Description
IusetheopportunityofcommentingonCassell,Myers,andSeidel(CMS)todiscussthebroaderissueoftherelationbetweendisclosurequalityandreportingquality.Threeaspectsofthisrelationareworthexploring
1)jointdecisionmaking,(2)incentives,and(3)temporalvariation.IplaceCMSinthecontextofthisresearchandpointoutavenuesforfutureresearch.
Accounting, Organizations and Society 46 (2015) 39–43
Contents lists available at ScienceDirect
Accounting, Organizations and Society
journal homepage: www.elsevier.com/locate/aos
The relation between disclosure quality and reporting quality: A
discussion of Cassell, Myers, and Seidel (2015)
R
Jennifer Wu Tucker
?
Fisher School of Accounting, Warrington College of Business Administration, University of Florida, United States
a r t i c l e i n f o
Article history:
Available online 6 June 2015
a b s t r a c t
I use the opportunity of commenting on Cassell, Myers, and Seidel (CMS) to discuss the broader issue
of the relation between disclosure quality and reporting quality. Three aspects of this relation are worth
exploring: (1) joint decision making, (2) incentives, and (3) temporal variation. I place CMS in the context
of this research and point out avenues for future research.
© 2015 Elsevier Ltd. All rights reserved.
Introduction
Cassell, Myers, and Seidel (2015, CMS) examine the relation be-
tween the transparency of disclosures about activity in the bad-
debt allowance, inventory allowance, and deferred tax assets al-
lowance accounts and accruals-based earnings management. The
study ?nds that ?rms manipulate earnings through accruals to a
smaller degree when they provide transparent disclosures about
activity in these allowance accounts. The authors also ?nd that the
placement of such transparent disclosures, whether in a summary
schedule presented after the ?nancial statements and notes or
spread throughout the notes to the ?nancial statements, does not
provide additional information about ?rms’ accruals-based earn-
ings management. The ?ndings suggest that users of ?nancial re-
ports may use ?rms’ disclosure behavior as a signal of ?rms’ re-
porting behavior.
1
CMS is distinctive in three ways. First, CMS is one of a few
studies that investigate the reporting of individual accounts for ev-
idence of earnings management (Jackson & Liu, 2010; Marquardt
& Wiedman, 2004; McNichols & Wilson, 1988; Schrand & Wong,
2003). Studying individual accounts for earnings management be-
R
I thank Marcus Kirk, Hun Tong Tan (the editor), Senyo Tse, Angie Wang, and
participants of the 2014 Accounting, Organization and Society Conference. I thank the
J. Michael Cook/Deloitte Professorship for ?nancial support and Deloitte & Touche
LLP for sponsoring the Conference.
?
Tel.: +1 (352) 273 0214.
E-mail address: [email protected]?.edu
1
In this discussion paper, c?reportingd? means the reporting of accounting num-
bers in a company’s ?nancial statements and c?disclosured? means the ?rm’s pre-
sentation of information outside of the ?nancial statements, such as in the notes,
the Management Discussion & Analysis, and press releases.
havior not only overcomes some measurement problems that re-
searchers face (e.g., what do unmanaged earnings look like? Which
aggregate earnings do managers target?), but also provides insights
into how earnings are managed.
Second, CMS is one of a limited number of studies that exam-
ine the disclosure of particular corporate activities. The vast ma-
jority of disclosure studies focus on management earnings fore-
casts (MEF)—managers’ projections of a summary operating per-
formance measure. This focus is due to the importance of earn-
ings in measuring performance and the availability of machine-
readable data. In practice, managers provide many types of dis-
closures beyond MEF, either voluntarily or with discretion in de-
ciding what to disclose and how to disclose mandatorily required
items. Yet, very few studies have examined the disclosure of partic-
ular corporate activities (e.g., capital expenditures, inventory man-
agement, and warranties) and data in these studies are typically
hand collected (Brown, Gordon, & Wermers, 2006; Cohen, Masako,
Huang, & Zach, 2011; Sun, 2012). Examining particular activities
complements traditional MEF research and helps investors, regula-
tors, and practitioners understand a ?rm’s disclosure strategy as a
whole.
Last, and more important, CMS is one of a few archival studies
that investigate the relation between ?nancial reporting and dis-
closure. Because the same management makes the reporting and
disclosure decisions, such investigations may uncover signals that
investors can glean from one type of managerial behavior and use
to better understand the other type of managerial behavior. Fi-
nancial reporting and disclosure differ in two main respects. First,
annual ?nancial statements are audited; quarterly ?nancial state-
ments are closely reviewed by auditors even though they are not
audited. In contrast, disclosure is not audited, except for the noteshttp://dx.doi.org/10.1016/j.aos.2015.05.002
0361-3682/© 2015 Elsevier Ltd. All rights reserved.
40 J.W. Tucker / Accounting, Organizations and Society 46 (2015) 39–43
to the ?nancial statements in annual reports. From the perspective
of auditor involvement, managerial discretion is larger for disclo-
sure than for reporting. Second, reporting is quantitative, whereas
most disclosure is qualitative. Managers have more discretion in
qualitative representation, because they can decide on the length,
tone, complexity, modi?cations, etc. beyond the numeric presenta-
tion, than in quantitative representation. Given these differences,
managers’ decisions in disclosure settings can reveal a wealth of
information for investors to gauge the implications of ?nancial re-
porting. On the other hand, managers’ reporting decisions may
help investors better understand corporate disclosures.
Three aspects of the relation between disclosure quality and re-
porting quality are worth exploring: (1) joint decision making, (2)
incentives, and (3) temporal variation.
