchmarks has changed post-scandals. While managers' propensity to rely on income-increasing discretionary accruals to meet analyst forecasts has decreased, downward expectations management has increased. This result is consistent with less reliance on earnings management, perhaps due to the increased scrutiny on such behavior, and more reliance on expectations management.
The decline in earnings management to meet or beat expectations raises ques- tions about the impact of this decline on earnings quality. One possibility is that managers use discretion in accruals to signal their private information and that curbing earnings management reduces their ability to communicate this informa- tion (e.g.. Watts and Zimmerman 1986; Sankar and Subramanyam 2001; Bowen, Rajgopal, and Venkatachalam 2008). Alternatively, managers may use earnings management for "opportunistic" reasons and reducing this behavior would increase the predictive ability of meeting/beating to convey information about future earnings. We investigate this question by examining the relation between meeting or beating expectations and future operating cash flows. Results show that, post-scandals, meeting/beating expectations is more positively related to future cash flows, which is consistent with the reduction in earnings management and increase in guidance improving the quality of the meet/beat "signal" (defined as the association between this signal and future cash flows). Hence, the reduction in the market premium associated with meeting or beating expectations does not appear to be due to a decrease in the information communicated in the meet/beat signal but occurs, possibly, due to an unwarranted increase in investor skepticism about firms that meet or beat expectations.
We find three issues of interest to governance advocates and regulators. First, the proportion of small EPS beats has fallen since the scandals, and the propensity to engage in income-increasing earnings management to meet or beat earnings benchmarks has declined. Second, this decline has led to meeting or beating being a stronger signal of future operating performance. Third, the stock market pre- mium assigned to small beats has disappeared in the post-scandals period. This decline could reduce the pressure on managers to meet analyst expectations. How- ever, our evidence suggests that expectations management to meet/beat analyst-set targets has increased in the post-scandals period.' Thus, it appears that some
CAR Vol. 25 No. 4 (Winter 2008)
Meeting or Beating Analyst Expectations in the Post-Scandals World 1069
managers continue to view meeting/beating analyst expectations as important and have, perhaps, replaced earnings management with expectations management.
Our paper is related to an emerging literature on financial reporting practices in the post-Enron climate, the majority of which concentrate on the impact of SOX. Cohen, Dey, and Lys (2005) find that earnings management declined after the pas- sage of SOX but do not examine earnings management to meet/beat expectations specifically. Lobo and Zhou (2006) show that accounting conservatism increased in the post-SOX period while Jain and Rezaee (2004) find no such change.
In a related working paper, Bartov and Cohen (2006, hereafter BC) also inves- tigate changes in meeting or beating expectations post-scandals. Consistent with our results, they find that accounting earnings management has declined post- SOX. However, contrary to our results, they find that expectations management has declined rather than increased. This difference arises partially because our analysis is based on the subsample of firms that meet or beat expectations whereas BC do not condition on firms who meet or beat expectations. That is, unlike BC, we com- pare firms that use downward expectations management to meet or beat analysts' forecasts with firms who are able to meet or beat expectations without the use of expectations management. Our papers also differ in that we examine changes in the market premium to meeting or beating expectations while they do not, and they examine changes in real earnings management while we do not.^
Numerous academic studies document various aspects of the meeting/beating expectations phenomenon in the pre-scandals period, but conclusions from these studies may no longer be applicable. One line of research finds an increasing pro- pensity for firms to report profits that exactly meet or slightly beat analyst estimates (e.g.. Brown 2001; Brown and Caylor 2005). Research shows that in the pre-scandals world, managers relied extensively on accruals (e.g., Kasznik 1999; Dhaliwal, Gleason, and Mills 2004) and expectations management (e.g. Matsumoto 2002; Bartov et al. 2002; Burgstahler and Eames 2006) to meet or beat analyst forecasts. We document that the emphasis on these tools has shifted in the post-scandals period. Bartov et al. (2002) show that meeting/beating expectations is a signal of better future performance. We find that the strength of this signal has increased in the post-scandals environment.
