Ball and Brown study

Bonus plan hypothesis (Managerial

incent)
-earnings news stock correlation
-bonus often accounting variables
-accounting income is informative
-stewardship role for financial variables
Methodology (decision Theory)
-management manipulate to maximize
-estimate investor expectation as
bonus
income
-classify each as GB BN (no degree) Debt covenant (see other slide)
-based on accounting variables
-estimate abnormal share return
month
-effort to maintain positive slack for Qs
lead
-calculate average, repeat, the plot
-average month for GN more positive Up to and include first covenant violation
than
Political Costs (Political/Public Scrutiny)
Average vice versa for BN firms
-profit and exec pay may generate pub
heat
-largely anticipated consistent EMT
-10-15% of info was attribute reports -larger firms are subject to scrutiny
, just technical, 1% mishap
-Magnitude of earnings asso
abnormal return
Desirable to find time market aware
Quality Accruals Dechow/Dichev of price
Desirable to find moment market
-price/value investor expec dcf
because of securities market efficiency.
-A/D future cash in and out
Efficient market reacts quickly to new
If too early or too late, no
-steadier A/D and cash better Accru information.
reaction found, although existed. Exact
Quality
found sometimes. Earnings
-firm specific using stand deviation of time
announcement, date of publication, date
E
of press. Maybe leaks that market may
be found early. Narrow window found can
-Greater variability lower accruals
be widened. Center around day 0 plus or
-better quality
better ERC and firm
Suprime
continued
Effect of bonus schemes on
disclosures (artic)
-Credit enhancement take out the
riskiest MBS
-managers have inside info manage
through
Out of CDOs keep themselves to
improve bundle
Accruals to maximize their bonus
-liquid support provide cash to cover -Healy examined bonus schemes of 94
securities
comps
If they went bad, especially subprime *based on net incomes, bogey and cap
ones
-total accruals as a measure of earnings
-SPE received credit enhance/liquid
measure
not consolid
*should have used discretionary accruals
But they were and not on the balance *discre A/R, A/P, inventory
sheet
Disc Depre,Amort
-firms suffered write downs as market *Non
-Bogey if below no bonus, cap if above
values
more
Dropped, more panicked and illiquid, more
-high and low state 90% of accruals are
downward
negative
Spiral in market value further
*mid stage is closer to 50/50
depressed values
about same firms and
-classified as level 1 or level 2 assets Question
price not having the same
-Fair value blamed by observers and share
effect
law makers
-difference
between expectations and
-FASB modify standards in response
actual; one firm might have higher
to fair val
expectations, but lower actuals causing
-fair value is exit value of asset
the differences. Different financial
through orderly
statement quality, persistence of
earnings
Transaction at measurement date
-orderly transaction is one that
unforced and
Unhurried (no orderly in financial
crisis)
-subprime valued at level 2 normal
times
-led to huge write-downs on those
subprimes
-provide better guidance, crisis
period and
When they are no longer orderly
-allow firms to reclassify to level 3
-expand disclosures of level 3, valued
at 3

Large Sample Debt Covenants

-restrictions/limit on borrow agreement,
ratios
Indicative of financial positive, penalties
-pub debt less risky and lower %, many
creditors
Private set tightly low negotiation costs
-current ratio covenant and net worth
-a lot companies have rations just above
the
Ratio line, suggest management
manipulate
-alternate covenants set up in way
companies
Will be just above ratios, illustrates the
pattern
Above requirement is more prevalent in
old
Agreements rather than recent, should
be rand
-not rare, no distress

Accounting in for Suprime (acc

Scandals)
-very low fed rates, tech crash, terrorist,
acc
-global growth huge amounts of
disposable $
-lax regulation in tax industry
-opacity exotic securitized assets (culp 1)
-unclear acc. Rules consolidation (shadow)
Big banks did not keep SPEs on their
books
Resecuritization is securitization of
themselves
MBS=Mortgage backed securities
(bundles)
CDO=Collateralized Debt Obligations
(MBSs)
CDO^2=bundles of CDOs
GE stock price falls
1.Beta company change in firms
prediction (firm value) 2.Market
expectations, did not meet analyst
expectations 3.Denominator effect didnt
change risk

Its Not How Much You Pay but How

(Article)
-Study showed how compensation did
not change
-issues it no how much they are paid
rather comp
Is not highly associated with
performance
-ceos do not face threat of dismissal,
takes note
Of a wealth change for change in
likelihood of dismissal, which is 5 cents
per $1000 decrease
-more aggressive pay for performance
models
Would result in less comp for less talent,
replace
By more talented managers who raise
average
-limitations: numbers are not trivial
looking at
Large comps; tiny market fluctuations
over
Which CEO has no control but affect
comp
-article recommend more equity based
comp
Led to explosion of stock portions as use
of comp

Managerial Power and Rent

Extraction
-power theory is basically agency theory
backwar.
Agency theory says control the board by
electing
Them and board controls management by
approve
Their hiring and advocating for
shareholders. Powa
Claims ceo is in control of board by bring
people in
Thus they control board indirectly
-a lot of the times ceo is also chairman, he
will elect
His own people, they are independent by
friends of
-important factor affect ceo ability to
increase comp
Is amount of outrage the proposal creates.
Outsiders
May be upset if comp is far and beyond
under norm.
Outrage can affect ability of ceo to get
approval for
Package. Produce social reputational costs
and boar
Who approves the comp. might affect
market forces
Designed to limit comp in first place.
-camouflage, nothing but when political
heat gets
Too high management will hide how much
paid
*minimize disclosure surround stock
options so
Public doesnt know how much exercised
at
*hire comp consultant that agrees ceo
gets what
He gets paid, good externally but just
cover
*ceo will compare themselves to other ceo
in
Similar company, if other paid more they