THE UNIVERSITY OF HONG KONG FAUCLTY OF BUSINESS AND ECONOMICS SCHOOL OF BUSINESS. BUSM6014 Doctoral Accounting Seminar II Spring 2017

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1 THE UNIVERSITY OF HONG KONG FAUCLTY OF BUSINESS AND ECONOMICS SCHOOL OF BUSINESS BUSM6014 Doctoral Accounting Seminar II Spring 2017 Instructor: Professor Guochang Zhang Office: KK1214; Tel: ; Consultation time: by appointment Tutor: None Pre-requisites: microeconomics, corporate finance, asset pricing; knowledge of calculus, probability theory and constrained optimization. Co-requisites: None Mutually exclusive: None Course website: None Other important details: Students should take this course for credit. Class time: 2-5pm on Fridays (February 3, 10, 17, 24; March 10, 17, 24, 31; April 7, 21, 28) Venue: KK Leung 1235 II. Course Description and Objectives This doctoral seminar introduces selected topics of theoretical accounting research, focusing on the usefulness of financial reporting information in capital markets, the behavior of firms in disclosing private information, and issues related to auditing of firms publicly released financial reports. While the theme of the seminar is theoretical research, we will also bring related empirical studies into discussion and show how theory is important for properly developing empirical research. The course consists of three parts. Part I introduces models of equity value and returns that feature the role of financial reporting information, and examines the implications of these models for users and regulators of financial reporting. Part II discusses models of corporate disclosures in settings where firms strategically interact with other economic players in the product and capital markets. In Part III, we introduce selected theoretical research on auditing. This course aims to: 1. Familiarize you with theoretical research on accounting-based valuation, voluntary disclosure, and auditing; 2. Develop your ability to read and critically evaluate theoretical research; 3. Help you generate innovative research topics; and 4. Develop your skills to conduct theoretical research and to empirically test theoretical predictions. 1

2 III. Course Learning Outcomes (CLOs) On completion of this course, you should be able to: 1. Perform critical evaluation of published papers. 2. Develop innovative research topics. 3. Demonstrate effective communication skills. IV. Alignment of Program Learning Outcomes (PLOs) and Course Learning Outcomes Learning Goals To conduct quality research independently in their area of specialisation To be able to teach subjects in their specialization To inculcate professionalism and leadership To master communication skills Program Learning Outcomes (PLOs) To be able to demonstrate: PLO1: a detailed understanding of research methodologies and techniques for advanced academic enquiry PLO2: the ability to conceptualize, design and implement a scholarly research project for the generation of new knowledge, applications or understanding and to have astute analysis and synthesis, critical interpretation and presentation of principles of the study field. PLO3: the ability to adjust the research project design in the light of unforeseen matters and ill-structured problems. PLO4: skills to support the learning of others effectively when involved in teaching or demonstrating activities. PLO5: a systematic acquisition and understanding of a substantial body of knowledge which is at the forefront of an academic discipline or area of applied/professional practice. PLO6: the ability for the creation and interpretation of new knowledge, through original research, or other advanced scholarship, of a quality to satisfy peer review, extend the forefront of discipline, and merit publications. PLO7: the ability to evaluate ethical and social issues, function in teams effectively and display leadership traits. PLO8: to understand and observe research integrity. PLO9: the ability to construct coherent arguments and articulate ideas clearly to a wider range of audiences. PLO10: the ability to make effective oral presentation of their research papers. Aligned Program Learning Outcomes Course Learning Outcomes PLOs 1~3 PLO 4 PLOs 5~8 PLOs 9~10 CLO1. Perform critical evaluation of published papers. x x CLO2. Develop innovative research topics. x x CLO3. Demonstrate effective communication skills. x x 2