The remainder of the paper is as follows. Section 2 discusses institutional back- ground. Section 3 presents our analysis of the stock market reaction to meeting/ beating analysts' expectations. Section 4 reports our analysis of managers' actions to meet/beat expectations. In section 5 we discuss the link between our two find- ings and discuss possible explanations. Section 6 concludes.
2. Institutional background
Enron's fall and loss of investor trust
In October 2001, Enron announced a $1 billion nonrecurring charge for accounting "errors", triggering a chain of events that eventually led to the demise of both the company and its external auditor, Arthur Andersen. Enron's record as the largest bankruptcy in U.S. history was soon eclipsed by WorldCom, whose less sophisticated
CAR Vol. 25 No. 4 (Winter 2008)
1070 Contemporary Accounting Research
accounting fraud led to a larger restatement of earnings, a larger bankruptcy filing, and equally far-reaching civil and criminal investigations. Federal and state regula- tors subsequently initiated fraud investigations at dozens of corporations, including Adelphia, HealthSouth, McKesson, Tyco, and Qwest.
Regulators, business leaders, and academics have argued that the Enron scan- dal and subsequent investigations left investors distrustful of the financial reporting process (Nanda 2003). The watchdog systems designed to protect investors failed, and that failure extended to investment bankers, auditors, regulators, and business leaders in general, few of whom acted to prevent the actions that led to Enron's fall (Healy and Palepu 2003). Jensen (2006) attributes these scandals to a breakdown in the integrity of corporate managers. Thus, investors are likely more skeptical of the integrity of published financial reports since the demise of Enron.
Structural reforms post Enron
Brickey (2004) describes several post-Enron structural reforms that provide regu- lators and the enforcement community significant resources to address corporate governance failures. The most important initiatives include the creation of the Cor- porate Fraud Task Force and the Enron Task Force within the Justice Department, enactment of the Sarbanes-Oxley Act, amendments to the United States Sentencing Guidelines, revisions to the Justice Department's Corporate Prosecution Guidance, publication of SEC enforcement criteria, and significant increases in the Securities and Exchange Commission (SEC) funding.
Deployment of federal regulatory and law enforcement resources has contrib- uted to higher criminal enforcement levels in the post-scandals era. Dechow, Ge, Larson, and Sloan (2007) report 209, 237, and 209 Accounting and Auditing Enforcement Releases (AAERs) in the years 2002-4, respectively, relative to 125 in 2001, the year Enron broke. These structural reforms likely diminished managers' incentives to engage in accounting "shenanigans".
Sarbanes-Oxley Act
A key legislative response to the Enron and Worldcom scandals is the passage of the Sarbanes-Oxley Act of 2002 (SOX) on July 30, 2002. Congress intended to restore investor confidence in the financial reporting system and to protect share- holders from fraudulent financial reporting practices. SOX instituted a number of provisions including improving the composition and function of audit committees, chief executive officer (CEO) and CFO financial statement certification, restric- tions on nonaudit-related work by the company's auditors, mandatory audit partner rotation, and an annual report on internal controls (SOX section 404). These SOX provisions likely increased the expected costs associated with fraudulent financial reporting. For example, Linck, Netter, and Yang (2006) find that corporate boards, since SOX, are manned by a greater number of lawyers and financial experts and that the average workload of directors has increased.
While the new requirements were designed to increase investor confidence in financial reporting, it is not clear whether the stock market views the net benefits of the requirements positively. Event-studies of legislative events surrounding the
CAR Vol. 25 No. 4 (Winter 2008)
Meeting or Beating Analyst Expectations in the Post-Scandals World 1071
passage of SOX have produced mixed results. Li, Pincus, and Rego (2008) and Jain and Rezaee (2006) document positive abnormal returns around the legislative events associated with SOX, while Zhang (2007) reports significant negative abnormal returns around these events. Bhattacharya, Groznik, and Haslem (2002) find no evidence of a stock market reaction to the first CEO and CFO financial statement certifications.
