Capital Market Pressure, Disclosure Frequency-Induced Earnings/Cash Flow Conflict,

and Managerial Myopia

Author(s): Sanjeev Bhojraj and Robert Libby
Source: The Accounting Review , Jan., 2005, Vol. 80, No. 1 (Jan., 2005), pp. 1-20
Published by: American Accounting Association

Stable URL: http://www.jstor.com/stable/4093159

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide
range of content in a trusted digital archive. We use information technology and tools to increase productivity and
facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected].

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at
https://about.jstor.org/terms

American Accounting Association is collaborating with JSTOR to digitize, preserve and extend
access to The Accounting Review

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 THE ACCOUNTING REVIEW
Vol. 80, No. 1
2005
pp. 1-20

Capital Market Pressure, Disclosure

Frequency-Induced Earnings/Cash Flow
Conflict, and Managerial Myopia
Sanjeev Bhojraj
Robert Libby
Cornell University

ABSTRACT: We examine the effects of increased capital market pressure and disclo-
sure frequency-induced earnings/cash flow conflict on myopic behavior. In our exper-
iments, experienced financial managers choose between projects where a conflict ex-
ists between near-term earnings and total cash flow. Managers more often choose
projects that they believe will maximize short-term earnings (and price) as opposed to
total cash flows in response to increased capital market pressure resulting from a pend-
ing stock issuance, holding constant agency frictions and other stock market pres-
sures. When faced with increased capital market pressure, changes in disclosure fre-
quency cause managers to behave more or less myopically depending on the impact
of the change on the pattern of earnings and the resulting earnings/cash flow conflict.
Our study provides insights into managers' beliefs about stock market pressures, man-
datory reporting, and the availability of alternative communications channels, and con-
tributes to literature on managerial myopia and earnings management, as well as cur-
rent debates over disclosure frequency.

Keywords: managerial myopia; capital market pressures; financial reporting; disclosure

frequency.

Data Availability: Contact authors.

I. INTRODUCTION

We examine whether managers behave myopically in response to increased capital

market pressure, controlling for agency frictions between the manager and ex-
isting stockholders. We also examine whether the prevalence of myopia is af-
fected by disclosure frequency. In our setting, myopic behavior strictly refers to giving up
projects with greater cash flows to report externally higher near-term earnings. Prior theo-
retical work (Stein 1989; Bar-Gill and Bebchuk 2003) suggests that the degree of myopic
behavior will be influenced by capital market incentives that determine the extent to which
managers care about short-term price relative to long-term value, even in the absence of

We thank Robert Bloomfield, Joel Demski, Tom Dyckman, Paul Hribar, Jim Hunton, Charles Lee, Mark Nelson,
Nick Seybert, and seminar participants at Cornell University, the FARS Doctoral Consortium, the AAA Doctoral
Consortium, and McMaster University for their feedback.
Editor's note: This paper was accepted by S. Jane Kennedy, Editor.
Submitted October 2003
Accepted June 2004

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 2 Bhojraj and Libby

agency frictions.1 Howe

In addition, in past and
claimed that increases
theoretical or empirical
debate in the EU, Japa
moving from a semiann
We examine these issu
of market pressure fac
frequency of mandatory
pattern of earnings gen
agency frictions and ot
what managers learn in
experienced financial m
approach is most simi
importance of tax and b
(1998) who study mana
disclosures.3
The managers are pre
lower short-term earn
lower total cash flows bu
The managers choose th
pressure and disclosure
they bring to the exper
and the availability of
earnings patterns expec
experiment, mandatory
tive than semiannual r
experiment, mandatory
ative than quarterly repo
Our study contributes
disclosure frequency. P
from agency frictions
from capital market pr
and complement existin
capital market pressur
and Bebchuk (2003), we
make more myopic pr
response to a pending
will maximize short-te

While the term managerial

interests of the manager and
and is not the case in our st
protect existing shareholders
2 See the Appendix for some
3 Libby et al. (2002, 802) disc
experiment is to "peer into t
have learned about relevant
4 In our study (as in Stein 19
design.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
Capital Market Pressure and Managerial Myopia 3

first direct evidence of myopic behavior that is not driven b

between the manager and existing stockholders. These findin
erature on earnings management, which suggests that manager
numbers in order to meet short-term financial reporting goal
(as in all of the myopia literature) is that real cash flow sacri
pure accounting manipulations.
We also contribute to the literatures on myopia and disclos
the first empirical demonstration of the relation between the
effect of change in disclosure frequency depends on the impact o
of earnings disclosed and the level of capital market pressure. Our
normal circumstances (i.e., in the absence of particularly stro
a change from semiannual to quarterly reporting is unlikely t
agers' investment choices. In our experiment, managers are un
of cash flows for the related disclosure gains. However, whe
market pressure resulting from a stock issuance, managers be
quarterly disclosure regime when quarterly reports increase th
earnings and total cash flows, and exhibit the opposite behav
reduce that conflict. The overall effect of a change in disclos
depend on the relative likelihood of the two settings, which
cause of the natural smoothing resulting from longer reportin
average, more frequent disclosure could cause greater myopia
added stock market pressure. This should be of interest to pol
systematic empirical evidence of the effect of disclosure freq
dence in this regard is primarily anecdotal.5
These findings also indicate managers believe that, in the ab
they are unable to credibly communicate information about th
term cash flows to investors through alternative channels, or
The use of experienced financial managers is of vital import
provides insights into the beliefs of people intimately involve
the disclosure process. This highlights the importance and seve
munication problem. The results should be of interest to reg
potential suboptimal resource allocation.
The remainder of the paper is organized as follows: Sectio
literature and develops our hypotheses. In Section III, we outl
experiments. Sections IV and V present method and results for
We conclude the paper in Section VI.

