A test of the market's pricing of nontransitory dirty surplus flows

Abstract

This study examines whether the market correctly prices nontransitory dirty surplus flows. Unlike the US Generally Accepted Accounting Principle (GAAP) and International Accounting Standards, Taiwanese Company Law allows employees' bonuses under the profit-sharing scheme to be directly taken to retained earnings, bypassing the income statement. We find that these compensation costs are positively associated with share price and return, indicating that the market values the incentive effect of the profit-sharing scheme. More importantly, we find that the market correctly prices the persistence of these compensation costs. Overall, this study indicates that investors are able to correctly price nontransitory dirty surplus flows. © 2013 Copyright City University of Hong Kong and National Taiwan University.

Publication Title

Asia-Pacific Journal of Accounting and Economics

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