Answers
1.
a. the information role [providing information to potential investors] and the stewardship role
[use accounting to motivate and measure the performance of managers] (2 points). This
paper studies the information role as it concerns the information in earnings
announcements for investors. (2 points)
b. i. It measures the extent of a stock’s abnormal return in response to unexpected
earnings.
ii. γ1+γ5; the total relation between AR and UE for late announcements, i.e. when
D =1, but ignoring the interaction with D negUE
late
iii. No. neither γ5 nor γ10 is significantly different from zero.
c. No; clearly when the EA reveals negative unexpected earnings, the market reacts more
negatively as can be seen from the significant negative interaction between UE and DnegUE: γ7
is significantly negative. [Note that you cannot conclude this based on the main effect of
DnegUE, as the intercept yields the positive standard return unrelated to the size of the UE and
this main effect reveals the correction on this main effect. This part is therefore relatively
symmetrical (as 0.013-0.029 is close to -0.013, the negative of the good news intercept)].
d. It may well be that the most important part of the information role of accounting is not to
provide new information but to confirm earlier released information and to discipline
management information provision prior to the earnings announcements. It is more difficult
to withhold information or to lie given that independently audited information will become
available in a reasonable time. Accounting therefore disciplines timely and correct
information provision by management. Without this, the information value of other sources
of information would decline.
2.
a. The equation is Price = BookValue of Equity + Present value of Abnormal Earnings (or
unrecorded goodwill) (1 point). In an efficient market the Price would remain unchanged,
Recognizing the losses in the P&L would lower the BV of equity (due to losses) and therefore
the unrecorded goodwill/abnormal earnings need to go up. The latter makes sense as the
losses used to be included in these abnormal earnings. (1 point per component)
b. Yes it matters. Only after the fair value changes are recognized, these changes are
structurally related to the share price. The relation between these value changes and the
stock price significantly increased after mandating recognition (DER*POST significantly
positive).
c. Not really. The overall relation to the price is the sum of the coefficients of DER and
POST*DER, i.e., 0.673+0.787 = 1.460, which is quite close to the 1.266-0.054 and |-
1.238+0.026| for other assets and liabilities valued at fair value. [If not arguing that it is
similar, you could say it is slightly higher based on similar reasoning]
d. A possible explanation is that auditors add reliability and that the market believes that notes
are audited less thoroughly compared to balance sheet and P&L items. If that is the case, not
much value is assigned to the disclosed information but it is when these numbers are
included in the balance sheet and P&L because they are now thought to be more reliable.
1
1.
a. the information role [providing information to potential investors] and the stewardship role
[use accounting to motivate and measure the performance of managers] (2 points). This
paper studies the information role as it concerns the information in earnings
announcements for investors. (2 points)
b. i. It measures the extent of a stock’s abnormal return in response to unexpected
earnings.
ii. γ1+γ5; the total relation between AR and UE for late announcements, i.e. when
D =1, but ignoring the interaction with D negUE
late
iii. No. neither γ5 nor γ10 is significantly different from zero.
c. No; clearly when the EA reveals negative unexpected earnings, the market reacts more
negatively as can be seen from the significant negative interaction between UE and DnegUE: γ7
is significantly negative. [Note that you cannot conclude this based on the main effect of
DnegUE, as the intercept yields the positive standard return unrelated to the size of the UE and
this main effect reveals the correction on this main effect. This part is therefore relatively
symmetrical (as 0.013-0.029 is close to -0.013, the negative of the good news intercept)].
d. It may well be that the most important part of the information role of accounting is not to
provide new information but to confirm earlier released information and to discipline
management information provision prior to the earnings announcements. It is more difficult
to withhold information or to lie given that independently audited information will become
available in a reasonable time. Accounting therefore disciplines timely and correct
information provision by management. Without this, the information value of other sources
of information would decline.
2.
a. The equation is Price = BookValue of Equity + Present value of Abnormal Earnings (or
unrecorded goodwill) (1 point). In an efficient market the Price would remain unchanged,
Recognizing the losses in the P&L would lower the BV of equity (due to losses) and therefore
the unrecorded goodwill/abnormal earnings need to go up. The latter makes sense as the
losses used to be included in these abnormal earnings. (1 point per component)
b. Yes it matters. Only after the fair value changes are recognized, these changes are
structurally related to the share price. The relation between these value changes and the
stock price significantly increased after mandating recognition (DER*POST significantly
positive).
c. Not really. The overall relation to the price is the sum of the coefficients of DER and
POST*DER, i.e., 0.673+0.787 = 1.460, which is quite close to the 1.266-0.054 and |-
1.238+0.026| for other assets and liabilities valued at fair value. [If not arguing that it is
similar, you could say it is slightly higher based on similar reasoning]
d. A possible explanation is that auditors add reliability and that the market believes that notes
are audited less thoroughly compared to balance sheet and P&L items. If that is the case, not
much value is assigned to the disclosed information but it is when these numbers are
included in the balance sheet and P&L because they are now thought to be more reliable.
1