This paper examines the impact of these changes in the financial reporting environment on meeting or beating expectations. Prior studies suggest that the market rewards firms that meet or beat analysts' expectations (Bartov et al. 2002; Kasznik and McNichols 2002). In addition, several papers (e.g., Jensen et al. 2004 and GHR 2005) have argued that (a) managers worry considerably about the stock market impact of failing to meet/beat analysts' expectations, and (b) managers' efforts to meet or beat analyst earnings expectations were the driving force behind the accounting scandals. Hence, we examine changes in the stock market percep- tion of meeting/beating analysts' expectations as well as changes in earnings and expectations management to avoid missing analysts' targets.
Time periods examined
We follow Cohen et al. 2005 and classify the period prior to the third quarter of 2001 as the "pre-scandals" period.3 Cohen et al. (2005) identify the second quarter of 2002 as the end of the scandals period. Although the majority of the scandals broke by the second quarter of 2002, the third and fourth quarters of 2002 were a period of significant changes in the financial reporting environment: the passage of SOX, the establishment of the Public Company Accounting Oversight Board (PCAOB), and the demise of Arthur Andersen. Therefore, we classify the period after the fourth quarter of 2002 as the "post-scandals" period (see Figure 1). Our data set ends with the second quarter of 2006; therefore, we have 14 quarters of data in the post-scandals period. Our analysis focuses on a comparison of the pre-scandals period to the post-scandals period, given that the scandal period itself is relatively short (six quarters) and marked by significant upheaval in the capital markets.'*
Figure 1 Time-line underlying the analysis
Ql:1987 Q3:2001 Ql:2003 Q2:2006
Pre-scandals Scandals Post-scandals period period period
Notes:
Figure 1 presents the time-line used in the analysis. The pre-scandals period is from Ql:1987 to Q2:2001, The scandals period is from Q3:2001 to Q4:2002. The post- scandals period is from Ql:2003 to Q2:2006, In subsequent analysis, SCA (POST) is a dummy variable set to one if the firm observation falls in the scandals (post-scandals) period, and zero otherwise.
CAR Vol. 25 No. 4 (Winter 2008)
1072 Contemporary Accounting Research
3. Stock market reaction to meeting/beating analysts' expectations
Research question
We first consider the stock market reaction to meeting or beating analysts' expecta- tions. Over the past decade, numerous studies suggest that meeting or beating analysts' expectations has become increasingly common (e.g.. Brown 2001; Mat- sumoto 2002; Brown and Caylor 2005). Prior studies also present evidence that the market assigns a premium to meeting or beating analyst expectations even after controlling for the news in earnings (Bartov et al. 2002; Kasznik and McNichols 2002) and that there is a market penalty to missing expectations for high-growth firms (Skinner and Sloan 2002). Survey evidence in GHR 2005 points to capital market pressures as the primary reason why managers avoid missing expectations. Jensen et al. (2004) argue that the pressure to meet analyst expectations was the driver behind the accounting shenanigans of the early 2000s. The publicity surround- ing the Enron, WorldCom, and other scandals likely raised investor skepticism about firms that meet or beat analyst expectations. If investors are more likely, post-scandals, to view meeting or beating expectations as a signal of managerial intervention, either by means of earnings management or analysts' expectations management (and if such actions are viewed negatively) the stock market premium assigned to meeting or beating quarterly estimates should decline post-scandals.
On the other hand, the scandals induced structural reforms designed to curtail managerial misbehavior. If investors view these reforms as effective, they could perceive meeting or beating analysts' forecasts as less likely to involve managerial intervention, thereby resulting in an increase in the stock market premium. Thus, whether the stock market premium to meeting or beating expectations has increased or decreased post-scandals is an empirical question.
Empirical tests of market reaction
To test our first research question, we estimate the following equation:
CAR¡ g= ßo+ ßiUEPSi^^ + ß2SMBEATi ^ + ß^IGBEAT, ^ + ß^SCA
+ ß^POST + ßcßCAWEPSi^ q + ß-jSCA*SMBEATi ^
i^ q + ßi iPOST*BIGBEAT¡ ^ + e, ^ (1).