II. LITERATURE AND HYPOTHESES

Capital Market Incentives and Myopia
Following Stein (1989), we define managerial myopia as the desire to ach
current stock price by inflating current earnings at the expense of longer-t
(or earnings). Prior accounting research on the effects of capital market pressure
on its effects on earnings management. For example, Teoh et al. (1998) find t

5 In settings where greater disclosure frequency results in lower myopia, firms could choose to v
information regardless of mandatory disclosure frequency, thereby increasing the disclosure fre
our results on myopia suggest that managers are either unable or unwilling to credibly commu
mation through voluntary disclosure.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 4 Bhojraj and Libby

adopt more income-increa

collectible accounts receiva
Empirical studies of myo
stream of research tends
(where managers take actio
example, Dechow and Sloa
in which managers are lik
retirement, firms likely t
expenditures during this p
play in monitoring manag
sured as reduction in R&D
that focuses on R&D, Grah
are willing to give up eco
lines, Roychowdhury (2003
abnormally low cash from
evidence of manipulation
whether myopic behavior
manager is acting in the i
theoretical literature. In th
a causal link between a cha
for agency frictions, and
myopic behavior.7
Stein (1989) shows that, in
total cash flows to boost near-term income in an effort to influence the market's current
assessment of the firm's value. Along similar lines, Bar-Gill and Bebchuk (2003) model
the misreporting of corporate performance when a firm is likely to issue stock and the
ability to misreport requires sacrificing cash. These models suggest that the extent of man-
agerial myopia depends on the extent to which managers care about near-term earnings
relative to longer-term objectives. Further, this focus on near-term earnings and resulting
myopic behavior can occur even when the managers are acting in the interests of existing
shareholders.8
In the case of a pending stock issuance, myopic behavior can protect the interests of
existing shareholders in two ways. First, undervaluation could occur because the choice of
the high-cash-flow project would lead to lower short-term earnings and lower expectations
about the future. This, in turn, would result in the existing shareholders' value being ad-
versely affected in the event of a stock offering. However, for myopic behavior to increase
in this setting, the manager must perceive an inability to credibly communicate information
about the future cash flows of the high-cash-flow project through alternative disclosures.
Second, managers could behave myopically even if they could credibly communicate in-
formation about future cash flows at the time of stock issuance. This occurs if the managers

6 Other studies suggest that managers use accounting methods and accruals in order to meet other short-term
goals related to analysts' earnings expectations, bonus targets, prior management forecasts, etc. (e.g., Healy
1985; Jones 1991; Kasznik 1999; Libby and Kinney 2000; Bartov et al. 2002).
7 Other related work includes Jacobson and Aaker (1993) who examine the effect of degree of information
asymmetry between the manager and the market on managerial myopia and Lys and Vincent (1995), who
document AT&T's willingness to "burn" cash to obtain short-term earnings benefits.
8 The term myopia is most often used to reflect agency frictions, i.e., actions by the manager that harm the existing
shareholders. In our setting, the term reflects actions by managers that benefit existing shareholders but adversely
affect incoming shareholders. Introducing additional agency frictions in this setting could produce myopic be-
havior that would be to the detriment of existing shareholders.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 Capital Market Pressure and Managerial Myopia 5

choose not to disclose information about the high-cash-flow alt

that the valuation that results from choosing and not disclosing ad
the low-cash-flow project is greater than the valuation from c
tional information about the high-cash-flow project (Bar-Gill a
in this setting might choose the low-cash-flow project and not disc
cash flows, thereby benefiting existing shareholders at the exp
holders.9 In keeping with the theoretical results of Stein (1989
(2003) we expect that:

HI: In the presence of a conflict between near-term earning

creasing stock market pressure will increase managerial m

Disclosure Frequency and Myopia

The issue of the relative costs and benefits of increasing th
disclosures has been of continuing interest to managers, investo
This topic elicited a great deal of interest when the U.S. was
mandated disclosure interval to a quarterly basis in 1969 (see
SEC 1969). More recently, this issue has surfaced in the E
Singapore where policy makers are considering changing inter
from semiannual to quarterly. Recent discussions in the U.S.
the disclosure frequency beyond the current quarterly basis. B
FASB (2000) have recognized the need for more frequent repor
The primary argument that proponents make for increased
on enhancing timeliness and transparency. Increasing disclosu
formation more timely, thereby increasing its value to investo
is seen as especially important in environments that change rap
increasing disclosure frequency is that it will promote manage
pia.'0 Opponents suggest that more frequent reporting will forc
emphasis on even shorter-run performance at the expense of l
example, in the U.K., Accountancy Magazine (Evans 2003) sugg
ing arguments against quarterly reporting is that it places pressure
on a more regular basis and produce short-term results, which is e
in the market."
Disclosure frequency is not a widely studied part of the disclosure literature. A few
papers including Baginski et al. (2002) and Bhojraj (2003) study factors that influence how
frequently firms issue voluntary earnings forecasts. Butler et al. (2003) study the effect of
disclosure frequency on the speed that information is impounded in prices. They find evi-
dence suggesting that increasing the frequency of mandated reporting is unlikely to increase
the timeliness of information disclosed. Using a sample of 215 financial managers, Hunton
et al. (2003), find that the managers believe that increasing mandated disclosure frequency
would increase the decision usefulness of financial statements and the quality of earnings.

