Week 10

Question 1

Perfectly efficient markets would make it

Answer 1

Perfectly efficient markets would make it impossible to identify mispriced stocks using public information such as published financial reports

– Implies that we can’t use public info to ‘buy low and sell high’ because any price reaction to the info happens instantaneously

Question 2

Perfectly Efficient Market

Answer 2

Unlikely to exist in equilibrium

If perfect efficiency exists at a point in time, there would be no incentive for people conduct such research

– Market would ‘slip away’ from efficiency, creating incentive for research

• More likely that the market is ‘close’ to efficient, as per following slide

Question 3

People who are able to read, analyse and understand the implications of the new info for the asset’s future returns more swiftly than others may be able to ‘buy low and sell high’

• Why doesn’t everyone do this?

Answer 3

– Barriers to entry: innate ability, financial and opportunity costs of formal education, practical experience etc

– Trading profits may be viewed as a return on an individual’s investment in developing their human capital

Question 4

Even if the market is very close to being efficient,

Answer 4

there is potential value to fundamental analysis (at least for the people who are the very best at it).

•

Question 5

fundamental analysis may assist in

Answer 5

assessing whether a security is consistent with risk preferences / intended investment horizon

Question 6

There is evidence that suggests that markets fail

Answer 6

Several studies, including Bernard and Thomas (1989, 1990) find evidence that suggests that markets fail to fully impound the implication of changes in current quarterly earnings for subsequent quarterly earnings

Question 7

‘Post Earnings Announcement Drift’

Answer 7

Markets Failure to fully recognise positive autocorrelation with next quarter earnings, negative autocorrelation with 4 th quarter earnings

Question 8

Does the relative amount of accruals and CFO within firms’ net profit affect the persistence of earnings (i.e. the extent to which the current level of earnings persists into the future)

Limitation

Answer 8

Accruals require more subjective judgement, and there is greater uncertainty as to whether an associated cash flow will EVER occur

Question 9

Does the relative amount of accruals and CFO within firms’ net profit affect the persistence of earnings (i.e. the extent to which the current level of earnings persists into the future)

Answer 9

current period earnings which are similar in magnitude to current CFO are more likely to persist next year, relative to current earnings which are very different to current CFO

Question 10

If the amount of accruals implied by a firm’s profits and CFOs does affect earnings persistence, do stock prices efficiently impound this information?

What is assumed

Answer 10

Given that the data underpinning Sloan’s findings are/were public info, and also the existence of anecdotal evidence that analysts consider the relation b/w Profit and CFO when valuing firms, one would expect that the greater persistence of cash flows is reflected in stock prices, and thus cannot be used to ‘beat the market’

Question 11

Sloan tested the market pricing of accruals and cash flows several ways

This includes

Answer 11

Constructing a ‘hedge portfolio’ which includes a positive investment in firms with very high CFO relative to Net Profit and a equivalent negative investment in firms with v. High Accruals relative to Net Profit

– This zero net investment portfolio should earn a zero return if market is efficient

Question 12

What did sloan’s study show in terms of market pricing

Answer 12

regardless of the method by which Sloan controlled for ‘normal’ market returns, a strategy of ‘buying’ firms with high CFO relative to Profit, and ‘selling’ those with high ‘Accruals’ relative to Profit earned positive returns

– Most of the return comes from the apparent mis-pricing of high accrual firms (row above ‘hedge’)

Question 13

DRS(2008) broke down sources of firms profit by using an alternate ROE breakdowns to decompose income into the following ‘components’:

Answer 13

ACCRUALS + (ΔCASH + DISTRIBUTIONS TO EQUITY + DISTRIBUTIONS TO DEBT)

Question 14

DRS(2008) thus decomposed income into the following ‘components’:

– ACCRUALS + (ΔCASH + DISTRIBUTIONS TO EQUITY + DISTRIBUTIONS TO DEBT)

– Are each of those components equally persistent over time?,

Answer 14

ACCRUALS and ΔCASH have similar persistence, and each much less likely to persist than DIST to EQUITY

Question 15

DRS(2008) Findings

• 1) ACCRUALS and ΔCASH have similar persistence, and each much less likely to persist than DIST to EQUITY

Explain

Answer 15

where annual earnings and distributions to equity and debt are very similar, those earnings are more likely to persist than occurs when firms earnings differ greatly from the amount distributed to equity holders.

