Job Market Paper
Firms increasingly discuss about the recurring revenue business model in their annual filings
Subscription Economy: Implications for Valuation and Earnings Management
The subscription economy — wherein firms offer products and services for recurring fees — has witnessed substantial growth in the last two decades. When valuing firms that rely on subscription revenue (hereafter subscription firms), investors adopt valuation methods that prioritize future revenue over current performance, which in turn alters the incentives and form of earnings management by these firms. Subscription firms tend to be relatively small and young, and they display heightened revenue persistence, improved investment efficiency, and greater profitability. They also experience more pronounced stock market reactions to their revenue and earnings, as evidenced by elevated multiples and earnings response coefficients (ERCs). However, the ERCs of subscription firms decrease when indicators of future revenue (e.g., deferred revenue) are low. Consistent with the valuation approaches used by investors, subscription firms avoid premature revenue recognition, as recognizing revenue prematurely compromises indicators of future revenue. Instead, they are more likely to cut discretionary expenses to meet earnings targets and defer more revenue to enhance valuation. These insights underscore the evolving nature of earnings management incentives in response to the changing economy and advocate for a prudent application of prior findings in this dynamic context.
Presented at: Columbia Business School BrownBag (2023), Accounting Design Project (scheduled 2023)
Draft available upon request
Dynamic analysis of management forecast issuance around the adoption of ASC 606
Draft available soon