2
The joint-decision-making
nature of the relation leads to two interesting questions. Is disclo-
sure quality a stronger signal for reporting quality or vice versa?
Do managers use their discretion in reporting and disclosure as
complementary or substitutive tools?
Incentives are key to understanding and predicting how man-
agers use their reporting and disclosure discretion. Are incentives
present in the suspected cases of managerial misuse of discretion?
What are the incentives that lead managers to use discretion in
reporting versus the incentives that lead them to use discretion in
disclosure?
Temporary variation or the lack of it can be considered a con-
straint to managers’ use of discretion. How feasible is it for man-
agers to use their discretion in reporting or in disclosure in the
same way from year to year? To what extent can a sticky corpo-
rate policy for the strategy of reporting explain temporal variation
in the disclosure strategy, and vice versa?
In my view, the most important contribution of CMS is to shed
light on the relation between disclosure quality and reporting qual-
ity. This contribution, however, seems to be incidental. CMS couch
their study in the c?detectiond? story instead of in the joint deci-
sion of reporting and disclosure. They argue that the likelihood of
detection decreases when a required disclosure is not transparent
and therefore predict that ?rms whose disclosure of the allowance
accounts is not transparent are more likely to manipulate the re-
porting of these accounts. CMS ignore the fact that the same man-
agement simultaneously makes the reporting and disclosure deci-
sions. In addition, CMS implicitly assume that managers have in-
centives to report higher earnings and do not identify situations
when such incentives are especially strong or absent. Moreover,
CMS do not address the issue of stickiness in corporate reporting
and disclosure. These comments are less about the shortcomings
of CMS, but more about the opportunities for future research.
In the next three sections I discuss extant literature; the con-
tribution of CMS; and future research opportunities related to the
joint decision making, incentives, and temporal variation aspects of
the relation between disclosure quality and reporting quality. Then,
I discuss a few execution issues in CMS. A short summary follows.
Joint decision making
Examining managers’ reporting or disclosure choices has been a
tradition in accounting research (Fields, Lys, & Vinent, 2001; Healy
& Palepu, 2001). These choices, however, are often examined as
standalone managerial decisions. Managers may adopt an overall
strategy for ?nancial reporting and disclosure and decide on the
mix of the elements in their communication package. This perspec-
2
In this discussion paper, c?high qualityd? means that managers use their
discretion to convey the economic information at the ?rm. CMS operationalize
c?disclosure qualityd? as disclosure transparency and c?reporting qualityd? as the
degree of upward earnings management.
tive has seldom been explicitly taken in prior research.
3
The lack of
research into the relation between reporting and disclosure might
be due to the view that ?nancial reporting is the primary source
of information to the capital markets (Gigler & Hemmer, 2001, p.
472). A secondary reason could be the high costs of collecting dis-
closure data in the ?rst three decades of archival ?nancial research.
The fact that multiple reporting and disclosure decisions are made
by the same management under the same incentives around the
same time has been largely ignored in prior accounting research.
Only a few analytical papers have investigated the relation be-
tween ?nancial reporting and disclosure. In a principal-agent set-
ting, Gigler and Hemmer (2001) conclude from the contract design
point of view that it may be optimal for ?rms that lack accounting
conservatism to disclose the yet-to-be-reported ?nancial numbers
early. In a risk-neutral valuation setting, Einhorn (2005) shows that
the voluntary disclosure of a value-relevant signal does not depend
on the realization of the mandatorily disclosed value-relevant sig-
nal (e.g., earnings), but depends on the variance–covariance struc-
ture of the voluntary signal, mandatory signal, and ?rm value.
Also in a risk-neutral valuation setting, Bagnoli and Watts (2007)
demonstrate that a ?rm’s voluntary disclosure decision depends
on its reporting: if the earnings report contains good (bad) news,
managers voluntarily disclose the variance of earnings components
only when the variance is small (large). These studies have differ-
ent or even con?icting predictions due to different model assump-
tions.
A few archival studies provide evidence on the sequential rela-
tion between corporate reporting and disclosure. Lang and Lund-
holm (1993) ?nd that the Association for Investment Management
and Research (AIMR) disclosure scores, which re?ect the quality
of mandatory and voluntary disclosures assessed by ?nancial an-
alysts, are higher for ?rms with lower value relevance of reported
earnings (measured by the earnings response coe?cient, ERC), sug-
gesting a substitutive relation between reporting and disclosure.
Lennox and Park (2006), however, ?nd a positive association be-
tween the ERC and managers’ issuance of earnings forecasts. Both
studies examine the voluntary disclosure decision conditional on a
?rm’s historical properties of reported earnings and the difference
in their ?ndings might be attributed to the limitations of AIMR
scores. In contrast, Kasznik (1999) examines the effect of volun-
tary disclosure on subsequent earnings reporting and ?nds some
evidence that ?rms manipulate reported earnings to meet the pre-
viously disclosed earnings forecasts.
Three novel archival studies explore the contemporaneous rela-
tion between reporting and disclosure. Gong, Li, and Xie (2009)
?nd that the unintentional errors in accruals and MEF, which are
issued around the same time as reported accruals, are positively
correlated. Feng, Ge, Li, and Nagarajan (2014) examine intentional
managerial behavior and ?nd that ?rms manipulating earnings use
MEF concurrently to delay the detection of earnings management,
although such orchestrated efforts have severe consequences once
misstatements are exposed. Francis, Nanda, and Olsson (2008) are
the closest to CMS and report that ?rms with higher earnings qual-
ity provide more expansive voluntary disclosures. They measure
disclosure by coding items in the annual report and their ?nding
suggests a complementary relation between reporting and disclo-
sure quality. This relation disappears, however, when Francis et al.
use alternative proxies for voluntary disclosure and they ?nd that
the issuance and precision of MEF and the number of conference
calls during the ?scal year are negatively associated with earnings
quality, suggesting a substitutive relation. These puzzling results
imply either that speci?c types of voluntary disclosure (e.g., annual
3
Exceptions include Clarkson, Kao, and Richardson (1999) and Lu and Tucker
(2012).