– The persistence of distributions to DEBT is similar to ACCRUALS and ΔCASH

Question 16

DRS(2008) thus decomposed income into the following ‘components’:

– ACCRUALS + (ΔCASH + DISTRIBUTIONS TO EQUITY + DISTRIBUTIONS TO DEBT)

If there are differences in persistence, does the market correctly price those differences

Answer 16

Most of the market mispricing relates to the ACCRUALS and ΔCASH components. These components represent the earnings retained in the business.

– Results suggest that the market over-estimates the return available on re-invested earnings,

– May imply that investors overestimate the persistence of historic ROE when BVE is growing strongly.

Question 17

Not all people accept Sloan’s (and later) results as evidence of mis-pricing
Why

Answer 17

As is the case with many theoretical trading strategies, an accrual based strategy implies the ability to short-sell firms that tend to be a) small and b) have illiquid equity securities

– If you actually traded on the strategy, your demand would affect the price transacted and thus the returns to the strategy

Question 18

Steps in the Overall Investment Advisory Process

Answer 18

– (1) Establish Investor’s Objective – (2) form expectations re future returns and risks of individual securities

– (3) use (2) to make investment decisions consistent with (1)

Question 19

Steps in the Overall Investment Advisory Process

– (1) Establish Investor’s Objective – (2) form expectations re future returns and risks of individual securities

– (3) use (2) to make investment decisions consistent with (1)

If we are writing a report for many potential clients, it may be hard to establish their objectives

– So, we

Answer 19

– So, we do 2) assuming a moderate level of risk aversion, but provide plenty of detail regarding expected riskiness in the short and long-term

Question 20

Analysts’ investment reports must consider (or at least acknowledge) the objectives of investors
Why

Answer 20

of the investors known or assumed to rely on the report •

Investor objectives are highly idiosyncratic and must be matched with the appropriate investment. •

For example, individuals vary in terms of their: – risk tolerance – tax exposure – stage of life – other assets held etc

Question 21

Sell-Side Analysts

What do they work for

Answer 21

work for investment banks, brokerage houses (or brokerage arms of other institutions), specialist research firms (to sell info to investment or broker firms or large companies)

Question 22

Sell side analysts

Answer 22

– Sell or otherwise provide their equity research to investors

Question 23

Sell side analyst incentive

Answer 23

Analysts working for brokerage firms may have incentive to encourage share trading by their firm’s clients

• Incentive for positive bias?

– Major incentive is to identify mis-priced stocks

Question 24

Buy-Side Analysts

Work for

Answer 24

Work for institutional investors (e.g. Mutual funds / unit trusts/Super funds

work for those who buy investments

Question 25

Buy-Side Analysts Role

Answer 25

Provide investment advice to their employing firm, who then use this to offer products customised to investor clienteles

Question 26

Buy-Side Analysts | They still are interested in

Answer 26

Still interested in identifying mis-priced securities, but also considers the suitability of the security for particular investment funds: – High Growth fund – Income (Dividend paying) generating fund – Index Fund (a fund designed to track a particular mkt index)

Question 27

End Investors They vary in They may

Answer 27

Different risk profiles, investment horizons, tax status, existing portfolio etc will influence suitability of any particular equity security to that investor • May conduct security analysis themself • Or: – Acquire research from sell-side analyst source – Invest in fund with characteristics suited to their objectives

Question 28

What does an Analyst do each day?

Answer 28

1. Selection of candidates to analyze 2. Inferring market expectations 3. Develop/refine our own expectations 4. Develop Investment Recommendation with supporting forecasts, discussion of strategic risks, investment horizon etc.

