Contents
Week 1 Testing the usefulness of accounting and financial reporting .......................................................3
Lecture - Video 1.1 Course Introduction ................................................................................................3
Lecture - Video 2.1 Nichols and Wahlen (2004) – Theoretical Framework ............................................3
Lecture - Video 2.2 Nichols and Wahlen (2004) – Empirical Framework ...............................................8
Knowledge clip - The intuition behind Regression Analysis .................................................................12
Lecture - Video 3 Regression refresher...............................................................................................12
Tutorial - Video 1 Q1-Q4 (Nichols Whalen 2004) ................................................................................13
Tutorial - Video 2 Q5-Q7 (Dechow 1994) ............................................................................................14
Week 2 Conservative accounting and impairments ................................................................................20
Lecture - Video 1 - Accounting Conservatism .....................................................................................20
Lecture - Video 2 - Basu97- Theoretical Framework ...........................................................................21
Lecture - Video 3 - Basu97- Empirical Framework Main Test ..............................................................24
Knowledge clip - The intuition behind the Basu Methodology ..............................................................28
Lecture - Video 4 - Basu97- Additional Tests ......................................................................................28
Tutorial - Video 1 - Banker et al (2017) ...............................................................................................30
Tutorial - Video 2 - Glaum et al (2018) ................................................................................................34
Week 3 Changing relevance of accounting information over time ...........................................................38
Lecture - Video 1.1 - Accounting for Intangible Assets case AJAX ......................................................40
Lecture - Video 1.2 - Accounting for Intangible Assets Lev (2019) ......................................................41
Knowledge clip - The intuition behind the Book-to-Market ratio ...........................................................46
Lecture - Video 2 - Alternative (non-GAAP) performance measures ...................................................46
Tutorial - Video 1 - He and Shan (2016)..............................................................................................49
Tutorial - Video 2 - Curtis et al (2020 ..................................................................................................53
Week 4 Investors’ processing of accounting information ........................................................................57
Lecture - Video 1 - Sloan (1996) Accounting .......................................................................................57
Lecture - Video 2 - Sloan (1996) Capital Markets ................................................................................64
Knowledge clip - The intuition behind the Sloan (1996) Trading Strategy............................................68
Tutorial - Video1 - Bamber et al (2010) ...............................................................................................68
Tutorial - Video2 - Jung et al (2018) ....................................................................................................72
Week 5 Earnings management, accruals, and financial reporting quality................................................76
Lecture Week 5 - Video 1 - Dechow Dichev (2002) .............................................................................76
Lecture Week 5 - Video 2 - Stubben (2010) ........................................................................................81
Knowledgeclip Week 5 The inuition behind Discretionary Revenues ..................................................86
Knowledgeclip Week 5 The inuition behind Discretionary Revenues- Part II .......................................86
Tutorial Week 5 - Video 1 - McVay (2006) ..........................................................................................86
Tutorial Week 5 - Video 2 - Amiram et al (2015) .................................................................................92
Week 6 Economic consequences of financial reporting ..........................................................................95
Lecture Week 6 – Video ......................................................................................................................95
Lecture Week 6 – Video - Landsman et al. (2012) ..............................................................................97
,Tutorial Week 6 - Video .................................................................................................................... 105
,Week 1 Testing the usefulness of accounting and financial reporting
Lecture - Video 1.1 Course Introduction
Lecture - Video 2.1 Nichols and Wahlen (2004) – Theoretical Framework
Introduction
• On Monday October 28, 2019, Philips reported earnings lower than last year in the same quarter
(a negative earnings change)
• The stock price drop of -1.79% makes sense, but can we also explain this theoretically and
empirically?
