impact

• Professor Steve Zeff’s digital library

  Rice University’s Jones Graduate School of Business is pleased to share Professor Steve Zeff’s digital library with the EAA community: https://business.rice.edu/stephen-zeff-digital-library.

  This open digital library was created by the Jones School as a permanent repository for Steve’s contributions to our understanding of the historical evolution of financial reporting standards and regulations in the U.S. and globally. The website includes several short video clips and two of Steve’s related publications.

  In the first video series, Steve summarizes, in his own incomparable style, his decades of research on the evolution of the regulation and standard-setting process for financial reporting in the U.S. from the 1930s to the early 2020s. In the second video series, he takes a global perspective and shares his deep insights on the evolution of the International Accounting Standards Committee into the International Accounting Standards Boards and the challenges it faced along the way.

  Please use the comments/feedback section on the website to share your thoughts on the digital library. Steve and the Jones School would love to hear from you.

  Regards,

  K. Ramesh

  Herbert S. Autrey Professor of Accounting

  Jones Graduate School of Business

  Rice University

• Update from the EAA Stakeholder Reporting Committee – Response to the Request for Information- Consultation on Agenda Priorities, issued by the International Sustainability Standards Board (ISSB) Posted by Liz Demers and Joanna Krasodomska on behalf of the EAA Stakeholder Reporting Committee (EAA SRC).

  The ISSB published the Request for Information Consultation on Agenda Priorities on 4 May 2023.

  The objective of the agenda consultation was to ask all those interested in sustainability-related financial reporting for their views on:

  • the strategic direction and balance of the ISSB’s activities;
  • the suitability of criteria for assessing which sustainability-related matters (including topics, industries and activities) to prioritize and add to the ISSB’s work plan; and
  • a proposed list of new research and standard-setting projects that could be added to the ISSB’s work plan.

  In reply to the Consultation Paper on Request for Information, the Stakeholder Reporting Committee of the European Accounting Association (“the SRC”) submitted its survey response on August 25th. This response outlines the SRC’s position in relation to the issues raised therein.

  In the submitted response, the SRC held the view that activities such as “beginning new research and standard-setting projects” and “supporting the implementation of ISSB Standards” should be assigned the highest priority among the ISSB activities. The SRC acknowledged that the ISSB had identified suitable criteria for assessing sustainability reporting matters that could be added to the ISSB’s work plan but presented some reservations about their practical implementation. Concerning new research and standard-setting projects that could have been added to the ISSB’s work plan, the SRC believed that projects focusing on “biodiversity, ecosystems, and ecosystem services” and “human capital and human rights” carried equal significance and were considerably more important than “integration in reporting”. The SRC also recommended either merging the two human-related projects into a single cohesive project (named “own workforce”), or alternatively, retaining both human-related projects but renaming them. Additionally, the SRC suggested leveraging and building upon the several frameworks that were currently in place because of their relevance to the raised issues and widespread application. Moreover, the SRC proposed adding Tax Transparency as a priority project.

  The detailed responses to survey questions can be found here.

• New version: Introductory Guide to Using Stata in Empirical Financial Accounting Research

  A new version of my Stata guide is now available and freely accessible via Github (including code and data examples). Please see https://github.com/dveenman/stataguide or here to go directly to the pdf.

  The objective of this guide is to assist BSc/MSc students, PhD students, and junior researchers in using Stata for empirical archival research. Stata is a powerful program that can be used to analyze many different research questions in the fields of accounting, finance, economics, and beyond. While many statistical packages exist, a major advantage of Stata is that it allows you to carefully manage your data and research process, compute key variables needed in empirical research (e.g., fitted or residual values from a prediction model), and easily merge large sets of data (e.g., combining financial statement data from Compustat with stock market data from CRSP and analyst forecast data from IBES). The purpose of this guide is to give students a head start in using Stata in empirical accounting and finance research settings.

