forester (1)

DECELERATED EARNINGS AND THE TEMPORARY CONSEQUENCES OF REGULATION

Clayton Forester Tippie College of Business, The University of Iowa

[email protected]

January 26, 2007

Preliminary Draft (Please do not circulate)

I am grateful to Paul Hribar and Danel Collins for their guidance and comments. I also appreciate helpful discussions and suggestions from John McInnis, Huishan Wan, Brad Badertscher, and Shibin Xie.

DECELERATED EARNINGS AND THE UNINTENDED CONSEQUENCES OF REGULATION

ABSTRACT

Altamuro, et. al. (2005) provide evidence in support of the earnings management hypothesis that firms accelerate revenues to manipulate the presentation of their financial results through acceleration of revenues and, somewhat puzzlingly, find support for the informativeness hypothesis which suggests that accelerated revenue recognition is more informative. My study replicates Altamuro, et. al. and further reconsiders the results in support of the informativeness hypothesis. I consider the components of earnings cash flows and the major categories of accruals in earnings to further understand which components of earnings lose informativeness after the adoption of SAB 101. I find that revenues are not to the primary driver of this decrease in informativeness. The degree of permanence of the informativeness evidence is tested by looking at a longer post-adoption window after SAB 101 became effective. I find the decrease in informativeness found in Altamuro, et. al. (2005) appears to be temporary in nature and also positively related to size of the cumulative effect adjustment recorded by the affected firms in the year of adoption. This indicates that the decrease in informativeness was due to a temporary shift in the relation between earnings and future cash flows due to the deferral and subsequent recognition of revenues in the periods immediately after SAB 101 adoption. My results provide evidence that, while the deceleration of revenues required by SAB 101 may have led to a temporary decline in earnings informativeness, this unintended consequence of regulation was short-lived and that informativeness in the longer post-adoption period seems to have improved. Keywords: revenue recognition, earnings management, earnings informativeness,

cash flows, accelerated revenues.

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I. INTRODUCTION

This paper investigates firms accelerated revenue recognition practices to

provide evidence on two competing hypotheses the earnings management hypothesis

and earnings informativeness hypothesis. The earnings management hypothesis suggests

that firms use accelerated revenue recognition practices to mask their true economic

performance. In contrast, the earnings informativeness hypothesis suggests that firms

use of accelerated revenue recognition practices are motivated by firms desire to provide

value-relevant information about future performance.

Recent research by Altamuro, Beatty & Weber (2005) considers the impact of the

issuance of the SECs Staff Accounting Bulletin (SAB) No. 101 on firms revenue

recognition practices. Altamuro, et. al. (2005) investigate the likelihood that firms meet

two earnings benchmarks (zero earnings and earnings changes) and find evidence

consistent with the notion that firms were using accelerated revenue practices to meet

these benchmarks, supportive of the earnings management hypothesis.1 They also find

that this benchmark-beating behavior declined for firms that were required to change

their revenue recognition practices as a result of SAB 101. In contrast, they find that

earnings for firms required to change their revenue recognition practices post-SAB 101

are less related to future performance evidence consistent with the earnings

informativeness hypothesis.

1 In this study I look at both of the benchmarks considered by Altamuro, et. al. (2005) and do not consider analysts earnings forecast errors as a benchmark. Following Altamuro, et. al. concerns about the impact of Regulation Fair Disclosure (Reg FD) on analysts earnings forecasts errors over the sample period, provides support for using earnings levels and earnings changes as the benchmarks of interest for this paper. While Brown & Caylor (2005) suggests that, during this sample period, analysts earnings forecast errors were replacing zero earnings and earnings changes in terms of the benchmark of importance to managers, the discontinuity around zero earnings and zero earning changes remains consistent across the sample period.

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This study further explores informativeness results of Altamuro, et. al. (2005) by

disaggregating earnings into cash flows and the major components of accruals to

determine the source of the decrease of informativeness for firms affected by SAB 101.

Barth, Cram & Nelson (2001) find that disaggregating earnings into cash flows and the

major components of accruals significantly enhances earnings predictive ability. I also

consider how permanent this informativeness result is by extending the sample period to

consider additional quarters of data and how this affects the main results

Following Altamuro, et. al. (2005), the current paper considers a sample of firms

that were required to change their revenue recognition practices due to the issuance of

SAB 101 (SAB 101 firms) as well as a matched sample of firms whose revenue

recognition practices did not change as a result of SAB 101 (unaffected firms).

First, I replicate the basic findings of Altamuro, et. al. (2005) and demonstrate

that benchmark beating behavior for two quarterly earnings benchmarks (levels and

changes) decline in the post-adoption period for SAB 101 firms and that this decline is

significantly greater than the change for unaffected firms. Second I test the relation

between earnings and future quarterly cash flows and find that this measure of earnings

informativeness the ability of earnings to map into future cash flows decreases in the

periods immediately following SAB 101 adoption. Third, I consider the decomposition

of earnings into current period cash flows and accruals components and how these

components relations with future cash flows are affected by SAB 101 adoption. I find

that the strength of the relation between current cash flows and future cash flows and that

between other accruals and future cash flows decline post-SAB 101. However, I do not

find a significant decline in the relation between the revenue component of accruals

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(change in receivables) and future cash flows, suggesting that the decline in

informativeness may not be related to the new decelerated recognition of revenues due to

SAB 101.

The decomposition results suggest that the decline in informativeness may be due

to the disruption in the accruals brought about by the deferral in the year of adoption of

revenues that had been previously recognized. To test this hypothesis, I reconsider the

informativeness results in a longer post-SAB 101 time period and find that the

informativeness results reverse. Over the longer horizon, informativeness has improved

in the post-SAB 101 period. Further, the amount of the improvement is directly and

statistically significantly related to the magnitude of the initial deferral required by the

cumulative effect adjustment due to SAB 101 adoption.

Gaining a better understanding of the interesting findings of Altamuro, et. al.

(2005) is important for at least three reasons. First, the SECs move to issue SAB 101

was a heavily contested regulatory event. On one hand, the SEC argued that SAB 101

did nothing more than provide guidance on their interpretation of current GAAP

regarding revenue recognition and was not new regulation. However, many firms

were required to change their revenue recognition practices in light of the issuance of

SAB 101 so, for these firms, it appears tantamount to new regulation. Second, the

Financial Accounting Standards Board (FASB) is undertaking a project in revenue

recognition guidance that will better align with the financial statement elements project in

which it is currently involved.2 The results of the current study provide information

2 The FASB stated recently during a board meeting that they would be remiss not to address this issue of revenue recognition. The FASB states that the reasons for reconsidering revenue recognition criteria are: (1) there is a gap between broad conceptual guidance and detailed authoritative literature; (2) there are flaws in the conceptual guidance provided in the FASBs Concepts Statement No. 6; and (3) the issues of

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useful to this process. Finally, this study provides evidence on unintended consequences

of financial reporting regulation. SAB 101 was intended to more clearly communicate

acceptable revenue recognition practices to prevent abusive revenue recognition practices

by firms. At the same time, however, it may have eliminated previously accepted

industry practices that may have been more informative to the users of financial

statements.

Altamuro, et. al.s (2005) results suggest that SAB 101 destroyed some of the

informativeness of earnings for firms that were affected by SAB 101. My paper provides

additional evidence on the informativeness of earnings components, the temporary nature

of the decrease in informativeness overall, and the relation of this result to the size of

adjustment required by SAB 101.

The remainder of the paper is organized as follows. Section two provides

background information on SAB 101 and the response of businesses and the Financial

Accounting Standards Board (FASB). Section three develops the hypotheses. Section

four discusses the sample selection and descriptive statistics of the sample. Section five

sets out the empirical tests along with their results. Finally, section six provides a

conclusion and discusses the implications of the empirical results.

II. BACKGROUND

Staff Accounting Bulletin (SAB) 101 was introduced by the Securities and

Exchange Commission (SEC) in response to a growing concern over firms use of

accelerated revenue techniques to manipulate earnings. By accelerating revenues, firms

revenue recognition are intimately tied to liability recognition issues currently under consideration by the FASB. This paper will provide information useful to this process.

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were potentially inflating results in a way that was misleading to investors and other users

of the financial reports. Concern for these types of abuses formed the central criticism

aimed at financial reporting by Arthur Levitt in his Numbers Game speech in 1998.

SAB 101 spells out the basic criteria for revenue recognition. At the time of its

introduction there were two opposing views on the implications of this bulletin. Firms

argued that this was tantamount to a new revenue recognition standard while others

(including the SEC) maintained that this bulletin merely reiterated the current

requirements in GAAP. Specifically, SAB 101 requires: (1) Persuasive evidence of an

arrangement (2) delivery has occurred or services have been rendered (3) the sellers

price to the buyer is fixed or determinable and (4) collectability is reasonably assured.

While these requirements seem to be clearly a reiteration of the FASBs revenue

recognition principle, SAB 101 went further, providing additional guidance on issues

related to (1) timing of approval for sales agreements, (2) side arrangements to the master

contract, (3) consignment arrangements, (4) criteria for delivery, (5) layaway programs,

(6) nonrefundable up-front fees, (7) cancellation provisions, and others.