9 In our experiment, the manager must issue stock. In this case, painting an optimistic earnings picture, thereby
increasing stock price, always hurts the new shareholders because they receive a smaller portion of the firm,
regardless of how the funds generated by the stock issuance are subsequently used.
1o Three additional arguments made against increased disclosure frequency are: (1) by increasing the frequency of
disclosure, while one is gaining on the timeliness dimension, the reliability of the information disclosure is
adversely affected. Reliability is further decreased by the fact that these disclosures are not audited; (2) to the
extent that there is a demand from the investors for more frequent disclosure, firms can voluntarily do so; and
(3) greater disclosure frequency places greater financial burden on reporting companies due to increased reporting
costs.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 6 Bhojraj and Libby

Finally, Bruns (1966) does

managers receive accoun
others) and the decisions
and empirical work has n
agerial myopia.
The discussion leading u
extent of capital market
near-term earnings. Capi
likelihood of stock issuan
etc. Thus, managers are
from period to period. G
quency on myopia should
reported near-term earni
conflict between total ca
in managerial myopia. Si
closure frequency causes
near-term earnings.
Consider a situation whe
disclosure environment, th
quarters prior to the sto
firm will issue interim i
semiannual disclosure env
higher earnings in the fir
choose the project that y
on whether there is grea
three or two quarters, i
behavior. This suggests tha
in disclosure frequency
our second hypothesis:

H2: Increasing disclosur

by an increase in stock
or lesser conflict betw

III. EXPERIMENTAL OVERVIEW

Our experiments are designed to test whether managers' propensity to
that will maximize short-term earnings as opposed to total cash flows (m
is affected by the degree of stock market pressure and external reportin
requires that we construct alternative projects that create a conflict bet
external reporting goals and total cash flows, while controlling other fa
affect managers' preference between projects.
Each of our experiments presents experienced financial managers of p
followed by analysts with an investment case where they are advising th
company followed by analysts."1 The case involves selecting from two alter
campaigns. Each is expected to be effective for four quarters and to produ

" We chose to put the financial managers in the position of advisors to the CEO rather tha
to minimize decisions driven by self-interest. By acting as advisors they are further dist
agency frictions between the CEO and the stockholders.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
Capital Market Pressure and Managerial Myopia 7

and gross profit in each quarter. For both alternatives, the c

make equal quarterly payments to the vendor (one-quarter of the
which equalizes the timing of the cash inflows and outflows a
constant the pattern of cash flows across the two project c
equalizes the cash flow risk between the alternatives and en
direction of differences in total cash flows and differences in th
flows.'2 The two alternatives differ in two ways. First, they
total costs, so they will generate different total cash flows a
of differences in the timing of expense recognition related
expected to produce different earnings patterns over the inte
the managers are presented with internal information including
profit, selling and general expenses, and income from operat
Alternative One is always the myopic choice.
In each experiment, two factors are varied between subject
and (2) frequency of reporting. To vary stock market pressur
company anticipates issuing additional shares through a seco
the fourth quarter of the year.13 As stated earlier, capital ma
several factors including the likelihood of stock issuance, pro
to meet analysts' forecasts, etc., which suggests that manage
these pressures. We vary the level of stock market pressure
because of its focus in the theoretical literature as a source
result in myopic behavior that is in the interests of existin
Bebchuk 2003), as well as its discrete nature. Other operation
meet analysts' forecasts have complex multiperiod effects tha
beating this period's forecast may make it harder to beat the
also naturally related to other incentives which may cause m
are not in the interests of shareholders (e.g., related to bonus
The no-stock issuance condition serves a vital role as a con
behavior driven by factors other than the stock issuance (oth
agency frictions) should manifest in this condition, allowing
effect of the stock issuance (the additional capital market pr
In other words, if the myopia we observe is primarily caus
as those related to internal performance evaluation or other s
those related to stock issuance, we should observe the same d
both the no stock issuance and stock issuance conditions. Fo
assume that they are being evaluated based on external report

12 Alternative Two always has higher total cash flows and higher net present
the two projects is exactly the same, the alternatives are designed such t
earnings and mistook them for cash flows, it would take a very high discoun
Alternative One to exceed that of Alternative Two (55 percent discount rat
discount rate in Experiment Two).
13 Note that the manager does not determine whether there will be a stock
the investment alternatives.
14 A stock issuance is a relatively low frequency cause of stock market pre
the results should generalize to any manipulation that successfully varies sto

The Accounting Review, Janua

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 8 Bhojraj and Libby

decisions to increase man

manifest in the no stock
To vary frequency of rep
exchange that requires qu
then selects between the
expected results (held con
earnings expected to res
randomly to treatments.

