Private lenders’ demand for audit


Hribar, P., et al. (2017). "Does managerial sentiment affect accrual estimates? Evidence from the banking industry." Journal of Accounting and Economics 63(1): 26-50



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Hribar, P., et al. (2017). "Does managerial sentiment affect accrual estimates? Evidence from the banking industry." Journal of Accounting and Economics 63(1): 26-50.

We examine whether managerial sentiment is associated with errors in accrual estimates. Using public banks we find (1) managerial sentiment is negatively associated with loan loss provision estimates, (2) future charge-offs per dollar of provision are positively associated with sentiment when the provision is estimated, and (3) the effects of sentiment are greater for firms with more uncertain charge-offs. Results are similar for private banks, suggesting accrual manipulation related to capital market incentives is unlikely to explain the results. Although economic fundamentals explain most of the variation in the provision, we find sentiment has an incremental and economically meaningful effect.


Lo, K., et al. (2017). "Earnings management and annual report readability." Journal of Accounting and Economics 63(1): 1-25.

We explore how the readability of annual reports varies with earnings management. Using the Fog Index to measure readability (Li, 2008), and focusing on the management discussion and analysis section of the annual report (MD&A), we predict and find that firms most likely to have managed earnings to beat the prior year's earnings have MD&As that are more complex. This disruption of the overall pattern of readability increasing with the level of earnings found in Li (2008) challenges the ontological explanation that good news is inherently easier to communicate, and shows that obfuscation contributes to making disclosures more complex.


Schoenfeld, J. (2017). "The effect of voluntary disclosure on stock liquidity: New evidence from index funds." Journal of Accounting and Economics 63(1): 51-74.

This study tests whether voluntary disclosure affects stock liquidity. I argue that index funds fit the profile of nonstrategic traders who, according to theory, are unambiguously more likely than managers and strategic investors to prefer high stock liquidity and thus high disclosure. This suggests that I can use index funds' disclosure preferences to construct an empirical model of voluntary disclosure that abstracts away from managers' strategic disclosure motives. Accordingly, I use an index-fund setting to construct a recursive structural equation model of voluntary disclosure, index fund ownership, and liquidity. I find that when a firm joins the S&P 500 index, voluntary disclosure increases with the level of ownership assumed by index funds, and this increase in disclosure is associated with increased stock liquidity. These results imply that voluntary disclosure increases stock liquidity.


Bernard, D. (2016). "Is the risk of product market predation a cost of disclosure?" Journal of Accounting and Economics 62(2–3): 305-325.

Competitors engage in product market predation when they lower prices or increase expenditures on nonprice competition with the goal of forcing a rival to exit. This study provides evidence that financially constrained firms avoid financial statement disclosure to mitigate predation risk. The empirical tests examine German private firms, most of which failed to comply with financial statement public disclosure requirements until an enforcement change increased noncompliance costs. The evidence shows more financially constrained firms were more likely to avoid disclosure until the change. Results from cross-sectional and supplemental analyses are consistent with predation risk driving this relation.


Call, A. C., et al. (2016). "Rank and file employees and the discovery of misreporting: The role of stock options." Journal of Accounting and Economics 62(2–3): 277-300.

We find that firms grant more rank and file stock options when involved in financial reporting violations, consistent with managements’ incentives to discourage employee whistle-blowing. Violating firms grant more rank and file options during periods of misreporting relative to control firms and to their own option grants in non-violation years. Moreover, misreporting firms that grant more rank and file options during violation years are more likely to avoid whistle-blowing allegations. Although the Dodd-Frank Act (2010) offers financial rewards to encourage whistle-blowing, our findings suggest that firms discourage whistle-blowing by giving employees incentives to remain quiet about financial irregularities.


Chircop, J. and Z. Novotny-Farkas (2016). "The economic consequences of extending the use of fair value accounting in regulatory capital calculations." Journal of Accounting and Economics 62(2–3): 183-203.

We investigate the economic consequences of the Basel III requirement to include unrealized fair value gains and losses on available-for-sale (AFS) securities in regulatory capital. Using data for U.S. banks we find negative market reactions around news indicating an increased likelihood of this regulatory change being implemented, consistent with increased regulatory costs. We also find that banks affected by this regulation reduce their investment in risky AFS securities relative to unaffected banks. This result suggests that extending the use of fair values for regulatory purposes reduces ex ante risk taking.


Dyer, T., et al. (2016). "Do managers really guide through the fog? On the challenges in assessing the causes of voluntary disclosure." Journal of Accounting and Economics 62(2–3): 270-276.