At the time that SAB 101 was first introduced, the businesses most likely to be

affected by this new guidance were not in favor of its implications. As one example,

firms that had revenues whose recognition relied on customer acceptance, argued that this

would create a shift of power within the supply chain and would adversely affect their

profit margins and credit terms with customers.

The FASB differs from the SEC in their opinion regarding the recognition of

revenues and, in line with their Conceptual Framework project, they favor a revenue

recognition standard whose focus is more on the change in value of assets and liabilities.

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During a May 11, 2005 board meeting, the FASB affirmed its past decision to

develop a standard for revenue recognition based on recognized changes in assets and

liabilitiesthat would not be overridden by additional recognition criteria such as

realization and completion of the earnings process. (FASB, board meeting minutes

from May 11, 2005). Given the apparent divergence of views between the SEC and the

FASB on the issue of revenue recognition, the current study seeks evidence that would be

informative to the standard setting process.

III. HYPOTHESIS DEVELOPMENT

Altamuro, et. al (2005) find that firms affected by SAB 101 exhibit less

benchmark beating in the post-adoption period and that the decline is significantly greater

than that for unaffected firms. Additionally, they find that SAB 101 firms have less

informative earnings post-adoption and that the decline is greater than that in unaffected

firms. It is paradoxical findings that both earnings management and earnings

informativeness were negatively impacted by the adoption of SAB 101. The first two

hypotheses follow directly from the findings in Altamuro, et. al. (2005).

H1: Post-adoption benchmark beating by firms affected by SAB 101 will exhibit a decline, relative to the pre-adoption period and this decline will be greater than that exhibited by unaffected firms.

H2: Post-adoption informativeness of earnings, by SAB 101 firms will exhibit

a decline, relative to the pre-adoption period and this decline will be greater than that exhibited by unaffected firms.

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Ex ante, there are two competing hypotheses concerning the decline of earnings

informativeness following SAB 101 adoption. First, decelerated revenues may be less

informative, as Altamuro, et. al. (2005) suggest. The informativeness hypothesis

considers firms acceleration of revenues as a tool used by management to convey

information about the underlying economics of the firm. By recognizing revenues earlier

in the earnings process, it is argued that they are providing users with information about

the future cash flows of the firm. Alternatively, the decline of earnings informativeness

following SAB 101 adoption may not be only related to the informativeness of revenues.

Rather, the decline in informativeness could be more related to other components of

earnings. This might be true for two reasons described as follows.

First, the decline in informativeness may be concentrated in expense components

of earnings rather than revenues. This is a possible outcome of SAB 101 adoption due to

the limitations that stricter revenue recognition guidelines placed on firms. If firms are

less able to manipulate revenues, they may respond by attempting to manipulate other

components of earnings. If this occurs then it is likely that these efforts would create

expense-related accruals that are less associated with future cash flows. However, if one

expects that this manipulation is unlikely, then the drop in informativeness should be

found in the revenue accruals found in the change in accounts receivable.

Second, the decline in informativeness may by temporary and mechanical in

nature. When firms adopted SAB 101, the adoption was treated as a change in

accounting policy by the affected firms. APB No. 20 requires that this change be

reflected as a cumulative effect adjustment to earnings of the period of adoption. For

most firms, the period of adoption was fiscal 2000. In most cases, this created a deferred

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revenue and a one-time charge to earnings for the difference between revenues under

accelerated and decelerated recognition. In the year following adoption of SAB 101, it is

likely that, for firms with an operating cycle less than one year, this deferral will be

recognized in revenues. This is likely to create a decline in the informativeness of

earnings as measured using the relation between earnings and future cash flows.

Recognition of the previously deferred revenues along with revenues initiated in the

period immediately after adoption should create a temporary effect that disrupts the

earnings-cash flow relation. If this effect is responsible for the decrease in earnings

informativeness, then the reduction in the deferral should be found in the other accruals

component of earnings and not in accounts receivable.

To the extent that this change in the other component of accruals is not

associated with a similar change in related cash flows, then one should expect to see a

short-term deterioration in the relation between this accrual component of earnings and

future cash flows. However, once these now deferred revenues are earned and flow into

income over a relatively short time horizon, it would seem likely that the deterioration in

the relation between earnings and future cash flow will reverse.

The preceding leads to the statement of my third and fourth hypotheses.

H3: The improvement in informativeness for SAB 101 firms will be concentrated in the other component of accruals and not in the revenue component of earnings.

H4: Informativeness of earnings will improve in the extended post-SAB 101

adoption period (i.e., there is a temporary reduction in informativeness due to the mechanics of SAB 101 adoption).

Finally, if the temporary result is related to the initial deferral required during the

year of adoption, then the reversal of the decline in informativeness over the longer

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horizon should be related to the magnitude of the original deferral. The greater the

original deferral required upon adoption of SAB 101, the greater are the revenues that

will be included in earnings immediately subsequent to adoption. Therefore, the reversal

of the effect should be stronger for firms with the greatest deferral. This leads to my fifth

hypothesis.

H5: As the post-adoption period increases, the size of the initial deferral

required by SAB 101, will be positively related to the reversal in the informativeness results.

IV. SAMPLE SELECTION

SAB No. 101 was adopted by most firms during the 2000 calendar year.3 The

adoption of SAB 101 resulted in some firms changing their revenue recognition policy.

For those firms who had been using a revenue recognition policy now deemed

inappropriate under SAB 101, a cumulative effect adjustment for the effects of adoption

of SAB 101 was required in the year of adoption.4 Using a keyword search of firms 10K

filings, I first identify all firms who mention SAB 101 by itself and in combination

with cumulative and adjustment. This yields an initial sample of 1,468 firms. Of

these firms, 257 report a cumulative effect adjustment to earnings due to SAB 101

adoption. Compustat data is unavailable for 28 of these initial firms. After eliminating

these firms from the sample, 229 firms remain as the final sample of SAB 101 firms. 3 There were 5 firms that reported a cumulative effect adjustment resulting from SAB No. 101 adoption during fiscal 1999 and 37 that reported a cumulative effect adjustment in 2001. These firms have not been included in the sample of SAB 101 firms used in this study so that a single and common year of adoption can be used in empirical tests. Future analysis may look at the 2001 sample and compare these late adopters with the majority of firms who adopted SAB No. 101 during fiscal 2000. 4 For comparison, this study follows closely the sample selection methods of Altamuro, et. al. (2005) in that firms are considered affected by SAB 101 based on whether or not they have a cumulative effect adjustment related to SAB 101.

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The majority of firms that mention SAB 101 and a related cumulative adjustment

but do not themselves have a cumulative effect adjustment, discuss SAB 101 adoption

and state either that (a) the cumulative effect of SAB 101 cannot be estimated or is

immaterial or (b) the firms revenue recognition policy requires no change in light of

SAB 101. Appendix A contains examples of how firms with and without adjustments

discussed SAB 101 within their significant accounting policies note.

A control sample of firms unaffected by SAB 101 is constructed in a manner

similar to Altamuro, et. al. (2005). I first match the SAB 101 firms to other Compustat

firms by their two-digit SIC code and select the firm closest in size (measured by total

assets) within that industry. Each matched firm is allowed to appear only once in the

control sample.

In constructing the matched control sample of firms that are unaffected by SAB

101, it is important to find firms that have similar revenue streams but did not have to

change their reporting in light of SAB 101. While searching 10K filings to identify SAB

101 firms for the treatment sample, firms were also identified that did not have a

cumulative effect adjustment but could arguably be considered affected by SAB 101.

These firms discussed the importance of SAB 101 not only to their revenue recognition

policies but also to their business practices. Some such firms describe the impact that

SAB 101 has had on recognition of revenues when such recognition now relies on

acceptance by the customer and how this acceptance has potential to shift power from

supplier to customer in the supply chain. One such example is included in Appendix B.

While it might be argued that firms such as these should be considered as SAB

101 firms, they have not been included in the SAB 101 sample so that my sample

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construction can be as close as possible in its construction to that of Altamuro, et.

al.(2005). However, caution was exercised to specifically exclude these firms from the

control sample of unaffected firms. It is possible that firms considered unaffected by

SAB No. 101 may not have a cumulative effect adjustment to income in the year of

adoption because they lack detailed information to calculate the cumulative effect. For

this reason, firms who mention that they make no cumulative effect adjustment for SAB

101 because they lack information to calculate the effect have also been excluded from

the control sample construction.

Table 1 provides industry membership information for SAB 101 firms. This

industry information is similar to that in Altamuro, et. al. (2005) which suggests

similarity in the sample selection process. Also included in Table 1 are the industry

average cumulative effect adjustments scaled by total market value (Compustat quarterly

data item 199 * data item 25) reported by the SAB 101 firms along with the overall

average. Industry average cumulative effect adjustments range from 1% of total market

value to 9% of total market which is likely economically important to these firms.

Further corroboration of the similarity of my sample characteristics with those SAB 101

firms selected in Altamuro, et. al. (2005) is the fact that the overall average cumulative

effect adjustment recorded by firms was 3% in both studies.

