Accounting →
- 16 Apr 2009
- Working Paper Summaries
Gray Markets and Multinational Transfer Pricing
Gray market goods are brand-name products that are initially sold into a designated market but then resold through unofficial channels into a different market. Gray markets can arise when transaction and search costs are low enough to allow products to "leak" from one market segment back into another. Examples of industries with active gray markets include pharmaceuticals, automobiles, and electronics. Understandably, reactions to gray market encroachment are mixed. On the one hand, consumer advocates and governments have applauded the increasing role that gray markets have played in improving competition for domestic goods. On the other hand, multinationals have decried the increasing role of gray markets in the economy, with an estimated $40 billion in cannibalized sales resulting from gray markets in the information technology sector alone. This study investigates the optimal price of a multinational's internal transfers and the consequences of regulations mandating arm's-length transfer pricing. Key concepts include: A shift to arm's-length transfer pricing erodes domestic consumer surplus by making the gray market less competitive domestically. In the presence of a gray market, the transfer price that maximizes a multinational's profits may also be the same one that maximizes the social welfare of the domestic economy that houses it. Arm's-length standard enforcement efforts targeting multinationals that observe little product leakage from foreign markets or that operate in domestic markets that are sufficiently competitive may lead to net welfare gains for the domestic economy. At the same time, focusing arm's-length standard enforcement efforts on multinationals that work in industries where gray markets provide the only means of domestic competition may make the domestic economy worse off. Closed for comment; 0 Comments.
- 24 Mar 2009
- Working Paper Summaries
Securing Jobs or the New Protectionism? Taxing the Overseas Activities of Multinational Firms
Popular imagination often links two significant economic developments: the rapid escalation of the foreign activities of American multinational firms over the last 15 years, and rising levels of economic insecurity, particularly among workers in certain sectors. The presumed linkages between these phenomena have led many to call for a reconsideration of the tax treatment of foreign investment. Increasing the tax burden on outbound investment by American multinational firms, it is claimed, offers the promise of alleviating domestic employment losses and insecurity while also raising considerable revenue. HBS professor Mihir A. Desai looks beneath the trends, examining the economic determinants of outbound investment decisions and synthesizing what is known about the relationship between domestic and foreign activities. Key concepts include: There is no clear evidence of significant negative impacts on domestic investment or employment due to the overseas activities of firms. Foreign activity by multinational firms does not necessarily displace domestic economic activity. Other factors—such as falling prices of investment goods, and/or trade patterns—may have driven the employment changes that are so worrisome. When policymakers decide the appropriate taxation of multinational firms, they should resist the tempting logic of protectionism. Closed for comment; 0 Comments.
- 10 Dec 2008
- Working Paper Summaries
Market Reaction to the Adoption of IFRS in Europe
How do investors in European firms react to a change in financial reporting? Prior to 2005, most European firms applied domestic accounting standards. The adoption of International Financial Reporting Standards (IFRS) would result in the application of a common set of financial reporting standards within Europe, and between Europe and the many other countries that require or permit application of IFRS. However, modification of IFRS by European regulators would result in European standards differing from those used in other countries, thereby eliminating some potential convergence benefits. This study investigates the equity market reaction to 16 events associated with the adoption of IFRS in Europe. Overall, the researchers' findings are consistent with investors expecting the benefits associated with IFRS adoption in Europe to exceed the expected costs. Key concepts include: Overall, investors reacted positively to the increased likelihood of IFRS adoption. Investors expected net benefits associated with increases in information quality, decreases in information asymmetry, more rigorous enforcement of the standards, and convergence. The reaction for firms domiciled in code law countries is less positive, consistent with investors' concerns over enforcement of IFRS in those countries. Closed for comment; 0 Comments.