Question 29

What does an Analyst do each day? Inferring market expectation

Answer 29

Identifying potentially mispriced securities requires a comparison of the analysts expectations with those of the market

Question 30

Selection of Candidates to Analyse Analysts tend to concentrate their coverage by

Answer 30

Analysts tend to concentrate their coverage by industry/sector – Specialisation allows for knowledge spill- overs (what you learn from analysing a firm is relevant to analysing that firm’s competitors), economises on general research time/costs

Question 31

Selection of candidates | Buy-side analysts choice of firms to cover will also be constrained by

Answer 31

the types of mutual funds offered by their employer (e.g. Growth, income, value etc)

Question 32

Selection of candidates | Others first

Answer 32

first screen firms based on some indicator of potential mispricing (e.g. Firms that have received positive revisions in earnings forecasts), and then analyse these firms in depth

Question 33

Inferring Market Expectations | we could infer market expectations about short-term or long-term growth in earnings if we know

Answer 33

Current price – Current cost of equity • And have information or informed beliefs regarding either long-term profits or short- run profits

Question 34

Develop Our Own Expectations

Answer 34

Using our original forecasts, refined by our initial valuation and our examination of differences between our expectations and those of the market, develop our final forecasts.

Question 35

Investment report

Answer 35

Includes: – Investment Recommendation (BUY/HOLD/SELL) – Supporting forecasts and valuations, with - underlying assumptions – Description of firm’s activities – Discussion of Strategic Risks and Opportunities

Question 36

Factors Associated with The Performance of Security Analysts Some recent research indicates that these analysts’ recommendations

Answer 36

analysts’ recommendations typically outperform market index and risk benchmarks – Research indicates that analysts play an important role in market efficiency.

Question 37

Factors Associated with The Performance of Security Analysts analysts’ recommendations typically outperform market index and risk benchmark Sell side?

Answer 37

sell-side analysts have incentives to be overly optimistic with their forecasts and recommendations

Question 38

Sell-Side Analysts, Biased Forecasts, Incentives What do studies show

Answer 38

Some studies find evidence of systematic optimistic bias in analysts output

Question 39

Some studies find evidence of systematic optimistic bias in analysts output How

Answer 39

Tendency to issue more positive recommendations – Earnings forecasts ‘too high’ realised actual earnings are lower than the forecast level of earnings

Question 40

Some studies find evidence of systematic optimistic bias in analysts output: Earnings forecasts ‘too high’ Time of the year influence this

Answer 40

Forecasts issued earlier in the reporting year more optimistic, gradual become less optimistic as reporting date approaches

Question 41

Possible Incentives for Bias | ‘Information Hypothesis’ / ‘Management Relations Hypothesis’

Answer 41

Analysts may believe that issuing ‘positive’ forecasts for a particular firm will win them favour with that firm’s managers, and give them access to private info, particularly in the case of firms for which they have issued a sell recommendation

Question 42

the provision of ‘private briefings’ to analysts is

Answer 42

Following the Regulation Fair Disclosure Act in the US (effective October 2000), the provision of ‘private briefings’ to analysts is illegal

Question 43

Following the Regulation Fair Disclosure Act in the US (effective October 2000), the provision of ‘private briefings’ to analysts is illegal In Australia

Answer 43

Australia, such behaviour has been proscribed for a long-time (ASX Guidance Note 8 etc) though some firms continue to be sanctioned for ignoring this requirement.

Question 44

Subsequent research (Eames et al 2002) using pre-Reg FD data, but which controlled for the level of actual earnings being forecast, found:

Answer 44

– Forecasts are systematically optimistic when recommendation = BUY – Forecasts are systematically pessimist when recommendation = SELL – NOT CONSISTENT with INFO HYPOTHESIS

Question 45

Bias in Analyst Forecasts and Recommendations Trading incentives

Answer 45

Where sell-side analysts work for a firm that offers brokerage services (i.e. Brokerage houses or investment banks with a brokerage function), more optimistic recommendations / forecasts may encourage trading (and thus transaction fees) – Any investor can act on a ‘buy’ recommendation – Acting on a ‘sell’ recommendation requires either that you already own the stock, or are able to ‘short-sell’ that stock

Question 46

Bias in Analyst Forecasts and Recommendations | Objectivity Illusion

Answer 46

behavioural tendency to unconsciously process information in a manner that supports one’s goal

Question 47

Bias in Analyst Forecasts and Recommendations Objectivity Illusion Example

Answer 47

– If I’ve issued a BUY recommendation, I may process subsequent info (e.g. Relevant to future earnings) in a manner that biases my forecasts upwards – If I’ve issued a SELL, the opposite may be true.