V. EMPIRICAL TESTS & RESULTS

1. Earnings Management Tests

Following Altamuro, et. al. (2005) I perform tests designed to investigate the

earnings hypothesis using the zero earnings and zero earnings changes benchmarks. I

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create a pre-SAB 101 period and include all quarters for 1997, 1998 and 1999 and a post-

SAB 101 period that initially includes all quarters for 2001, 2002 and 2003.5 For both the

SAB 101 firms and the unaffected firms, histograms are created for the pre-SAB 101

period as well as the post-SAB 101 period for both quarterly earnings (Compustat data

item 69) scaled by end-of period total assets (Compustat data item 44) and the seasonally

adjusted change in quarterly earnings scaled by end-of-period total assets. As in

Altamuro, et. al. (2005), I use bin widths of 0.75 percent to construct my histograms.6

For the earnings level histogram I construct a variable, Earn_Diff, that is

measured according to Burgstahler and Dichev (1997) as the difference between the

actual number of firms in each bin and the expected number of firms in each bin.7 A

similar variable, Earn_Change_Diff, is constructed for the histograms for the seasonally

adjusted change in earnings. Finally, following Altamuro, et. al. (2005), I create the

variable Netbin that is 1 if it is the bin just to the right of zero earnings (zero change in

earnings) and -1 if it is in the bin just to the left of zero earnings (and changes), and zero

otherwise.

Figure 1 provides a graphical representation of the effects of SAB 101 on the

distributions of earnings levels and changes for SAB 101 firms. The histogram in Panel

A of Figure 1 is derived from the pre-adoption period for the SAB 101 affected firms.

Panel B is derived from the post-adoption period. Visually, it is apparent that the

discontinuity around zero earnings seems to have declined. Panels C and D provide a 5 Later tests consider variations in the length of the post-SAB 101 time period and consider how this affects the results of both the earning management tests and the earnings informativeness tests. Results for the earnings management tests do not differ qualitatively from the short post-SAB 101 period to the extended post-SAB 101 period and are, therefore not tabled. 6 Varying widths of bins were tested as well, with results not qualitatively different from those using 0.75 percent. 7 The expected number of firms in each bin is calculated as the mean number of firms in the two adjacent bins.

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similar comparison for the histograms of the seasonally adjusted change in earnings for

the SAB 101 firms.

To verify that the visual change in the distributions statistically, the following

regressions are estimated to establish whether there has been a significant decrease in the

amount of benchmark beating behavior from the pre-SAB 101 period to the post-SAB

101 period and whether any such change is more significant for SAB 101 firms than for

the sample of unaffected firms.

( ) ( ) ( ) ++++= tbtbtb NetbinPostNetbinPostDiffEarn ,3,310, *_ (1)

( ) ( ) ( ) ++++= tbtbtb NetbinPostNetbinPostDiffChangeEarn ,3,310, *__ (2)

Where:

( )tbDiffEarn ,_ = the difference between the expected number of firms and the actual number of firms for each bin b in each period t for the histogram of net income scaled by end-of-period total assets.

( )tbDiffChangeEarn ,__ = the difference between the expected number of firms and

the actual number of firms for each bin b in each period t for the histogram of seasonally adjusted change in net income.

Post = a dummy variable set equal to one if the observation is

from the post-SAB 101 period, 0 otherwise. ( )tbNetbin , = a dummy variable set equal to 1 if the firm is in the bin

just to the right of the appropriate benchmark (zero earnings or zero change in earnings), -1 if the firm is in the bin just to the left of the benchmark of interest and 0 otherwise.

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( )tbNetbinPost ,* = the interaction of Post and ( )tbNetbin , (calculated as Post multiplied by ( )tbNetbin , ).

Table two presents the results from the estimation of equations (1) and (2) and

confirms the results found in Altamuro, et. al. (2005). Panel A presents the results where

the benchmark of interest is zero earnings while Panel B presents the results where the

benchmark of interest is last years earnings for the corresponding quarter.

The significantly negative coefficient on ( )tbNetbinPost ,* for the SAB 101 firms

(first column) indicates that the level of unexpected number of firms around the

benchmark of interest declines significantly in the post-SAB 101 period. Further, an F-

test on the difference between the coefficients on ( )tbNetbinPost ,* for the SAB 101 firms

and the unaffected firms provides further confidence that the decline in benchmark

beating behavior is likely caused by the effects of SAB 101 adoption. This result

provides support for the result in Altamuro, et. al. (2005) that suggests the deceleration of

revenues has lessened the amount of earnings management to reach targets of importance

to management.

Having established that my sample of SAB 101 firms and the matched control

sample of unaffected firms exhibit the characteristics that support Altamuro, et. al.s

(2005) finding that acceleration of earnings was done, in part, to meet benchmarks and

that, this behavior is lessened after the adoption of SAB 101 for affected firms, I now turn

my attention to tests of earnings informativeness.

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2. Earnings Informativeness Tests

Earnings & Future Cash Flows

To test the hypothesis that acceleration of earnings by SAB 101 firms in the

period prior to SAB 101 adoption was done to provide information about the underlying

economics of firms, I now consider the relation between earnings and future cash flows.

The ability of earnings to map into future cash flows was tested by Altamuro, et. al.

(2005) based on the FASBs assertion that financial reporting should provide users with

information that allows them to assess amounts, timing and uncertainty of future cash

flows. To test the relation between earnings and future cash flows, I estimate the

following regression using firm and quarter fixed effects to study the impact of SAB 101

adoption on the strength of the relation between earnings and future cash flows.8

++++=+ qiqitqi EarnPostEarnPostLeadCFO ,3,210),( * (3)

Where:

),( tqiLeadCFO + = accumulated cash flow from operations (Compustat data item 108) scaled by end-of period total assets (Compustat data item 44) for firm i in quarters q + 1, q + 2, q + 3, and q + 4.

qiEarn , = earnings (Compustat data item 69) for firm i in quarter q

scaled by end-of-period q total assets (Compustat data item 44).

8 The relation between current earnings and future cash flows as a measure of earnings informativeness is selected as the measure of choice as the main analysis of the paper and extension of Altamuro, et. al. (2005). This choice was made since the major extension in the current paper is to consider the components of earnings and their relation to future cash flows and how these relations are affected differentially by the adoption of SAB 101. Future investigations may consider other measures of earnings informativeness.

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Post = a dummy variable set equal to one if the observation is from the post-SAB 101 period, 0 otherwise.

qiEarnPost ,* = the interaction of Post and qiEarn , (calculated as Post

multiplied by qiEarn , ). Results from the estimation of equation (3) for a sample period similar to

Altamuro, et. al. (2005) are found on the left half of Table 3 in Panels A through D for 1

through 4 subsequent quarters of accumulated cash flows. The right-hand side of Tables

3, 4 and 5 present results for a longer post-adoption period and discussion of these results

are found in sections 3.1, 3.2, and 3.3. Overall, results on the left-hand side of Table 3

are qualitatively similar to those found in Altamuro, et. al. (2005) and show that SAB 101

firms had a decrease in earnings informativess in the post-adoption period relative to the

pre-adoption period. This is exhibited by the significantly negative coefficient on

qiEarnPost ,* in Panels A and B. Also, a similar decline is not found for the unaffected

sample of firms, providing evidence that the decline in informativeness is related to

adoption of SAB 101. This main result is found in the third column, where F-tests for

qiEarnPost ,* show a significantly greater decrease for SAB 101 firms than for

unaffected firms. This provides us assurance that the affect was more concentrated in

affected firms.

Table 2 and Table 3 present results that are consistent with the earnings

management hypothesis and the informativeness hypothesis. Although benchmark

beating behavior declined as a result of SAB 101, earnings in the post-adoption period

are less informative. Since earnings management is considered an attempt to hide the

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underlying economics of a firms performance, it is somewhat puzzling that less

benchmark beating behavior is associated with less informative earnings.

Given the puzzling result of the first two tests, I consider three alternative ways to

gain a better understanding of these results. First, I disaggregate earnings into its cash

flow and accrual components as suggested by Barth, Cram, and Nelson (2001) to

determine which components of earnings are driving these results. Following this, I

consider the permanence of the initial informativeness findings by extending my post-

SAB 101 sample to include quarters extending further in time after SAB 101 adoption.

This allows me to consider whether informativeness declined temporarily and, perhaps

mechanically, as a result of SAB 101 adoption or whether the post SAB 101 financial

reporting environment of decelerated earnings leads to less informative earnings.