- 24 Oct 2008
- Working Paper Summaries
Signaling Firm Performance Through Financial Statement Presentation: An Analysis Using Special Items
Do managers' presentation decisions within their financial statements reflect informational motivations (that is, revealing the underlying economics of the firm) or opportunistic motivations (that is, attempts to bias perceptions of firm performance)? The authors examine managers' choices to present special items (such as write-offs and restructuring charges) separately on the income statement rather than aggregated in other line items with disclosure only in the footnotes. Prior research suggests that managers engage in opportunistic reporting in other presentation decisions, and that managers' presentation decisions on the financial statement affects users' judgments. The distinction also matters because current changes in reporting standards are likely to increase the occurrence of "nonrecurring" type charges similar to special items, such as fair value changes. Key concepts include: Managers, in most instances, appear to use the flexibility afforded in the presentation of special items to inform users of the underlying economics of these items. Special items receiving income statement presentation are more transitory than those receiving footnote presentation. These results are consistent with managers using discretion in the financial statement presentation of special items for informational reasons. There is limited evidence that opportunistic motivations underlie this presentation decision. Closed for comment; 0 Comments.
- 17 Oct 2008
- Working Paper Summaries
Consequences of Voluntary and Mandatory Fair Value Accounting: Evidence Surrounding IFRS Adoption in the EU Real Estate Industry
The required adoption of International Financial Reporting Standards (IFRS) in the European Union, effective January 1, 2005, resulted in a number of significant changes in how firms report their financial results. Mandatory IFRS adoption has been criticized for both the flexibility afforded under the standards and the encroachment of the fair value paradigm. Specifically, common accounting standards alone may not be sufficient to provide the benefits of common accounting practices. This paper examines the causes and consequences of different forms of fair value disclosures for tangible long-lived assets. Insights may assist standard setters and users in understanding the factors influencing firms' current and future accounting choices, and may also interest U.S. standard setters and managers of the almost 250 publicly traded U.S. real estate firms. Key concepts include: Investors believe that investment property fair values are reliable enough to warrant a significantly lower cost of capital for those firms providing them. The demand for fair value information (reflected in a firm's ownership structure) and the firm's commitment to reporting transparency is associated with the decision to provide fair values. Critically, adoption of this fair value standard under IFRS, in and of itself, is insufficient to fully overcome previous perceived reporting differences across these firms. This is consistent with investors perceiving that property firms across EU countries vary in how they implement this standard. Closed for comment; 0 Comments.
- 19 Jun 2008
- Working Paper Summaries
Accounting Information as Political Currency
The study of accounting and the political process has long been viewed through the political cost hypothesis, the basic premise of which is that firms manage earnings in order to extract first-order benefits (or avoid first-order costs) from regulators. This paper develops and tests a distinct, yet likely, complementary hypothesis: Firms manage reported earnings in order to supply first-order benefits to regulators. Focusing on Democratic and Republican candidates in congressional races in 2004, Ramanna and Roychowdhury test whether the management of accounting information is in some circumstances akin to a political contribution from firms to politicians: in other words, whether accounting information can be used as political currency. The authors predict and find that identified corporate donors to candidates in closely watched races in 2004 managed information related to outsourcing, a hot-button issue in those races. Key concepts include: While corporate donors in general do not exhibit evidence of downward earnings management, corporate donors to candidates in closely watched congressional races exhibit significant evidence of downward earnings management in the second and third quarters of 2004. The evidence of downward earnings management is stronger for firms likely to have greater outsourcing activities. These findings are consistent with firms managing accounting information in circumstances where this is likely to benefit allied politicians, thus supporting the idea of a "political currency" hypothesis. Closed for comment; 0 Comments.
