Now showing 1 - 2 of 2
  • Publication
    A Comparison of Error Rates for EVA, Residual Income, GAAP-earnings, and Other Metrics Using a Long-window Valuation Approach
    (Taylor and Francis, 2008) ;
    Predictability and variability are two measures commonly used in the empirical literature to gauge the quality of earnings and hence, decision usefulness to investors. We adopt both measures to investigate empirically the relative quality of Stern Stewart's measure of economic value added (EVA) compared to GAAP (generally accepted accounting principles) earnings, residual income, cash flows and other mandated metrics in the USA and UK. We proxy for accounting quality by applying a long-window methodology to obtain hindsight valuation errors based on the difference between ex ante market value and discounted ex post metrics. Decision usefulness, in terms of ease of forecasting, is proxied by differences in valuation errors between the benchmark and alternative accounting methods. Contrary to the Biddle et al. (Journal of Accounting and Economics, 24, pp. 301–336, 1997) finding that mandated earnings were superior to EVA and residual income, we find that EVA and other residual income metrics consistently give rise to lower average valuation errors and thus have higher predictability across a variety of windows and terminal dates. Further, on the basis of our second measure of accounting quality, the variability of valuation errors, EVA performs best in the USA and third in the UK. The results strongly indicate that differences between residual income constructs, including EVA, are generally small but that earnings quality will be improved by recognition of a cost of equity capital in measuring reported income.
      515Scopus© Citations 6
  • Publication
    The market response to information quality shocks: the case of Enron
    (Taylor and Francis, 2008-07-07) ; ; ;
    Relying on the market to provide incentives that would bring about optimal information quality is potentially a cost effective alternative to regulatory oversight. However, this depends on the ability of the market to recognize and price this attribute. In this article, we gain insights into the disciplinary role of the market by examining its response to Enron-related accounting scandals. We report evidence that information quality was in decline, leading upto the Enron-related scandals, but that the market was not sensitive to this decline. We confirm, however, that there was an abrupt decline in perceived information quality post-Enron. Furthermore, using an ex-ante methodology we provide strong evidence that auditor reputations were differentially affected by the scandals. We also find evidence that the Enron-related scandals adversely affected the market risk premium implying that information quality is part of systematic risk. Our results indicate that the market was operating effectively in recognizing lower quality information through an auditor reputation effect prior to the Sarbanes-Oxley Act. This calls into question the need for regulation to address the perceived deficit in information quality.
      293Scopus© Citations 3