In (1), CARj „ refers to cumulative market-adjusted (value-weighted) abnor- mal returns over the period beginning two days after the first forecast (labeled "Pfirst") foi' quarter q made at least three days subsequent to the announcement of the previous quarter's earnings and ending one day after the quarter's earnings release.5 UEPS¡ ^ is unexpected earnings for the quarter defined as (EPS, g – Fß^^,)/ Pg _ J where EPS is actual earnings per share for the quarter, and the difference between EPS and Fy;„, is scaled by /'^ _ i, the stock price per share at the begin- ning of the quarter. Thus, UEPSi g should capture the earnings information released during the quarter.
CAR Vol, 25 No. 4 (Winter 2008)
Meeting or Beating Analyst Expectations in the Post-Scandals World 1073
We then classify firms that meet or beat expectations at the earnings announcement into two groups, on the basis of whether they beat expectations by a narrow or wide margin. The market could be more suspicious of firms that exactly meet or just beat expectations because of the greater likelihood of managerial intervention (i.e., earnings or expectations management, see Burgstahler and Eames 2006). SMBEAT is a dummy variable that is set to one if the firm's actual earnings per share exceeds the last analysts' forecast at least three days prior to the earnings announcement (labeled "Fi^s,") by a cent per share or less.^ BIGBEAT is a dummy variable that is set to one if actual earnings exceeds F/^^, by more than one cent per share. Thus, SMBEAT {BIGBEAT) is a dummy variable that is set to one if 0 < EPS – Eias, ^ 0.01 {EPS – Fias, > 0.01). We focus on the 1 cent cutoff because managers' incentives to scramble for the last cent to meet or beat esti- mates has been the topic of extensive discussion in the academic literature (e.g., Bartov et al. 2002, Brown and Caylor 2005, Jensen et al. 2004) and in the financial press (e.g. Morgensen 2004). Untabulated results are insensitive to redefining SMBEAT {BIGBEAT) as a beat by < 2 cents per share (> 2 cents per share).
In (1), ß2 and ß^ capture the incremental market reward (i.e., the market pre- mium or discount) to meeting or beating expectations at the earnings announcement, after controlling for the unexpected earnings news released during the quarter, UEPS. To investigate whether the premium to meeting or beating expectations has changed with the new financial reporting environment, we interact SMBEAT and BIGBEAT with dummy variables to represent the scandals period {SCA) and the post-scandals period {POST).
We obtain analyst forecast and actual earnings data from Thomson Financial's split-unadjusted I/B/E/S detail tapes for the period Ql:1987 to Q2:2006.'' Stock returns are obtained from Center for Research in Security Prices (CRSP). The intersection of these databases yields 108,764 firm-quarter observations to esti- mate (1). To account for potential outlier effects, we winsorize the independent variables at the 1 percent and 99 percent levels of their respective distributions.^ Table 1 provides descriptive statistics on our variables. The mean (median) CAR is 0.9 percent (1.1 percent), while the mean (median) UEPS is -0.002 (0.000). Approximately 18 percent of firm-quarters meet or beat analyst forecasts by a cent or less {SMBEAT) and 51 percent beat expectations by more than one cent {BIGBEAT).
We report results for (1) in column (1) of Table 2. All i-statistics reported in the paper are computed using clustered White standard errors to correct for possi- ble serial and cross-sectional correlations (Petersen 2007). In particular, to adjust for both serial and cross-sectional correlation, we estimate standard errors adjusted to account for correlations across time for a given firm (serial correlation) and across firms for a given quarter (cross-sectional correlation).