3 V. Teaching and Learning Activities (TLA) Course Teaching and Learning Activities Expected Study Load contact hour (% of study) TLA1. Lecture TLA2. Paper presentation and interactive Q&A TLA3. Reading and evaluation of papers TLA4. Research proposal 27 hours 20 hours 73 hours 80 hours 14% 10% 36% 40% Total 200 hours 100% VI. Assessment (AS) Points AS1. Participation and leadership in class discussions 20 AS2. Paper presentation and critique 30 AS3. Research proposal 50 Total 100 CLO Teaching and Learning Activities (TLA) TLA1 TLA2 TLA3 TLA4 AS1 AS2 AS3 CLO1 x x x x x x x CLO2 x x x CLO3 x x x x x x VII. Assessment Standards Course grade descriptors The table below describes grades and the corresponding performance standards (expected performance on the course learning outcomes). Grade A+ A A- ( ) B+ B B- ( ) C+ C C- ( ) D+ D ( ) Performance Standard Excellent Presentation that demonstrates logical consistency, a strong understanding of all relevant knowledge, and professional handling of questions Active participation in discussions A research proposal that provides innovative ideas and has the potential to significantly advance the related literature Good Presentation that demonstrates logical consistency, a good understanding of all relevant knowledge, and good handling of questions Good participation in discussions A research proposal that provides good ideas and has the potential to advance the related literature Satisfactory Presentation that demonstrates a basic understanding of the concepts involved and fair handling of questions Moderate participation in discussions A research proposal that provides limited innovations and has low potential to advance the related literature Pass Presentation that displays a poor understanding of the concepts involved and poor handling of questions 3

4 F (0.0) Minimal participation in discussions A research proposal that provides little new idea and has little potential to advance the related literature Fail Presentation that displays little understanding of the concepts involved and inability to handle questions No participation in discussions A research proposal that has little value Course grades are assigned based on the total you earn on the assessment items. In general, a total of is regarded as "excellent", is regarded as "good", is "satisfactory", is a "pass", and 49-1 is a "fail". These ranges have flexibility of up to plus or minus five points to allow for unforeseeable factors. Specific grading criteria for assessment items Each of the assessment items describe below will be graded using the performance standards in the course grade descriptors section ( for excellent, for good, for satisfactory, for pass, and 49-1 for fail). The total marks will be determined as a weighted average of your marks on the individual assessment items. The weights on AS1/2/3 are 0.2/0.3/0.5, respectively. AS1. Participation in class discussions All students are expected to participate actively in class discussions by raising insightful points about the paper being discussed and by asking intelligent questions. AS2. Paper presentation and critique Students will be assigned to published papers for presentation in class. Your presentation will be divided into two parts. In Part 1, you should present the assigned paper as if you were the author. You should cover the following aspects: the research question, motivation, related literature, analysis, and main results and implications. In part 2, you should critique the paper as a discussant. You should evaluate the strengths and weaknesses of the paper and give some direction for future work. AS3. Research proposal Each student is required to write a research proposal on a topic related to accounting-based valuation, company disclosure, and/or auditing. In your proposal, you should specify the research question, explain the motivation, and discuss the related literature and the expected contribution of your proposed study to the literature. For an empirical research proposal, you need to develop hypotheses, and describe the methods to test the hypotheses (e.g., regression equations) and what data you plan to use. For a theoretical research proposal, you should sketch out a rough model structure (the players and their decisions, the information available to the various players, etc.) and the steps for carrying out the analysis. This is an open-ended assignment. You are encouraged to develop the idea and move forward as far as you can. Empirical data analysis is encouraged where feasible, but not required for this assignment (I am aware of the time limitation). Your work will be evaluated in terms of novelty of the idea, innovativeness of the research design, and the potential for eventually developing the proposal into a complete paper. The deadline for proposal submission is Wednesday, May 31,

5 VIII. Academic Conduct Academic dishonesty is behavior in which a deliberately fraudulent misrepresentation is employed in an attempt to gain undeserved intellectual credit, either for oneself or for another. It includes, but is not necessarily limited to, the following types of cases: a. Plagiarism - The representation of someone else's ideas as if they are their own. Where the arguments, data, designs, etc., of someone else are being used in a paper, report, oral presentation, or similar academic project, this fact must be made explicitly clear by citing the appropriate references. The references must fully indicate the extent to which any parts of the project are not one's own work. Paraphrasing of someone else's ideas is still using someone else's ideas, and must be acknowledged. b. Unauthorized Collaboration on Out-of-Class Projects - The representation of work as solely one's own when in fact it is the result of a joint effort. c. Cheating on In-Class Exams - The covert gathering of information from other students, the use of unauthorized notes, unauthorized aids, etc. d. Unauthorized Advance Access to an Exam - The representation of materials prepared at leisure, as a result of unauthorized advance access (however obtained), as if it were prepared under the rigors of the exam setting. This misrepresentation is dishonest in itself even if there are not compounding factors, such as unauthorized uses of books or notes. You are expected to do your own work whenever you are supposed to. Incident(s) of academic dishonesty will NOT be tolerated. Cheating or plagiarism of any kind would result in an automatic F grade for the course plus strict enforcement of all Faculty and/or University regulations regarding such behavior. The University Regulations on academic dishonesty will be strictly enforced! Please check the University Statement on plagiarism on the web: 5