Question 48

Analyst Incentives Surrounding Particular Events | Investment Banking Incentives

Answer 48

In addition to evidence of general optimism in analyst forecasts, the investment banking business of some analysts’ employers may provide incentives to bias recommendations/forecasts

Question 49

Investment Banking Incentives

Answer 49

Optimistic recommendations / forecasts for a firm expected to need advisory services may: – Increase the chance that the analysts’ employer actually wins the tender for the advisory services – If they do get the deal, optimism might increase the chance that the transaction is executed successfully

Question 50

Analyst Bias and Seasoned Equity Offerings When a listed firm issues additional equity to the market,

Answer 50

it is common to engage an investment bank to: – Advise on price / terms of issue and help market the issue – Underwrite the issue (i.e. Agree to purchase any unsubscribed stock)

Question 51

Lin and McNicholls (1998) find that recommendations issued by analysts who work for the investment bank(s)

Answer 51

acting as underwriters for a firm are systematically more positive than the recommendations issued by ‘unaffiliated’ analysts

Question 52

• Lin and McNicholls (1998) find that recommendations issued by analysts who work for the investment bank(s) acting as underwriters for a firm are systematically more positive than the recommendations issued by ‘unaffiliated’ analysts When are recommendations observed

Answer 52

Recommendations observed immediately prior to the public announcement of the SEO and who is underwriting it

Question 53

Investment bias Sources of Bias Strategic bias

Answer 53

Stronger recommendation before the SEO could increase the chance of winning the underwriting contract.

Question 54

Investment bias Sources of Bias Non Strategic bias

Answer 54

Investment banks genuine positive beliefs about the client are more likely to bid for the underwriting offer.

Question 55

Lin and McNicholls also found some (weak) evidence

Answer 55

evidence the stock market responds differently to the recommendations issued by affiliated analysts in the 2-year period following the SEO – Market views ‘HOLD’ recommendations made by affiliated analysts as ‘optimistic’ • Found no bias in earnings forecasts

Question 56

Post-Global Settlement

Answer 56

Appears that the GS has been effective in reducing the apparent bias in recommendations issued by affiliated analysts – Kadan et al (2009) & Clarke et al (2009) systematic difference in recommendations across affiliated and unaffiliated analysts has become smaller since GS. However, a difference persists

Question 57

NYAG and SEC Investigations into Analysts

Answer 57

Following the Dotcom crash, the New York Attorney General, and the Securities Exchange Commission commenced inquiries into the behaviour of analysts at a number of investment banks.

Question 58

SRO Rules 2002

Answer 58

At about the same time as the GS was being negotiated, the most important US self-regulatory authorities (NYSE, NASDAQ) introduced reforms to their rules regarding analyst conduct which mirrored several of the provisions of the Global Settlement, and applied to basically all analysts operating in the US.

Question 59

Global Settlement 2002/03 Following evidence of widespread undue influence of investment banking (and trading) activities on research analyst behavior, the SEC, NYSE and NASD reached an agreement with 12 investment banks

Answer 59

– IBs to separate their research division from IB and Trading arms – IBs to pay for the provision of independent analyst reports for a period of 5 years – IBs to pay fines of approx $900m

Question 60

The (semi-strong) EMH posits that

Answer 60

security prices reflect all publicly available information immediately and without bias.