IV. EXPERIMENT ONE

Materials and Procedures

As noted above, participants are presented with two alternatives that differ in t
expense to be recognized and pattern of expense recognition in a manner that creat
conflict between shorter-run financial reporting objectives and total cash flows. In this firs
experiment, the values are selected such that, during the fourth quarter when any secondar
share offering would be made, high-cash-flow Alternative Two looks inferior to low-
flow Alternative One when quarterly reports are issued, but not when viewed throu
semiannual reports. This is accomplished in Experiment One by choosing amounts su
that Alternative Two would result in 7.5 percent higher total earnings and cash flows
the year, but lower, more irregular earnings to date and for the immediate prior qua
when observed during the fourth quarter.16 The internal information on the expected resu
from the two alternatives is depicted below:

Alternative One Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total

Gross profit 3,200 3,200 3,200 3,200 12,800
Selling and general expenses 2,200 2,200 2,200 2,200 8,800
Income from operations 1,000 1,000 1,000 1,000 4,000

Alternative Two Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total

Gross profit 3,200 3,200 3,200 3,200 12,800
Selling and general expenses 3,300 950 3,300 950 8,500
Income from operations (100) 2,250 (100) 2,250 4,300

All subjects in the four experimental conditions see the sam

information.
Subjects also see the external reports expected to result f
native. The external reports expected in the quarterly and sem
are presented in Figure 1, Panels A and B. The shading indic
be visible to the stock market at the time of the stock issuan
Figure 1 illustrate that the superiority of Alternative Two is

15 This still leaves open the possibility that additional personal benefits may
a more successful stock issuance. For example, the manager's compensation
stock issuance. We acknowledge this possibility. However, these personal
managers to act in a manner consistent with the current shareholders' intere
16 We purposely create a number of differences between the two alternatives
chances that we can generate the effect of interest. It is not our purpose
Alternative Two might or might not be preferred (lack of smoothness, lower
period earnings, the existence of losses, etc.), but to test the effects of sto
frequency on that preference. It is important to reemphasize that cash flows

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
Capital Market Pressure and Managerial Myopia 9

the time of the stock issuance (the fourth quarter) in the

quarterly setting.
Page One of the experimental materials requests parti
explains the setting, describes the elements of the project
the quarterly internal information, and indicates whethe
interim quarterly or semiannual reports and whether a secon
quarter is anticipated (the levels of the two independent v
two pro forma income statements indicating the expected
holders for each alternative and asks participants to selec
strength of preference on a seven-point scale. Page Four a
to prior pages and includes debriefing questions. These i
tionale behind their selection," (2) which project they be

FIGURE 1
Experiment One: Pro Forma External Reports Expected
to Result from Each Investment Alternative

Panel A: Quarterly Reporting Condition

Presented below are two sets of pro forma financial statements indicating the expected amounts t
be reported to shareholders if the company chooses each of the two alternatives. Please examine
and compare them carefully. Then make your choice considering these statements and the facts
presented on the prior page.

Alternative One 1
Statement of Earnings (in $000)
Quarter 1 Quarter 2 Qua
Net sales $6,000 $6,000 $6,000 $6,000
Less: Cost of goods sold 2,800 2,800 2,800 2,800
Gross profit 3,200 3,200 3,200 3,200
Selling and general expenses 2,200 2,200 2,200 2,200
Income from operations 1,000 1,000 1,000 1,000

Alternative Two
Statement of Earnings (in $000)
Quarter 1 Quarter 2 Quarter 3 Q
Net sales $6,000 $6,000 $6,000 $6,000
Less: Cost of goods sold 2,800 2,800 2,800 2,800
Gross profit 3,200 3,200 3,200 3,200
Selling and general expenses 3,300 950 3,300 950
Income from operations (100) 2,250 (100) 2,250

The fourth quarter is shaded here, but not in the instrument, t

be disclosed at the time of the stock issuance.

(continued on next page)

17 Useable responses did not result from this question, and it is not discussed further in the paper.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 10 Bhojraj and Libby

FIGURE 1 (continued)

Panel B: Semiannual Reporting Condition

Presented below are two sets of pro forma financial statements indicating the expected amounts to
be reported to shareholders if the company chooses each of the two alternatives. Please examine
and compare them carefully. Then make your choice considering these statements and the facts
presented on the prior page.

Alternative One I
Statement of Earnings (in $000)
1st Half 2nd Half
Net sales $12,000 $12,000
Less: Cost of goods sold 5,600 5,600
Gross profit 6,400 6,400
Selling and general expenses 4,400 4,400
Income from operations 2,000 2,000

Alternative Two

Statement of Earnings (in $000)

1st Half 2nd Half
Net sales $12,000 $12,000
Less: Cost of goods sold 5,600 5,600
Gross profit 6,400 6,400
Selling and general expenses 4,250 4,250
Income from operations 2,150 2,150

The second half is shaded here, but not in the instrument, to illus
disclosed at the time of the stock issuance.

stock price in November,'" (3) whether interim reports to shareholders are issued quarterly
or semiannually, and (4) whether shares are to be issued in the fourth quarter. The latter
two questions serve as manipulation checks. Background questions are administered before
completion of the instrument.

Participants
Our participants in Experiment One are 44 experienced financial managers (mean busi-
ness experience = 16.1 years; mean accounting/financial experience = 15.1 years) from
six publicly traded companies followed by financial analysts (median assets = $11 billion).
The companies include an airline, a bank, a hotel chain, a publisher, a manufacturer, and
an information technology company. Job titles range from CFO (4) to Assistant Plant Con-
troller (2). Fifty-nine percent of the participants are CPAs, 25 percent are CFAs, and

18 The responses to this question are highly correlated with the main dependent variable and are not discussed
further.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 Capital Market Pressure and Managerial Myopia 11

16 percent CMAs. On average, 30 percent of their wealth is tied u

Anonymity for the individuals and firms is guaranteed. The exper
take place during a training program, last about 20 minutes.

