The relevance of the value-relevance literature for financial accounting standard setting

“Holthausen and Watts (2001) suggest that debt holders should exclude goodwill from covenant calculations, since goodwill is unlikely to have any value if there is a default.”

“When surveying the fair value accounting literature, we focus on value and risk relevance research published after the thorough reviews by Barth et al. (2001) and Holthausen and Watts (2001).”

“In particular, certain items that would be included as income under clean surplus accounting are unlikely to provide useful information for managerial performance measurement purposes (Holthausen and Watts, 2001, pp. 43–49).”

“Notwithstanding the preceding findings, the extent to which evidence of value relevance is helpful in assessing accounting standards has been debated (see Holthausen and Watts, 2001; Barth, Beaver, and Landsman, 2001).”

“Prior research suggests that there is variation across time in antitrust enforcement (Lin et al., 2000) and that time-series variation in litigation risk affects accounting conservatism (Basu, 1997; Holthausen and Watts, 2001).”

“3 Contrast Lev (1989) with Ball and Shivakumar (2008b), and Barth et al. (2001) with Holthausen and Watts (2001).”

“A second related strand of the accounting literature studies value relevance, the impact of accounting metrics on market values (Holthausen and Watts 2001).”

“Accounting measures are closely associated with stock returns since they express firms' financial performance (Holthausen & Watts, 2001; Kothari, 2001; Beaver, 2002).”

“Valuable reviews of this literature are provided, for instance, by Healy and Palepu (2001), Holthausen and Watts (2001), Beyer et al. (2010), Berger (2011), and Leuz and Wysocki (2016).”

“Prior research implies that debt contracting is partly responsible for the demand for conservative financial reporting (e.g., Leftwich 1983; Holthausen and Watts 2001).”

“3 See Holthausen and Watts (2001) and Barth et al. (2001) for a review on value relevance literature.”

“Holthausen and Watts (2001), Barth et al. (2001), and Watts (2003a, 2003b) also discuss the dual roles of accounting information and how conservatism may or may not be useful in each of these roles.”

“…has the potential to overstate results because the disclosure in one year may not be independent from the following year. literature by documenting the value-relevance of RP disclosures (see Barth et al., 2001; Healy and Palepu, 2001; Holthausen and Watts, 2001, for reviews of this literature).”

“As discussed in Holthausen and Watts (2001), Watts (2003), and Kothari et al. (2010), debt contracting parties rely on a conservative balance sheet, with high thresholds of verifiability, to reflect the lower bound of the liquidation value of net assets.”

“This is consistent with the incremental costs of obtaining reliable fair value estimates for financial reporting purposes being low when they are already produced for financing purposes (Holthausen and Watts 2001).”

“Of late, doubts regarding the validity of value relevance studies (Holthausen and Watts, 2001) have been rebutted by Hellström (2006).”

“Ball and Shivakumar (2008, p. 976) conclude that quarterly earnings 1 This issue is debated in Barth, Beaver and Landsman, (2001) and Holthausen and Watts (2001). announcements are associated with 1% - 2% of the total annual amount of information incorporated in stock prices and with approximately…”

“16Our study is not designed to provide explicit standard setting inferences (Holthausen and Watts, 2001) or participate in the well-known, ongoing debate in the literature on the merits and shortcomings of the value-relevance concept in this context.”

“If standard-setters were to decide that all value-relevant gains and losses should be recognized as components of net income (Barth et al. 2001a; Holthausen and Watts 2001), then our results could be viewed as support for recognizing both OCI and SI gains and losses in net income.”

“…because it has been argued to provide several governance benefits, such as reducing agency conflicts and improving managerial investment decisions (Holthausen and Watts 2001; Watts 2003; Ball and Shivakumar 2005), enhancing the efficiency of debt contracts (Ahmed et al. 2002; Zhang 2008), and…”

“Even though researchers can specify known nonlinearities and interactions, more are possible (Holthausen and Watts 2001). For example, Riffe and Thomson (1998) shows the relation between price and earnings (equity book value) can be nonlinear when earnings (equity”

“Armstrong et al. (2010) provide an excellent discussion on informational problems between firms and creditors, and how accounting conservatism can help address them (also see Holthausen and Watts 2001; Watts 2003a).”