Introduction
• Prior research provides many insights that helps us understand the relevance of financial
reporting This paper: summarizes the intuition (“theory”) and empirical evidence on how
accounting earnings information relates to firms’ stock returns, “particularly for the benefit of
students, practitioners, and others who may not yet have been exposed to this literature”
1. Present a framework to link earnings and stock returns
2. Replicate and extend three classis studies using newer data
a. Relation between earnings and returns: Ball and Brown (1968)
b. The role of earnings “persistence” in this relation
c. Market efficiency and the speed of stock market reactions to earnings news
Introduction
• Earnings = net income = “bottom-line” measure of accounting performance
o Earnings is an “accrual accounting measure of the firm’s profit or loss from business
activities and events during a quarter or annual period”
o It is “an accounting measure of the change in the value of the firm to common equity
shareholders during a period”
• Stock return = relative change in stock price of a firm ଵ ଵ
• Stock return equals the change in the market value of a firm over a period of time plus any
dividends that are paid
• Represents the stock market’s estimate of the firm’s bottom-line performance over the period
This paper: how do these alternative bottom-lines relate, and why?
Flashback to the beginning: Ball and Brown (1968)
• Why should we care about this relation?
o Informs us about the relevance of accounting and financial reporting
• Ball and Brown (1968) were the first to empirically test this relation
o They induced a significant shift in the accounting research paradigm and changed …
▪ … the way in which academics conducted research towards evidence-based
research.
▪ … academic’s beliefs about the relevance of accounting information
• They asked the simple question: do earnings capture information that investors consider useful
and “value relevant”?
Flashback to the beginning: Ball and Brown (1968)
• As explained 50 years later by Ball and Brown (2019), accounting research before 1968
“comprised largely of a priori reasoning, occasionally backed by anecdotal evidence” (p. 411)
o Primary view from the literature: financial statements are completely meaningless!
o Much discussion on how to improve the usefulness of accounting information by changing
accounting systems
• Nichols and Wahlen (2004, footnote 2): “Prior to Ball and Brown (1968), accounting research was
generally concerned with theoretical (rather than empirical) analysis of the usefulness of
, accounting information vis-à-vis conceptual models for usefulness or desirable attributes of
accounting numbers. While this approach can be useful, it is limited because it generally cannot
provide empirical evidence for evaluating the validity of the author’s conjectures.”
Flashback to the beginning: Ball and Brown (1968)
• Ball and Brown (2019, p. 411): “We both had been thoroughly schooled in the reigning paradigm
[…] when we arrived to study at Chicago. We quickly found the culture was entirely different from
anything we had experienced. All ideas were viewed as candidates for challenge, with alternative
arguments and with data. A frequently heard question was: “what's the evidence for that?” The
school crackled with energy. They were exciting times.”
• P412: “there was a strong belief that economic analysis could provide the key to unlocking
puzzles as to why institutions take the shape they do. That background culture must have
influenced our thinking, because we began asking questions like “why do firms and auditors put
so many resources into calculating net income and preparing balance sheets, if they're
meaningless?” Perhaps because investors actually find them useful? We decided to find out.”
Flashback to the beginning: Ball and Brown (1968)
Key insights from Ball and Brown (1968):
• Accounting information, as reflected in earnings, is useful: changes in earnings are empirically
related with stock returns
• But: accounting earnings information is not particularly timely in providing useful information;
much of the information (85 percent) has been anticipated by investors and pre-empted by other
sources of information
• Stock market investors react rapidly to new information in earnings, but not their reaction is not
complete; evidence of “post-earnings announcement drift” (PEAD)
The framework
• But why should earnings relate to stock returns?