3.1 Components of Earnings & Future Cash Flows

Cash & Accruals

First, I estimate the following equation to establish a baseline of how the various

components of cash flows and accruals are related to the future cash flows:

+++++++=+

qiqi

qiqiqiqitqi

OTHERDEPRAPINVARCFOLeadCFO

,6,5

,4,3,2,10),( (4)

Where:


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qiCFO , = cash flow from operations (Compustat data item 108) for firm i in quarter q scaled by end-of-period q total assets (Compustat data item 44).

qiAR , = the change in receivables for firm i from quarter q 1 to

quarter q, (quarterly Compustat data item 103 from the cash flow statement), scaled by end-of-period total assets (Compustat data item 44)

qiINV , = the change in inventory for firm i from quarter q 1 to

quarter q, (quarterly Compustat data item 104 from the cash flow statement) , scaled by end-of-period total assets (Compustat data item 44).

qiAP, = the change in accounts payable for firm i from quarter q 1 to quarter q, (quarterly Compustat data item 105 from the cash flow statement), scaled by end-of-period total assets (Compustat data item 44).

qiDEPR , = depreciation and amortization for firm i in quarter q

(Compustat data item number 77 from the statement of cash flows), scaled by end-of-period total assets (Compustat data item 44).

qiOTHER , = the other component of accruals for firm i in quarter q not

included in specific categories above (calculated as qiEarn , [ qiCFO , + qiAR , + qiINV , - qiAP, -

qiDEPR , ],scaled by end-of-period total assets (Compustat data item 44).

Results from the estimation of equation (4) are found in Table 4 and are marked

by results consistent with directional predictions found in Barth, Cram & Nelson (2001).

Since results are, for the most part, consistent across panels, I will focus discussion on

Panel A. Findings in Panel A show a significantly positive relation between future cash

flows from operations and current cash flows from operations, change in receivables,

change in inventory, and other accruals. There is a negative relation between future cash

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flows from operations and accounts payable. The relation between depreciation and

future cash flows is the only consistently insignificant relation.

To understand how these components of earnings are related to the decrease in

informativeness of earnings in the post-adoption period, I use the above decomposition of

earnings into its cash flow and accrual components and then estimate the following

regression to test whether the impact of SAB 101 on affected firms earnings

informativeness is found in cash flows, accruals or both components of earnings.

++++++

++++++++=+

qiqi

qiqiqi

qiqiqi

qiqiqiqitqi

OTHERPOSTDEPRPOSTAPPOSTINVPOSTARPOST

CFOPOSTPOSTOTHERDEPRAPINVARCFOLeadCFO

,13,12

,11,10,9

,87,6,5

,4,3,2,10),(

**

***

* (5)

Where:


qiCFO , = cash flow from operations (Compustat data item 108) for

firm i in quarter q scaled by end-of-period q total assets (Compustat data item 44).

qiAR , = the change in receivables for firm i from quarter q 1 to

quarter q, (quarterly Compustat data item 103 from the cash flow statement), scaled by end-of-period total assets (Compustat data item 44)

qiINV , = the change in inventory for firm i from quarter q 1 to

quarter q, (quarterly Compustat data item 104 from the cash flow statement) , scaled by end-of-period total assets (Compustat data item 44).

qiAP, = the change in accounts payable for firm i from quarter q 1 to quarter q, (quarterly Compustat data item 105 from

-20-

the cash flow statement), scaled by end-of-period total assets (Compustat data item 44).

qiDEPR , = depreciation and amortization for firm i in quarter q

(Compustat data item number 77 from the statement of cash flows), scaled by end-of-period total assets (Compustat data item 44).

qiOTHER , = the other component of accruals for firm i in quarter q not

included in specific categories above (calculated as qiEarn , [ qiCFO , + qiAR , + qiINV , - qiAP, -

qiDEPR , ],scaled by end-of-period total assets (Compustat data item 44).


from the post-SAB 101 period, 0 otherwise. qiCFOPost ,* = the interaction of Post and qiCFO , (calculated as Post

multiplied by qiCFO , ). qiARPOST ,* = the interaction of Post and qiAR , (calculated as Post

multiplied by qiAR , ). qiINVPOST ,* = the interaction of Post and qiINV , (calculated as Post

multiplied by qiINV , ). qiAPPOST ,* = the interaction of Post and qiAP, (calculated as Post

multiplied by qiAP, ). qiDEPRPOST ,* = the interaction of Post and qiDEPR , (calculated as Post

multiplied by qiDEPR , ). qiOTHERPOST ,* = the interaction of Post and qiOTHER , (calculated as Post

multiplied by qiOTHER , ).

Results from the estimation of equation (5) for a sample period similar to

Altamuro, et. al. (2005) are found on the left half of Table 5 in Panels A through D for 1

through 4 subsequent quarters of accumulated cash flows. Going from the pre-adoption

period to the post-adoption period, the only variable that consistently loses

informativeness for future cash flows is the other component of accruals. Across

-21-

Panels A, B, and C, the coefficient on qiOTHERPOST ,* is significantly negative. This

indicates that the other component of accruals is related to the drop in informativeness of

earnings, providing support for hypothesis 3. In all 4 panels presented, the F-test on the

difference between the coefficient on qiOTHERPOST ,* for SAB 101 firms and

unaffected firms is significantly negative, providing further evidence that the other

component of earnings is the main component in which a reduction in informativeness

occurs. The coefficient on qiARPOST ,* is positive and insignificant in Panels A

through C of Table 5 and significantly positive in Panel D. This suggests there has been

no change in the relation between accounts receivable and future cash flows, providing

evidence that decelerated revenues are not less informative.

3.2 Permanence of the Informativeness Decline

Since SAB 101 adoption created a cumulative effect adjustment for affected firms

as well as a deferral of revenues previously recognized as earned, it is possible that the

reduction in informativeness of earnings due to SAB 101 was temporary and somewhat

mechanical in nature. If affected firms defer a portion of previously recognized earnings

until a period just shortly after SAB 101 adoption, and related cash flows are unaffected,

then, in the period immediately after adoption of SAB 101, it would be reasonable to

expect a temporary reduction in the relation between earnings and cash flows. Whether

this reduction is permanent or temporary is an important empirical question since revenue

recognition guidelines currently under reconsideration by the FASB should take into

account whether the deceleration of revenues permanently or only temporarily reduced

the informativeness of reported earnings.

-22-

To test whether the reduction of earnings informativeness in the post-SAB 101

period is permanent or temporary, I re-estimate equations (3) and (5) using a longer

sample period, including all quarters in the post-SAB 101 period for 2001, 2002, and

2003. The results of these estimations can be found in Tables 3 and 5 in the right-hand

columns under the heading Extended Post Period.

The results in Table 3 for the extended post period exhibit a dramatic reversal of

the results from the left-hand side of Table 3 from the limited post period. Based on the

extended time period, SAB 101 firms earnings informativeness has statistically

improved from the pre-adoption period to the post-adoption period. Moreover, the

improvement for the SAB 101 firms is statistically greater than that of the unaffected

firms, suggesting that SAB 101 has actually improved the informativeness of earnings by

decelerating revenues for firms that had accelerated them in the pre-adoption period.

Panels A through C in Table 3 present similar results in that the coefficient on

qiEarnPost ,* changes from significantly negative in the first column of Table 3 to

significantly positive in the third column of Table 3. In addition the F-test for the

difference between SAB 101 firms and unaffected firms becomes insignificant in Panels

B, C and D of Table 3 and in Panel A, the significantly positive result shows that SAB

101 firms informativeness may have improved more over the longer post-adoption

period than unaffected firms.

In Table 5, a similar reversal can be seen in Panels A through D for the

informativeness of the other accruals category for SAB 101 firms. The negative

relation between qiOTHERPOST ,* and future cash flows found in the first column of

Table 5 either become positive in the third column or insignificant. This suggests that the

-23-

relation between other accruals and future cash flows was temporarily negatively affected

by the adoption of SAB 101 and that this relation goes away in the longer post-SAB 101

period.

3.3 Magnitude of Deferral

To further investigate whether this reversal is a result of SAB 101 effects, I sort

firms according to the amount of their cumulative effect adjustment to earnings due to

adoption of SAB 101 and then partition the sample into quartiles. I split the sample into

large and small cumulative adjustments and I then estimate the following equation to

determine how the size of the SAB 101 cumulative adjustment affected the reversal.

++++++=+

qiqi

qiqitqi

EarnPostAdjSizeEarnPostAdjSizeEarnPostLeadCFO

,5,4

,3,210),(

**_*

_ (6)

Where:


qiAdjSize ,_ = a dummy variable set to 1 if the observation comes from

the quartile of firms with the highest cumulative effect adjustment (scaled by total market value) due to SAB 101 adoption and 0 if the observation comes from firms in the smallest quartile of cumulative effect adjustment.

qiEarnPost ,* = the change in receivables for firm i from quarter q 1 to

quarter q, (quarterly Compustat data item 103 from the cash flow statement), scaled by end-of-period total assets (Compustat data item 44).

-24-

qiEarnPostAdjSize ,**_ = the interaction of the size of the cumulative effect adjustment and the change in earnings informativeness from the early post period to the later post period.


from the early post-SAB 101 period, 0 otherwise.

The results from estimating equation (6) can be found in Table 6. Table 6

provides evidence that the reversal of the informativeness that occurs between the year

immediately after SAB 101 adoption and the subsequent two years is stronger for firms

that had the highest cumulative effect adjustment to earnings in the year of adoption. This

is found in the positive and significant coefficient on qiEarnPostAdjSize ,**_ . Since

the magnitude of the deferral of revenues (as measured by the cumulative effect

adjustment) has a direct relationship with the reversal of the informativeness finding, this

provides corroborative evidence that the decrease in SAB 101 was temporary in nature as

well as tied to the mechanics of the deferral of revenues.

