Hayes, R. M. (2015). "Discussion of “The revolving door and the SEC׳s enforcement outcomes: Initial evidence from civil litigation” by DeHaan, Kedia, Koh, and Rajgopal (2015)." Journal of Accounting and Economics 60(2–3): 1-7. The study by deHaan et al. (2015) provides an empirical analysis of the effects of revolving door incentives at the SEC. Using a sample of SEC lawyers prosecuting civil cases of accounting misrepresentation, the authors examine how three measures of enforcement outcomes are related to the lawyers׳ career paths. I discuss specific elements of the study׳s research design, including the measurement of the study׳s two key elements, revolving door incentives and regulatory oversight, and comment on the paper׳s findings. While the study is interesting and creative, I believe that its limitations are too great to allow for meaningful conclusions.
Hansen, R. S. (2015). "What is the value of sell-side analysts? Evidence from coverage changes – A discussion." Journal of Accounting and Economics 60(2–3): 58-64. Li and You (this volume) study public firms’ common stock return reactions to two events: when analysts’ initiate coverage of the firm and when they terminate coverage. They test the returns for evidence of three sources of value added by analysts: (1) more monitoring of the firm, (2) reduced information asymmetry about the firm, and (3) greater demand for the firm’s common stock. They find consistent support for analysts adding value by increasing demand, but not monitoring or by reducing information asymmetry. Their findings also indicate that analysts’ initiations supply little new information. I review these findings, put them in perspective with related research, and note research directions.
Gao, H., et al. (2015). "Effects of managerial labor market on executive compensation: Evidence from job-hopping." Journal of Accounting and Economics 59(2–3): 203-220. We find that companies dramatically raise their incumbent executives’ pay, especially equity-based pay, after losing executives to other firms. The pay raise is larger when incumbent executives have greater employment mobility in the labor market, when companies lose senior executives, and when job-hopping executives receive favorable job offers in their new firms. A company׳s subsequent pay raise to incumbent executives after losing an executive diminishes its deficiency in executive compensation relative to its industry peer firms, and is effective at retaining its incumbent executives. Overall, our evidence suggests that executive job-hopping activity has significant effects on firms’ compensation policies.
Dyreng, S. D., et al. (2015). "The effect of tax and nontax country characteristics on the global equity supply chains of U.S. multinationals." Journal of Accounting and Economics 59(2–3): 182-202. We examine the global equity supply chains of U.S. multinationals to explore how tax and nontax country characteristics affect whether firms use foreign holding companies and where they locate them. We find that U.S. multinationals supply equity from headquarters to their foreign operating companies through foreign holding companies located in countries that lightly tax equity distributions. We also find that foreign holding companies tend to be located in countries with less corruption and investment risk than the countries in which the operating companies they own are located. In addition, we provide empirical evidence that the Netherlands, a well-known location for international tax planning, is a particularly popular site for foreign equity holding companies. Our findings contribute to a nascent literature that examines ownership chains in multinational companies and a larger literature on subsidiary location decisions for multinationals. The findings also provide empirical evidence that could be useful to governments in developed countries as they attempt to reform international tax policy.
deHaan, E., et al. (2015). "The revolving door and the SEC’s enforcement outcomes: Initial evidence from civil litigation." Journal of Accounting and Economics 60(2–3): 65-96. We investigate the consequences of the “revolving door” for trial lawyers at the SEC’s enforcement division. If future job opportunities motivate SEC lawyers to develop and/or showcase their enforcement expertise, then the revolving door phenomenon will promote more aggressive regulatory activity (the “human capital” hypothesis). In contrast, SEC lawyers can relax enforcement efforts in order to develop networking skills and/or curry favor with prospective employers at private law firms (the “rent seeking” hypothesis”). We collect data on the career paths of 336 SEC lawyers that span 284 SEC civil cases against accounting misrepresentation over the period 1990–2007. Our overall evidence is consistent with the “human capital” hypothesis. However, we find some evidence of “rent seeking” when SEC lawyers are based in Washington DC and when defense firms employ more former SEC lawyers. The revolving door likely impacts numerous aspects of SEC regulation setting and enforcement. This study examines accounting-related civil cases and is not able to study administrative or non-accounting enforcement cases. Further, the study does not address the choice of which cases to pursue, the incentives of employees other than trial lawyers, or how the revolving door affects rule making. Subject to these caveats, our study provides an important first look into the effects of revolving door incentives on the SEC’s enforcement process and lays the groundwork for future research.