Results

All participants answered the two manipulation check questions correctly. Participant
preferences for the two projects are measured by coding their choices as "-" for Alter-
native One and "+" for Alternative Two and combining them with the seven-point strength-
of-preference scale to produce a 14-point-interval scale ranging from -13 to + 13 in inter-
vals of two.19 Participants mean preference scores, standard deviations and choices by
treatment combination are presented in Table 1, Panel A (and the means are graphed in
Figure 3, Panel A). The overall analysis of variance is presented in Table 1, Panel B, while
the simple main effects tests are presented in Panel C. The two main effects as well as the
interaction are highly significant.
Hypothesis 1 suggests that, in the presence of a conflict between near-term reported
earnings and total cash flow, managerial myopia will be greater when a firm anticipates
issuing stock in the near future. In Experiment One, there is a conflict between near-term
reported earnings and total cash flow in the quarterly reporting setting. Thus, the hypothesis
can be tested by comparing the managers' weighted preferences between those facing the
need to issue stock in the fourth quarter and those without that additional capital market
incentive in the quarterly setting. The difference in weighted preferences is highly signifi-
cant (F = 160.9, p = .000).20 When there is no pending stock issuance, 10 of 11 participants
select Alternative Two, which has lower year-to-date earnings, but higher total cash flows.
However, consistent with Stein, when the pending stock issuance is added in the fourth
quarter, 11 of 11 participants select Alternative One (the myopic choice), which has higher
year-to-date earnings, but lower total cash flows. This difference is highly significant (Fisher
test, p < .005).
Hypothesis 2 suggests that increasing disclosure frequency will increase or reduce man-
agerial myopia caused by an increase in stock market pressure, depending on whether it
causes greater or lesser conflict between near-term earnings and total cash flows. In Ex-
periment One, there is greater conflict between near-term earnings and total cash flows after
three quarters. Consequently, we should see the stock issuance cause a greater increase in
myopic behavior in the quarterly setting than the semiannual setting. As predicted, the
difference in weighted preferences caused by the addition of the stock issuance is signifi-
cantly larger in the quarterly setting than in the semiannual setting (F = 81.8, p = .000).21
In the semiannual setting where there is no conflict between near-term earnings and total
cash flows, all 11 participants in the no stock issuance condition and in the stock issuance
condition choose Alternative Two. In the quarterly setting where there is a conflict between
near-term earnings and total cash flows, as indicated above, 10 of 11 participants choose
Alternative Two in the no stock issuance condition, whereas in the stock issuance condition
11 of 11 participants choose Alternative One, the myopic alternative. This finding strongly
supports the hypothesis. However, to demonstrate that this phenomenon can occur in either
a quarterly or a semiannual setting and is not a consequence of more frequent reporting

19 A scale of -7 to +7 would not be appropriate because that would cause an interval of two points between -1
to +1. To ensure uniformity of the scale intervals we chose intervals of two.
20 All p-values are two-tailed.
21 An analysis of variance using the choices as the dichotomous dependent variable produces the same results.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 12 Bhojraj and Libby

TABLE 1
Results of Experiment One

The data come from an experiment where 44 experienced financial managers select betwe
alternative investment projects and indicate their strength of preference. A negative prefere
indicates a preference for the higher short-run earnings, lower total cash flows alternative (t
myopic choice). A positive preference score indicates a preference for the lower short-run
higher total cash flows alternative. The "Interim Reporting" treatment manipulates whethe
semiannual or quarterly reports are issued to investors. The "Stock Issuance" treatment ma
whether a stock issuance is anticipated in the fourth quarter.

Panel A: Mean Managers' Preferences across Conditions (Standard Deviations in pare

[# Choosing the Myopic Alternative/Sample Size in Brackets]
Interim Reporting
Stock Issuance Semiannual Quarterly
No Stock Issuance 11.9 (1.6) 9.7 (7.8)
[0/11] [1/11]
Stock Issuance 12.1 (1.9) -12.5 (0.9)
[0/11] [11/11]

Panel B: Two-Way ANOVA (Effec

Source df Mean Squares F-statistic p-value
Interim Reporting 1 1964 116.8 .000
Stock Issuance 1 1331 79.1 .000
Interim Reporting x Stock Issuance 1 1375 81.8 .000
Error 40 16.8

Panel C: Simple Main

Simple Main Effects df F-statistic p-value
Stock Issuance at Quarterly 1 160.9 .000
Stock Issuance at Semiannual 1 0.0 .918
Interim Reporting at No Stock Issuance 1 1.6 .219
Interim Reporting at Stock Issuance 1 197.0 .000

per se, this hypothesis must also be tested in a setting wher

near-term earnings and total cash flows after two quarters
provides such a test.

V. EXPERIMENT TWO
Materials and Procedures

As in Experiment One, participants are presented with two alternatives that differ
total expense to be recognized and pattern of expense recognition in a manner that cre
a conflict between shorter-run financial reporting objectives and total cash flows. Howe
in Experiment Two the earnings pattern in Alternative Two is altered so that there is greate
conflict between near-term earnings and total cash flows after two quarters than three. Thi
is accomplished by keeping the smooth pattern for Alternative One and creating a pat
where earnings rise for the first three quarters and then fall in the fourth quarter for Alte
native Two. The internal information presented to all participants on the two alternat
are depicted below:

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
Capital Market Pressure and Managerial Myopia 13

Alternative One Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total

Grows profit 3,200 3,200 3,200 3,200 12,800
Selling and general expenses 2,200 2,200 2,200 2,200 8,800
Income from operations 1,000 1,000 1,000 1,000 4,000

Alternative Two Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total

Gross profit 3,200 3,200 3,200 3,200 12,800
Selling and general expenses 2,750 2,600 1,000 2,150 8,500
Income from operations 450 600 2,200 1,050 4,300

Again, all subjects in the four experimental conditions se

internal information. The external reports expected in th
porting conditions are presented in Figure 2, Panels A an

FIGURE 2
Experiment Two: Pro Forma External Reports Expected
to Result from Each Investment Alternative

Panel A: Quarterly Reporting Condition

Presented below are two sets of pro forma financial statements indicating the expected amounts to
be reported to shareholders if the company chooses each of the two alternatives. Please examine
and compare them carefully. Then make your choice considering these statements and the facts
presented on the prior page.

