Week 4 papers Flashcards
What is absolute information and what is relative information?
Eyring et al. (2021): Less Information, More Comparison, and Better Performance: Evidence from a Field Experiment
Absolute performance is a number you get, such as customer satisfaction is a 7.
Relative is in comparison with others, such as top 10%
What reasons are there to expect relative is better than absolute?
Eyring et al. (2021): Less Information, More Comparison, and Better Performance: Evidence from a Field Experiment
- Peer-performance comparison: you compare yourself to others, people do not want to underperform to others.
- Absolute doesn’t contain much information by itself (is a 5 good or bad?). Relative provides more context as absolute doesn’t have a benchmark. With relative a benchmark is included because you have a natural point to compare to.
What reason is there to expect relative leads to better performance than relative + absolute?
Eyring et al. (2021): Less Information, More Comparison, and Better Performance: Evidence from a Field Experiment
Because relative+absolute (1) can lead to information overload (too many KPIs) and (2) because focus might shift from relative to absolute if both are shown (decreasing peer-comparison)
In what setting is absolute information very important?
Eyring et al. (2021): Less Information, More Comparison, and Better Performance: Evidence from a Field Experiment
A setting where you want standardization, cost reduction and efficiency. In this case you explicitly want to measure on absolute amounts.
So absolute is very important if you want to standardize, such as premium shopping experience, starbucks or mc donalds.
What is the relevance of SOX with regard to financial reporting practices?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
Investors use the FS and the FS must be trustworthy. Goal of SOX is to increase the faith in FS. Managers periodically report to shareholders, but if this is not faithful then investors can’t make decisions and this breaks the capital market.
What are the 2 important differences between real EM and accrual-based EM?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
Real EM is harder to detect, but more expensive
What is real EM and what is accrual-based EM?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
accrual-based EM is done through the accounting system, and does not influence the underlying business
Real EM is done through the business, by making different business decisions.
Why is real EM more expensive and why would it be a substitution after SOX?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
Real is more expensive because you change business decisions, which can lower firm value (delay investments), while accrual-based only changes the accounting data.
Firm don’t want to be caught again for EM, so they choose real EM and less accrual-based EM.
What are the 3 types of real EM?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
- Delay investments, reduce discretionary spending
- Boost sales with discounts: start contracts earlier, more lenient credit terms, costly to firm
- Overproduction: spread part of MOH over more products to reduce COGS. Also costly for firm because of costs for working capital
What does the difference in real vs accrual-based EM show before vs after SOX?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
Before SOX accrual-based EM increased and real decreased. After SOX accrual-based decreased and real increased. Firms still require EM, but make more use of Real EM. They are used as substitutes, if you use more real, you use less accrual-based.
What is the effect of a Big 4 audit firm on EM?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
If a firm has Big 4 as auditor they use less accrual-based EM. Reason is that they are more effective at stopping accrual-based EM. This is not the case for real EM. The focus of the auditor is on accounting information, so real EM is outside of the scope of the auditor.
What is the effect of options granted on EM?
Cohen et al. (2008): Real and Accrual-based Earnings Management (EM) in the Pre- and Post-Sarbanes-Oxley Periods
Managers receive options at the money. If you receive options you want a lower share price. If managers receive options they are more inclined to use income decreasing EM. They can lower the strike price of the options by lowering the stock price.
What are the 2 main responsibilities of CFOs?
Kroos et al. (2018): Voluntary Clawback Adoption and the Use of Financial Measures in CFO Bonus Plans
Fiduciary responsibilities: responsible for correct preparation and integrity of FS. Also quality of internal controls.
Decision making responsibilities: cost reduction, budgeting & forecasting, financing, M&A
What problem exists with accounting earnings based bonuses for CFOs?
Kroos et al. (2018): Voluntary Clawback Adoption and the Use of Financial Measures in CFO Bonus Plans
This will not properly motivate him for his fiduciary responsibilities. The CFO is responsible for the financial reporting quality, you reward him based on numbers he can influence and is responsible for himself. For his decision responsibility it is fine.
A problem exists. Bonus on accounting earnings decreased his gatekeeper responsibilities. But no bonus decreases his decision-making responsibilities. So using the bonus yes or no increases the costs of one or the other.
What are clawbacks and do they solve the problem?
Kroos et al. (2018): Voluntary Clawback Adoption and the Use of Financial Measures in CFO Bonus Plans
Clawbacks allow the firm to reclaim all previous compensation. There is a trigger event in the contract, this could be a misstatement, fraud or misconduct.
Clawbacks solve the problem. CFOs are less inclined to manipulate accounting numbers because the costs are larger. You can give more bonuses based on accounting earnings to properly motivate their decision responsibilities.