6 PART I: FINANCIAL REPORTING AND FIRM VLUATION The textbook for Part I is Zhang G Accounting Information and Equity Valuation: Theory, Evidence, and Applications. New York: Springer. This book provides a synthesis of theoretical research on valuation, along with a critique of the empirical literature (ERC and value relevance research). Lecture notes will be provided to registered students before each class. Students may also read the original papers of this literature (most of which are listed below). SESSION 1. INTRODUCTION; THE RESIDUAL INCOME MODEL Zhang, G Chapter 1. Ohlson, J A synthesis of security valuation theory and the role of dividends, cash flows, and earnings. CAR Vol. 6 (Spring): Ohlson. J Earnings, book values, and dividends in equity valuation. CAR Vol.11 No.2 (Spring): Feltham, G., and J. Ohlson Valuation and clean surplus accounting for operating and financial activities. CAR Vol.11 No.2 (Spring): SESSIONS 2. EQUITY VALUE MODELS BASED ON THE LINEAR INFORMATION DYNAMICS APPROACH Zhang, G Chapter 2. Ohlson (1995) and Feltham and Ohlson (1995) listed for Session 1 above. Bernard, V The Feltham-Ohlson framework: Implications for empiricists. CAR 11 No.2 (Spring): Lunduholm, R A tutorial on the Ohlson and Feltham/Ohlson models: Answers to some frequently asked questions. CAR 11 No.2 (Spring): Feltham, G., and J. Ohlson Uncertain resolution and the theory of depreciation measurement. JAR 34 No.2 (Autumn): Verrecchia, R Discussion of accrual accounting and equity valuation. JAR 36: Lo, K. and T. Lys The Ohlson model: Contribution to valuation theory, limitations, and empirical applications. JAAF 15: Christensen, P., and G. Feltham Economics of Accounting Vol. I: Information in Markets, Chapter 10. Kluwer Academic Publishers. SESSIONS 3-4. EQUITY VALUE AS A FUNCTION OF REALIZED ACCOUNTING DATA: RECOGNIZING REAL OPTIONS Zhang, G Chapters 3 6. Burgstahler, D. and I. Dichev Earnings, adaptation and equity valuation. TAR Vol. 72 (April): Collins, D., M. Pincus, and H. Xie Equity value and negative earnings: The role of book value of equity. TAR 74 (January): Yee, K Opportunities knocking: Residual income valuation of an adaptive firm. JAAF 15 (Summer): Zhang, G Accounting information, capital investment decisions, and equity valuation: Theory and empirical implications. JAR Vol.38 (Autumn): Holthausen, R., and R. Watts The relevance of the value relevance literature for financial accounting standard setting. JAE Vol. 31, Nos. 1-3 (September). 6