• Nichols and Wahlen (2004) use the framework of Beaver (1998) to illustrate the three links that
form the foundation of the relation between earnings and returns (p. 264):
o Current period earnings provides information to predict future periods’ earnings, which …
o … provide information to develop expectations about dividends in future periods, which …
o … provide information to determine share value, which represents the present value of
expected future dividends
The framework
• Let’s think a bit more about how to determine the value of a common share
• In the long run, a common shareholder cares about receiving a return on his/her investment
o Either a constant periodic payoff (dividend)
o And/or the ability to liquidate the investment at a higher price
• The expected/required payoff structure from buying the share:
The framework
• Thus: the value of an equity share can be seen as the present value of expected future dividends
Week 1 Testing the usefulness of accounting and financial reporting .......................................................3
Lecture - Video 1.1 Course Introduction ................................................................................................3
Lecture - Video 2.1 Nichols and Wahlen (2004) – Theoretical Framework ............................................3
Lecture - Video 2.2 Nichols and Wahlen (2004) – Empirical Framework ...............................................8
Knowledge clip - The intuition behind Regression Analysis .................................................................12
Lecture - Video 3 Regression refresher...............................................................................................12
Tutorial - Video 1 Q1-Q4 (Nichols Whalen 2004) ................................................................................13
Tutorial - Video 2 Q5-Q7 (Dechow 1994) ............................................................................................14
Week 2 Conservative accounting and impairments ................................................................................20
Lecture - Video 1 - Accounting Conservatism .....................................................................................20
Lecture - Video 2 - Basu97- Theoretical Framework ...........................................................................21
Lecture - Video 3 - Basu97- Empirical Framework Main Test ..............................................................24
Knowledge clip - The intuition behind the Basu Methodology ..............................................................28
Lecture - Video 4 - Basu97- Additional Tests ......................................................................................28
Tutorial - Video 1 - Banker et al (2017) ...............................................................................................30
Tutorial - Video 2 - Glaum et al (2018) ................................................................................................34
Week 3 Changing relevance of accounting information over time ...........................................................38
Lecture - Video 1.1 - Accounting for Intangible Assets case AJAX ......................................................40
Lecture - Video 1.2 - Accounting for Intangible Assets Lev (2019) ......................................................41
Knowledge clip - The intuition behind the Book-to-Market ratio ...........................................................46
Lecture - Video 2 - Alternative (non-GAAP) performance measures ...................................................46
Tutorial - Video 1 - He and Shan (2016)..............................................................................................49
Tutorial - Video 2 - Curtis et al (2020 ..................................................................................................53
Week 4 Investors’ processing of accounting information ........................................................................57
Lecture - Video 1 - Sloan (1996) Accounting .......................................................................................57
Lecture - Video 2 - Sloan (1996) Capital Markets ................................................................................64
Knowledge clip - The intuition behind the Sloan (1996) Trading Strategy............................................68
Tutorial - Video1 - Bamber et al (2010) ...............................................................................................68
Tutorial - Video2 - Jung et al (2018) ....................................................................................................72
Week 5 Earnings management, accruals, and financial reporting quality................................................76
Lecture Week 5 - Video 1 - Dechow Dichev (2002) .............................................................................76
Lecture Week 5 - Video 2 - Stubben (2010) ........................................................................................81
Knowledgeclip Week 5 The inuition behind Discretionary Revenues ..................................................86
Knowledgeclip Week 5 The inuition behind Discretionary Revenues- Part II .......................................86
Tutorial Week 5 - Video 1 - McVay (2006) ..........................................................................................86
Tutorial Week 5 - Video 2 - Amiram et al (2015) .................................................................................92
Week 6 Economic consequences of financial reporting ..........................................................................95
Lecture Week 6 – Video ......................................................................................................................95
Lecture Week 6 – Video - Landsman et al. (2012) ..............................................................................97
,Tutorial Week 6 - Video .................................................................................................................... 105
,Week 1 Testing the usefulness of accounting and financial reporting
Lecture - Video 1.1 Course Introduction
Lecture - Video 2.1 Nichols and Wahlen (2004) – Theoretical Framework
Introduction
• On Monday October 28, 2019, Philips reported earnings lower than last year in the same quarter
(a negative earnings change)
• The stock price drop of -1.79% makes sense, but can we also explain this theoretically and
empirically?