Alternative One
Statement of Earnings (in $000)
Quarter I Quarter 2 Quarter 3 Quarter 4
Net sales $6,000 $6,000 $6,000 $6,000
Less: Cost of goods sold 2,800 2,800 2,800 2,800
Gross profit 3,200 3,200 3,200 3,200
Selling and general expenses 2,200 2,200 2,200 2,200
Income from operations 1,000 1,000 1,000 1,000

Alternative Two
Statement of Earnings (in $000)
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Net sales $6,000 $6,000 $6,000 $6,000
Less: Cost of goods sold 2,800 2,800 2,800 2,800
Gross profit 3,200 3,200 3,200 3,200
Selling and general expenses 2,750 2,600 1,000 2,150
Income from operations 450 600 2,200 1,050
__ [,m
The fourth quarter is
be disclosed at the time of the stock issuance.

(continued on next page)

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 14 Bhojraj and Libby

FIGURE 2 (continued)

Panel B: Semiannual Reporting Condition

Presented below are two sets of pro forma financial statements indicating the expected amounts to
be reported to shareholders if the company chooses each of the two alternatives. Please examine
and compare them carefully. Then make your choice considering these statements and the facts
presented on the prior page.

Alternative One I I I
Statement of Earnings (in $000)
11st Half 2nd Half
Net sales $12,000 $12,000
Less: Cost of goods sold 5,600 5,600
Gross profit 6,400 6,400
Selling and general expenses 4,400 4,400
Income from operations 2,000 2,000

Alternative Two

Statement of Earnings (in $000)

1 st Half 2nd Half
Net sales $12,000 $12,000
Less: Cost of goods sold 5,600 5,600
Gross profit 6,400 6,400
Selling and general expenses 5,350 3,150
Income from operations 1,050 3,250

The second half is shaded here, but not in the instrument, to illust
disclosed at the time of the stock issuance.

period that will not be visible to the stock market at the time of the stock issuance. The
unshaded portions of Figure 2 illustrate that the superiority of Alternative Two is visible to
the stock market at the time of the stock issuance (the fourth quarter) in the quarterly
setting, but not in the semiannual setting. All other aspects of the experiment are the same
as in Experiment One.

Participants
Our participants in Experiment Two are 45 experienced financial managers (mean busi-
ness experience = 23.5 years; mean accounting/financial experience = 21.5 years) from
17 publicly traded companies followed by financial analysts (median assets = $931 mil-
lion).22 The companies include a bank, a hotel chain, three retailers, three restaurant chains,
two pharmaceutical companies, two information technology companies, one mining and
processing company, and four manufacturers. Job titles range from CEO or CFO (seven)
to Assistant Controller (two). Forty-nine percent of the participants are CPAs, four percent

22 Four of the companies overlap those in Experiment One.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
Capital Market Pressure and Managerial Myopia 15

are CFAs, and nine percent CMAs. On average, 26.7 percent of

company stock. Again, anonymity for the individuals and firm
perimental sessions take place during a training program.

Results

All participants answered the two manipulation check questions correctly. Mean pref-
erence scores, standard deviations, and participant choices by treatment combination are
presented in Table 2, Panel A (and the means are graphed in Figure 3, Panel B). The overall
analysis of variance is presented in Table 2, Panel B, while the simple main effects tests
are presented in Panel C. The two main effects as well as the interaction are highly
significant.
As noted above, the conflict between near-term reported earnings and total cash flow
exists in the semiannual setting in Experiment Two. Thus, H1 can be tested by comparing
the managers' weighted preferences between those facing the need to issue stock in the
fourth quarter and those without that additional capital market incentive in the semiannual

TABLE 2
Results of Experiment Two

The data come from an experiment where 44 experienced financial managers select betw
alternative investment projects and indicate their strength of preference. A negative prefer
indicates a preference for the higher short-run earnings, lower total cash flows alternative
myopic choice). A positive preference score indicates a preference for the lower short-run
higher total cash flows alternative. The "Interim Reporting" treatment manipulates wheth
semiannual or quarterly reports are issued to investors. The "Stock Issuance" treatment
whether a stock issuance is anticipated in the fourth quarter.