VI. CONCLUSION

This paper investigates two competing hypotheses related to accelerated revenues

the earnings management hypothesis and earnings informativeness hypothesis. In a

prior paper, Altamuro, et. al. (2005) found evidence in support of both hypotheses. They

find that SAB 101 firms showed a decline in earnings management indicators in the post-

SAB 101 period relative to the pre-SAB 101 period. However, they also find evidence

that these SAB 101 firms have less informative earnings in the post-SAB 101 period

relative to the pre-SAB 101 period.

-25-

Given the concern over accounting manipulations and scandals related to

aggressive financial reporting and the fact that the FASB is in the beginning stages of

revising revenue recognition criteria in conjunction with its conceptual framework project,

this paper reconsiders the affects of SAB 101 on earnings management and earnings

informativeness and provides important additional evidence that both complements and

extends the results of Altamuro, et. al (2005).

The decrease of earnings informativeness documented in Altamuro, et. al. (2005)

appears to be limited to the period shortly after adoption of SAB 101. This decrease in

informativeness reverses over the longer period leading to an overall increase in earnings

informativeness for the sample of SAB 101 firms. This finding has potentially important

regulatory implications for future revenue recognition projects under consideration by the

FASB. It seems that, not only do decelerated revenues reduce the amount of benchmark

beating, but they also improve the informativeness of earnings. This finding suggests

that worries over SAB 101 and its potential to diminish the informativeness of earnings

may not be as serious as previously thought. The results of the current study do not

diminish the results from Altamuro, et. al. (2005). In combination, the results allow us

to see the unintended consequence of SAB 101 and how its adoption by affected firms

temporarily disrupted the informativeness of reported earnings.

Future research might consider whether this temporary informativeness effect had

implications for investors or whether they corrected for this unusual event. Possible

further tests will look at changes in the business model due to SAB 101. These might

help to explain the decrease in relative informativeness of earnings in the post-SAB 101

period for affected firms. Critics of SAB 101 argued that these requirements would place

-26-

greater power in the hands of the customer in the supply chain. Since one implication of

SAB 101 was that firms were required to wait for customer approval prior to recognition

of revenues, firms that have a greater concentration of revenues with relatively few

customers might be more affected operationally than would firms that have a wider

customer base. For example, if 90% of a firms revenues come from one customer, then

SAB 101 could impact that firm more than a firm with many customers. Of interest

would be whether the reduction of informativeness of earnings was concentrated in firms

more likely to lose power in the supply chain as a result of SAB 101.

Additionally, research could test whether the seemingly temporary decrease in

earnings informativeness documented in Altamuro, et. al. (2005) is a result of SAB 101s

elimination of previously informative revenue recognition practices or whether the

decrease in informativeness is concentrated in firms that made additional changes beyond

revenue practices.

-27-

CITED REFERENCES

Altamuro, J., A. Beatty, and J. Weber. 2005. The effects of accelerated revenue recognition on earnings management and earnings informativeness: evidence from SEC staff accounting bulletin no. 101. The Accounting Review 80 (April): 373 401.

Barth, M., D. Cram, and K. Nelson. 2001. Accruals and the prediction of future cash

flows. The Accounting Review 76 (January): 27 58. Brown, L., and M. Caylor. 2005. A temporal analysis of quarterly earnings thresholds:

propensities and valuation concequences. The Accounting Review 80 (April): 423 440.

Burgstahler, D., and I. Dichev. 1997. Earnings management to avoid earnings decreases

and losses. Journal of Accounting and Economics 24 (December): 99 126. Degeorge, F., J. Patel, and R. Zeckhauser. 1999. Earnings management to exceed

thresholds. Journal of Business 72: 1 33. Ewart and Wagenhofer paper Gunny, K. 2005. What are the consequences of real earnings management? Working

Paper, University of California, Berkely. Securities and Exchange Commission (SEC). 1999. Revenue Recognition. Staff

Accounting Bulletin No. 101. Washington, D.C.: Government Printing Office. Wang, S. and J DSouza. 2006. The effect of accounting flexibility and investor

sentiment on R&D choices. Working Paper, Cornell University. Zang, A. 2006. Evidence on the tradeoff between real manipulation and accrual

manipulation. Working Paper, University of Rochester.

-28-

APPENDIX A

Exerpt from ROSE HILLS COMPANys Significant Accounting Policy Footnote for Fiscal 2001 (4) Change in Accounting Principles In response to the issuance of Staff Accounting Bulletin No. 101 (SAB 101) and consultation with the U.S. Securities Exchange Commission, the Company changed the following accounting principles effective January 1, 2000: Revenue recognition of pre-need interment rights are now accounted for in accordance with FAS 66. The direct and acquisitions costs for the deferred sales are now deferred and recognized concurrent with the recognition of the deferred sales. Previously, the Company recognized the sale of pre-need interment rights, and their related costs, at the time of sale. Revenue recognition of pre-need cemetery services and merchandise, and their direct and acquisition costs, are now deferred until time of delivery or performance of service. Previously, the Company recognized the sale of pre- need service and merchandise, and their related costs, at the time of sale. Earnings realized by the cemetery service and merchandise trust funds are now deferred until the underlying service and merchandise is delivered. Previously, the Company recognized the earnings as they accrued. The cumulative effect of these changes in accounting principles on prior years resulted in $12,329,000 decrease in net earnings before taxes and $7,467,000 decrease in net earnings after taxes. The Company realized cemetery sales and services revenue of $2,152,000 and $1,324,000 during the years ended December 31, 2001 and 2000, respectively, that were previously included in the cumulative effect of accounting change (pre-tax) as of January 1, 2000. Excerpt from BELLSOUTH Corporations Significant Accounting Policy Footnote for Fiscal 2001 REVENUE RECOGNITION Revenues are recognized when earned. Certain revenues derived from local telephone and wireless services are billed monthly in advance and are recognized the following month when services are provided. Print advertising and publishing revenues and related directory costs are recognized upon publication of directories. Revenues derived from other telecommunications services, principally network access, long distance and wireless airtime usage, are recognized monthly as services are provided. Revenues from installation and activation activities are deferred and recognized over the life of the customer relationship which is generally four years. Allowances for uncollectible billed services are adjusted monthly. The provision for such uncollectible accounts was $365 for 1999, $372 for 2000 and $574 for 2001. In December 1999, the SEC issued Staff Accounting Bulletin No. 101 Revenue Recognition in Financial Statements (SAB 101) which provides guidance on revenue recognition. SAB 101 is effective for fiscal years beginning after December 15, 1999. During 1999 and prior years, consistent with industry practice, we recognized telecommunications service activation fees and related costs at the time of service initiation. Based on guidance in SAB 101, we changed our accounting policies, effectively deferring the recognition of revenue and certain related costs associated with new service activation over the life of the customer relationship. Costs are deferred only to the extent that revenue is deferred. We accounted for SAB 101 as a change in accounting principle effective January 1, 2000, and therefore have not restated our 1999 financial statements included herein. The net effect of adoption resulted in deferring $1,426 in revenues and certain related costs related to activation services provided prior to January 1, 2000. These revenues and costs are to be recognized over a period of approximately 4 years. Because an equal amount of revenue and expense was deferred, there was no impact on net income for the change in accounting principle.

-29-

APPENDIX B

Excerpt from Mattson Technology Inc.s MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for Fiscal 2001 RISK FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK New Accounting Guidance Under SAB 101 Has Resulted in Delayed Recognition of Our Revenue. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial Statements. SAB 101 provides guidance on applying generally accepted accounting principles to revenue recognition issues in financial statements. Among other things, SAB 101 has resulted in a change from the established practice of recognizing revenue at the time of shipment of a system, and instead delaying revenue recognition in part or totally until the time of customer acceptance. We adopted SAB 101 effective in the fourth quarter of fiscal 2000, retroactive to January 1, 2000, with the impact recorded as a cumulative effect in the first quarter of 2000. In some situations, application of this accounting guidance delays the recognition of revenue that would otherwise have been recognized in earlier periods. As a result, our reported revenue may fluctuate more widely and reported revenue for a particular fiscal period might not meet the expectations of financial analysts or investors. A delay in recognition of revenue resulting from application of this guidance, while not affecting our cash flow, could adversely affect our results of operations, which could cause the value of our common stock to fall. We Depend on Large Purchases From a Few Customers, and Any Loss, Cancellation, Reduction or Delay in Purchases By, or Failure to Collect Receivables From, These Customers Could Harm Our Business. Currently, we derive most of our revenues from the sale of a relatively small number of systems to a relatively small number of customers, which makes our relationship with each customer critical to our business. The list prices on our systems range from $500,000 to over $2.2 million. Our lengthy sales cycle for each system, coupled with customers' capital budget considerations, make the timing of customer orders uneven and difficult to predict. In addition, our backlog at the beginning of a quarter is not expected to include all orders required to achieve our sales objectives for that quarter. As a result, our net sales and operating results for a quarter depend on our ability to ship orders as scheduled during that quarter as well as obtain new orders for systems to be shipped in that same quarter. During the fourth quarter of 2001, we experienced lower bookings, significant push outs and cancellation of orders. Any delay in scheduled shipments or in acceptances of shipped products would delay our ability to recognize revenue, collect outstanding accounts receivable, and would materially adversely affect our operating results for that quarter. A delay in a shipment or customer acceptance near the end of a quarter may cause net sales in that quarter to fall below our expectations and the expectations of market analysts or investors.