J.W. Tucker / Accounting, Organizations and Society 46 (2015) 39–43 41
report, MEF, and conference calls) play different roles in managers’
overall communication package or that the composite scores used
by Francis et al. do not measure a ?rm’s overall voluntary disclo-
sure.
CMS extend this line of research by examining the contempora-
neous reporting and disclosure of speci?c accounts. By examining
speci?c accounts for which managerial discretion in reporting and
disclosure is high, CMS identify a conceptual relation that is more
direct and an empirical relation that is subject to fewer measure-
ment errors than prior research. Although the ?ndings of CMS may
not necessarily generalize to other reporting and disclosure items,
understanding pieces of a puzzle would be helpful for readers to
understand the whole.
One weakness of CMS is that the authors view their study
in the traditional misstatement framework instead of the joint-
decision framework. The misstatement framework includes three
elements: incentives, opportunities, and detection. CMS focus on
detection and argue that when managers do not manipulate the
allowance accounts, they can afford transparent disclosure of these
accounts. Otherwise, transparent disclosure would increase the de-
tection rate of misstatements in these accounts. CMS examine
the extent of earnings management conditional on the disclosure
transparency of these accounts or the lack of transparency. In con-
trast, in the joint-decision framework managers simultaneously de-
cide on the reporting and disclosure of these accounts. Therefore,
how managers report the accounts could serve as a signal of how
managers disclose these accounts and vice versa. In this frame-
work, a simultaneous empirical analysis would be more appropri-
ate.
The comment of one conference participant was related to this
weakness of CMS. The participant pointed out that the original title
of the study suggested causality but that the authors had not con-
ducted the reserves causality analysis. Although reverse causality
could be addressed by additional empirical analysis, the real un-
derlying issue is that the authors take the perspective of ?nancial
misreporting with a focus on detection instead of the perspective
of joint decision making.
The joint-decision perspective invites interesting questions for
future research. For example, researchers may identify situations in
which the signal gleaned from reporting for disclosure is stronger
than the signal gleaned from disclosure for reporting or vice versa.
It is also interesting to identify situations in which reporting and
disclosure are used as complements and situations in which they
are used as substitutes.
Incentives
Incentives are key to understanding and predicting how man-
agers use their reporting and disclosure discretion. Some manage-
rial incentives are driven by valuation considerations and others
are driven by evaluation. Managerial incentives could also be re-
lated to stakeholders other than shareholders and creditors, such
as customers, suppliers, and the Internal Revenue Service. A major
reason why investors may learn from one type of managerial de-
cision about another type is incentive consistency: multiple deci-
sions are made by the management under the same, perhaps non-
transparent, incentives.
4
In general, when managers have discretion over reporting and
disclosure choices, they prefer the choices that help them project
a picture of steady earnings growth (Gordon, 1964). Managers may
not always seek to report higher earnings, however. Managers may
prefer to understate earnings when (1) the excess earnings would
4
An interesting study by Goodman, Neamtiu, Shroff, and White (2014) examines
the relation between management forecast quality and investment e?ciency based
on the intuition that managers use the same forecasting skills in both tasks.
not translate into extra compensation for the current period or
would not be sustainable in the future, (2) the management has
just taken over the ?rm, (3) ?rms want to avoid political or union
attention, or (4) ?rms want to avoid renegotiations with major
suppliers and customers. Moreover, given the reversal property of
accounting accruals, it is infeasible for managers to use their dis-
cretion to report higher earnings year after year.
Therefore, studies of managerial discretion are remiss if they
ignore managerial incentives. The problem is more severe when
earnings management or disclosure management is more di?cult
to identify and measure. CMS do not discuss managerial incentives
and most of their empirical analyses assume that managers pre-
fer higher reported earnings. Although CMS’ focus on speci?c ac-
counts allows them to sharpen their measures of reporting and
disclosure quality, the lack of discussion of managerial incentives
and the failure to incorporate incentives into their empirical analy-
sis is a shortcoming of the study. Future research could incorporate
managerial incentives in the investigations of the relation between
disclosure quality and reporting quality.
Temporal variation
The interaction between a company and the capital markets
is a multi-period game. Managers’ past reporting and disclosure
practices may constrain their practices in future periods (Barton &
Simko, 2006). Perhaps to maintain ?exibility, managers rarely de-
clare their philosophy or policy for corporate disclosure. Investors,
however, form expectations of corporate disclosure from a ?rm’s
past practices. The theorized bene?ts of disclosure in improving
risk sharing and stock liquidity and in reducing the cost of capital
arise from managers’ commitment to a corporate policy of high-
quality disclosure (Diamond, 1985; Diamond & Verrecchia, 1991).
The commitment bene?ts are perhaps the reason why disclosure
practices are often sticky from year to year. Chen, DeFond, and
Park (2002) ?nd that after ?rms start to include balance-sheet data
in their earnings announcement press releases, two thirds of the
?rms continue to do so. Lansford, Lev, and Tucker (2013) report
that ?rms largely continue their practices of either disaggregating
MEF or not disaggregating it in the subsequent year. If ?rms de-
viate from past practices, the change is a signal to investors. For
example, Houston, Lev, and Tucker (2010) and Chen, Matsumoto,
and Rajgopal (2011) document serious consequences when ?rms
stop providing quarterly MEF.