Panel A: Mean Managers' Preferences across Conditions (Standard Deviations in Pa

[# Choosing the Myopic Alternative/Sample Size in Brackets]
Interim Reporting
Stock Issuance Semiannual Quarterly
No Stock Issuance 13.0 (0) 12.6 (0.8)
[0/111] [0//11]
Stock Issuance -10.2 (6.8) 11.9 (1.6)
[11/12] [0/11]

Panel B: Two-Way ANOVA (Effect

Source df Mean Squares F-statistic p-value
Interim Reporting 1 1324.0 100.3 .000
Stock Issuance 1 1603.4 121.5 .000
Interim Reporting x Stock Issuance 1 1414.2 107.2 .000
Error 41 13.2

Panel C: Simple Main

Simple Main Effects df F-statistic p-value
Stock Issuance at Quarterly 1 0.2 .641
Stock Issuance at Semiannual 1 233.4 .000
Interim Reporting at No Stock Issuance 1 0.1 .816
Interim Reporting at Stock Issuance 1 211.9 .000

The Accounting Review, Jan

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 16 Bhojraj and Libby

FIGURE 3
Results of Experiment One and Experiment Two

Panel A: Results of Experiment One

15

10

C:

0
-- --- Semi-Annual

-5
.- ,- - - - Quarterly
-10

-15
No Stock Issuance Stock Issuance

Panel B: Results of Experiment Two

15

10

Clo
co
5

S----- Semi-Annual
0_ 0-0 i - .-Quarterly
a -5

-10

-15
No Stock Issuance Stock Issuance

setting. The difference in weighted preferences is highly s

When there is no pending stock issuance, 11 of 11 partici
which has lower year to date earnings, but higher total c
with Stein (1989), in response to the addition of a pending
quarter, 11 of 12 participants select Alternative One (the m

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 Capital Market Pressure and Managerial Myopia 17

year-to-date earnings, but lower total cash flows. This difference is

test, p < .005).
Since there is greater conflict between near-term earnings and total cash flows after
two quarters than three in Experiment Two, H2 predicts that the stock issuance will cause
a greater increase in myopic behavior in the semiannual setting than the quarterly setting.
As predicted, the difference in weighted preferences caused by the addition of the stock
issuance is significantly larger in the semiannual setting than in the quarterly setting (F
= 107.2, p = .000).23 In the quarterly setting where there is no conflict between near-term
earnings and total cash flows, all 11 participants in the no stock issuance condition and in
the stock issuance condition choose Alternative Two. As noted above, in the semiannual
setting where there is a conflict between near-term earnings and total cash flows, all 11
participants choose Alternative Two in the no stock issuance condition, whereas in the stock
issuance condition 11 of 12 participants choose Alternative One, the myopic alternative.
This finding strongly supports the hypothesis.24

VI. CONCLUSION
In this study, we examine whether managers exhibit more myopic behavior
to increased capital market pressure, controlling for agency frictions. We also
effect of change in disclosure frequency on myopic behavior. Using two exper
manipulate the degree of market pressure faced by the manager, frequency o
and whether the increase in reporting frequency increases or decreases the con
near-term earnings and total cash flows, while controlling the internal information
to the manager and agency frictions. Our experienced financial managers' resp
that increases in stock market pressure can increase managerial myopia, even
agers are acting in the interests of existing shareholders. This behavior could
perceived inability or unwillingness to credibly communicate information abou
flows (of the high-cash-flow project). Our results also suggest that, in the presence
specific capital market pressure, increasing frequency of reporting from semiannu
terly can either increase or decrease myopic behavior. The effect depends on w
frequent disclosure causes greater or lesser conflict between near-term earnin
cash flows of the project choices. Because of the natural smoothing resulting
reporting periods, we expect that, on average, more frequent disclosure will c
myopia in the presence of significant stock market pressure.25 Had we manipu
frictions in our setting, this could produce similar myopic behavior, which wo
detriment of existing shareholders, rather than the new shareholders, as is th
study.
This study also suggests that not only do managers use accounting choices and esti-
mates to meet short-term disclosure goals, as evidenced by studies of earnings management,
but they are also willing to sacrifice cash flows in order to do so. This speaks to the value
of providing managers with some accounting discretion. One potential implication of our

23 An analysis of variance using the choices as the dichotomous dependent variable produces the same results.
24 Since subjects are not assigned randomly between the two experiments, a three-way ANOVA, including exper-
iment as well as capital market incentives and reporting frequency as factors, is not formally correct. For
completeness, as expected, the three-way interaction in such an analysis is highly significant (F = 181.8, p
= .000).
25 AS noted above, we do not speak to other factors that must be considered in the debate on disclosure frequency
such as cost of disclosure, reliability of the information disclosed, excessive managerial time commitment to
the disclosure process, etc.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 18 Bhojraj and Libby

results is that the absence

flows in order to meet sh
firm. However, this conjec
Our study uses experienc
market pressure, disclosu
While this is a key streng
participants might respond
setting of semiannual vers
behave differently in a di
Finally, our study is limit
choices that we present to
to sacrifice 7.5 percent of
provided by the stock issu
different had the cash flow
myopia in the presence of
had the cash flow sacrific
diminish our fundamental
incentives and disclosure f

APPENDIX
Excerpts from articles on disclosure frequency and managerial myopia:
1. "Both Goldman Sachs and Deutsche Bank executives at the World Economic Fo-
rum in Davos on Monday argued that quarterly reporting not only encourages short-
termism by investors and corporate management ..." (Investor Relations Magazine,
January 30, 2003)
2. "Some of Europe's most powerful investors are calling on the European Commis-
sion to drop plans to introduce mandatory quarterly reporting for companies ... i
(quarterly reporting) has not helped prevent corporate scandals in the U.S., and
there is risk that it will encourage short-termism." (Financial Times, January 27,
2003)
3. "Hong Kong says no to quarterly reporting ... Critics say an unintended conse
quence will be short-termism in the market with investors focused on seasonal
profits rather than long-term earnings growth." (Investor Relations Magazine, No-
vember 15, 2002)
4. "Short-termism ... The council does not believe that quarterly reporting will nec-
essarily lead to or sharpen, short-term perspectives by companies ... nor does it
accept the view that more frequent reporting will necessarily persuade companies
to defer measures that would benefit their stakeholders in the long run." (Counci
on Corporate Disclosure and Governance, Singapore Exchange Limited, October
14, 2002)
5. "The Tokyo stock exchange has confirmed plans to require quarterly reporting b
listed companies starting in two years." (Investor Relations Magazine, July 1, 2002)