-30-

FIGURE 1 Panel A

Earnings Level Histogram for SAB 101 Firms in the Pre-Adoption Period

0

50

100

150

200

250

300

350

-20 -10 0 10

Panel B

Earnings Level Histogram for SAB 101 Firms in the Post-Adoption Period

0

50

100

150

200

250

300

350

-20 -10 0 10 20

-31-

Panel C

Seasonally Adjusted Earnings Change Scaled by End-of-Period Total Assets for the Pre-SAB 101 Period

0

100

200

300

400

500

600

-20 -10 0 10 20

Panel DSeasonally Adjusted Earnings Change Scaled by End-of-Period Total Assets for the Post-SAB 101 Period

0

100

200

300

400

500

600

700

-20 -10 0 10 20

-32-

TABLE 1Average industry Cumulative Adjusment, Scaled by Market Value of Equity

SIC Cumulative Number ofIndustry Code Adjustment FirmsPharmaceuticals and Chemicals 28 0.026 48Machinery 35 0.034 28Electrical 36 0.020 8Measuring Instruments 38 0.036 35Transportation By Air 45 0.091 5Communications 48 0.005 8Miscellaneous Retail 59 0.024 10Holding Companies 67 0.010 6Computer and Business Services 73 0.038 24Educational Services 82 0.008 5Management Services 87 0.076 8All Other Industries 44

Total 0.031

-33-

TABLE 2Coefficients (t-statistics) from a Regression of the Unexpected Number of firms within Three

Earnings-Based Distributions on Important Benchmarks for Samples of Firms both Affected and Unaffected by SAB 101

Panel A: Earnings Levels

SAB 101Firms Unaffected Firms Difference in

Coefficients Coefficients CoefficientsVariable (t-statistics) (t-statistics) (F-test)

Intercept -.03 -0.02 -.01(-0.03) (-0.01) (-0.005)

Post 0.07 0.002 0.05(0.04) (0.00) (0.02)

Netbin 100.25*** 65.25 *** 35.00 ***(14.26) (8.01) (3.25)

Post*Netbin -29.25*** 14.75 -44.00 ***(-2.94) (1.28) (-2.89)

Number of Observations 120 114Adjusted R2 0.72 0.58

Panel B: Earnings Changes

SAB 101Firms Unaffected Firms Difference in

Coefficients Coefficients CoefficientsVariable (t-statistics) (t-statistics) (F-test)

Intercept 0.00 0.00 0.00(0.00) (0.00)

Post 0.04 0.04 0.00(0.01) (0.01)

Netbin 177.50*** 161.75 *** 15.75(12.81) (8.69) (0.68)

Post*Netbin -116.50*** -60.50 *** -56.00**(-5.94) (-2.30) ** (-1.71)

Number of Observations 137 132Adjusted R2 0.57 0.44

***, **, * Indicates significance at the 1 percent, 5 percent, and 10 pecent levels, respectively

( ) ( ) ( ) ++++= tbtbtb NetbinPostNetbinPostDiffEarn ,3,310, *_

( ) ( ) ( ) ++++= tbtbtb NetbinPostNetbinPostDiffChangeEarn ,3,310, *__

Where:

( )tbDiffEarn ,_ = the difference between the expected number of firms and the actual number of firms for each bin b in each period t for the histogram of net income scaled by end-of-period total assets.

( )tbDiffChangeEarn ,__ = the difference between the expected number of firms and the actual number of firms for each bin b in

each period t for the histogram of seasonally adjusted change in net income. Post = a dummy variable set equal to one if the observation is from the post-SAB 101 period, 0 otherwise. ( )tbNetbin , = a dummy variable set equal to 1 if the firm is in the bin just to the right of the appropriate benchmark

(zero earnings or zero change in earnings), -1 if the firm is in the bin just to the left of the benchmark of interest and 0 otherwise.

( )tbNetbinPost ,* = the interaction of Post and ( )tbNetbin , (calculated as Post multiplied by ( )tbNetbin , ).

34

TABLE 3Coefficients (t-statistics) from Regressions of Future Cash Flows for One, Two, Three and Four Quarters Ahead on

Current Quarterly Earnings for Samples of Firms both Affected and Unaffected by SAB 101 using Limited and Extended Post-SAB 101 Time Periods

Limited ExtendedPost Period Post Period

SAB 101 SAB 101Firms Unaffected Firms Difference in Firms Unaffected Firms Difference in

Coefficients Coefficients Coefficients Coefficients Coefficients CoefficientsVariable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)

Panel A: Cash Flowsq+1Intercept -0.004 0.024 -0.028 0.031 0.030* 0.001

(-0.10) 0.95() (-0.62) (1.13) (1.64) (0.03)Post 0.007** 0.003 0.003 0.008*** -0.002 -0.002***

(2.20) (0.91) (0.78) (3.67) (-0.67) (2.98)Earn 0.182*** 0.102*** 0.081*** 0.219*** 0.140*** 0.078***

(13.92) (6.80) (4.06) (17.03) (10.23) (4.17)Post*Earn -0.194*** -0.152*** -0.042 0.036** -0.261*** 0.297***

(-6.37) (-5.52) (-1.03) (2.16) (-17.58) (13.26)Number of Observations 3,371 2,722 5,087 4,078Adjusted R2 0.43 0.50 0.44 0.47

Panel B: Cash Flowsq+2Intercept -0.015 0.083 -0.097 0.025 0.085* -0.060

(-0.29) (0.78) (-0.82) (0.47) (1.81) (-0.86)Post 0.013*** 0.012** 0.001 0.015*** -0.002 0.017***

(2.79) (2.37) (0.19) (3.60) (-0.47) (3.09)Earn 0.137*** 0.129*** 0.008 0.195*** 0.199*** -0.004

(6.56) (5.80) (0.25) (7.93) (10.01) (-0.12)Post*Earn -0.178*** 0.046 -0.225*** 0.176*** -0.297*** 0.472***

(-3.67) (1.22) (-3.65) (5.45) (-13.81) (12.19)Number of Observations 3,370 2,740 5,070 3,995Adjusted R2 0.50 0.62 0.45 0.58

++++=+ ),3),(210),( * qiqitqi EarnPostEarnPostLeadCFO

35

TABLE 3 continued



Coefficients Coefficients Coefficients Coefficients Coefficients CoefficientsVariable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)

Panel C: Cash Flowsq+3Intercept 0.005 0.081 -0.075 0.039 0.097*** 0.039

(0.08) (1.41) (-0.84) (0.45) (2.53) (-0.62)Post 0.020*** 0.015** 0.005 0.019*** 0.003 0.015

(3.26) (1.99) (0.54) (2.83) (0.66) (1.83)

Earn 0.095*** 0.079** 0.016 0.154*** 0.224*** -0.069**(3.51) (2.34) (0.38) (4.07) (7.69) (-1.45)

Post*Earn -0.046 0.099 -0.145** 0.158*** -0.265*** 0.423***(-0.71) (1.57) (1.75) (3.14) (8.36) (7.12)

Number of Observations 3,368 2,706 5,051 4,090Adjusted R2 0.57 0.61 0.44 0.58

Panel D: Cash Flowsq+4Intercept 0.053 0.166 -0.112 0.077 0.148* 0.077

(0.65) (0.81) (-0.51) (0.67) (1.70) (-0.05)Post 0.02** 0.012 0.008 0.013 0.008 0.013

(2.38) (1.22) (0.63) (1.35) (1.24) (0.39)Earn 0.091*** 0.091** -0.018 0.135*** 0.317*** -0.182***

(2.66) (2.21) (-0.00) (2.64) (8.80) (-2.91)Post*Earn 0.131 0.148** -0.017 -0.94 -0.091* -0.003

(1.54) (1.99) (-0.15) (-1.36) (1.75) (-0.04)Number of Observations 3,366 2,777 5,030 4,078Adjusted R2 0.59 0.63 0.42 0.47

***, **, * Indicates significance at the 1 percent, 5 percent, and 10 pecent levels, respectively, based on a one- or two-tailed test as appropriateVariable Definitions:

= accumulated cash flow from operations (quarterly Compustat data item #108) scaled by end-of quarter q+t assets (quarterly Compustat data item #44) for firm i in one, two, three, and four subsequent quarters;

Post = dummy variable with a value set equal to 1 for periods after adoption of SAB 101 and 0 otherwise; = earnings, measured as net income (quarterly Compustat data item #69) for firm i in quarter q, scaled by end of period assets (quarterly Compustat data item #44) = Post multiplied by Earn

),( tqiLeadCFO +

),( qiEarn

),* qiEarnPost

36


Components of Current Quarterly Earnings for Samples of Firms both Affected and Unaffected by SAB 101



