Firms that Manage Earnings Routinely Overvalued
The corporate practice of managing earnings by carefully timing the sale of investment securities leads analysts to overvalue a company's common stock, says Eric Hirst, an accounting professor at the University of Texas at Austin.
In studies he conducted with a colleague at Indiana University, Hirst found that when seasoned analysts were presented with information revealing "comprehensive income," disclosing earnings management behavior, they valued the company's stock much lower than analysts who had no such information, even when the ending balance sheets were identical.
Further, Hirst found that revelation of comprehensive income in the statement of changes in owners' equity (as is allowed by a recent standard issued by the Financial Accounting Standards Board), rather than in a separate statement, may not be enough to counter the overvaluation of companies that manage earnings.
"Financial statement analysis is a difficult task, even for the most seasoned professional equity analysts," says Hirst. His study highlights the need for clearer disclosure of items that can be managed in reported income.
Contact: Dr. Eric Hirst, 512/471-5565 or [email protected]
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