- 22 May 2008
- Working Paper Summaries
Testing Strategy with Multiple Performance Measures Evidence from a Balanced Scorecard at Store24
To what extent do balanced scorecards provide useful information for testing and validating an organization's strategy? Numerous case studies of balanced scorecard implementations document their use in translating organizational strategies to objectives and measures, communicating strategic objectives to employees, evaluating the performance of business units, and aligning the incentives of employees across business units and functions. There has been comparatively little research, however, on the potential learning and feedback role of balanced scorecards. Analyzing balanced scorecard data from Store24—a privately held convenience store retailer in New England—during the implementation of an innovative but ultimately unsuccessful strategy, this study investigates whether, when, and how information about problems with the firm's strategy was captured in the multiple performance measures of its balanced scorecard. Key concepts include: Store24's balanced scorecard contained useful and timely information for detecting problems in its strategy. The results also suggest that Store24 executives eventually learned about problems with the strategy despite a lack of reliance on such formal analysis. Analysis of the balanced scorecard could have yielded more timely information as well as more detail on why the strategy was not working as planned. Multiple measures in a balanced scorecard might systematically be used to test how well different drivers of performance are working to achieve strategic objectives and superior financial performance. Closed for comment; 0 Comments.
- 12 May 2008
- Research & Ideas
Accounting Information as Political Currency
Corporate donors that gave at least $10,000 to closely watched races in the U.S. congressional elections of 2004 were more likely to understate their earnings, say Harvard Business School's Karthik Ramanna and MIT colleague Sugata Roychowdhury. Such "downward earnings management" may have functioned as a political contribution. In this Q&A, Ramanna explains how accounting and politics influence each other. Key concepts include: Firms manage accounting numbers to avoid regulatory scrutiny. The implication is that firms manage accounting numbers to influence political decisions. Accrual accounting gives managers some flexibility to make estimates about the future. The data used to construct these measures are available for the larger companies in most developed and fast-developing nations. Closed for comment; 0 Comments.
- 08 May 2008
- Working Paper Summaries
Organizational Design and Control across Multiple Markets: The Case of Franchising in the Convenience Store Industry
Chain organizations operate units that are typically dispersed across different types of markets, and thus serve significantly different customer bases. Such "market-type dispersion" is likely to compromise the headquarters' ability to control its stores for two reasons: Relative differences in local conditions make it difficult to monitor a store manager's behavior, and a chain with wide-ranging customer bases will have a harder time serving its customers and will need to rely more heavily on store managers' ability to adapt to local needs. This study identifies market-type dispersion as a factor that is systematically related to firms' organizational design choices. The results may help managers and consultants who deal with control challenges related to a chain's geographic expansion into different markets. Key concepts include: Chains experiencing higher levels of variation in customer demands across different locations are more likely to increase delegation and the provision of incentives through the organizational design choice of franchising. Stores are more likely to be franchised when their location characteristics are more divergent from the most prevalent location characteristics of the chain as a whole. Non-franchisor chains with higher levels of such market-type dispersion tend to decentralize operations to a greater extent. It is also possible that they provide higher variable pay. Closed for comment; 0 Comments.
- 24 Apr 2008
- Working Paper Summaries
Bank Accounting Standards in Mexico: A Layman’s Guide to Changes 10 Years after the 1995 Bank Crisis
Mexico was the first emerging market compelled to reformulate the financial reporting of its banks as a result of a financial crisis. In the last decade, Mexico has undergone a process of internationalization of its banking industry. Today, more than 80 percent of the equity of Mexican banks belongs to internationally active bank corporations. This internationalization demands more transparent regulation, including standardized accounting rules and better disclosure of information. The case of Mexico can therefore serve as an example of the relevance of these changes, as well as of their scope and limitations. This paper attempts to clarify the nature and structure of the new accounting standards, and explains how they have affected financial statements and their interpretation. Key concepts include: Mexican bank accounting standards enjoyed special treatment during most of the 20th century because banking was an industry protected from foreign competition in a relatively closed economy. More transparent bank accounts and stricter accounting processes in Mexico are especially crucial today, in light of the predominantly foreign ownership of the Mexican banking system. The classification of financial operations still varies from country to country. National differences emerge despite the fact that financial instruments, products, and transactions are either very similar or the same worldwide. Legal and regulatory stipulations, accounting history, tax structure, and local business practices create differences in the way financial transactions are recorded in the financial statements. Closed for comment; 0 Comments.