Guay et al. (2016) document that firms with longer and more complex 10-Ks provide relatively more voluntary disclosure, which they interpret as evidence that managers use voluntary disclosure to mitigate negative effects of complex mandatory disclosure. We review the results of Guay et al. and focus on two main challenges to inferring causality: (1) the coincidence of upward over-time trends in annual report length, complexity, and voluntary disclosure, and (2) the potential for omitted correlated variables, such as changes in firm economics, to drive changes in 10-K textual characteristics and voluntary disclosure. While the results in Guay et al. are extensive and robust, we argue that economic drivers of, and trends in, voluntary disclosure present important avenues for future research.


Frankel, R., et al. (2016). "Using unstructured and qualitative disclosures to explain accruals." Journal of Accounting and Economics 62(2–3): 209-227.

We examine the usefulness of support vector regressions (SVRs) in assessing the content of unstructured, qualitative disclosures by relating MD&A-based SVR-accrual estimates (MD&A accruals) to actual accruals. We find that MD&A accruals explain a statistically and economically significant portion of firm-level accruals and identify more persistent accruals. We find that the explanatory power of MD&A accruals is higher for more readable 10-Ks, thereby providing evidence for the construct validity of the readability measures. To highlight the flexibility of the SVR method, we apply it to other dependent variables and disclosures. We find that MD&A-based cash-flow forecasts produced by SVR predict next period’s cash flows. We apply SVR to conference call transcripts and find accruals estimates have similar explanatory power to MD&A accruals. Finally, the explanatory power of MD&A accruals increases between 1994 and 2013.


Guay, W., et al. (2016). "Guiding through the Fog: Financial statement complexity and voluntary disclosure." Journal of Accounting and Economics 62(2–3): 234-269.

A growing literature documents that complex financial statements negatively affect the information environment. In this paper, we examine whether managers use voluntary disclosure to mitigate these negative effects. Employing cross-sectional and within-firm designs, we find a robust positive relation between financial statement complexity and voluntary disclosure. This relation is stronger when liquidity decreases around the filing of the financial statements, is stronger when firms have more outside monitors, and is weaker when firms have poor performance and greater earnings management. We also examine the relation between financial statement complexity and voluntary disclosure using two quasi-natural experiments. Employing a generalized difference-in-differences design, we find firms affected by the adoption of complex accounting standards (e.g., SFAS 133 and SFAS 157) increase their voluntary disclosure to a greater extent than unaffected firms. Collectively, these findings suggest managers use voluntary disclosure to mitigate the negative effects of complex financial statements on the information environment.


Hoberg, G. (2016). "Discussion of using unstructured and qualitative disclosures to explain accruals." Journal of Accounting and Economics 62(2–3): 228-233.

Laux, C. (2016). "The economic consequences of extending the use of fair value accounting in regulatory capital calculations: A discussion." Journal of Accounting and Economics 62(2–3): 204-208.

When the Federal Reserve, following Basel III, proposed removing the accumulated other comprehensive income (AOCI) filter that shields regulatory capital from unrealized gains and losses on available-for-sale (AFS) debt securities, it triggered fierce opposition. The topic is at the heart of the debate about the role of fair value accounting for financial stability. Chircop and Novotny-Farkas (2016) investigate banks' stock price reaction and investment behavior around news events up to the announcement of the final decision. I focus on the question of whether their evidence is sufficiently strong to convince either side in the debate.


Shroff, N. (2016). "Discussion of “Is the risk of product market predation a cost of disclosure?”." Journal of Accounting and Economics 62(2–3): 326-332.

Bernard (2016) proposes that financially constrained firms susceptible to “product market predation” are more likely to avoid complying with a mandatory requirement to publicly disclose financial statements. Bernard tests and finds that financially constrained private firms in Germany are less likely to disclose their financial statements despite being subject to a law requiring them to do so and interprets this evidence as consistent with predation risk affecting firms’ disclosure decisions. I discuss how Bernard׳s findings advance our understanding of the incentives and disincentives for disclosure. I evaluate the theoretical rationale – i.e., product market predation – as the motive for non-disclosure as well as the strengths and weaknesses of his empirical analyses. My discussion highlights the implications of these findings for disclosure regulation, especially as it relates to small private firms. I end my discussion with suggestions for future research, including ideas to use the empirical setting identified by Bernard for answering other research questions.


Sloan, R. G. (2016). "Discussion of: Rank and file employees and the discovery of misreporting: The role of stock options." Journal of Accounting and Economics 62(2–3): 301-304.

Call, Kedia and Rajgopal (2016) provide intriguing evidence concerning the apparent role of employee stock options in inducing rank and file employees to be complicit in corporate misconduct. They conclude that granting options to rank and file employees provides incentives for them to facilitate misreporting and discourages them from whistleblowing. In this discussion, I argue that the evidence is largely circumstantial and puzzling in several respects. I conclude that while Call et al. have identified intriguing evidence, further research is required to rule out alternative explanations and to better understand employees’ motives.