In contrast, a ?rm’s discretionary use of accounting choices to
boost reporting earnings cannot be persistent in theory because
most accounting accruals reverse in the subsequent accounting cy-
cle. To counter the reversal of accruals and continue to report de-
sired earnings, managers have to become increasingly aggressive
in using their discretion—a slippery slope to fraudulent reporting
(Schrand & Zechman, 2012).
As in most prior accounting research, CMS treat each ?rm-year
as standalone and do not discuss the temporal variation properties
of the reporting and the disclosure of the bad-debt allowance, in-
ventory allowance, and deferred tax asset allowance accounts. The
lack of discussion of disclosure stickiness and the implications of
stickiness is a shortcoming of CMS.
The investigations of reporting and disclosure stickiness and the
implications of stickiness are promising areas for future research.
To what extent can a fairly sticky corporate disclosure strategy pre-
dict a reporting strategy that has to exhibit temporal variation? Do
managers use their discretion differently depending on the con-
straints of temporal variation in the use of discretion? Under what
circumstances are the constraints less binding, and does the rela-
tion between disclosure quality and reporting quality change ac-
cordingly?
42 J.W. Tucker / Accounting, Organizations and Society 46 (2015) 39–43
Execution issues
In CMS, the estimate of discretionary aggregate accruals using
the modi?ed Jones model for the transparent and non-transparent
disclosure samples combined is close to zero or only slightly neg-
ative, whereas prior research reports a much larger magnitude of
negative discretionary accruals using the same model speci?cation
(Kothari, Leone, & Wasley, 2005; Tucker & Zarowin, 2006). In ad-
dition, CMS’s estimate of discretionary accruals using the model
speci?cation of Ball and Shivakumar (2006) is positive and of fairly
large magnitude. In contrast, the estimate of discretionary (cur-
rent) accruals in Hope, Thomas, and Vyas (2013) is negative. Con-
ference participants pointed out these empirical discrepancies, al-
though there are no theoretical grounds for the mean or median
of discretionary accruals (which empirically are residuals of re-
gression estimations) of a large sample to be either signi?cantly
positive or negative. The discrepancies may be because CMS se-
lect ?rms that report material balances of the three allowance
accounts and therefore derive a sample that is different from
those used in prior research. Future research may examine why
prior research documents systematically negative or positive dis-
cretionary accruals for samples that are supposed to represent the
population of interest before researchers even consider subsamples
of incentive suspects. The investigation would re?ne our under-
standing of the generalizability of ?ndings related to discretionary
accruals.
The reported deferred tax assets (DTA) allowance in Appendix A
of CMS is surprisingly high and right-skewed. After scaling by to-
tal assets, the mean (median) for the transparent-disclosure group
is 0.238 (0.021) and that for the non-transparent-disclosure group
is 2.642 (0.147). The large magnitude of the allowance is concern-
ing even though it is mathematically possible. When the mean al-
lowance is 2.642, for example, the gross DTA should be even larger.
DTA arise from the bene?ts of paying less tax in the future due
to net operating losses or higher taxable income than ?nancial in-
come in past ?scal periods. Thus, DTA are a cumulative number of
a percentage of ?ow measures. It is unusual for the cumulative ef-
fects of such ?ow measures to be many times larger than a ?rm’s
total assets—a stock measure. In comparison, the mean of the DTA
valuation allowance is only 13.1% of the gross DTA in Schrand and
Wong (2003, Table 1). CMS provide a note in Appendix A about
the large magnitude of this allowance account. It would be helpful
to readers if the paper also provides information about the num-
ber of ?rms with unusually large magnitudes of the allowance, the
characteristics of these ?rms, and the robustness of ?ndings after
excluding these observations. As Miller and Skinner (1998) point
out, the DTA due to net operating loss carryforwards is the most
important component of DTA. Firms with net operating loss under
the tax rules might be quite different from ?rms that record DTA
due to higher taxable income than ?nancial income in past peri-
ods. Future research may separate these two types of ?rms and
examine managers’ use of discretion in the DTA allowance from
these two different sources.
The sample of CMS excludes observations when ?rms provide
transparent disclosures for some, but not all, of three material (dis-
closed) valuation allowance accounts. The exclusion of c?partially
transparentd? observations is reasonable because CMS focus on the
dichotomy of transparent disclosure versus non-transparent disclo-
sure. Given the fact that managers have three major allowance
accounts in their c?tool box,d? however, it would be interest-
ing to examine the phenomenon of partial transparency. In par-
ticular, why do managers select a particular allowance account
to manipulate earnings and withhold information? How do in-
vestors interpret partial transparency differently from full trans-
parency and no-transparency? These are opportunities for future
research.
Conclusion
CMS ask an interesting question about the relation between dis-
closure quality and reporting quality. To answer this question, the
authors have painstakingly hand-collected a large set of data and
provided preliminary evidence that a ?rm’s decision on how trans-
parently it discloses activity in the bad-debt allowance, inventory
allowance, and deferred tax assets allowance accounts can serve as
a signal to investors of managers’ misuse of discretion in reporting
these allowance accounts and in their overall accruals reporting.
Despite some shortcomings, CMS make a nice contribution to the
accounting literature. I expect more future research to explore the
relation between disclosure quality and reporting quality.