Column (1) suggests that the stock market used to assign a 2.5 percent (7.2 per- cent) premium for SMBEAT {BIGBEAT) events in the pre-scandals period. This premium has declined for both SMBEATs (coefficient on POST*SMBEAT = -0.023, i-statistic = -5.42) mdBIGBEATs (coefficient on POST*BIGBEAT = -0.034, i-statistic = 10.36) between the pre- and post-scandals period.^ It appears as
CAR Vol. 25 No, 4 (Winter 2008)
1074 Contemporary Accounting Research
TABLE 1 Descriptive statistics of sample firms {n = 108,764)
Variable
CAR UEPS
SMBEAT
BIGBEAT
SALES
ROA CFO ACCRUALS
MARKET CAPITALIZATION
GDP INDROA
Mean
0.009 -0.002
0.178 0.506 5.173 0.008 0.022
-0.014 4,093.06
0.014 0.004
Median
0.011 0.000 0.000 1.000 5.141 0,011 0.023
-0.012 826.85
0,014 0,008
s.d.
0.202 0.016 0.383 0.500 1.793 0.035 0.049 0.045
11,838.18 0.005 0.018
25th percentile
-0.088 -0.003
0,000 0.000 3.940 0.002 0.002
-0.031 265,38
0.011 0.001
75th percentile
0.110 0.002 0.000 1.000 6.400 0.023 0.045 0.005
2,681.95 0.017 0.014
Notes:
CAR refers to cumulative market-adjusted (value-weighted) abnormal retum over the period beginning two days following the date of the first forecast for the quarter q made at least three days subsequent to the announcement of previous quarter's earnings (labeled "Fp¡¡') and ending one day after the release of the quarter's results. UEPS is unexpected earnings for the quarter defined as {EPS¡ ^ — Ffi^^,)/Pg _ i where EPS is the actual earnings per share number announced by the firm for the quarter cind the difference between EPS and Ffi^¡¡ is scaled by /*„ _ ], the stock price per share at the beginning for the quarter q. SMBEAT is a dummy variable that is set to one if the firm beats expectations by a cent per share or less {EPS — F/^^i s $0,01), where F/^^, is the last forecast for the quarter made at least three days prior to the release of the earnings announcement for that quarter. BIGBEAT is a dummy variable that is set to one if the firm beats expectations by more than a cent per share {EPS — F/^^, > $0,01). SALES refers to the firm's natural logarithm of net sales. ROA is the firm's retum on assets, defined as income before extraordinary items scaled by beginning total assets, ACCRUALS is the difference between income before extraordinary items and operating cash flows, adjusted for extraordinary items and discontinued operations. CFO refers to the firm's operating cash flows. Both ACCRUALS and CFO are scaled by beginning total assets. MARKET CAPITALIZATION is the market value of equity, computed as stock price multiplied by number of shares outstanding. GDP is the percentage change in seasonally adjusted gross domestic product (GDP) over the previous quarter. INDROA denotes the average of quarter q ROA computed for the two-digit SIC code to which firm / belongs (excluding the ROA of ñrm /)•
CAR Vol. 25 No. 4 (Winter 2008)
Meeting or Beating Analyst Expectations in the Post-Scandals World 1075
though, in the post-scandals period, the stock market has (a) stopped rewarding managers who just manage to beat the analyst estimate by a cent (the combined coefficient of SMBEAT and POST*SMBEAT = 0.002); and (b) halved the reward to managers who beat analyst estimates by more than a cent per share (combined coefficient on BIGBEAT and POST*BIGBEAT = 0.038). 10 Both effects are eco- nomically significant as 2.3 percent and 3.4 percent reductions in returns over an
TABLE 2 Stock market reaction in the post-scandals period
<p
Collepals.com Plagiarism Free Papers
Are you looking for custom essay writing service or even dissertation writing services? Just request for our write my paper service, and we'll match you with the best essay writer in your subject! With an exceptional team of professional academic experts in a wide range of subjects, we can guarantee you an unrivaled quality of custom-written papers.
Get ZERO PLAGIARISM, HUMAN WRITTEN ESSAYS
Why Hire Collepals.com writers to do your paper?
Quality- We are experienced and have access to ample research materials.
We write plagiarism Free Content
Confidential- We never share or sell your personal information to third parties.
Support-Chat with us today! We are always waiting to answer all your questions.