  Version history:

  • Version 5.0: September 2023
  • Version 4.1: May 2019
  • Version 4.0: January 2019
  • Version 3.0: December 2013
  • Version 2.0: December 2011
  • Version 1.0: December 2010

  New in version 5:

  • Update to Stata 18;
  • Publication of code on Github;
  • Improved and expanded section on standard errors;
  • Improved section of fixed effects estimation;
  • Improved section on matching and added entropy balancing;
  • Added section on robust regression estimators in Chapter 4;
  • Added section on difference-in-differences estimators in Chapter 4;
  • Added section on creating and formatting graphs in Chapter 4;
  • Added a separate chapter on simulations and programming in Chapter 5;
  • Added Appendix on the use of Stata for downloading of data from WRDS;
  • Improved Appendix on implied cost of capital estimation;

• One ESG metric is like squaring a circle

  It appears to be extremely hard to produce  a meaningful ESG score. Standard and Poor’s recently decided that it will no longer rank companies’ environmental, social and governance risks from 1 to 5 . This decision can be understood in the light of how aggregate ESG scores are constructed as  discussed in a recent FT publication: “Companies with good ESG scores pollute as much as low-rated rivals.” This article made it clear that the current ESG metrics system has a major flaw which entails that it de facto allows firms to hide bad performance in one metric as it will be compensated by good performance in another metric.  The fact that such a compensation is possible at all just illustrates that the current ESG measurement system sets out to squaring the circle.

  Even a cursory reading of the economics literature would reveal that creating aggregated ESG scores cannot work, as it is impossible to assign meaningful weights to the individual elements that make up such an aggregate measure, see for example Srikant’s work Datar, Susan Kulp and Richard Lambert and by Paul Milgrom and John Roberts. If you fall short of your target A in measure 1 (say carbon emissions), then it cannot be offset by a top performance in measure 2 (say profit). Such assumptions are made in the current metrics and we therefore see in research that companies that perform very poorly in emissions still receive a favorable overall ESG evaluation.

  If carbon emissions performance is important, then any (overall) ESG aggregate measure cannot be positive unless carbon emissions performance is positive. The reason is that unfavorable performance on carbon emissions cannot be offset by positive performance on other metrics. This could indicate that unfavorable performance in any metric included in the “aggregate ESG measure” that captures a key performance area (e.g. carbon emissions) should imply a negative overall performance rating. It’s a bit like safety performance in chemical plants, where factory management doesn’t get a positive performance evaluation if a safety target is missed. Factory management may be able to report exceptionally high profits, but this performance cannot compensate for the safety risk the company faces if safety targets are missed.

  Applying this idea means developing targets for each specific metric to decide when aggregate level performance will reach the desired level. Setting such goals is a very difficult task, as on the one hand they have to motivate employees to improve ESG performance, while at the same time the goals have to be consistent with external requirements (e.g. Paris Agreement). To the extent that employees are unable to achieve ESG performance levels in line with externally imposed requirements, it is better from a motivational point of view to set more achievable goals for these employees than set in externally imposed goals. Hundreds of studies show that people only really start working if the assigned goal is actually achievable for them. If the outside world discovers that the (external) target is not being met, the company finds itself in a difficult position of having to explain why targets were set lower than they should be according to the external requirements.

  Reality is too complex to capture ESG performance in one overall [ESG] metric. Using an oversimplified overall ESG measure is not going to help us, on the contrary it puts us a farther distance from achieving the ultimate net-zero goal. Hopefully the world’s major investors will see Standard & Poor’s problem and lead the way and replace the current overall benchmark with a (set of) metric(s) that does justice to the complexity of performance measurement!

   

  Jan Bouwens

  Professor of accounting University of Amsterdam

• The lease standard has changed, and firms’ transition disclosures confuse more than they clarify

  In a paper recently published in the European Accounting Review, we study the text of the transition disclosures in firms’ financial statements explaining the likely effects of a new standard. For a sample of almost all affected firms, we extract the text that refers to how firms plan to transition to the new lease standard. The text runs from a couple of dozen to sometimes over 500 words per disclosure. We then quantify this text on three dimensions of investor comprehension: readability (the use of jargon, long sentences, heavy words, and acronyms), year-to-year dissimilarity (the change in wording from one year to the next), and extent of detail on materiality (the likely impact of the accounting change on assets, profits, and internal controls). Our study documents that firms’ lease transition disclosures become less readable, more dissimilar, and increasingly detailed on materiality the closer to adoption.