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doc_804737871.pdf
IusetheopportunityofcommentingonCassell,Myers,andSeidel(CMS)todiscussthebroaderissueoftherelationbetweendisclosurequalityandreportingquality.Threeaspectsofthisrelationareworthexploring
1)jointdecisionmaking,(2)incentives,and(3)temporalvariation.IplaceCMSinthecontextofthisresearchandpointoutavenuesforfutureresearch.Accounting, Organizations and Society 46 (2015) 39–43
Contents lists available at ScienceDirect
Accounting, Organizations and Society
journal homepage: www.elsevier.com/locate/aos
The relation between disclosure quality and reporting quality: A
discussion of Cassell, Myers, and Seidel (2015)
R
Jennifer Wu Tucker
?
Fisher School of Accounting, Warrington College of Business Administration, University of Florida, United States
a r t i c l e i n f o
Article history:
Available online 6 June 2015
a b s t r a c t
I use the opportunity of commenting on Cassell, Myers, and Seidel (CMS) to discuss the broader issue
of the relation between disclosure quality and reporting quality. Three aspects of this relation are worth
exploring: (1) joint decision making, (2) incentives, and (3) temporal variation. I place CMS in the context
of this research and point out avenues for future research.
© 2015 Elsevier Ltd. All rights reserved.
Introduction
Cassell, Myers, and Seidel (2015, CMS) examine the relation be-
tween the transparency of disclosures about activity in the bad-
debt allowance, inventory allowance, and deferred tax assets al-
lowance accounts and accruals-based earnings management. The
study ?nds that ?rms manipulate earnings through accruals to a
smaller degree when they provide transparent disclosures about
activity in these allowance accounts. The authors also ?nd that the
placement of such transparent disclosures, whether in a summary
schedule presented after the ?nancial statements and notes or
spread throughout the notes to the ?nancial statements, does not
provide additional information about ?rms’ accruals-based earn-
ings management. The ?ndings suggest that users of ?nancial re-
ports may use ?rms’ disclosure behavior as a signal of ?rms’ re-
porting behavior.
1
CMS is distinctive in three ways. First, CMS is one of a few
studies that investigate the reporting of individual accounts for ev-
idence of earnings management (Jackson & Liu, 2010; Marquardt
& Wiedman, 2004; McNichols & Wilson, 1988; Schrand & Wong,
2003). Studying individual accounts for earnings management be-
R
I thank Marcus Kirk, Hun Tong Tan (the editor), Senyo Tse, Angie Wang, and
participants of the 2014 Accounting, Organization and Society Conference. I thank the
J. Michael Cook/Deloitte Professorship for ?nancial support and Deloitte & Touche
LLP for sponsoring the Conference.
?
Tel.: +1 (352) 273 0214.
E-mail address: [email protected]?.edu
1
In this discussion paper, c?reportingd? means the reporting of accounting num-
bers in a company’s ?nancial statements and c?disclosured? means the ?rm’s pre-
sentation of information outside of the ?nancial statements, such as in the notes,
the Management Discussion & Analysis, and press releases.
havior not only overcomes some measurement problems that re-
searchers face (e.g., what do unmanaged earnings look like? Which
aggregate earnings do managers target?), but also provides insights
into how earnings are managed.
Second, CMS is one of a limited number of studies that exam-
ine the disclosure of particular corporate activities. The vast ma-
jority of disclosure studies focus on management earnings fore-
casts (MEF)—managers’ projections of a summary operating per-
formance measure. This focus is due to the importance of earn-
ings in measuring performance and the availability of machine-
readable data. In practice, managers provide many types of dis-
closures beyond MEF, either voluntarily or with discretion in de-
ciding what to disclose and how to disclose mandatorily required
items. Yet, very few studies have examined the disclosure of partic-
ular corporate activities (e.g., capital expenditures, inventory man-
agement, and warranties) and data in these studies are typically
hand collected (Brown, Gordon, & Wermers, 2006; Cohen, Masako,
Huang, & Zach, 2011; Sun, 2012). Examining particular activities
complements traditional MEF research and helps investors, regula-
tors, and practitioners understand a ?rm’s disclosure strategy as a
whole.
Last, and more important, CMS is one of a few archival studies
that investigate the relation between ?nancial reporting and dis-
closure. Because the same management makes the reporting and
disclosure decisions, such investigations may uncover signals that
investors can glean from one type of managerial behavior and use
to better understand the other type of managerial behavior. Fi-
nancial reporting and disclosure differ in two main respects. First,
annual ?nancial statements are audited; quarterly ?nancial state-
ments are closely reviewed by auditors even though they are not
audited. In contrast, disclosure is not audited, except for the noteshttp://dx.doi.org/10.1016/j.aos.2015.05.002
0361-3682/© 2015 Elsevier Ltd. All rights reserved.
40 J.W. Tucker / Accounting, Organizations and Society 46 (2015) 39–43
to the ?nancial statements in annual reports. From the perspective
of auditor involvement, managerial discretion is larger for disclo-
sure than for reporting. Second, reporting is quantitative, whereas
most disclosure is qualitative. Managers have more discretion in
qualitative representation, because they can decide on the length,
tone, complexity, modi?cations, etc. beyond the numeric presenta-
tion, than in quantitative representation. Given these differences,
managers’ decisions in disclosure settings can reveal a wealth of
information for investors to gauge the implications of ?nancial re-
porting. On the other hand, managers’ reporting decisions may
help investors better understand corporate disclosures.
Three aspects of the relation between disclosure quality and re-
porting quality are worth exploring: (1) joint decision making, (2)
incentives, and (3) temporal variation.
