Critical Accounting Estimate Disclosures and the Predictive Value of Earnings

Abstract

SYNOPSIS In the early 2000s, the Securities and Exchange Commission (SEC) called on firms to provide new Management's Discussion and Analysis (MD&A) disclosures about their critical accounting estimates (CAEs). The quantitative sensitivity disclosures outline reasonably likely changes in firms' highly uncertain accounting estimates and allow firms to communicate with users about accounting measurement uncertainty. Using a sample of S&P 500 firms, I find that the predictive value of earnings with respect to future cash flows is negatively associated with the presence of a CAE disclosure. Consistent with the SEC's intended purpose of the new disclosure practice, this finding suggests that CAE disclosures convey instances of heightened accounting measurement uncertainty and potentially aid users in assessing the level of uncertainty in accounting estimates. JEL Classifications: M41.