Essays on off-balance sheet liabilities

Guide(s)

Rangan, Srinivasan

Department

Finance and Accounting

Area

Finance and Accounting

University

Indian Institute of Management Bangalore

Place

Bangalore

Publication Date

3-31-2024

Year Awarded

March 2024

Year Completed

March 2024

Year Registered

June 2017

Abstract

A large body of research in accounting has evaluated the usefulness of disclosures in financial filings made by corporations (Barth et al. (2001)). To evaluate the usefulness of disclosures for equity investors, academic research has generally examined how these disclosures have correlated with stock prices and returns. In this thesis, I study two economically significant disclosures that relate to off-balance sheet liabilities - contingent liabilities and purchase obligations. Both these liabilities are not accrued on company balance sheets; rather they are reported in footnotes outside the main financial statements. My research purpose is to (a) examine the value relevance of these liability disclosures and (b) assess if investors react to them when the annual form 10-Ks containing them are filed. In my essay on contingent liabilities, I examine their influence on share prices, stock returns, future performance, idiosyncratic risk, and financial reporting policies. The subjective and discretionary nature of contingent liabilities raises the question of whether investors view these disclosures as reliable. To provide empirical evidence on how contingent liabilities are priced by investors, I employ a sample of 29,962 firm-years from 2011 to 2019. My panel regression estimates that account for the endogeneity of the decision to disclose contingent liabilities and year and industry effects show that these liabilities are valued negatively by investors. When I examine two-day returns around the 10-K filing date, I find that changes in contingent liabilities are not significantly related to 10-K filing date returns. Collectively, the results suggest that contingent liabilities are value-relevant and are incorporated in prices in periods before the 10-K filing date. In additional analyses, I find that while lawsuit contingent liabilities are negatively related to share prices, environmental and tax liabilities are positively related to share prices. To understand the channel that causes contingent liabilities to be negatively priced, 1 examine their relationship with one-year and two-year-ahead cash flows and unsystematic risk. My results indicate that contingent labilities are significantly and negatively related to two year ahead operating cash flow, but not one-year-ahead operating cash flows. I also find a significant positive relation between contingent liabilities and unsystematic risk measured as the daily return volatility over the thirty days following the 10-K filing date. Among the individual contingent liabilities, environmental liabilities predict both one year ahead and two-year ahead negative cash flows, Further, environmental, lawsuit. and other liabilities are positively related to daily return volatility, Collectively, these findings suggest that contingent liabilities and some of its components reduce share prices because of their negative implications for future cash flows and positive implications for unsystematic risk. I also explore the relationship between the earnings conservatism (Basu (1907)) of firms and contingent liability disclosures. Prior studies show that conservative reporting can be viewed as a tool to reduce perceived uncertainty. Because contingent liabilities are positively related to uncertainty, firms that desire to mitigate the perceived uncertainty associated with contingent liabilities would engage in higher level of conservatism - that is, the two reporting variables are complements. My findings support the complementary nature of contingent liabilities and uncertainty-mitigating earnings conservatism. A robustness check where & regress the Khan and Watts (9009) measure of conservation on contingent liabilities also support this Interpretation. While prior studies have employed smaller hand collected samples of one tope of specific category of contingent liability (Barth and McNichols (1994); Hennes (2014); Gleason and Mille (2002), I examine aggregate contingent liabilities as well as five of Its individual components for a common sample for the years 2011-2019. My results indicate that aggregate contingent liabilities are value relevant and influence future cash flows and risk. However, individual contingent liabilities differ in their impact on prices, performance, and risk. My findings suggest that conservatism is used to mitigate the uncertainty that is associated with the disclosure of contingent liabilities. Thus, I show that different aspects of financial reporting policy are interrelated. In my essay on purchase obligations, I examine their impact on prices, performance, and risk. Purchase obligations are legally binding agreements to purchase goods or services with well-defined quantities (in the case of goods), prices, and payment schedules. Because these obligations relate to mutually unexecuted contracts, accounting standards do not allow them to be recognized and reported on the balance sheet. However, since April 2003, the Sarbanes Oxley Act (SOX) has mandatorily required firms to disclose tabular data on future amounts owed for purchase obligations in the Management, Discussion, and Analysis sections of annual form 10-Ks filed with the Securities and Exchange Commission (SEC). My findings suggest that stock prices are positively related to purchase obligations that are due within one year. However, longer-term obligations are not reflected in stock prices suggesting that investors do not consider them useful. Additionally, I find that 10-K filing date returns are positively related to changes in purchase obligations strengthening the conclusion that this information is used by investors. To provide further evidence on whether market participants use information on purchase obligations, I correlate analyst forecast revisions with changes in purchase obligations. In contrast to the investor reaction result, I find that analyst forecast revisions are not influenced by changes in purchase obligations. I also examine the relationship between purchase obligations and one-year ahead performance and unsystematic risk. I find that future asset turnover and operating cash flows are positively related to purchase obligations. This finding suggests that purchase obligations are a credible positive signal about future sales and cash profitability. However, future profit margins and overall return on assets are not significantly related to purchase obligations. In contrast to the performance results, I find that purchase obligations do not significantly affect post-10-K filing return volatility, my measure of unsystematic risk. My work on purchase obligations contributes to the nascent literature on this topic. My work differs from prior research (Lee (2018); Naidu and Shane (2020)) in terms of sample periods, choice of variables examined, and sample studied. Specifically, my work updates Lee (2018) by examining a more recent time period when data on purchase obligations became easier to extract from 10-K filings. While the dependent variables 1 study overlap with those studied in previous work, my work examines two new variables - operating cash flows and idiosyncratic risk. Further, unlike prior studies, because I examine both disclosers and non-disclosers my results are less susceptible to sample selection biases.

Pagination

xiv, 120p.

Copyright

Indian Institute of Management Bangalore

Document Type

Dissertation

DAC Chairperson

Rangan, Srinivasan

DAC Members

Thampy, Ashok; Venkateswaran, Anand

Type of Degree

Ph.D.

Relation

DIS-IIMB-FPM-P24-06

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