   

  We then use a machine-learning algorithm to identify the underlying topics that best explain the three textual dimensions. For example, if a firm’s transition disclosure readability is poor and worsens the closer to adoption date, the algorithm can identify what particular topic or aspect of readability best explains that outcome.

   

  The algorithm tells that the textual dimensions of readability, year-to-year dissimilarity, and details on materiality all increase because of firms’ higher use of technical and complex language. The other topics identified by the algorithm, which reflect descriptive and everyday language, do not explain the trends in the three textual dimensions.

   

  Investors also treat lease transition disclosures as technical and complex. Financial analysts take longer to update their earnings forecasts and the level of uncertainty in stock market prices increases as a result of firms’ lease transition disclosures.

   

  Our conclusion is that the transition disclosures for the new lease standard are likelier to have been confusing rather than clarifying for the average investor by favoring those investors most able to benefit from technical and complex information such as large asset managers like BlackRock.

   

  Contrary to the SEC’s historical mission, the transition disclosures that the SEC requires to make the markets fair for all may have ended up favoring one class of investors over another.

   

  The published version of our study titled “Clarification or Confusion: A Textual Analysis of ASC 842 Lease Transition Disclosures” is available at the following link: https://doi.org/10.1080/09638180.2023.2244990.

  Luminita Enache is Associate Professor and Future Fund Fellow at Haskayne School of Business, University of Calgary, Calgary, Canada.

  Paul A. Griffin is Distinguished Professor of Management at the Graduate School of Management, University of California, Davis, USA.

  Rucsandra Moldovan is Associate Professor of Accounting at John Molson School of Business, Concordia University, Montreal, Canada.

• How often and how much information should publicly listed firms report?

  Disclosure regulation is pervasive and has been increasing in developed economies, despite regulators’ difficulty determining the socially optimal level of disclosure. Showcasing this difficulty, regulators have struggled to reach a consensus on the frequency and content of interim reporting for decades. For example, the European Union (EU) introduced mandatory quarterly reports in 2004, only to abolish the mandate in 2013, returning to a semi-annual reporting frequency for firms whose securities are trading on a regulated market within the EU.

  The question of how often and how much firms should report is not trivial. On the one hand, a higher reporting frequency allows stakeholders to monitor managerial action in a timely manner, thereby disciplining managers and reducing agency costs. On the other hand, more frequent reporting may lead to managerial short-termism, lower investment efficiency, higher reporting costs, and less efficient capital allocation to firms with seasonal business.

  In our study “The Consequences of Abandoning the Quarterly Reporting Mandate in the Prime Market Segment” (forthcoming at European Accounting Review), we investigate firms’ responses to the step-wise de-regulation of the quarterly reporting mandate in the prime market segment of the Vienna Stock Exchange (VSE).

  Only a few firms terminate quarterly reporting entirely, while most firms reduce the content of quarterly reports predominantly by omitting the notes disclosures. We combine interview and empirical evidence to show that firms primarily consider the information needs of their key stakeholders, such as institutional (foreign) investors and analysts, as well as their transparency preferences in their interim reporting decisions. Unlike in other settings, reporting and proprietary costs are less important to prime market firms because of frequent internal reporting and integrated managerial and financial reporting.

  We also analyze the potential consequences of firms’ interim reporting decisions around the de-regulation of the interim reporting mandate. Our results suggest that firms’ stock liquidity decreases following the return to a semi-annual reporting frequency or following a significant reduction of the content of quarterly reports relative to firms that continue extensive quarterly reporting. We also find that investors react negatively to the VSE’s announcement to abandon the quarterly reporting mandate in the prime market. Taken together, our results suggest that a quarterly reporting frequency is important to investors.

  However, we do not find evidence that analysts’ yearly forecasts are negatively affected after firms return to semi-annual reporting or significantly reduce information in quarterly reports. This finding is in line with our interview evidence that firms and analysts are in continuous exchange through other timely information channels such as road shows and conference calls and that firms tailor their quarterly reporting to the specific information needs of key stakeholders such as analysts.

  Collectively, our results suggest that stakeholders demand quarterly reporting but not necessarily full quarterly reports. Large investors and analysts primarily demand financial statement information and a few key performance metrics allowing them to update their valuation models on a quarterly basis.

  Our study that is forthcoming at European Accounting Review provides more insights for regulators on firms’ interim reporting decisions and the ensuing capital market consequences.