- 17 Sep 2007
- Working Paper Summaries
Evidence on the Effects of Unverifiable Fair-Value Accounting
Since the late 1990s, the Financial Accounting Standards Board (FASB) has pressed for the use of fair values in accounting. When such fair values are based on verifiable market prices, they are less likely to be managed. However, in some FASB standards, fair values are based on managers' or appraisers' unverifiable subjective estimates. Agency theory suggests that managers will take advantage of this unverifiability to manage financial reports in order to extract rents. This paper considers a recent FASB standard known as SFAS 142, which relies on unverifiable fair-value estimates when accounting for acquired goodwill. The goal of the research is to see whether firms are using this standard to manage their financial reports. Key concepts include: The increased use of unverifiable fair-value estimates in accounting will lead to more opportunistic management in financial reports, absent increased monitoring. Firms that were predicted to have discretion are indeed managing their financials according to SFAS 142. Closed for comment; 0 Comments.
- 26 Jun 2007
- Working Paper Summaries
Contracting in the Self-reporting Economy
Intellectual property can be used by its owner directly, licensed to a third party for a fixed royalty, or licensed to a third party for a variable royalty. The variable royalty arrangement depends on self-reporting by the licensee, which in turn induces demand for auditing by the licensor. This research studies a setting with the following features: a production cost advantage on the part of the outside party that creates gains from licensing; a limited liability constraint that prevents the licensee from owing more royalties than the gross profits of licensing the intellectual property and prevents the licensor from capturing all of the economic surplus via a fixed royalty agreement; and accounting and auditing costs that reduce the benefits of a variable royalty agreement. Key concepts include: The owner of intellectual property will enter into a variable royalty agreement with an outside party if—and only if—the accounting and auditing costs are sufficiently low. With higher cost levels, the owner will use the property directly if the owner can do so profitably. Otherwise, the owner will prefer to license the property in exchange for a fixed royalty. The expected aggregate accounting system and audit costs are minimized when the licensor can compel the licensee to bear the audit costs in case underreporting is detected. Internal control provisions within the Sarbanes-Oxley Act make variable royalty arrangements based on self-reporting and auditing relatively more attractive than such arrangements prior to Sarbanes-Oxley. Sarbanes-Oxley effectively lowers the licensor's audit costs even though the licensor must audit all low reports, because auditing all low reports deters the licensee from underreporting in the first place. Closed for comment; 0 Comments.
- 18 Jun 2007
- Op-Ed
Leveling the Executive Options Playing Field
Harvard Business School professor Mihir A. Desai recently presented testimony to a U.S. Senate subcommittee looking at the subject of executive stock options. His theme: A "dual-reporting system" makes it difficult for investors and tax authorities to learn the real numbers. Closed for comment; 0 Comments.
- 11 Apr 2007
- Research & Ideas
Adding Time to Activity-Based Costing
Determining a company's true costs and profitability has always been difficult, although advancements such as activity-based costing (ABC) have helped. In a new book, Professor Robert Kaplan and Acorn Systems' Steven Anderson offer a simplified system based on time-driven ABC that leverages existing enterprise resource planning systems. Key concepts include: The activity-based costing system developed in the 1980s fell out of favor for a number of reasons, including the need for lengthy employee interviews and surveys to collect data. The arrival of enterprise resource planning systems allows crucial data to be pumped automatically into a TDABC system. Managers must answer two questions to build an effective TDABC system: How much does it cost to supply resource capacity for each business process in our organization? How much resource capacity (time) is required to perform work for each of our company's transactions, products, and customers? Profit improvements of up to 2 percent of sales generally come in less than a year. Closed for comment; 0 Comments.
- 29 Jan 2007
- Research & Ideas
The Business Press Is a Watchdog that Bites
When financial fraud is at stake, the press is a watchdog that bites more often than we think, says HBS professor Gregory S. Miller, an expert in financial communication. Many times, the press is on the case long before analysts or even the SEC. In this Q&A he describes what he learned and what managers should keep in mind. Key concepts include: The press is a very early source for uncovering accounting malfeasance. Specialized analytical skills are strong in the business and trade press. When an article based on original research is published, the market response is huge. The press spends more energy examining big-name companies or small companies with a "dirty laundry" angle. Try to develop a good relationship with the press over time. "No comment" is not the best option. Closed for comment; 0 Comments.
