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UBC Theses and Dissertations

Voluntary income increasing accounting changes : theory and further empirical investigation Coulombe, Daniel


This thesis presents a three step analysis of voluntary income increasing accounting changes. We first propose a theory as to why managers would elect to modify their reporting strategy. This theory builds on research on the economic factors motivating accounting choices, since it is assumed that accounting choices are a function of political costs, manager's compensation plans and debt constraints. Specifically, we claim that adversity motivates the manager to effect an income increasing accounting change. Secondly, the thesis proposes a theoretical analysis of the potential market responses to a change announcement. The stock price effect of a change announcement is examined as a function of investors' rational anticipations of the manager's reporting actions and as a function of the level of information about adversity that investors may have prior to a change announcement. An empirical analysis is presented in the third step of this thesis. Our empirical findings are that: 1- Change announcements, on average, have no significant impact on the market. 2- Relative to the Compustat population as a whole, firms that voluntarily adopt income increasing accounting changes exhibit symptoms of financial distress, suggesting that such change announcements are associated with financial adversity. 3- Firms which voluntarily adopt income increasing accounting changes tend to exhibit symptoms of financial distress one or more years prior to the change year, suggesting that change announcements tend not to be a timely source of information conveying distress to the market. 4- There is a significant negative association between investors' proxies for prior information about adversity and the market impact of the change, especially for the subset of firms with above average leverage, suggesting that the information content of the accounting change signal is inversely related to investors prior information about adversity. The empirical results thus support the view that investors, at the time a change occurs, have information about the prevailing state of the world, and that they have rational anticipations with respect to the manager's reporting behavior. In this respect, the accounting change is, on average, an inconsequential signal that adds little to what investors already knew before the change announcement.

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