• Compensation Shifting from Salary to Dividends

  This study focuses on the strategic behavior of owner-managers in relation to their compensation and its impact on reported earnings. We investigate whether owner-managers of smaller firms manipulate their compensation, specifically by decreasing their salaries and increasing dividends, to meet or beat the zero earnings benchmark.

  We emphasize that owner-managers have significant compensation discretion, enabling them to choose between salary (which decreases earnings) and dividends (which does not decrease earnings). We conduct our analysis using data from small Danish owner-managed firms, which enables us to examine compensation shifting in an approximately tax-neutral setting, where compensation shifting has minimal direct costs to owner-managers.

  Our study’s first objective is to explore whether reporting incentives, specifically beating the zero earnings benchmark, influence owner-managers’ compensation-shifting behavior. We find that owner-managers who have the potential to shift their compensation to beat the benchmark are almost twice as likely to decrease their salaries as nonpotential beaters are. In addition, when they decrease their salaries to meet or beat the benchmark, they are likely to increase their dividends simultaneously, indicating compensation shifting from salary to dividends.

  Our study then investigates whether benchmark beating through compensation shifting is associated with cost of debt benefits, particularly lower interest rates. We document that firms strategically shifting their compensation to beat the benchmark obtain lower interest rates on their debt than firms reporting losses.

  Overall, our article contributes to the literature in two main ways. First, it highlights the strategic use of compensation by owner-managers to manage reported earnings, specifically through salary decreases and dividend increases. Second, it expands on previous research by documenting an association between benchmark beating and lower interest rates, even for small privately held firms.

  The findings have implications for financial statement users, including banks, suppliers, customers, employees, and potential investors. These users should be aware of owner-managers’ discretion over their compensation and their ability to strategically alter reported earnings. Additionally, we suggest that regulators should consider the suitability of current frameworks and standards that prioritize shareholders as the primary users of financial statements, particularly for owner-managed firms where agency conflicts between managers and owners are minimal.

   

  This paper has been accepted at the European Accounting Review, and the link to the published manuscript is: https://doi.org/10.1080/09638180.2023.2226724

• Red flags in research as a means to overcome group think

  Red flags in research as a means to overcome group think

   

  How independent tests can help to overcome group think so as to enhance fraud detection.

  In his classic experiment in 1955, Solomon Asch showed that as soon as one person paints an incorrect picture, this picture is confirmed by a non-trivial number of others. In his research Asch shows four lines: the test line and lines 1, 2 and 3. Participants in his research must indicate which of the lines 1, 2 or 3 is of the same length as the test line. Of the individual participants, 99% give the correct answer 2. But if the first in the row of participants (Asch’s assistant) points to the evidently shorter line 1, 3 percent follows Asch’s assistant. This percentage rises to 33% if the first three participants select 1. This phenomenon has been coined conformity bias or group think where people are willing to ignore reality and give an incorrect answer in order to conform to the rest of the group. I reproduce the original card Asch used in Figure 1.

  

  Figure 1: Original instrument in Opinions and Social Pressure.

  The original instrument can be found at: https://www.jstor.org/stable/pdf/24943779.pdf

  Unfortunately we tend to believe cheaters in a similar fashion. As long as leading individuals applaud the work of a cheater the cheater is unlikely to be revealed as a fraud. Diederik Stapel was applauded by the academic society as the most prolific researcher in psychology until he was caught by a group of Phd students. When the president of Tilburg University presented the inexorable facts to Stapel he defended himself with the words that his methods were simply unorthodox. It now appears that the worldwide renown academic Francesca Gino has been tampering with the data so that she would get the results she was looking for. In her case co- author Max Bazerman called the evidence presented to him by the University “compelling.”

  Both researchers were acclaimed scholars by both academics as well as practitioners. We -including university executives and university regulators- love academics who publish at the top podium and  keep hitting the headlines of the News Papers. Academics who cast doubt on the importance of the work and/or its credibility are ridiculed. So, hardly any individual dares to say that line 2 is equally long as the test line; group think at work!

  Couldn’t we have and should we have known better? The answer is yes to both questions, but what mechanism could we use to do away with the group think coined by Solomon Asch? I propose to ask a simple question that should trigger the question whether an audit is warranted or not.