Chen, J. V. and F. Li (2015). "Discussion of “Textual analysis and international financial reporting: Large sample evidence”." Journal of Accounting and Economics 60(2–3): 181-186. Lang and Stice-Lawrence (2015) find that firms which have adopted IFRS exhibit higher quality textual characteristics in their annual reports. In addition, they find that the textual characteristics of these annual reports are associated with firm economic outcomes. In this discussion, we first examine different explanations for each of these findings. We then examine the association between the length of U.S. 10-K filings and institutional ownership in U.S. firms. In addition, we use a case study to illustrate the challenges in establishing a causal relation between textual characteristics and economic outcomes. Lastly, we provide suggestions for areas of future research.
Cassar, G., et al. (2015). "Alternative information sources and information asymmetry reduction: Evidence from small business debt." Journal of Accounting and Economics 59(2–3): 242-263. We examine whether more sophisticated accounting methods (in the form of accrual accounting) interact with other information sources to reduce information asymmetries between small business borrowers and lenders, thereby lowering borrowers׳ probability of loan denial and cost of debt. We find that higher third party credit scores, but not the use of accrual accounting, decrease the likelihood of loan denial. However, firms using accrual accounting exhibit statistically lower interest rates after controlling for many factors associated with the cost of debt. Further, the interest rate benefits from accrual accounting are greatest when the borrower׳s credit score is low and/or the length of its banking relationship with the lender is short. This evidence indicates that accrual accounting can benefit small business borrowers, but that the information contained in third-party credit scores and obtained through ongoing banking relationships can substitute for the incremental information provided by accrual accounting.
Bloomfield, M. J. and R. Bloomfield (2015). "Discussion of delegated trade and the pricing of public and private information." Journal of Accounting and Economics 60(2–3): 104-109. Taylor and Verrecchia (2015) show that idiosyncratic risk can be priced in efficient but imperfectly competitive equity markets. We discuss how the model is structured, how it might apply to the pricing of financial reporting quality, and how empiricists might test its predictions.
Billings, M. B., et al. (2015). "On guidance and volatility." Journal of Accounting and Economics 60(2–3): 161-180. In contrast to theoretical and empirical evidence linking disclosure to information environment benefits, recent research concludes that guidance increases volatility, but leaves open the question of whether volatility plays a role in prompting the issuance of guidance. Consistent with the notion that managers react to rising volatility by providing guidance, we document a link between abnormal run-ups in volatility and the decision to issue a forecast after controlling for the market’s ability to anticipate the guidance. Upon disentangling pre-guidance volatility changes from post-guidance volatility changes, we find no evidence that guidance increases volatility. Indeed, our evidence consistently supports the view that managers seek to and do mitigate share price volatility with guidance.
Billings, M. B. and M. C. Cedergren (2015). "Strategic silence, insider selling and litigation risk." Journal of Accounting and Economics 59(2–3): 119-142. Prior work finds that managers beneficially time their purchases, but not sales, prior to forecasts. Focusing on if (as opposed to when) a forecast is given, we link insider selling to silence in advance of earnings disappointments. This raises the question of whether the absence of incriminating trading drives reductions in litigation risk potentially attributed to warnings. We find that the absence of a warning combined with the presence of selling exacerbates the consequences associated with the individual behaviors. Yet, selling prior to a warning typically does not offset all of the warning׳s benefit. In so doing, we supply the first robust evidence of a litigation benefit associated with warning.
Bertomeu, J. and R. P. Magee (2015). "Mandatory disclosure and asymmetry in financial reporting." Journal of Accounting and Economics 59(2–3): 284-299. This paper examines the demand for disclosure rules by informed managers interested in increasing the market price of their firms. Within a model of political influence, a majority of managers chooses disclosure rules with which all firms must comply. In equilibrium, disclosure rules are asymmetric with greater levels of disclosure over adverse events. This asymmetry is positively associated with the informativeness of the measurement and increasing in the level of verifiability and ex-ante uncertainty of the information. The theory also offers implications about the relation between mandatory and voluntary disclosure, when both channels are endogenous.
Beneish, M. D., et al. (2015). "In short supply: Short-sellers and stock returns." Journal of Accounting and Economics 60(2–3): 33-57. We examine the economic determinants of short-sale supply, and its consequences for future stock returns. Lendable supply increases with expected borrowing costs and decreases with financial statement constructs that indicate overvaluation. Although rising loan fees help ease supply constraints, we find shares are still least available when they are most attractive to short sellers. Using a number of firm characteristics, we derive useful instruments for real-time loan supply and demand conditions in the lending market. Further, we show that (1) when lendable supply is binding (non-binding), short-sale supply (demand) is the main predictor of future stock returns, (2) abnormal returns to the short-side of nine well-known market anomalies are attributable solely to “special” stocks, and (3) loan fees significantly reduce the profitability of the short side and several of these anomalies cease to be profitable. Overall our evidence highlights the central role played by the supply of lendable shares in equity price formation and returns prediction.
