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Journal of Undergraduate Research

Keywords

SAB 101, quality of earnings, SEC, Securities and Exchange Commission

College

Marriott School of Management

Department

Accountancy

Abstract

On December 3, 1999 the Securities and Exchange Commission (SEC) issued an important accounting regulation, Staff Accounting Bulletin 101 (SAB 101), in response to concerns that many publicly traded companies were recognizing revenues inappropriately. Prior to the release of SAB 101 many investors and Wall Street analysts suspected that companies had the ability to manipulate their reported earnings numbers by inflating their sales figures. This new regulation is a direct signal that the SEC felt companies were too liberal in their policies for recording revenues since the purpose of SAB 101 is to provide clear instructions and restrictions on when companies can consider revenues to be “earned”. I predict that as a result of this regulation, the earnings of many publicly traded companies have declined since the conservative standards of SAB 101 were imposed. Because the SEC announced this bulletin so abruptly, the corporate community was taken by surprise. Therefore, I expect dramatic changes in revenues of adopting companies immediately following the implementation of SAB 101, but more importantly, I predict differences in investor behavior. The specific research question I investigate is, “Has SAB 101 increased investors’ perceptions of the quality of earnings?” If investors are indeed more confident and trusting of reported earnings numbers following the implementation of SAB 101, then this regulation adds significant value to capital market participants. If investors’ perceptions, on the other hand, are not affected, then the regulation proves to be a significant waste of time and money for companies who file with the SEC that have been forced to comply with this regulation. I hypothesize that SAB 101 has rendered earnings numbers more credible or believable to investors. Therefore, I expect to find a stronger positive correlation between stock returns and earnings of companies affected by SAB 101 following its implementation.

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