2
The joint-decision-making
nature of the relation leads to two interesting questions. Is disclo-
sure quality a stronger signal for reporting quality or vice versa?
Do managers use their discretion in reporting and disclosure as
complementary or substitutive tools?
Incentives are key to understanding and predicting how man-
agers use their reporting and disclosure discretion. Are incentives
present in the suspected cases of managerial misuse of discretion?
What are the incentives that lead managers to use discretion in
reporting versus the incentives that lead them to use discretion in
disclosure?
Temporary variation or the lack of it can be considered a con-
straint to managers’ use of discretion. How feasible is it for man-
agers to use their discretion in reporting or in disclosure in the
same way from year to year? To what extent can a sticky corpo-
rate policy for the strategy of reporting explain temporal variation
in the disclosure strategy, and vice versa?
In my view, the most important contribution of CMS is to shed
light on the relation between disclosure quality and reporting qual-
ity. This contribution, however, seems to be incidental. CMS couch
their study in the c?detectiond? story instead of in the joint deci-
sion of reporting and disclosure. They argue that the likelihood of
detection decreases when a required disclosure is not transparent
and therefore predict that ?rms whose disclosure of the allowance
accounts is not transparent are more likely to manipulate the re-
porting of these accounts. CMS ignore the fact that the same man-
agement simultaneously makes the reporting and disclosure deci-
sions. In addition, CMS implicitly assume that managers have in-
centives to report higher earnings and do not identify situations
when such incentives are especially strong or absent. Moreover,
CMS do not address the issue of stickiness in corporate reporting
and disclosure. These comments are less about the shortcomings
of CMS, but more about the opportunities for future research.
In the next three sections I discuss extant literature; the con-
tribution of CMS; and future research opportunities related to the
joint decision making, incentives, and temporal variation aspects of
the relation between disclosure quality and reporting quality. Then,
I discuss a few execution issues in CMS. A short summary follows.
Joint decision making
Examining managers’ reporting or disclosure choices has been a
tradition in accounting research (Fields, Lys, & Vinent, 2001; Healy
& Palepu, 2001). These choices, however, are often examined as
standalone managerial decisions. Managers may adopt an overall
strategy for ?nancial reporting and disclosure and decide on the
mix of the elements in their communication package. This perspec-
2
In this discussion paper, c?high qualityd? means that managers use their
discretion to convey the economic information at the ?rm. CMS operationalize
c?disclosure qualityd? as disclosure transparency and c?reporting qualityd? as the
degree of upward earnings management.
tive has seldom been explicitly taken in prior research.
3
The lack of
research into the relation between reporting and disclosure might
be due to the view that ?nancial reporting is the primary source
of information to the capital markets (Gigler & Hemmer, 2001, p.
472). A secondary reason could be the high costs of collecting dis-
closure data in the ?rst three decades of archival ?nancial research.
The fact that multiple reporting and disclosure decisions are made
by the same management under the same incentives around the
same time has been largely ignored in prior accounting research.
Only a few analytical papers have investigated the relation be-
tween ?nancial reporting and disclosure. In a principal-agent set-
ting, Gigler and Hemmer (2001) conclude from the contract design
point of view that it may be optimal for ?rms that lack accounting
conservatism to disclose the yet-to-be-reported ?nancial numbers
early. In a risk-neutral valuation setting, Einhorn (2005) shows that
the voluntary disclosure of a value-relevant signal does not depend
on the realization of the mandatorily disclosed value-relevant sig-
nal (e.g., earnings), but depends on the variance–covariance struc-
ture of the voluntary signal, mandatory signal, and ?rm value.
Also in a risk-neutral valuation setting, Bagnoli and Watts (2007)
demonstrate that a ?rm’s voluntary disclosure decision depends
on its reporting: if the earnings report contains good (bad) news,
managers voluntarily disclose the variance of earnings components
only when the variance is small (large). These studies have differ-
ent or even con?icting predictions due to different model assump-
tions.
A few archival studies provide evidence on the sequential rela-
tion between corporate reporting and disclosure. Lang and Lund-
holm (1993) ?nd that the Association for Investment Management
and Research (AIMR) disclosure scores, which re?ect the quality
of mandatory and voluntary disclosures assessed by ?nancial an-
alysts, are higher for ?rms with lower value relevance of reported
earnings (measured by the earnings response coe?cient, ERC), sug-
gesting a substitutive relation between reporting and disclosure.
Lennox and Park (2006), however, ?nd a positive association be-
tween the ERC and managers’ issuance of earnings forecasts. Both
studies examine the voluntary disclosure decision conditional on a
?rm’s historical properties of reported earnings and the difference
in their ?ndings might be attributed to the limitations of AIMR
scores. In contrast, Kasznik (1999) examines the effect of volun-
tary disclosure on subsequent earnings reporting and ?nds some
evidence that ?rms manipulate reported earnings to meet the pre-
viously disclosed earnings forecasts.
Three novel archival studies explore the contemporaneous rela-
tion between reporting and disclosure. Gong, Li, and Xie (2009)
?nd that the unintentional errors in accruals and MEF, which are
issued around the same time as reported accruals, are positively
correlated. Feng, Ge, Li, and Nagarajan (2014) examine intentional
managerial behavior and ?nd that ?rms manipulating earnings use
MEF concurrently to delay the detection of earnings management,
although such orchestrated efforts have severe consequences once
misstatements are exposed. Francis, Nanda, and Olsson (2008) are
the closest to CMS and report that ?rms with higher earnings qual-
ity provide more expansive voluntary disclosures. They measure
disclosure by coding items in the annual report and their ?nding
suggests a complementary relation between reporting and disclo-
sure quality. This relation disappears, however, when Francis et al.
use alternative proxies for voluntary disclosure and they ?nd that
the issuance and precision of MEF and the number of conference
calls during the ?scal year are negatively associated with earnings
quality, suggesting a substitutive relation. These puzzling results
imply either that speci?c types of voluntary disclosure (e.g., annual
3
Exceptions include Clarkson, Kao, and Richardson (1999) and Lu and Tucker
(2012).