Coefficients Coefficients Coefficients Coefficients Coefficients CoefficientsVariable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)Panel A: Cash Flowsq+1Intercept 0.003 0.025 -0.023 -0.009 0.027 -0.036

(0.08) (0.71) (-0.439) (-0.39) (1.21) (-1.13)0.091*** 0.103 *** -0.012 0.310*** 0.144 *** 0.166

(4.51) (4.80) (-0.402) (21.04) (7.72) (7.02)0.258*** 0.099 *** 0.160 0.335*** 0.156 *** 0.179

(8.50) (2.92) (3.51) (12.76) (5.27) (4.52)0.151*** -0.124 *** 0.275 0.316*** 0.011 0.305

(3.55) (-2.65) (4.35) (9.42) (0.29) (5.92)-0.089*** -0.024 -0.065 -0.197*** -0.176 *** -0.021(-2.39) (-0.88) (-1.41) (-6.61) (-7.07) (-0.54)0.107 -0.182 0.289 -0.015 -0.326 ** 0.310(0.72) (-0.99) (1.22) (-0.21) (-2.20) (1.87)0.065*** 0.061 *** 0.004 0.101*** 0.106 *** -0.005

(6.02) (2.46) (0.16) (10.12) (5.24) (-0.22)Number of Observations 2,931 2,376 4,478 3,566Adjusted R2 0.42 0.46 0.46 0.41

Panel B: Cash Flowsq+2Intercept 0.012 0.056 -0.044 -0.017 0.056* -0.074

(0.20) (1.06) (-0.54) (-0.39) (1.80) (-1.36)0.080*** 0.119 *** -0.039 0.509*** 0.301 *** 0.208

(2.38) (3.74) (-0.84) (17.25) (11.45) (5.27)0.289*** 0.367 *** -0.078 0.390*** 0.383 *** 0.007

(5.72) (7.35) (-1.10) (7.43) (9.10) (0.11)0.175*** 0.024 0.152 0.420*** 0.081 0.339

(2.49) (0.34) (1.54) (6.21) (1.47) (3.88)-0.114* -0.427 *** 0.313 -0.180*** -0.502 *** 0.322(-1.82) (-10.60) (4.22) (-3.01) (-14.20) (4.64)0.125 -0.377 0.502 0.282* -0.575 *** 0.856(0.51) (-1.37) (1.36) (1.91) (-2.71) (3.31)0.067*** 0.114 *** -0.047 0.120*** 0.158 *** -0.038

(3.73) (3.10) (-1.15) (6.00) (5.46) (-1.08)Number of Observations 2,923 2,362 4,458 3,521Adjusted R2 0.49 0.64 0.46 0.58

qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiO TH ER ,

+++++++=+ qiqiqiqiqiqitqi OTHERDEPRAPINVARCFOLeadCFO ,6,5,4,3,2,10),(

qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiO TH ER ,

37

TABLE 4 continuedLimited Extended

Post Period Post PeriodSAB 101 SAB 101

Firms Unaffected Firms Difference in Firms Unaffected Firms Difference inCoefficients Coefficients Coefficients Coefficients Coefficients Coefficients

Variable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)

Panel C: Cash Flowsq+3Intercept 0.050 0.096 -0.046 -0.005 0.099 ** -0.103

(0.63) (1.16) (-0.40) (-0.07) (2.16) (-1.24)-0.020 0.034 -0.055 0.420*** 0.299 *** 0.122(-0.45) (0.71) (-0.82) (9.06) (7.43) (1.98)0.255*** 0.268 *** -0.014 0.335*** 0.281 *** 0.054

(3.85) (3.42) (-0.13) (4.05) (4.46) (0.52)0.253*** 0.246 ** 0.007 0.387*** 0.268 *** 0.119

(2.72) (2.27) (0.05) (3.61) (3.29) (0.89)-0.145* -0.475 *** 0.330 -0.030 -0.583 *** 0.553(-1.78) (-7.54) (3.20) (-0.32) (-10.88) (5.13)

0.629** 0.321 0.308 0.741*** -0.150 0.891(1.95) (0.74) (0.57) (3.20) (-0.48) (2.28)0.067*** 0.295 *** -0.228 0.106*** 0.302 *** -0.197

(2.88) (5.14) (-3.67) (3.36) (7.08) (-3.71)Number of Observations 2,916 2,351 4,436 3,482Adjusted R2 0.57 0.62 0.44 0.58

Panel D: Cash Flowsq+4Intercept 0.072 0.120 -0.048 0.081 0.128 ** -0.046

(0.69) (1.14) (-0.33) (0.24) (2.20) (-0.13)0.104* 0.124 ** -0.020 0.231*** 0.487 *** -0.257(1.81) (1.94) (-0.23) (3.51) (9.47) (-3.07)0.230*** 0.402 *** -0.171 0.175 0.362 *** -0.187

(2.64) (3.95) (-1.28) (1.49) (4.50) (-1.32) 0.248** -0.342 ** 0.590 -0.034 -0.185* 0.151(2.03) (-2.40) (3.14) (-0.22) (-1.76) (0.81)-0.204** -0.246 *** 0.042 0.283** -0.413 *** 0.697(-1.91) (-3.03) (0.31) (2.14) (-6.00) (4.67)3.123*** 1.536 *** 1.587 1.652*** 0.488 1.163

(6.64) (2.68) (2.14) (4.92) (1.21) (2.21)0.041 0.341 *** -0.300 0.009 0.346 *** -0.338(1.32) (4.58) (-3.73) (0.19) (6.34) (-4.79)

Number of Observations 2,908 2,340 4,413 3,451Adjusted R2 0.60 0.64 0.43 0.60***, **, * Indicates significance at the 1 percent, 5 percent, and 10 pecent levels, respectively, based on a one- or two-tailed test as appropriate

qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiO TH ER ,

qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiO TH ER ,

38


Components of Current Quarterly Earnings for Samples of Firms both Affected and Unaffected by SAB 101and the Change from pre-SAB 101 to post-SAB 101 Periods



Coefficients Coefficients Coefficients Coefficients Coefficients CoefficientsVariable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)Panel A: Cash Flowsq+1Intercept -0.009 0.026 -0.035 -0.025 0.034 -0.059 **

(-0.24) (0.76) (-0.70) (-1.10) (1.55) (-1.87)Post 0.012*** 0.003 0.009 0.013*** -0.001 0.014 ***

(2.95) (0.62) (1.41) (4.14) (-0.33) (2.79)0.097*** 0.162*** -0.064 *** 0.196*** 0.247*** -0.051 *

(4.68) (7.59) (-2.16) (10.02) (11.77) (-1.77)0.241*** 0.245*** -0.004 0.282*** 0.252*** 0.030

(7.01) (6.07) (-0.08) (7.98) (5.72) (0.54)0.147*** -0.078 0.225 *** 0.210*** -0.041 0.251 ***

(3.10) (-1.53) (3.24) (4.31) (-0.74) (3.41)-0.053 -0.469*** 0.417 *** -0.111*** -0.514*** 0.403 ***(-1.27) (-9.67) (6.54) (-2.60) (-9.77) (5.96)0.042 -0.181 0.223 0.062 -0.592*** 0.654 ***(0.26) (-0.89) (0.86) (0.52) (-2.89) (2.77)

0.070*** 0.012 0.058 *** 0.083*** 0.046* 0.038(6.45) (0.45) (2.04) (7.40) (1.62) (1.24)

-0.220*** -0.257*** 0.038 0.213*** -0.267*** 0.480 ***(-4.56) (-6.10) (0.59) (8.71) (-8.68) (12.22)-0.006 -0.053 0.047 0.115** -0.111* 0.226 ***(-0.08) (-0.66) (0.43) (2.18) (-1.80) (2.78)-0.085 0.217* -0.302 ** 0.172*** 0.127* 0.045(-0.83) (1.85) (-1.94) (2.58) (1.61) (0.44)0.006 0.613*** -0.607 *** -0.067 0.467*** -0.534 ***(0.06) (10.44) (-5.37) (-1.12) (7.90) (-6.32)0.228 0.283 -0.054 -0.096 0.327 -0.423(1.34) (1.02) (-0.17) (-0.75) (1.43) (-1.61)

-0.181*** 0.135*** -0.317 *** 0.061*** 0.064* -0.003(-3.61) (2.62) (-4.40) (2.50) (1.68) (-0.07)


qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiO TH ER ,

+++++++

+++++++=+

qiqi

qiqiqiqi

qiqiqiqiqiqitqi

OTHERPOSTDEPRPOST

APPOSTINVPOSTARPOSTCFOPOSTPOSTOTHERDEPRAPINVARCFOLeadCFO

,13,12

,11,10,9,8

7,6,5,4,3,2,10),(

**

****

qiCFOPOST ,*

qiARPOST ,*

qiINVPOST ,*

qiAPP O S T ,*

qiDEPRPOST ,*

qiO TH ERPO S T ,*

39




Variable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)Panel B: Cash Flowsq+2Intercept -0.012 0.054 -0.066 -0.044 0.063** -0.075

(-0.20) (1.03) (-0.82) (-1.00) (2.01) (-1.10)Post 0.020*** 0.004 0.016 0.017*** -0.007 0.027 ***