Question 61

A simple measure of the impact of accrual accounting is

Answer 61

Total Accruals = Net Profit - Cash From Operations | • E.g. Uncollected credit sale makes Profit higher, but does not affect CFO

Question 62

Finding of Dechow Richardson and Sloan (2008) First finding

Answer 62

1. Only FCFE has greater persistence than accruals

Question 63

Accruals, the Quality of Earnings and Stock Prices | Firms vary according to the extent to which

Answer 63

Firms vary according to the extent to which reported Net Profit is composed of CFO and Accruals

Question 64

Change in cash + accruals represent

Answer 64

funds reinvested in firms | because both will become operating assets

Question 65

Finding of Dechow Richardson and Sloan (2008) | second finding

Answer 65

2. Change in cash and distribution to debt (FCF debt) have similar persistence with accruals

Question 66

Finding of Dechow Richardson and Sloan (2008) | 3rd finding

Answer 66

3. investors misprice the funds reinvested / the proportion of free cash flow the firm retains

Question 67

how to interpret the Dechow Richardson and Sloan finding

Answer 67

investors normally overestimate on the return on the funds reinvested in the company

Question 68

Why would investors overestimate the return on the reinvested funds

Answer 68

If investors believe ROA/ROE will persist, they will overestimate the return

Question 69

companies with high ROA/ROE will they be able to sustain

Answer 69

Not sustainable because of competition equilibrium | New competitors will come into market and share a proportion of profit --> reduce ROA/ROE

Question 70

Why would FCFE have higher persistence than accruals? | Dechow Richardson and Sloan (2008)

Answer 70

High FCFE signals management's positive view of the future | they believe will be able to sustain enough cash in future to distribute to shareholders as dividends

Question 71

Suppose you observe two firm’s current annual financial statements. Firm A has net income of $100, comprising $10 of accruals, a $5 increase in the cash balance over the year, and distributions to equity (dividends) total $85. Firm B also has net income of $100, $10 of accruals, a $50 increase in the cash balance, and $40 of distributions to equity holders. According to DRS’s evidence, which of these firms is most likely to be able to sustain earnings of $100 next year? Again, according to DRS’s evidence, does the market appear to efficiently price the information contained in the components of earnings? Explain Which company will have higher persistence for earnings?

Answer 71

Company A is more likely to sustain earnings next year because FCFE is higher and FCFE has higher persistence than cash balance and accruals

Question 72

Suppose you observe two firm’s current annual financial statements. Firm A has net income of $100, comprising $10 of accruals, a $5 increase in the cash balance over the year, and distributions to equity (dividends) total $85. Firm B also has net income of $100, $10 of accruals, a $50 increase in the cash balance, and $40 of distributions to equity holders. According to DRS’s evidence, which of these firms is most likely to be able to sustain earnings of $100 next year? Again, according to DRS’s evidence, does the market appear to efficiently price the information contained in the components of earnings? Explain How about company B

Answer 72

Company B, has a large increase in cash balance. Unless it immediately reinvests cash in operations, the ROA and ROE will drop. Why? cash balance earns lower rate than ROA and ROE

Question 73

A firm’s net profit is composed of two elements

Answer 73

transactions for which a related operating cash flow occurred during the period, and accruals (such as uncollected credit sales): Earnings = Cash From Operating Activities + Accruals

Question 74

Earnings = cash from operations + accruals Why might the relative magnitudes of Cash From Operations and Accruals in relation to Earnings affect the usefulness of current earnings for predicting future earnings

Answer 74

Higher accruals means earnings is less useful for predicting future earnings

Question 75

What are some usually recommendations

Answer 75

Buy shares, sell shares or hold shares

Question 76

What recommendation is the most effective

Answer 76

Buy because it is applicable to anyone. You

Question 77

Why might sell analysts recommendations be subject to bias

Answer 77

to get info from management, improve relationship with management Increase the chance of their employers having more contracts underwriting IPO Increase chance of mergers and acquisition being executed Boost the trading volume (or revenues) of employer so they get higher remuneration

Question 78

Sloan's paper showers

Answer 78

Chance of persistence for accruals is lower than cash flows Want to predict earnings, more useful to use cash flow Cash flow is more useful because persistence is higher

Question 79

DRS 2008 | what is cash equal to

Answer 79

If income + interest expense – accruals = cash

Question 80

Regulation Fair Disclosure Act 2000

Answer 80

Purpose: Prevents companies from leaking private info to analysts

Question 81

DRS 2008 | Income =

Answer 81

Change of cash + distribution to debt (payment to loans) (FCF debt) + distribution to equity (FCFE)