J.W. Tucker / Accounting, Organizations and Society 46 (2015) 39–43 41
report, MEF, and conference calls) play different roles in managers’
overall communication package or that the composite scores used
by Francis et al. do not measure a ?rm’s overall voluntary disclo-
sure.
CMS extend this line of research by examining the contempora-
neous reporting and disclosure of speci?c accounts. By examining
speci?c accounts for which managerial discretion in reporting and
disclosure is high, CMS identify a conceptual relation that is more
direct and an empirical relation that is subject to fewer measure-
ment errors than prior research. Although the ?ndings of CMS may
not necessarily generalize to other reporting and disclosure items,
understanding pieces of a puzzle would be helpful for readers to
understand the whole.
One weakness of CMS is that the authors view their study
in the traditional misstatement framework instead of the joint-
decision framework. The misstatement framework includes three
elements: incentives, opportunities, and detection. CMS focus on
detection and argue that when managers do not manipulate the
allowance accounts, they can afford transparent disclosure of these
accounts. Otherwise, transparent disclosure would increase the de-
tection rate of misstatements in these accounts. CMS examine
the extent of earnings management conditional on the disclosure
transparency of these accounts or the lack of transparency. In con-
trast, in the joint-decision framework managers simultaneously de-
cide on the reporting and disclosure of these accounts. Therefore,
how managers report the accounts could serve as a signal of how
managers disclose these accounts and vice versa. In this frame-
work, a simultaneous empirical analysis would be more appropri-
ate.
The comment of one conference participant was related to this
weakness of CMS. The participant pointed out that the original title
of the study suggested causality but that the authors had not con-
ducted the reserves causality analysis. Although reverse causality
could be addressed by additional empirical analysis, the real un-
derlying issue is that the authors take the perspective of ?nancial
misreporting with a focus on detection instead of the perspective
of joint decision making.
The joint-decision perspective invites interesting questions for
future research. For example, researchers may identify situations in
which the signal gleaned from reporting for disclosure is stronger
than the signal gleaned from disclosure for reporting or vice versa.
It is also interesting to identify situations in which reporting and
disclosure are used as complements and situations in which they
are used as substitutes.
Incentives
Incentives are key to understanding and predicting how man-
agers use their reporting and disclosure discretion. Some manage-
rial incentives are driven by valuation considerations and others
are driven by evaluation. Managerial incentives could also be re-
lated to stakeholders other than shareholders and creditors, such
as customers, suppliers, and the Internal Revenue Service. A major
reason why investors may learn from one type of managerial de-
cision about another type is incentive consistency: multiple deci-
sions are made by the management under the same, perhaps non-
transparent, incentives.
4
In general, when managers have discretion over reporting and
disclosure choices, they prefer the choices that help them project
a picture of steady earnings growth (Gordon, 1964). Managers may
not always seek to report higher earnings, however. Managers may
prefer to understate earnings when (1) the excess earnings would
4
An interesting study by Goodman, Neamtiu, Shroff, and White (2014) examines
the relation between management forecast quality and investment e?ciency based
on the intuition that managers use the same forecasting skills in both tasks.
not translate into extra compensation for the current period or
would not be sustainable in the future, (2) the management has
just taken over the ?rm, (3) ?rms want to avoid political or union
attention, or (4) ?rms want to avoid renegotiations with major
suppliers and customers. Moreover, given the reversal property of
accounting accruals, it is infeasible for managers to use their dis-
cretion to report higher earnings year after year.
Therefore, studies of managerial discretion are remiss if they
ignore managerial incentives. The problem is more severe when
earnings management or disclosure management is more di?cult
to identify and measure. CMS do not discuss managerial incentives
and most of their empirical analyses assume that managers pre-
fer higher reported earnings. Although CMS’ focus on speci?c ac-
counts allows them to sharpen their measures of reporting and
disclosure quality, the lack of discussion of managerial incentives
and the failure to incorporate incentives into their empirical analy-
sis is a shortcoming of the study. Future research could incorporate
managerial incentives in the investigations of the relation between
disclosure quality and reporting quality.
Temporal variation
The interaction between a company and the capital markets
is a multi-period game. Managers’ past reporting and disclosure
practices may constrain their practices in future periods (Barton &
Simko, 2006). Perhaps to maintain ?exibility, managers rarely de-
clare their philosophy or policy for corporate disclosure. Investors,
however, form expectations of corporate disclosure from a ?rm’s
past practices. The theorized bene?ts of disclosure in improving
risk sharing and stock liquidity and in reducing the cost of capital
arise from managers’ commitment to a corporate policy of high-
quality disclosure (Diamond, 1985; Diamond & Verrecchia, 1991).
The commitment bene?ts are perhaps the reason why disclosure
practices are often sticky from year to year. Chen, DeFond, and
Park (2002) ?nd that after ?rms start to include balance-sheet data
in their earnings announcement press releases, two thirds of the
?rms continue to do so. Lansford, Lev, and Tucker (2013) report
that ?rms largely continue their practices of either disaggregating
MEF or not disaggregating it in the subsequent year. If ?rms de-
viate from past practices, the change is a signal to investors. For
example, Houston, Lev, and Tucker (2010) and Chen, Matsumoto,
and Rajgopal (2011) document serious consequences when ?rms
stop providing quarterly MEF.