Corporate governance, incentives, and tax avoidance
Armstrong, Christopher S., Blouin, Jennifer L., Jagolinzer, Alan D., Larcker, David F.
Vol.60, Issue 1, 1-17 (2015)
We examine the link between corporate governance, managerial incentives, and corporate tax avoidance. Similar to other investment opportunities that involve risky expected cash flows, unresolved agency problems may lead managers to engage in more or less corporate tax avoidance than shareholders would otherwise prefer. Consistent with the mixed results reported in prior studies, we find no relation between various corporate governance mechanisms and tax avoidance at the conditional mean and median of the tax avoidance distribution. However, using quantile regression, we find a positive relation between board independence and financial sophistication for low levels of tax avoidance, but a negative relation for high levels of tax avoidance. These results indicate that these governance attributes have a stronger relation with more extreme levels of tax avoidance, which are more likely to be symptomatic of over- and under-investment by managers.
CEO opportunism?: Option grants and stock trades around stock splits
Devos, Erik, Elliott, William B., Warr, Richard S.
Vol.60, Issue 1, 18-35 (2015)
Decades of research confirm that, on average, stock split announcements generate positive abnormal returns. In our sample, 80% of CEO stock option grants are timed to occur on or before the split announcement date. With the average market-adjusted announcement return of 3.1%, awarding the grant before the split announcement results in an average gain per CEO-grant of $451,748. We find additional evidence consistent with timing of CEO stock trading around the split announcement. In the case of CEO stock sales, about two-thirds occur after the split announcement, resulting in an average gain of $345,613.
Market (in)attention and the strategic scheduling and timing of earnings announcements
deHaan, Ed, Shevlin, Terry, Thornock, Jacob
Vol.60, Issue 1, 36-55 (2015)
We investigate whether managers “hide” bad news by announcing earnings during periods of low attention, or by providing less forewarning of an upcoming earnings announcement. Our findings are consistent with managers reporting bad news after market hours, on busy days, and with less advance notice, and with earnings receiving less attention in these settings. Paradoxically, our findings indicate that managers also report bad news on Fridays, but we do not find lower attention on Fridays. Further, we find negative returns when the market is notified of an upcoming Friday earnings announcement, which is consistent with investors inferring forthcoming bad news.
Signaling through corporate accountability reporting
Lys, Thomas, Naughton, James P., Wang, Clare
Vol.60, Issue 1, 56-72 (2015)
We document that corporate social responsibility (“CSR”) expenditures are not a form of corporate charity nor do they improve future financial performance. Rather, firms undertake CSR expenditures in the current period when they anticipate stronger future financial performance. We show that the causality of the positive association between CSR expenditures and future firm performance differs from what is claimed in the vast majority of the literature and that corporate accountability reporting is another channel through which outsiders may infer insiders’ private information about firms’ future financial prospects.
Koh, Ping-Sheng, Reeb, David M.
Vol.60, Issue 1, 73-94 (2015)
We investigate whether missing R&D expenditures in financial statements indicates a lack of innovation activity. Patent records reveal that 10.5% of missing R&D firms file and receive patents, which is 14 times greater than zero R&D firms. Pseudo-Blank R&D firms (missing R&D firms with patent activity) demonstrate patent filings analogous to the bottom 90–95% of the positive R&D population. Multivariate difference-in-differences tests indicate that Pseudo-Blank R&D firms are more likely to report R&D after an exogenous auditor change. Finally, we provide simple Monte Carlo simulations to evaluate different methods to handle missing R&D in empirical research.
Assessing financial reporting quality of family firms: The auditors perspective
Ghosh, Aloke(Al), Tang, Charles Y.
Vol.60, Issue 1, 95-116 (2015)
We analyze audit fees and audit risk to extract auditors assessment of family-firms financial reporting quality. Relative to non-family firms, we find that auditors charge family firms significantly less, and the fee difference shrinks in magnitude when family firms have high audit risk. Using constructs for audit risk and audit effort, we show that family firms have lower audit risk, and that their auditors work less to provide assurance. Our findings suggest that superior reporting quality lowers audit risk and the need for greater audit investments, which is why auditors charge family firms less.
Evidence that the zero-earnings discontinuity has disappeared
Gilliam, Thomas A., Heflin, Frank, Paterson, Jeffrey S.
Vol.60, Issue 1, 117-132 (2015)
Discontinuities in earnings distributions at zero have been widely cited as evidence of earnings management but not without controversy. Recent research suggests discontinuities may be mere artifacts of certain research design choices. We find that the well-known zero-earnings discontinuity disappears soon after passage of the Sarbanes–Oxley Act (SOX) and has not returned. We also find that neither the discontinuity nor its disappearance require the effects of widely cited alternative (non-earnings management) explanations for the zero-earnings discontinuity.