Question 82

Main provision of Regulation Fair Disclosure Act 2000

Answer 82

Companies must disclose market sensitive info to all investors at the same time reduces incentive to bias recommendation

Question 83

Regulation Fair Disclosure Act of 2000 | What impact might this act have had on sell-side analysts’ incentives to intentionally bias their recommendations

Answer 83

If analyst doesn't get private info from managers beforehand, they can only base forecast on calculation

Question 84

In 2002 two related regulatory reforms were effected in the US Global Research Settlement and SRO Rules Explain the major provisions of Global Research Settlement

Answer 84

separate investment banking decision with research division. Applies to all investment banks so that they do not get info from research division, reduces conflict of interest - separate analyst compensation from investment banking outcomes so they wont get high pay if company gets high revenue --> less incentive to bias recommendation and forecast Fixed salary

Question 85

In 2002 two related regulatory reforms were effected in the US Global Research Settlement and SRO Rules Explain the major provisions of SRO Rules

Answer 85

separate analyst compensation from investment banking outcomes so they wont get high pay if company gets high revenue Fixed salary For US based analysts and brokers

Question 86

Dechow, Richardson and Sloan (2008) extended the Sloan (1996) analysis, to study the relationship between

Answer 86

earnings persistence, and the following components of current year earnings: accruals (the increase in net operating assets), the increase in the cash balance held, distributions to equity holders, and distributions to debt holders.

Question 87

Accurals vs cash flows

Answer 87

accruals are less persistent than cash flows, i.e., conditional on earnings today, firms with higher accruals tend to be less profitable in the future

Question 88

Explain why accruals have low persistence reason 1

Answer 88

accruals contain transitory measurement error that inflates today’s earnings at the expense of future profits

Question 89

Explain why accruals have low persistence | reason 2

Answer 89

the second is that accruals are closely linked to investment and predict lower future profitability because of diminishing marginal returns, adjustment costs associated with investment, or conservatism in accounting

Question 90

what did sloan's study 1996 say about accruals

Answer 90

accruals might contain transitory measurement error that reduces the persistence of accruals relative to cash flows.

Question 91

implications of accruals having a transitory measurement error

Answer 91

b/c accruals contain transitory measurement error high accruals are a sign that earnings are inflated and will likely drop in the future.

Question 92

the measurement-error hypothesis also implies

Answer 92

that accruals should predict earnings more strongly in the short run than in the long run.

Question 93

Explain how accruals are a poor predictor of profit with reference to competition in the short term

Answer 93

firms sell differentiated products and can earn temporary abnormal profits because of product innovation or an increase in demand. When this happens, the firm should grow—sales, working capital, and long-term assets would all increase

Question 94

Explain how accruals are a poor predictor of profit with reference to competition in the long term

Answer 94

—because of growth in sales, WC, LA, will also attract new competition that would be expected to reduce subsequent profit margins. high accruals today might predict a profit decline in the future as margins are driven down by new competition.

Question 95

Stock prices do not

Answer 95

stock prices would appear not to respond completely and immediately to information as visible and freely available as publicly announced earnings

Question 96

As Bernard and Thomas note, the evidence is consistent with a market that

Answer 96

As Bernard and Thomas note, the evidence is consistent with a market that ‘fails to adequately revise its expectations for quarter t + 1 earnings upon receipt of the news for quarter t’

Question 97

Post earnings announcement drift

Answer 97

Firms’ stock prices move predictably after earnings announcements Tendency for stock prices react quickly to earnings reports, but continue to drift in the same direction for three quarters and then partially reverse in quarter four. PEAD is the tendency of a share price to drift downwards weeks after a company has announced an earnings downgrade (or to drift upwards after a company has announced an earnings upgrade

Question 98

Finding by Bernard and Thomas

Answer 98

on average, companies that announced the greatest positive earnings surprise tended to outperform the general market by 2% in the following 60 days. companies with the largest negative earnings surprise tended to under perform the market by 2% in the following 60 days

Question 99

What causes PEAD

Answer 99

A company’s results simply don’t switch from one quarter to another. Good and bad trading results tend to flow on for several quarters. analysts who are surprised two or three times by a company’s downgrade announcements learn to factor it into their estimates, to the point where they tend to over-compensate in their estimates.