In contrast, a ?rm’s discretionary use of accounting choices to
boost reporting earnings cannot be persistent in theory because
most accounting accruals reverse in the subsequent accounting cy-
cle. To counter the reversal of accruals and continue to report de-
sired earnings, managers have to become increasingly aggressive
in using their discretion—a slippery slope to fraudulent reporting
(Schrand & Zechman, 2012).
As in most prior accounting research, CMS treat each ?rm-year
as standalone and do not discuss the temporal variation properties
of the reporting and the disclosure of the bad-debt allowance, in-
ventory allowance, and deferred tax asset allowance accounts. The
lack of discussion of disclosure stickiness and the implications of
stickiness is a shortcoming of CMS.
The investigations of reporting and disclosure stickiness and the
implications of stickiness are promising areas for future research.
To what extent can a fairly sticky corporate disclosure strategy pre-
dict a reporting strategy that has to exhibit temporal variation? Do
managers use their discretion differently depending on the con-
straints of temporal variation in the use of discretion? Under what
circumstances are the constraints less binding, and does the rela-
tion between disclosure quality and reporting quality change ac-
cordingly?
42 J.W. Tucker / Accounting, Organizations and Society 46 (2015) 39–43
Execution issues
In CMS, the estimate of discretionary aggregate accruals using
the modi?ed Jones model for the transparent and non-transparent
disclosure samples combined is close to zero or only slightly neg-
ative, whereas prior research reports a much larger magnitude of
negative discretionary accruals using the same model speci?cation
(Kothari, Leone, & Wasley, 2005; Tucker & Zarowin, 2006). In ad-
dition, CMS’s estimate of discretionary accruals using the model
speci?cation of Ball and Shivakumar (2006) is positive and of fairly
large magnitude. In contrast, the estimate of discretionary (cur-
rent) accruals in Hope, Thomas, and Vyas (2013) is negative. Con-
ference participants pointed out these empirical discrepancies, al-
though there are no theoretical grounds for the mean or median
of discretionary accruals (which empirically are residuals of re-
gression estimations) of a large sample to be either signi?cantly
positive or negative. The discrepancies may be because CMS se-
lect ?rms that report material balances of the three allowance
accounts and therefore derive a sample that is different from
those used in prior research. Future research may examine why
prior research documents systematically negative or positive dis-
cretionary accruals for samples that are supposed to represent the
population of interest before researchers even consider subsamples
of incentive suspects. The investigation would re?ne our under-
standing of the generalizability of ?ndings related to discretionary
accruals.
The reported deferred tax assets (DTA) allowance in Appendix A
of CMS is surprisingly high and right-skewed. After scaling by to-
tal assets, the mean (median) for the transparent-disclosure group
is 0.238 (0.021) and that for the non-transparent-disclosure group
is 2.642 (0.147). The large magnitude of the allowance is concern-
ing even though it is mathematically possible. When the mean al-
lowance is 2.642, for example, the gross DTA should be even larger.
DTA arise from the bene?ts of paying less tax in the future due
to net operating losses or higher taxable income than ?nancial in-
come in past ?scal periods. Thus, DTA are a cumulative number of
a percentage of ?ow measures. It is unusual for the cumulative ef-
fects of such ?ow measures to be many times larger than a ?rm’s
total assets—a stock measure. In comparison, the mean of the DTA
valuation allowance is only 13.1% of the gross DTA in Schrand and
Wong (2003, Table 1). CMS provide a note in Appendix A about
the large magnitude of this allowance account. It would be helpful
to readers if the paper also provides information about the num-
ber of ?rms with unusually large magnitudes of the allowance, the
characteristics of these ?rms, and the robustness of ?ndings after
excluding these observations. As Miller and Skinner (1998) point
out, the DTA due to net operating loss carryforwards is the most
important component of DTA. Firms with net operating loss under
the tax rules might be quite different from ?rms that record DTA
due to higher taxable income than ?nancial income in past peri-
ods. Future research may separate these two types of ?rms and
examine managers’ use of discretion in the DTA allowance from
these two different sources.
The sample of CMS excludes observations when ?rms provide
transparent disclosures for some, but not all, of three material (dis-
closed) valuation allowance accounts. The exclusion of c?partially
transparentd? observations is reasonable because CMS focus on the
dichotomy of transparent disclosure versus non-transparent disclo-
sure. Given the fact that managers have three major allowance
accounts in their c?tool box,d? however, it would be interest-
ing to examine the phenomenon of partial transparency. In par-
ticular, why do managers select a particular allowance account
to manipulate earnings and withhold information? How do in-
vestors interpret partial transparency differently from full trans-
parency and no-transparency? These are opportunities for future
research.
Conclusion
CMS ask an interesting question about the relation between dis-
closure quality and reporting quality. To answer this question, the
authors have painstakingly hand-collected a large set of data and
provided preliminary evidence that a ?rm’s decision on how trans-
parently it discloses activity in the bad-debt allowance, inventory
allowance, and deferred tax assets allowance accounts can serve as
a signal to investors of managers’ misuse of discretion in reporting
these allowance accounts and in their overall accruals reporting.
Despite some shortcomings, CMS make a nice contribution to the
accounting literature. I expect more future research to explore the
relation between disclosure quality and reporting quality.
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