“This is, admittedly, a limited perspective for studying the informativeness of accounting information; it focuses on equity investors while ignoring the other uses of financial statements such as in debt and compensation contracts (Holthausen & Watts, 2001).”

“Furthermore, the threat of litigation provides bond investors with limited recourse because, until 2010, courts have imposed a lower standard of care on rating agencies than on accountants and auditors (Husisian (1990), Partnoy (2006)).”

“2 Holthausen and Watts (2001) note that accounting values have multiple uses beyond equity investment.”

“The literature includes Leftwich (1983), Watts and Zimmerman (1986), Ball et al. (2000a), Ball (2001), Holthausen and Watts (2001), Ahmed et al. (2002), Watts (2003a,b), Ball and Shivakumar (2005, 2006), Beatty et al. (2008), Wittenberg-Moerman (2008), Zhang (2008), and Aier et al. (2014).”

“Based on the literature, most applications of value relevance of CSR disclosure focused on accounting variables (Brammer & Pavelin, 2008; Holthausen & Watts, 2001; Ohlson, 1995).”

“In light of the evidence that conservatism increased over parts of the sample period (Basu 1997; Givoly and Hayn 2000; Holthausen and Watts 2001; Ryan and Zarowin 2003), we adopt a difference-in-differences approach.”

“11 For a discussion of these models, see Holthausen and Watts (2001).”

“It is argued extensively in the accounting literature that contracting is an important use of accounting numbers (e.g., Watts and Zimmerman, 1986; Holthausen and Watts, 2001).”

“Thus, whilst acknowledging the accounting information must be useful for predicting future cash flows, Holthausen and Watts (2001) argue that a contracting theory view of accounting significantly enhances our ability to understand financial reporting practices.”

“17 We do not analyze scenarios in which investors distinguish recognized from disclosed amounts because contracts are based on recognized amounts (Holthausen and Watts 2001).”

“However, while useful in assessing the market impact of accounting standards, such value relevance research exhibits some limitations and cannot serve as a sole basis for standard development and regulatory interventions (Holthausen and Watts, 2001).”

“The fixed-effects year indicator variables included in the regression control for periods of high auditor litigation (Basu 1997, Holthausen and Watts 2001) and the passage of the Sarbanes-Oxley Act.”

“…and weaknesses of experimental (Kachelmeier and King, 2002; Mains et al., 2006) as well as empirical archival research designs (Allee et al., 2007; Holthausen and Watts, 2001), survey studies allow direct investigation of subjects’ attitudes, thus avoiding the internal validity concerns of…”

“The paper is also in part an answer to Holthausen and Watts’ (2001, 26) call for research into how accounting information is utilized by financial statement users other than equity investors, stating that “it is not clear that the relevance of a given number would be the same for equity investors…”

“F reconciliation and stock returns, they do not provide direct evidence on whether investors use the reconciliation information (Kothari, 2001; Holthausen and Watts, 2001).”

“The research stream that compares different accounting standards by examining their association with securities prices is also called “ value-relevance ” research (Holthausen and Watts, 2001).”

“The stewardship role of accounting predicts that one important outcome of accounting is its ex-ante effect of curtailing bad corporate practices (Watts and Zimmerman, 1979; Holthausen and Watts, 2001).”

“statement users other than equity holders (Holthausen and Watts 2001).”

“8 For positive-accounting reviews, see for example, Watts and Zimmerman (1986), Ball (2001), Holthausen and Watts (2001), and Kothari, Ramanna, and Skinner (2010).”

“I would rather leave this discussion to others (Holthausen and Watts 2001, Kothari et al. 2010) and, in line with Lambert (2010), argue that valuation is among the several important roles of a multi-attribute system such as accounting, and therefore deserves its due attention.”

“Share prices may not necessarily be an accurate benchmark of the ‘true value’ of variables of interest, especially if capital markets lack efficiency (Holthausen and Watts, 2001).”

“intangibles restrict their effective use as loan collateral (Williamson, 1988; Shleifer and Vishny, 1992; Holthausen and Watts, 2001).”

“The aim of value-relevance studies is to assess the usefulness of accounting and non-accounting numbers in equity valuation ( Holthausen and Watts, 2001”