Just Say No to Wall Street: Putting a Stop to the Earnings Game

Fuller, Joseph B.; Jensen, Michael C.

doi:10.1111/j.1745-6622.2002.tb00447.x

Cited by 202 publications

(50 citation statements)

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“…Our estimates imply that firms with one additional analyst following them are 1.5 percentage points more likely to use the ETR and 1.2 (0.6) percentage points less likely to use the STR (MTR). To the extent financial analysts increase capital market pressure as suggested by prior research (e.g., Fuller and Jensen, 2002;He and Tian, 2013), an increase in analyst following is likely to increase managerial focus on financial accounting earnings. As discussed previously, an increased focus on accounting earnings potentially increases the salience of the GAAP ETR.…”

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confidence: 86%

Tax Rates and Corporate Decision-making

Graham

Hanlon

Shevlin

et al. 2017

The Review of Financial Studies

131

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Abstract:We survey companies and find that many use incorrect tax rate inputs into important corporate decisions. Specifically, many companies use an average tax rate (the GAAP effective tax rate, ETR) to evaluate incremental decisions, rather than using the theoretically correct marginal tax rate. We find evidence consistent with behavioral biases (heuristics, salience) and managers' educational backgrounds affecting these choices. We estimate the economic consequences of using the theoretically incorrect tax rate and find that using the ETR for capital structure decisions leads to suboptimal leverage choices and using the ETR in investment decisions makes firms less responsive to investment opportunities. This paper is the winner of the American Accounting Association 2015 FARS Midyear Meeting Best Paper Award. We thank John Barrios for sharing data on the LinkedIn profiles of our survey respondents. We appreciate helpful comments from Robin Greenwood (the editor), two anonymous referees, Mary Barth, James Chyz, Bryan Cloyd, Russ Lundholm, Lil Mills (discussant), Richard Sansing, Joel Slemrod (discussant), seminar participants at the Baruch College, Columbia Law School, INSEAD conference, International Institute for Public Finance (IIPF) Annual Congress (Dublin), MaTax Conference in Germany, Stanford Summer Camp, University of California, Davis, University of Tennessee, and Virginia Tech University. Thanks to the following people for helpful comments on the development of survey questions: Jennifer Blouin, Merle Erickson, Ken Klassen, Ed Maydew, Peter Merrill, Lil Mills, Sonja Rego, Richard Sansing, Stephanie Sikes, Joel Slemrod, and Ryan Wilson. We also appreciate the support of PricewaterhouseCoopers (especially Peter Merrill) and the Tax Executives Institute (especially Tim McCormally) in asking firms to participate and in reviewing the survey document. We are grateful for the discussions with several tax executives about their role in their company. Finally, each author is grateful for the financial support of the Fuqua School of Business, Paton Accounting Fund at the University of Michigan, MIT Junior Faculty Research Assistance Program, and the Paul Merage School of Business at the University of California-Irvine. All errors are our own. 1Taxes represent a significant cost for most profitable corporations and, thus, are an important input into many corporate decisions (see Shackelford and Shevlin (2001), Graham (2003), and Hanlon and Heitzman (2010) for reviews). According to theory, the marginal tax rate (MTR), defined as the present value of additional taxes paid on an additional dollar of income earned today (Scholes et al., 2014), is the appropriate rate to use to evaluate incremental corporate decisions (MacKie-Mason, 1990; Graham, 1996a, b;Brealey, Myers, and Allen, 2014;and Scholes et al., 2014). Consistent with this theory, prior research finds that the MTR is correlated with firms' capital structure decisions (e.g., Graham, 1996a;Heider and Ljungqvist, 2015). However, prior research also finds...

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confidence: 86%

Tax Rates and Corporate Decision-making

Graham

Hanlon

Shevlin

et al. 2017

The Review of Financial Studies

131

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“…But most of them admit major weaknesses in the approach. Today, Jensen (The Economist, November 16, 2002: 66;Fuller & Jensen, 2002) accepts that the existing system of managing compensation, especially using stock options, is seriously deficient; he argues that it has proven to be "managerial heroin", encouraging a focus on short-term highs, with destructive long-term consequences. But he believes that the system can be salvaged by better-designed share options.…”

Section: Introductionmentioning

confidence: 99%

Yes, Managers Should Be Paid Like Bureaucrats

Frey

Osterloh

2005

Journal of Management Inquiry

208

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may YES, MANAGERS SHOULD BE PAID LIKE BUREAUCRATS AbstractCorporate scandals, reflected in excessive management compensation and fraudulent accounts, cause considerable damage. Agency theory's insistence on linking the compensation of managers and directors as closely as possible to firm performance is a major reason for these scandals. They cannot be overcome by improving variable pay for performance, as selfish extrinsic motivation is reinforced. Based on the common pool approach to the firm, institutions are proposed which serve to raise intrinsically motivated corporate virtue. More importance is to be attributed to fixed pay and strengthening the legitimacy of authorities by procedural fairness, relational contracts and organizational citizenship behavior.JEL Code: D21, D23, J33, L20.

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“…Because the market assumes that a company is doing poorly when a forecast is missed, investors lose confidence (McCafferty 2007), placing management under intense pressure to meet their forecasts (Barsky 2002;Fuller and Jensen 2002;Oakley 2002;Taub 2006). Thus, managers may sacrifice long-term company health to meet short-term earnings goals (Donohue 2005;Fuller and Jensen 2002;Horowitz 2005;Koller and Rajan 2006;Chamber of Commerce 2007). Opponents also believe that it is costly for managers to provide and meet quarterly earnings targets.…”

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confidence: 99%

Do management EPS forecasts allow returns to reflect future earnings? Implications for the continuation of management’s quarterly earnings guidance

et al. 2010

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Using 18,253 firm-year observations from 1998 through 2003, we build on literature suggesting that more informative disclosures allow returns to better reflect future earnings and test whether management earnings per share forecasts and their characteristics influence the future earnings response coefficient (FERC). We find that FERCs are greater for forecasting firms and when forecasts are more frequent or precise. We suggest that more frequent and more precise forecasts assist investors in better predicting future earnings. Importantly, we find that quarterly and short-term forecasts incrementally increase the association between returns and future earnings beyond annual and long-term forecasts; thus, even short-term, quarterly forecasts allow investors to form better expectations about future earnings. This suggests a benefit of quarterly earnings forecasts possibly overlooked in recommendations from the United States Chamber of Commerce, CFA Institute,

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Just Say No to Wall Street: Putting a Stop to the Earnings Game

Cited by 202 publications

References 0 publications

Tax Rates and Corporate Decision-making

Tax Rates and Corporate Decision-making

Yes, Managers Should Be Paid Like Bureaucrats

Do management EPS forecasts allow returns to reflect future earnings? Implications for the continuation of management’s quarterly earnings guidance

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