Question 100

Sloan shows that | investors act as if

Answer 100

if they do not anticipate the lower persistence of the accrual component of earnings, resulting in significant security mispricing

Question 101

Sloan argues that the key factor driving the different properties of the accrual and cash flow components of earnings is

Answer 101

the greater subjectivity involved in the estimation of accruals. Accountants more typically refer to the degree of subjectivity involved in an accounting measurement in terms of the verifiability of that measurement

Question 102

Sloan defines accruals as

Answer 102

Non cash working capital less depreciate expense

Question 103

Findings of Sloan

Answer 103

accrual portion of earnings is less persistent than cash portion profitability drops when accrual reverses

Question 104

Results of Sloan's findings

Answer 104

Current earnings is less likely to persist if it is attributable to accrual portion rather than cash portion

Question 105

DRS demonstrate that the persistence of the free cash flow component of accounting earnings depends

Answer 105

on how the firm chooses to distribute (fund) free cash flow | surpluses (deficits)

Question 106

Earnings or net income reported under the accrual accounting basis is

Answer 106

a combination of | cash flow from operations and accrual components (Sloan; DRS)

Question 107

share prices do not fully differentiate

Answer 107

the information content between | accruals and cash flows information (Sloan 1996

Question 108

Persistency means

Answer 108

the degree in which the current period components transpire again in the future periods

Question 109

lower persistence of accruals in future periods may be due to

Answer 109

the poor | reliability aspect of accruals resulting from estimation errors or intentional opportunistic manipulations

Question 110

also lower accruals persistency is not due to earnings management or manipulations, but instead associated with

Answer 110

economic growth factors, such as diminishing marginal returns from increasing level of investments rather than accounting distortion

Question 111

Market and accruals

Answer 111

the market systematically over-estimates the persistence of accruals that have a tendency to reverse and under-estimates the persistence of cash flows.

Question 112

Sloan who argued

Answer 112

that investors are unable to distinguish between the more persistent cash component of earnings and the accrual component of earnings that has a greater tendency to reverse.

Question 113

Dechow, Richardson, & Sloan (2008) observed that

Answer 113

observed that a company’s free cash flows could be alternately paid out to investors as dividends or stock repurchases, used to retire company debt, or retained within the company as cash balances.

Question 114

Dechow, Richardson, & Sloan found that cash paid out to

Answer 114

investors was most valuable

Question 115

Dechow, Richardson, & | Sloan offered four conclusions from their research: First,

Answer 115

earnings alone were an insufficient benchmark with which | to evaluate a company.

Question 116

DRC | Second,

Answer 116

cash retained by a company for its projects was less valuable than cash paid out to investors or used to retire debt.

Question 117

DRC | Third

Answer 117

companies with large accruals had lower earnings persistence and lower future returns to investors than companies with relatively higher cas

Question 118

DRC | Fourth

Answer 118

in valuing a company, cash retained | within the company was less valuable than cash paid out.

Question 119

What is the global settlement

Answer 119

is an enforcement agreement that took effect in 2003 between SEC, NAD, NYSE, New York Attorney General and 10 of the largest investment firms

Question 120

As part of the Global Settlement, the Settling Firms | agreed to

Answer 120

several rules designed to prevent abuse stemming from pressure by investment bankers on research analysts to provide favorable coverage of specific issuers or securities

Question 121

Rules arising from Global Settlement

Answer 121

Settling Firms were required to separate their Investment Banking and Research departments from each other both physically and with information “firewalls.”

Question 122

Another rule of Global Settlement

Answer 122

budget allocation for Research was to be independent of | Investment Banking

Question 123

Objective of global settlement

Answer 123

promote analyst independence, additional disclosure re conflicts

Question 124

What did SRO do

Answer 124

rules and safeguards to separate research | analysts from the review, pressure and oversight of investment banking sector

Question 125

Object of SRO

Answer 125

intended to ensure the integrity of research, and to protect investors from being misled as a result of a failure to disclose potential conflicts of interest.