7 Biddle, G., P. Chen and G. Zhang When capital follows profitability: Nonlinear residual income dynamics. RAST Vol.6 (June-Sept): Hao, S., Q. Jin, and G. Zhang. 2011a. Investment growth and the relation between equity value, earnings, and equity book value. TAR 86 (March): Chen, C.Y., P. Chen, and Q. Jin Economic freedom, investment flexibility, and equity value: A cross-country study. The Accounting Review, 90 (5): SESSION 5. APPLYING REAL OPTIONS BASED VALUATION TO MULTIPLE-SEGMENT FIRMS Zhang, G Chapters 7 8. Chen, P., and G. Zhang Heterogeneous investment opportunities in multiple segment firms and the incremental value relevance of segment accounting data. TAR Vol. 78 (April): Chen, P. and G. Zhang. 2007a. Segment profitability, misvaluation, and divestment. TAR 82 (1): Tse, S Attributes of industry, industry segment and firm-specific information in security valuation. CAR 5 Vol 2: Horwitz, B Discussion of "Attributes of industry, industry segment and firmspecific information in security valuation". CAR 5 Vol 2: McNichols, M Discussion of "Attributes of industry, industry segment and firm-specific information in security valuation". CAR 5 Vol 2: SESSION 6. ACCOUNTING MODELS OF STOCK RETURNS Zhang, G Chapters 9, 10, and 12. Easton, P., and T. Harris Earnings as an explanatory variable for returns. JAR 29. Hayn, C The information content of losses. JAE 26 (September): Lev, B On the usefulness of earnings and earnings research: Lessons and directions from two decades of empirical research. JAR 27 (Supplement): Kothari, S.P Capital market research in accounting. JAE 31: Chen, P. and G. Zhang. 2007b. How do accounting variables explain stock price movements? Theory and evidence. JAE 43 (2007): Hao, S., Q. Jin, and G. Zhang. 2011b. Relative firm profitability and return sensitvity to indsutry-level news. TAR 86 (July): Huang, Y., and G. Zhang An examination of the incremental usefulness of balance-sheet information beyond earnings in explaining stock returns. JAAF 27 (2): SESSION 7. IMPLICATIONS OF VALUATION THEORY FOR STANDARD SETTING Zhang, G Fair value accounting and income measurement: An application to standard setting. Chapter 11. Holthausen, R., and R. Watts The relevance of the value relevance literature for financial accounting standard setting. JAE Vol. 31, Nos. 1-3 (September): Barth, M., W. Beaver, and W. Landsman The relevance of the value relevance literature for financial accounting standard setting: another view. JAE Vol. 31:

8 ADDITIONAL PAPERS (FOR REFERENCE) Other valuation models Ohlson, J On accounting-based valuation formulae. RAST 10: Ohlson, J., and B. Juettner-Nauroth Expected EPS and EPS growth as determinants of value. RAST 10: Empirical implementation of valuation models Penman, S., and T. Sougiannis. A comparison of dividend, cash flow, and earnings approaches to equity valuation. CAR Vol. 5 No.3 (Fall 1998): Lundholm, R., and T. O Keefe. Reconciling value estimates from the discounted cash flow model and residual income model. CAR Vol.18 No.2 (Summer 2001): Penman, S. On comparing cash flow and accrual accounting models for use in equity valuation. CAR (Winter 2001): Lundholm, R., and T. O Keefe. On comparing residual income and discounted cash flow models of equity valuation: A response to Penman CAR (Winter 2001): Begley, J. and G. Feltham. The relation between market values, earnings forecasts, and reported earnings. CAR (2002). Testing linear models Dechow, P., A Hutton and R. Sloan. An empirical assessment of the residual income valuation model. JAE 26 (1999): Myers, J. Implementing residual income valuation with linear information dynamics. AR 74 (1999): Callen, J., and D. Segal Empirical tests of the Feltham-Ohlson (1995) model. RAST 10: Using accounting data to explain stock prices Penman, D. Combining earnings and book value in equity valuation. CAR Vol.15 (1998): Burgstahler, D. Discussion of Combining earnings and book value in equity valuation. CAR Vol.15 (1998): PART II: VOLUNTARY DISCLOSURE BACKGROUND Akerlof, G The Market for 'Lemons': Quality Uncertainty and the Market Mechanism. Quarterly Journal of Economics 84: Grossman, S.J The Informational Role of Warranties and Private Disclosure about Product Quality. JAE 24 (December): Milgrom, P Good News and Bad News: Representation Theorems and Application. Bell Journal of Economics 12 (Autumn): Verrecchia, R.E Essays on disclosure. JAE 32 (December): Dye, R.A An evaluation of essays on disclosure and the disclosure literature in accounting. JAE 32 (December): Beyer, A., D. Cohen, T. Lys, and B. Walther The financial reporting environment: review of the recent literature. JAE 50 (2 3), SESSION 8. BEHAVIOR OF VOLUNTARY DISCLOSURES Models of voluntary disclosure in financial markets Verrecchia, R.E Discretionary disclosure. JAE 5 (1983): Dye, R.A Disclosure of Nonproprietary Information. JAR 23 (Spring): Jung, W., and Y.K. Kwon Disclosure when the market is unsure of information endowment of managers. JAR 26 (Spring 1988): Verrecchia, R.E Information quality and discretionary disclosure. JAE 12:

9 Models of voluntary disclosure in product markets Darrough, M Disclosure policy and competition: Cournot and Bertrand. TAR 68 (July): Darrough, M., and N. Stoughton Financial disclosure policy in an entry game. JAE 12: Related empirical studies Bamber, L. S., and Y. S. Cheon Discretionary management earnings forecast disclosures: Antecedents and outcomes associated with forecast venue and forecast specificity choices, JAR 36, Ali, A., S. Klasa, and E. Yeung Industry concentration and corporate disclosure policy. JAE 58, Hui, KW., X. Li, C. Lin, L. Wei, and G. Zhang Industry Competition and Firms Incentives to Withhold Information: Evidence from a Quasi-natural Experiment. Working paper, HK University of Science and Technology and University of Hong Kong. SESSION 9. DISCLOSURE AND COST OF CAPITAL Diamond, D., and R. Verrecchia Disclosure, liquidity, and the cost of capital. The Journal of Finance 46, Zhang, G Private information production, public disclosure, and the cost of capital: theory and implications. CAR 18: Easley, D., and M. O Hara Information and the cost of capital. The Journal of Finance 59, Hughes, J., J. Liu, and J. Liu Information, diversification, and cost of capital. TAR 82: Lambert, R., C. Leuz, R. Verrecchia Accounting information, disclosure, and the cost of capital. JAR 45: Zhang, G Accounting standards, cost of capital, resource allocation, and welfare in a large economy. TAR 88 (4): Related empirical studies Botosan, C Disclosure level and the cost of equity capital. TAR 72: Francis, J., R. LaFond, P. Olsson, and K. Schipper The market pricing of accruals quality. JAE 39:

10 READINGS FOR PART III: AUDITNG THEORY SESSIONS Antle, Rick The Auditor as an Economic Agent. Journal of Accounting Research, 20: Titman, S., and B. Trueman Information quality and the valuation of new issues. Journal of Accounting and Economics 8: Melumad, N. and L. Thoman On Auditors and the Courts in an Adverse selection Setting. Journal of Accounting Research, 28: Datar, S., G. Feltham, and J. Hughes The role of audits and audit quality in valuing new issues. Journal of Accounting and Economics 14: Dye, Ron Auditing Standards, Legal Liability, and Auditor Wealth. Journal of Political Economy, 101: Incorporation and the Audit Market. Journal of Accounting and Economics, 19: Hillegeist, S.A., 1999, Financial Reporting and Auditing Under Alternative Damage Apportionment Rules. The Accounting Review 74 (July): Patterson, Evelyn R., and Smith, J. Reed The Effects of Sarbanes-Oxley on Auditing and Internal Control Strength. The Accounting Review, 82, No. 2: Lu, Tong, and Haresh, Sapra Auditor Conservatism and Investment Efficiency. The Accounting Review, 84, No. 6: Laux, Volker, and Newman, D. Paul Auditor Liability and Client Acceptance Decisions. The Accounting Review, 85, No. 1: Deng, Mingcherng, Melumad, Nahum, and Shibano, Toshi Auditors' Liability, Investments, and Capital Markets: A Potential Unintended Consequence of the Sarbanes Oxley Act. Journal of Accounting Research, 50, No. 5: Chen, Qi, Jiang, Xu, and Zhang, Yun Does Audit Transparency Improve Audit Quality and Investment Efficiency? Working Paper. Duke University. Chan, Derek The Effects of Internal Control Reporting Regulation on Control Quality, Compensation and Audit Quality. Working Paper. The University of Hong Kong. Empirical studies DeFond, M., and Zhang, Jieying A Review of Archival Auditing Research. Journal of Accounting and Economics 58: Lennox, C, and B. Li The consequences of protecting audit partners personal assets from the threat of liability. JAE Journal abbreviations: CAR Contemporary Accounting Research; JAAF Journal of Accounting, Auditing, and Finance; JAE Journal of Accounting and Economics; JAR Journal of Accounting Research; RAST Review of Accounting Studies; TAR The Accounting Review 10