Cuny, C. (2016). "Voluntary disclosure incentives: Evidence from the municipal bond market." Journal of Accounting and Economics 62(1): 87-102.

I investigate the trade-off between capital market incentives, reputational concerns, and administrative costs in the public disclosure decisions of municipal bond issuers. After Ambac׳s bankruptcy, issuers of insured debt increase disclosure relative to issuers of uninsured debt. After local per capita income declines or expenditures increase, issuers, particularly those with strong electoral incentives and weak voter oversight, reduce disclosure. After the implementation of an online filing repository, issuers with few dissemination channels increase disclosure relative to other issuers. Overall, my findings support a positive relationship between voluntary disclosure, risk, and low-cost dissemination, to the extent reputational capital is not threatened.



Arif, S., et al. (2016). "Understanding the relation between accruals and volatility: A real options-based investment approach." Journal of Accounting and Economics 62(1): 65-86.

Accruals are fundamental to financial reporting and are the underlying innovation of accounting. Despite this, accounting research has provided little understanding of how economic forces affect a firm׳s level of accruals and limited guidance for forming expectations of accruals based on ex ante firm characteristics. We consider accruals as a form of investment and examine whether theoretical predictions from a real options-based investment framework provide insight into the relation between accruals and the ex ante expected volatility faced by the firm. Specifically, the theory predicts that higher volatility dampens investment because firms prefer to ‘wait and see’ instead of investing immediately. Consistent with this theory, we document a robust negative relation between year-ahead net working capital accruals and expected volatility. We also predict and find that the negative association between year-ahead net working capital accruals and expected volatility is less pronounced for distressed firms and more pronounced for firms with a longer operating cycle, and that current asset accruals are more sensitive to volatility than current liability accruals. Finally, we find that the residuals from an investment-based expected accrual model outperform those from the widely-used performance-adjusted modified Jones model in identifying companies that just meet or beat analysts’ earnings forecasts. Collectively, our findings suggest that the investment perspective of accruals, and in particular the real options-based investment framework, provide useful insights for forming expectations of accruals.


Kausar, A., et al. (2016). "Real effects of the audit choice." Journal of Accounting and Economics 62(1): 157-181.

We hypothesize that the choice to obtain a financial statement audit provides external financiers with incremental information about the firm, which helps reduce information asymmetry and financing frictions. Using a natural experiment, we show that when external financiers observe a firm׳s choice to voluntarily obtain an audit, the firms obtaining an audit significantly increase their debt, investment, and operating performance, and become more responsive to their investment opportunities. Further, we find that these effects are stronger for firms that are financially constrained and weaker for firms with other means to reduce financing frictions. Overall, our evidence suggests that the audit choice conveys information to capital providers, which reduces financing frictions and improves performance.


Michaely, R., et al. (2016). "Further evidence on the strategic timing of earnings news: Joint analysis of weekdays and times of day." Journal of Accounting and Economics 62(1): 24-45.

Using combinations of weekdays and times of day (before, during, and after trading hours) of earnings announcements, we examine whether managers attempt to strategically time these announcements. We document that the worst earnings news is announced on Friday evening and find robust evidence that only Friday evening announcements represent managers’ rational opportunistic behavior. Friday evening announcements are followed by insider trading in the direction of earnings news and the largest post-earnings announcement drift. Managers also attempt to reduce interaction with investors and hide more than just earnings news by announcing on Friday evening. We find that Friday evening announcements occur later in the evening than announcements on other evenings, firms have a reduced propensity to hold conference calls, and major firm restructuring events are relatively more likely to occur after Friday evening announcements.


Amiram, D., et al. (2016). "Do information releases increase or decrease information asymmetry? New evidence from analyst forecast announcements." Journal of Accounting and Economics 62(1): 121-138.

Prior literature documents that both earnings announcements and management earnings forecasts increase information asymmetry at announcement. In contrast, we predict and document that analyst earnings forecasts decrease information asymmetry at announcement. As expected, this directional contrast is temporary, in that all three information release types lead to a decrease in information asymmetry following the short-window announcement period. Our evidence demonstrates that the direction of the effect of a public information release on announcement-period information asymmetry is determined by how the information contained in the release relates to prior information held by sophisticated and unsophisticated investors, which supports extant disclosure theory.


Akbas, F., et al. (2016). "Director networks and informed traders." Journal of Accounting and Economics 62(1): 1-23.