REFERENCES
Baber, W. R., P. M. Fairfield, and J. A. Haggard. 1991. The effect of concern abou
on discretionary spending decisions: The case of research and development.
Review 66 (4): 818-829.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
Capital Market Pressure and Managerial Myopia 19

Baginski, S. P., J. M. Hassell, and M. D. Kimbrough. 2002. The eff

voluntary disclosure: Evidence from management earnings forecas
dian markets. The Accounting Review 77 (1): 25-50.
Bar-Gill, 0., and L. A. Bebchuk. 2003. Misreporting corporate performa
Law School.
Bartov, E., D. Givoly, and C. Hayn. 2002. The rewards to meeting or beating earnings expectati
Journal of Accounting & Economics 33 (2): 173-204.
Bhojraj, S. 2003. Managerial characteristics and disclosure decisions. Working paper, Co
University.
Bruns, W. J. 1966. The accounting period concept and its effect on management decisions. Journal
of Accounting Research 4 (3): 1-14.
Bushee, B. J. 1998. The influence of institutional investors on myopic R&D investment behavior. The
Accounting Review 73 (3): 305-333.
Butler, M., A. G. Kraft, and I. S. Weiss. 2003. The effect of reporting frequency on the timeliness of
earnings: The cases of voluntary and mandatory interim reports. Working paper, University of
Rochester, London Business School, and Columbia University.
Cloyd, C. B., J. Pratt, and T. Stock. 1996. The use of financial accounting choice to support aggressive
tax positions: Public and private firms. Journal of Accounting Research 34 (1): 23-43.
Dechow, P. M., and R. G. Sloan. 1991. Executive incentives and the horizon problem: An empirical
investigation. Journal of Accounting & Economics 14 (1): 51-89.
Evans, C. 2003. Reporting-Quarterly complications. Accountancy (April).
Financial Accounting Standards Board (FASB). 2000. Electronic Distribution of Business Reporting
Information. Steering Committee Report Series. Business Reporting Research Project. Stamford,
CT: FASB.
Graham, J. R., C. R. Harvey, and S. Rajagopal. 2004. The Economic Implications of Cor
Financial Reporting. Working paper, Duke University and University of Washington.
Healy, P. M. 1985. The effect of bonus schemes on accounting decisions. Journal of Accoun
Economics 7 (1-3): 85-107.
, and J. M. Wahlen. 1999. A review of the earnings management literature and its implic
for standard setting. Accounting Horizons 13 (4): 365-383.
Hunton, J., A. Wright, and S. Wright. 2003. Assessing the impact of more frequent external fi
statement reporting and independent auditor assurance of quality of earnings and stock m
effects. Working paper, Bentley College, Boston University, and University of Massachu
Boston.
Jacobson, R., and D. Aaker. 1993. Myopic management behavior with efficient, but imperfect,
financial-markets-A comparison of information asymmetries in the United-States and Japan.
Journal of Accounting & Economics 16 (4): 383-405.
Jones, J. J. 1991. Earnings management during import relief investigations. Journal of Accounting
Research 29 (2): 193-228.
Kasznik, R. 1999. On the association between voluntary disclosure and earnings management. Journal
of Accounting Research 37 (1): 57-81.
Kennedy, J., T. Mitchell, and S. E. Sefcik. 1998. Disclosure of contingent environmental liabilities:
Some unintended consequences? Journal of Accounting Research 36 (2): 257-277.
Libby, R., and W. R. Kinney. 2000. Does mandated audit communication reduce opportunistic cor-
rections to manage earnings to forecasts? The Accounting Review 75 (4): 383-404.
~-, R. Bloomfield, and M. W. Nelson. 2002. Experimental research in financial accounting.
Accounting, Organizations & Society 27 (8): 775-810.
Lys, T., and L. Vincent. 1995. An analysis of value destruction in AT&T's acquisition of NCR. Journal
of Financial Economics 39 (2-3): 353-378.
Roychowdhury, S. 2003. Management of earnings through manipulation of real activities that affect
cash from operations. Working paper, Massachusetts Institute of Technology.
Securities and Exchange Commission (SEC). 1969. Disclosure to Investors: A Reappraisal of Federal
Administrative Policies under the '33 and '34 Acts: The Wheat Report. Washington, D.C.: SEC.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms
 20 Bhojraj and Libby

--. 2000. Interpretation: U

SEC.
Stein, J. C. 1989. Efficient capital markets, inefficient firms: A model of myopic corporate behav
The Quarterly Journal of Economics 104 (4): 655-669.
Teoh, S. H., T. J. Wong, and G. R. Rao. 1998. Are accruals during initial public offerings opportu
istic? Review of Accounting Studies 3 (1-2): 175-208.

The Accounting Review, January 2005

This content downloaded from

137.189.241.67 on Sun, 25 Aug 2024 07:42:14 UTC
All use subject to https://about.jstor.org/terms