  One question that might trigger such an audit is: How many top publications can one individual get published to claim that (s)he paid serious attention to the paper and how did the data come about? For instance, in economics scholars already reach the league of  stardom if they publish about 2 papers in a top 5 journal a year.  Let’s set the average number of top publications at 2 and the standard deviation as well. If the academic then was able to produce 6 publications, it would be considered a fantastic result.

  Too fantastic?

  The good news is that academics exposed the cases of both Stapel and Gino  as fraudulent. The publication rates of both Stapel and Gino extend far beyond the measure of two papers a year. The chance that someone passes the mark of 6 times the standard deviation is small. Be careful here, it is not impossible for someone to get a lot of publications. For example, we see that the mathematician Paul Erdős   published more than 1500 papers with others during his lifetime. The field of expertise also determines production. Some academics run a business like Rembrandt van Rijn with many apprentices, but it does make a heck of a difference whether Rembrandt’s did or did not work on the painting himself. It is the same with academic work.

  On twitter Sa-kiera Hudson of Berkeley’s Haas School of Business stated that she was “supremely sceptical of the folks who decide to police what is real vs fake science and who is doing it ‘well’”. The answer to that question is simple: the executive board of the university should decide who to police.

  Now I do not have the exact standard deviation or the average number of top publications representing the psychology discipline, but it would be good to make such a calculation for each discipline in order to be able to ask our self: Do I see a red flag or not? This approach should help universities to look into the question whether an audit about contribution and potential fraud is called for and indeed establish with more certainty that we do have an academic star in our midst or a pretender. An independent test should help us overcome group think.

  After all Super(wo)man only exists in comics.

   

  Asch, Solomon E. “Opinions and Social Pressure.” Scientific American, vol. 193, no. 5, 1955, pp. 31–35. JSTOR, http://www.jstor.org/stable/24943779.

   

• Why not use a funny game to start your next class?

   

  It was great having Patricia Everaert hosting a fantastic hands-on Classroom session during the EAA Annual Congress at Espoo, Helsinki.

   

  We left the room with several ideas and readily-available tools to use in our accounting courses, that will certainly make learning more engaging, novel, surprising and exciting!

   

  More specifically, to have a look at the DUGA tool, you can go to www.duga.castars.net and register.  Add the code 590de1 and you can start playing some sample questions of financial accounting.

  Interested to use DUGA as a teacher with your students? Please contact the creators and they will be happy to give you a personal code. To get access as a teacher, please take a moment to fill out this form.

  More information is provided on the creators’ website: www.accountingeducation.ugent.be  under the heading of the events, select EAA class room session or follow this link: https://www.accountingeducation.ugent.be/en/events/eaa-2023-classroom-session

   

• Innovative Data – Use-cases in management accounting research and practice

  With recent advances in technology, the amount of data available for academics and practitioners to analyze has grown exponentially. However, at this stage, the potential of this data to assist managers in improving decision-making and managerial control has not been fully realized.

   

  The editorial

  In their editorial for the European Accounting Review special issue on innovative data sources in management accounting research, Matthias Mahlendorf, Melissa Martin, and David Smith present a series of ‘use-cases’ drawn from prior research and industry, highlighting exciting new data sources and explain the implications of their use for management accounting research and practice. The editorial covers the use of data such as natural language, crowd-sourced ratings on online platforms, images, sound and videos, wearables, geolocation, and satellite data.

   

  Goal and key contribution/s

  The goal of the editorial is to highlight opportunities and stimulate further research in this area. To this end, a key contribution of the editorial is to present a matrix, setting out the management accounting research that has been conducted so far using these data sources and identifying areas in which research (at this stage) is lacking. In so doing, the editorial highlights combinations of data and topics that represent promising starting points for future research. Additionally, the editorial provides a series of management accounting research questions that can potentially be explored using innovative data. Finally, the compilation of use cases can also serve as inspiration for practitioners who want to strengthen data-driven decision-making.

   

  The editorial “Innovative Data – Use-cases in management accounting research and practice” was written by Matthias Mahlendorf (Frankfurt School of Finance and Management), Melissa Martin (University of Illinois), and David Smith (RMIT University) and can be found in the European Accounting Review (forthcoming) here.