We provide evidence that sophisticated investors like short sellers, option traders, and financial institutions are more informed when trading stocks of companies with more connected board members. For firms with large director networks, the annualized return difference between the highest and lowest quintile of informed trading ranges from 4% to 7.2% compared to the same return difference in firms with less connected directors. Sophisticated investors better predict outcomes of upcoming earnings surprises and firm-specific news sentiment for companies with more connected directors. Changes in board connectedness are positively associated with changes in measures of adverse selection.


Hilary, G., et al. (2016). "The bright side of managerial over-optimism." Journal of Accounting and Economics 62(1): 46-64.

Human estimation and inference are subject to systematic biases such as overconfidence and over-optimism. In contrast to prior research that has identified multiple negative consequences of these biases, we focus on positive effects. We empirically examine a setting in which over-optimism a) is a related but different bias from overconfidence, b) emerges dynamically in a rational economic framework, and c) generates higher managerial effort. Importantly, this additional effort improves firm profitability and market value.


Gallo, L. A., et al. (2016). "Aggregate earnings surprises, monetary policy, and stock returns." Journal of Accounting and Economics 62(1): 103-120.

This paper examines whether the negative association between aggregate earnings and returns is explained by the monetary policy news in aggregate earnings. Using Federal funds futures data to construct a measure of policy news, we find that aggregate earnings convey information about the Fed׳s policy actions. Additionally, the negative aggregate earnings-returns association is muted when we control for policy surprises. This result is more pronounced in periods with negative policy surprises, which tend to trigger a more significant market reaction. Taken together, these results suggest that aggregate earnings convey policy news and the market reacts negatively to policy surprises, which drives the negative aggregate earnings-returns association.


Brown, L. D., et al. (2016). "The activities of buy-side analysts and the determinants of their stock recommendations." Journal of Accounting and Economics 62(1): 139-156.

We survey 344 buy-side analysts from 181 investment firms and conduct 16 detailed follow-up interviews to gain insights into the activities of buy-side analysts, including the determinants of their compensation, the inputs to their stock recommendations, their beliefs about financial reporting quality, and the role of sell-side analysts in buy-side research. One important finding is that 10-K or 10-Q reports are more useful than quarterly conference calls and management earnings guidance for determining buy-side analysts׳ stock recommendations. Our results also suggest that sell-side analysts add value by providing buy-side analysts with in-depth industry knowledge and access to company management.


Arya, A. and B. Mittendorf (2016). "On the synergy between disclosure and investment beauty contests." Journal of Accounting and Economics 61(2–3): 255-273.

Many investments are noted for their "beauty contest" features in that decision makers desire conformity with others׳ choices due to inherent complementarities. This paper examines the incentives of firms to take preemptive action and publicly disclose their investments in such beauty contests. In this case, it is the beauty contest desire for coordination that incentivizes a firm to disclose because doing so allows it to convey information that establishes norms and thereby influence subsequent actions of others. Disclosure recipients too benefit from this arrangement because they access additional information on which to base their decisions.


Baldenius, T., et al. (2016). "Relational contracts with and between agents." Journal of Accounting and Economics 61(2–3): 369-390.

We study a dynamic multi-agent model with a verifiable team performance measure and non-verifiable individual measures. The optimal contract can be interpreted as an explicit contract that specifies a minimum bonus pool as a function of the verifiable measure and an implicit contract that gives the principal discretion to increase the size of the pool and to allocate it among the agents. To mitigate the threat of collusion, the optimal contract often converts any exogenous productive interdependence into strategic payoff independence for the agents. Under productive complements, an unconditional bonus pool (pay without performance) can be less costly than one conditioned on the verifiable team measure.


Chang, H. S., et al. (2016). "Do analysts understand the economic and reporting complexities of derivatives?" Journal of Accounting and Economics 61(2–3): 584-604.

We investigate whether and how the complexity of derivatives influences analysts׳ earnings forecast properties. Using a difference-in-differences design, we find that, relative to a matched control sample of non-users, analysts׳ earnings forecasts for new derivatives users are less accurate and more dispersed after derivatives initiation. These results do not appear to be driven by the economic complexity of derivatives, but rather the financial reporting of such economic complexity. Overall, despite their financial expertise, analysts routinely misjudge the earnings implications of firms׳ derivatives activity. However, we find evidence that a series of derivatives accounting standards has helped analysts improve their forecasts over time.


Demerjian, P. R. and E. L. Owens (2016). "Measuring the probability of financial covenant violation in private debt contracts." Journal of Accounting and Economics 61(2–3): 433-447.

We measure the probability that a borrower will violate financial covenants in private debt contracts. We analyze hand-coded data and specify standard covenant definitions using Compustat data that minimize measurement error for all individual Dealscan covenants. We use these definitions to create a measure of aggregate probability of violation, which can be used across all covenants in a loan or among covenant subsets of interest. We provide evidence that our aggregate probability measure is superior to alternatives used in prior literature.



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