Introduction
• Prior research provides many insights that helps us understand the relevance of financial
reporting This paper: summarizes the intuition (“theory”) and empirical evidence on how
accounting earnings information relates to firms’ stock returns, “particularly for the benefit of
students, practitioners, and others who may not yet have been exposed to this literature”
1. Present a framework to link earnings and stock returns
2. Replicate and extend three classis studies using newer data
a. Relation between earnings and returns: Ball and Brown (1968)
b. The role of earnings “persistence” in this relation
c. Market efficiency and the speed of stock market reactions to earnings news
Introduction
• Earnings = net income = “bottom-line” measure of accounting performance
o Earnings is an “accrual accounting measure of the firm’s profit or loss from business
activities and events during a quarter or annual period”
o It is “an accounting measure of the change in the value of the firm to common equity
shareholders during a period”
• Stock return = relative change in stock price of a firm ଵ ଵ
• Stock return equals the change in the market value of a firm over a period of time plus any
dividends that are paid
• Represents the stock market’s estimate of the firm’s bottom-line performance over the period
This paper: how do these alternative bottom-lines relate, and why?
Flashback to the beginning: Ball and Brown (1968)
• Why should we care about this relation?
o Informs us about the relevance of accounting and financial reporting
• Ball and Brown (1968) were the first to empirically test this relation
o They induced a significant shift in the accounting research paradigm and changed …
▪ … the way in which academics conducted research towards evidence-based
research.
▪ … academic’s beliefs about the relevance of accounting information
• They asked the simple question: do earnings capture information that investors consider useful
and “value relevant”?
Flashback to the beginning: Ball and Brown (1968)
• As explained 50 years later by Ball and Brown (2019), accounting research before 1968
“comprised largely of a priori reasoning, occasionally backed by anecdotal evidence” (p. 411)
o Primary view from the literature: financial statements are completely meaningless!
o Much discussion on how to improve the usefulness of accounting information by changing
accounting systems
• Nichols and Wahlen (2004, footnote 2): “Prior to Ball and Brown (1968), accounting research was
generally concerned with theoretical (rather than empirical) analysis of the usefulness of
, accounting information vis-à-vis conceptual models for usefulness or desirable attributes of
accounting numbers. While this approach can be useful, it is limited because it generally cannot
provide empirical evidence for evaluating the validity of the author’s conjectures.”
Flashback to the beginning: Ball and Brown (1968)
• Ball and Brown (2019, p. 411): “We both had been thoroughly schooled in the reigning paradigm
[…] when we arrived to study at Chicago. We quickly found the culture was entirely different from
anything we had experienced. All ideas were viewed as candidates for challenge, with alternative
arguments and with data. A frequently heard question was: “what's the evidence for that?” The
school crackled with energy. They were exciting times.”
• P412: “there was a strong belief that economic analysis could provide the key to unlocking
puzzles as to why institutions take the shape they do. That background culture must have
influenced our thinking, because we began asking questions like “why do firms and auditors put
so many resources into calculating net income and preparing balance sheets, if they're
meaningless?” Perhaps because investors actually find them useful? We decided to find out.”
Flashback to the beginning: Ball and Brown (1968)
Key insights from Ball and Brown (1968):
• Accounting information, as reflected in earnings, is useful: changes in earnings are empirically
related with stock returns
• But: accounting earnings information is not particularly timely in providing useful information;
much of the information (85 percent) has been anticipated by investors and pre-empted by other
sources of information
• Stock market investors react rapidly to new information in earnings, but not their reaction is not
complete; evidence of “post-earnings announcement drift” (PEAD)
The framework
• But why should earnings relate to stock returns?
• Nichols and Wahlen (2004) use the framework of Beaver (1998) to illustrate the three links that
form the foundation of the relation between earnings and returns (p. 264):
o Current period earnings provides information to predict future periods’ earnings, which …
o … provide information to develop expectations about dividends in future periods, which …
o … provide information to determine share value, which represents the present value of
expected future dividends
The framework
• Let’s think a bit more about how to determine the value of a common share
• In the long run, a common shareholder cares about receiving a return on his/her investment
o Either a constant periodic payoff (dividend)
o And/or the ability to liquidate the investment at a higher price
• The expected/required payoff structure from buying the share:
The framework
• Thus: the value of an equity share can be seen as the present value of expected future dividends
