Recognition Versus Disclosure in The Oil and Gas Industry
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Recognition Versus Disclosure in The Oil and Gas Industry
Recognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industry Angeles, CA 90095-1481E-mail: david.aboody(g)anderson.ucla.edu35247I wish to thank Shlomo Benartzi, Nicholas Dopuch, Stephen Hansen, Robert Holthausen, Pat Hughes, Gil Mehrez, Judy Rayburn, and participants in the JAR conference for their helpful comments. I also wish to thank the anonymous referee Recognition Versus Disclosure in The Oil and Gas Industrys and editor for their patience and helpful comments. I am especially grateful to Keith Klaver from Price Waterhouse LLP for providing me with a practRecognition Versus Disclosure in The Oil and Gas Industry
itioner's view of oil and gas accounting.Recognition Versus Disclosure in The Oil and Gas Industry1. IntroductionThis paper investigates whether recogRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industrystry because Securities and Exchange Commission (SEC) regulation sx 4-10 provides a unique opportunity for testing the stock price consequences of recognition versus disclosure. The SEC regulation requires the firm-specific effect of a macroeconomic event to be formally recognized in the financial s Recognition Versus Disclosure in The Oil and Gas Industrytatements for oil and gas firms adopting the full cost method and disclosed in footnotes for firms following the successful efforts method. Results ofRecognition Versus Disclosure in The Oil and Gas Industry
multivariate tests indicate that in an investment setting footnote disclosure is not equivalent to recognition.Whether users of financial statements Recognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industryly empirically tested (for a literature review, see Bernard and Schipper [1994]). Existing empirical studies (e.g., Amir [1993], Barth [1994]) investigate the association between the firm's market value and an estimate of the disclosed item. However, although the coefficient estimates on the disclos Recognition Versus Disclosure in The Oil and Gas Industryed item have the predicted sign, the coefficient estimates are significantly different (in both directions) from the theoretical predictions. The resuRecognition Versus Disclosure in The Oil and Gas Industry
lts may be attributed to market inefficiency, measurement error in the disclosed items, or because disclosed items are less reliable than recognized iRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industryial statements users' perceptions. However, the experimental studies do not address the issue of whether different users' perceptions will result in different pricing in the marketplace.The accounting treatment for oil and gas firms provides a unique opportunity for testing the pricing implications Recognition Versus Disclosure in The Oil and Gas Industryof recognition and disclosure. SEC regulation sx 4-10 allows firms adopting the FC method to capitalize all costs associated with property acquisitionRecognition Versus Disclosure in The Oil and Gas Industry
, exploration, and developments activities. However, if the net capitalized cost of FC firms exceeds the net discounted future cash flows from proved Recognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industrynd their net capitalized asset value. However, the SEC and Generally Accepted Accounting Principles (GAAP) force SE firms to recognize a write-down only if the capitalized costs exceed the net undiscounted future cash flows from proved oil and gas reserves. Consequently, if the net capitalized costs Recognition Versus Disclosure in The Oil and Gas Industry exceed the "ceiling" but are less than the undiscounted cash flows, an FC firm must write-down its assets to the discounted cash flow while an SE firRecognition Versus Disclosure in The Oil and Gas Industry
m will only report an as-if write-down in its footnotes.This study focuses on a sample of 21 FC firms that formally recognize a write-down and a samplRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industryturns at the write-downs announcement date and the 10-K filing date.For FC firms the market generally observes the write-down at the write-downs announcement date and for SE firms the market can estimate the disclosed write-down at the 10-K filing.1 When investigating the market reaction, I test whe Recognition Versus Disclosure in The Oil and Gas Industryther the market responds similarly to FC firms recognizing a loss and SE firms disclosing one.2Pooled cross-sectional regression results document, atRecognition Versus Disclosure in The Oil and Gas Industry
the write-downs announcement date, a significant negative market reaction to firms recognizing a write-down. At the 10-K filing date there is no signiRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industryon is negatively associated with stock returns for both SE and FC firms. The main result that investors price differently recognized and disclosed write-downs is robust to several competing hypotheses.My results suggest that information disclosed in footnotes to the financial statements is used diff Recognition Versus Disclosure in The Oil and Gas Industryerently by investors from information recognized in the primary financial statements. The main finding is that the market reaction to firms recognizinRecognition Versus Disclosure in The Oil and Gas Industry
g a write-down significantly differs from the reaction to firms disclosing it. One explanation is that the FC firms' write-downs are visible while favRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industrynet-All but two firms disclosed the write-down at the earnings announcement date. The 3-day return for the 2 firms disclosing the write-down before the earnings release was -66 67% and -12 5%.In a Wall Street Journal ankle dated April 17, 1992 Catherine Montgomery, an analyst with Donaldson. Lufkin Recognition Versus Disclosure in The Oil and Gas Industry& Jentette. discusses the market reaction to FC firms recognizing a loss "Ỉ think that serious investors, institutions and analysts understand these wRecognition Versus Disclosure in The Oil and Gas Industry
ritedowns and what they say about the companies forced to take them. But the average investor out there lias a knee-jerk response and stock prices mayRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industryction 2 includes the related oil and gas accounting background and the method for estimating the SE firms' economic loss. Empirical tests are developed in section 3. Section 4 details the sample selection and descriptive statistics. Results and diagnostic tests are presented in section 5, and summar Recognition Versus Disclosure in The Oil and Gas Industryy and concluding remarks are presented in section 6.’In an interview with Mr Braverman, an investment officer with standard & Poors, the Wall street JRecognition Versus Disclosure in The Oil and Gas Industry
ournal (December 21. 1995) reports the following: "Nor says Mr Braverman should they [investors) ignore that a big write-off knocks down a company's bRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industryrms 2.1. Accounting background. Securities and Exchange Commission (SEC) regulation sx 4-10 prescribes financial reporting for firms engaged in oil and gas producing activities. According to sx 4-10, firms adopting the FC method (from hereon FC firms) may capitalize all costs associated with propert Recognition Versus Disclosure in The Oil and Gas Industryy acquisition, exploration and development activities. Firms are required to capitalize the costs within the appropriate cost center that is based onRecognition Versus Disclosure in The Oil and Gas Industry
a country-by-country basis. In contrast, firms following the successful efforts method (from hereon SE firms) are allowed to capitalize the same costsRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industryh quarter. The ceiling for each country is the sum of: (1) the present value of proved oil and gas revenues from estimated production of proved oil and gas reserves, based on the oil and gas prices at the end of each quarter and a discount rate of 10%, (2) the cost of properties not being amortized, Recognition Versus Disclosure in The Oil and Gas Industry and (3) the lower of cost or estimated fair value of unproved properties included in the costs being amortized, less (4) income tax effects related tRecognition Versus Disclosure in The Oil and Gas Industry
o the difference between book and tax basis of the properties involved/Subsequently, if the net capitalized costs within a cost center, less related dRecognition Versus Disclosure in The Oil and Gas IndustryDavid AboodyAnderson Graduate School of Management University of California, Los Angeles Los Recognition Versus Disclosure in The Oil and Gas Industrya subsequent increase in the cost center ceiling. The SEC did not apply thisJCited from regulation sx 4-10, Full Cost Method paragraph (4).5Gọi ngay
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