- 20 Dec 2006
- Op-Ed
Investors Hurt by Dual-Track Tax Reporting
What corporations report in profit to the IRS and what they report to shareholders are often two different numbers—sometimes wildly so. That's why the IRS and Securities and Exchange Commission are proposing that companies publicly report taxes paid—and Professor Mihir Desai thinks this is only a first step. Key concepts include: Corporations are allowed to report different profit figures to capital markets and to tax authorities, creating large, unexplained gaps that potentially confuse investors. The IRS and SEC have jointly called for a simple but controversial proposal: Companies would be required to disclose how much they pay in taxes, an amount not now decipherable from public filings. More ambitious alternatives should be considered, including making corporate tax returns public, an end to the dual-book system, and a lower corporate tax rate on profits reported to capital markets. Closed for comment; 0 Comments.
- 05 Jul 2006
- Working Paper Summaries
Time-Driven Activity-Based Costing
Activity-based costing (ABC) has become popular in business writing and management circles. (An example of an activity would be process customer complaints.) However, calculating baselines for activities, developing the model, and retesting the model once it is implemented is time-consuming and costly. Kaplan and Anderson developed improvements in the process through what they call time-driven ABC. Time-driven ABC decreases the amount of data needed, and only requires estimates of two things: (1) the practical capacity of committed resources and their cost, and (2) unit times for performing transactional activities. Key concepts include: Building an accurate time-based algorithm in one facility will typically serve as a template that can be easily applied and customized to other plants, or even other companies in an industry. Time-driven ABC requires less time and resources to implement. At one company cited, it took two people two days per month to load, calculate, validate, and report findings, compared to the ten-person team spending over three weeks to maintain the previous (traditional ABC) model. Closed for comment; 0 Comments.
- 05 Jul 2006
- Working Paper Summaries
Analyst Disagreement, Forecast Bias and Stock Returns
It is well documented that financial analysts' opinions are reflected in stock prices. The problem: Analysts often operate under incentives that are inconsistent with telling the truth. Retail investors, who tend to be less sophisticated, may fail to make proper adjustments for the more nuanced of the resulting biases, some of which might be reflected in market prices. To study the scope of market efficiency, Scherbina studied analysts' incentives, resulting forecast biases, and their potential impact on market prices. Key concepts include: When the level of analyst disagreement about future earnings is high, the average forecast tends to be overly optimistic. The "marginal investor," on average, fails to interpret analysts' earnings forecasts with an eye to inherent biases. Sophisticated investors have a beneficial effect on market efficiency. Closed for comment; 0 Comments.
- 01 May 2006
- Research & Ideas
What Companies Lose from Forced Disclosure
Increased corporate financial reporting may benefit many parties, but not necessarily the companies themselves. New research from Harvard Business School professor Romana Autrey and coauthors looks at the relationship between executive performance and public disclosure. Closed for comment; 0 Comments.
Elections and Discretionary Accruals: Evidence from 2004
How does the political process affect accounting? During the 2004 U.S. congressional elections, outsourcing of American jobs was a major campaign issue. Because outsourcing is assumed to be net profitable, the use of income-decreasing accruals would enable donor firms to deflect public scrutiny of both the firm and the political candidate over outsourcing. HBS professor Karthik Ramanna and MIT Sloan School professor Sugata Roychowdhury examine the accrual choices made by outsourcing firms with links to U.S. congressional candidates during the 2004 elections, and specifically test for income-decreasing discretionary accruals. Evidence is consistent with firms using earnings management to reduce both direct political costs and the costs associated with causing embarrassment to affiliated political candidates. Key concepts include: Politically connected firms with more extensive outsourcing activities had more income-decreasing discretionary accruals in the two calendar quarters immediately preceding the 2004 congressional elections. The use of accounting discretion to manage political costs is potentially more evolved than currently discussed in academic literature. Closed for comment; 0 Comments.