(2.99) (0.52) (1.60) (2.78) (-1.24) (3.10)0.071** 0.164*** -0.092 ** 0.242*** 0.371*** -0.300 ***(2.06) (5.04) (-1.84) (6.22) (12.35) (-6.54)

0.274*** 0.332*** -0.058 0.345*** 0.365*** -0.092(4.77) (5.39) (-0.69) (4.92) (5.81) (-1.08)

0.172** -0.004 0.177 0.294*** 0.073 0.099(2.18) (-0.06) (1.60) (3.05) (0.93) (0.88)-0.100 -0.525*** 0.425 *** -0.211*** -0.652*** 0.552 ***(-1.46) (-7.10) (4.21) (-2.50) (-8.67) (5.42)0.059 0.663** 0.722 0.316 -1.238*** 1.297 ***(0.22) (-2.13) (1.76) (1.35) (-4.23) (3.26)

0.075*** 0.059 0.016 0.100*** 0.151*** -0.076(4.14) (1.46) (0.37) (4.49) (3.77) (-1.74)

-0.141* -0.239*** 0.098 0.538*** -0.138*** -0.003(-1.75) (-3.65) (0.95) (11.06) (-3.11) (-0.03)0.012 0.380*** -0.368 *** 0.084 0.152* -0.140(0.10) (3.03) (-2.09) (0.80) (1.71) (-0.92)-0.066 0.330* -0.396 0.217* 0.158 -0.224(-0.38) (1.81) (-1.58) (1.62) (1.39) (-1.09)0.166 0.186** -0.021 0.313*** 0.240*** -0.074(1.01) (2.07) (-0.11) (2.60) (2.84) (-0.40)0.263 0.887** -0.624 -0.037 1.099*** -0.836 **(0.93) (2.04) (-1.20) (-0.14) (3.33) (-1.92)

-0.235*** 0.157** -0.393 *** 0.076 -0.010 -0.225 ***(-2.79) (1.92) (-3.35) (1.58) (-0.18) (-2.24)


qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiO TH ER ,

qiCFOPOST ,*

qiARPOST ,*

qiINVPOST ,*

qiAPP O S T ,*

qiDEPRPOST ,*

qiO TH ERPO S T ,*

40




Variable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)

Panel C: Cash Flowsq+3Intercept 0.008 0.095 -0.087 -0.044 0.109** -0.154 **

(0.10) (1.15) (-0.76) (-0.64) (2.38) (-1.84)Post 0.029*** -0.010 0.039 *** 0.024*** -0.011 0.035 ***

(3.20) (-0.83) (2.57) (2.49) (-1.31) (2.73)-0.044 0.076 -0.120 * 0.137** 0.393*** -0.256 ***(-0.96) (1.49) (-1.75) (2.23) (8.89) (-3.38)

0.256*** 0.241*** 0.015 0.322*** 0.268*** 0.055(3.40) (2.50) (0.12) (2.92) (2.92) (0.38)0.173* 0.198* -0.025 0.315** 0.315*** 0.000('1.67) (1.63) (-0.16) (2.07) (2.74) (0.00)-0.109 -0.556*** 0.447 *** -0.237* -0.734*** 0.497 ***(-1.21) (-4.80) (3.04) (-1.78) (-6.68) (2.88)0.639* -0.299 0.938 0.918*** -1.292*** 2.210 ***(1.81) (-0.61) (1.56) (2.48) (-3.01) (3.90)

0.074*** 0.256*** -0.183 *** 0.102*** 0.375*** -0.273 ***(3.10) (4.06) (-2.71) (2.91) (6.39) (-3.99)0.014 -0.119 0.133 0.600*** -0.196*** 0.796 ***(0.13) (-1.15) (0.90) (7.81) (-2.76) (7.61)0.016 0.479*** -0.463 * 0.028 0.195 -0.167(0.10) (2.40) (-1.79) (0.17) (1.48) (-0.78)0.343 0.665** -0.321 0.192 0.130 0.062(1.52) (2.29) (-0.87) (0.89) (0.78) (0.23)0.009 0.211 -0.202 0.708*** 0.275** 0.433 **(0.05) (1.49) (-0.79) (3.72) (2.20) (1.90)0.035 2.317*** -2.282 *** -0.237 1.776*** -2.013 ***(0.09) (3.29) (-2.86) (-0.59) (3.63) (-3.17)

-0.186* 0.135 -0.322 ** 0.024 -0.165** 0.189 *(-1.68) (1.04) (-1.89) (0.31) (-2.04) (1.69)


qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiO TH ER ,

qiCFOPOST ,*

qiARPOST ,*

qiINVPOST ,*

qiAPP O S T ,*

qiDEPRPOST ,*

qiO TH ERPO S T ,*

41




Variable (t-statistics) (t-statistics) (F-test) (t-statistics) (t-statistics) (F-test)Panel D: Cash Flowsq+4Intercept 0.026 0.130 -0.103 0.038 0.140** -0.102

(0.25) (1.22) (-0.69) (0.11) (2.40) (-0.30)Post 0.024** -0.033** 0.057 *** 0.026** -0.018* 0.044 ***

(2.03) (-2.06) (2.87) (1.95) (-1.65) (2.55)0.062 0.148** -0.086 0.112 0.568*** -0.456 ***(1.04) (2.26) (-0.97) (1.28) (10.04) (-4.38)0.165* 0.336*** -0.171 0.166 0.374*** -0.208(1.67) (2.70) (-1.08) (1.05) (3.20) (-1.06)0.153 -0.371** 0.524 *** 0.209 -0.201 0.411(1.12) (-2.37) (2.52) (0.96) (-1.37) (1.57)-0.132 -0.306** 0.174 -0.217 -0.534*** 0.317(-1.11) (-2.05) (0.91) (-1.14) (-3.81) (1.34)

3.124*** 0.693 2.432 *** 1.999*** -0.748 2.747 ***(6.38) (1.10) (3.04) (3.78) (-1.36) (3.61)0.032 0.266*** -0.233 *** 0.044 0.421*** -0.376 ***(1.03) (3.26) (-2.68) (0.89) (5.60) (-4.17)

0.493*** 0.081 0.412 *** 0.320*** -0.101 0.421 ***(3.52) (0.60) (2.13) (2.93) (-1.10) (2.95)

0.598*** 0.628*** -0.030 0.078 0.172 -0.094(2.76) (2.40) (-0.09) (0.33) (1.02) (-0.32)

0.751*** 0.828** -0.077 -0.310 0.347 -0.657 ***(2.46) (1.93) (-0.15) (-1.01) (1.60) (-1.74)

-0.508* 0.147 -0.655 1.163*** 0.239 0.924 ***(-1.81) (0.79) (-1.95) (4.29) (1.48) (2.93)0.092 3.751*** -3.660 -0.529 2.169*** -2.698 ***(0.18) (4.05) (--0.60) (-0.92) (3.46) (-3.16)0.274* 0.414** -0.139 *** -0.068 -0.163 0.095(1.86) (2.30) (-3.46) (-0.62) (-1.55) (0.62)


***, **, * Indicates significance at the 1 percent, 5 percent, and 10 pecent levels, respectively, based on a one- or two-tailed test as appropriate

qiCFO ,

qiAR ,

qiINV ,

qiAP ,

qiDEPR ,

qiOTH ER ,

qiCFOPOST ,*

qiARPOST ,*

qiINVPOST ,*

qiAPP O S T ,*

qiDEPRPOST ,*

qiO TH ERPO S T ,*

42

TABLE 6The Relation Between Earnings and Future Cash Flows in the Early Post-SAB 101 Period

and the Later Post-SAB 101 Period and How Size of the Cumulative Effect Adjustment Affects the Change in Informativeness

SAB 101Firms

Coefficients

Variable (t-statistics)Intercept 0.011

(-0.39)Post 0.0004

(0.05)Earn -0.159 *

(1.80)Post*Earn 0.142

(1.03)Size_Adj -0.039

(-1.40)Size_Adj*Post*Earn 0.319 ***

(2.66)Number of Observations 850Adjusted R2 0.54

***, **, * Indicates significance at the 1 percent, 5 percent, and 10 pecent levels, respectively.

Where:


qiAdjSize ,_ = the size of the cumulative effect adjustment required by SAB 101 for firm i in quarter q, scaled by

end-of-period total assets (Compustat data item 44). qiEarnPost ,* = the change in receivables for firm i from quarter q 1 to quarter q, (quarterly Compustat data item 103

from the cash flow statement), scaled by end-of-period total assets (Compustat data item 44).

qiEarnPostAdjSize ,**_ = the interaction of the size of the cumulative effect adjustment and the change in earningsinformativeness from the early post period to the later post period.

Post = a dummy variable set equal to one if the observation is from the early post-SAB 101 period, 0

otherwise.

++++++=+

qiqi

qiqitqi

EarnPostAdjSizeEarnPostAdjSizeEarnPostLeadCFO

,5,4

,3,210),(

**_*

_

forester (1)

Documents

decelerated earnings

earnings management

earnings changes

earnings benchmarks

informativeness evidence

accelerated revenues

adoption of sab

affected firms