Does return dispersion explain the accrual and investment anomalies?
Chichernea, Doina C., Holder, Anthony D., Petkevich, Alex
Vol.60, Issue 1, 133-148 (2015)
Recent research shows that high return dispersion (RD) is associated with economic conditions characterized by high discount rates, which are not conducive to growth and investment. We propose that RD risk can explain the accrual and investment anomalies. We conduct asset-pricing tests that include RD as a potential risk factor and show that low-accrual and low-investment firms have significantly higher exposure to the risk captured by RD. RD significantly explains future returns and the excess returns to accrual and investment hedge portfolios shrink in magnitude and become insignificant during periods of low RD. We conclude that risk explains the accrual and investment anomalies.
The importance of the internal information environment for tax avoidance
Gallemore, John, Labro, Eva
Vol.60, Issue 1, 149-167 (2015)
We show that firms ability to avoid taxes is affected by the quality of their internal information environment, with lower effective tax rates (ETRs) for firms that have high internal information quality. The effect of internal information quality on tax avoidance is stronger for firms in which information is likely to play a more important role. For example, firms with greater coordination needs because of a dispersed geographical presence benefit more from high internal information quality. Similarly, firms operating in a more uncertain environment benefit more from the quality of their internal information in helping them to reduce ETRs. In addition, we provide evidence that high internal information quality allows firms to achieve lower ETRs without increasing the risk of their tax strategies (as measured by ETR volatility). Overall, our study contributes to the literature on tax avoidance by providing evidence that the internal information environment of the firm is important for understanding its tax avoidance outcomes.
Do scaling and selection explain earnings discontinuities?
Burgstahler, David, Chuk, Elizabeth
Vol.60, Issue 1, 168-186 (2015)
Earnings distributions commonly exhibit statistically significant discontinuities at zero earnings, which are widely interpreted as evidence of earnings management to avoid a loss. In contrast, Durtschi and Easton (2005, 2009, hereafter DE) assert that discontinuities are instead explained by some combination of prior researchers choice(s) of scaling and sample selection as well as a scaling-related effect due to a systematic relation between the sign of earnings and market prices. Resolution of the conflicting interpretations of discontinuities is important because (1) it affects how investors, regulators, and scholars view earnings management and (2) it demonstrates the importance of a close linkage between theory and research design choices. We point out that DE provide no evidence that scaling or selection create discontinuities, but only evidence showing that changes in scaling or selection eliminate discontinuities. We demonstrate why the research designs used by DE eliminate discontinuities and why alternative designs using the same data yield statistically significant discontinuities that cannot be attributed to either scaling or selection.
Strategic silence, insider selling and litigation risk
Billings, Mary Brooke, Cedergren, Matthew C.
Vol.59, Issue 2-3, 119-142 (2015)
Prior work finds that managers beneficially time their purchases, but not sales, prior to forecasts. Focusing on if (as opposed to when) a forecast is given, we link insider selling to silence in advance of earnings disappointments. This raises the question of whether the absence of incriminating trading drives reductions in litigation risk potentially attributed to warnings. We find that the absence of a warning combined with the presence of selling exacerbates the consequences associated with the individual behaviors. Yet, selling prior to a warning typically does not offset all of the warnings benefit. In so doing, we supply the first robust evidence of a litigation benefit associated with warning.
Information asymmetry and capital structure: Evidence from regulation FD
Vol.59, Issue 2-3, 143-162 (2015)
This study uses Regulation Fair Disclosure (FD) as a plausibly exogenous shock to the information environment to identify the causal effect of information asymmetry on corporate financing behavior. Although Regulation FD prevents firms from selectively disclosing material information to market professionals in the equity market, firms can still do so to banks and rating agencies in the debt market. The standards differential disclosure requirements lead to differential changes in the information environments between the two markets, providing a reasonably useful setting to examine the effect of information asymmetry on firms capital structure. I find that firms with a high level of information asymmetry increase debt more than firms with a low level of information asymmetry post-Regulation FD. The results suggest that managers adjust the target leverage ratios to rely more on debt when facing higher costs of equity.
Why do analysts revise their stock recommendations after earnings announcements?
Vol.59, Issue 2-3, 163-181 (2015)
Recent research finds that many analyst recommendation revisions take place shortly after earnings announcements. Altinkilic and Hansen (2009) attribute the clustering of recommendations to analysts strategically piggybacking on earnings information to improve the perceived performance of their recommendations. This study proposes an alternative view: I find that analysts issue recommendations when they face greater demand from investors, when the relative supply of information available on earnings announcements is higher and when they detect mispricings. These results are consistent with analysts striving to meet the demands of investors by providing useful recommendations after earnings announcements.