Private lenders’ demand for audit


Knowledge, compensation, and firm value: An empirical analysis of firm communication



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Knowledge, compensation, and firm value: An empirical analysis of firm communication

Feng, Li, Minnis, Michael, Nagar, Venky, Rajan, Madhav

Vol 58, Issue 1, 96-116 (2014)

Knowledge is central to managing an organization, but its presence in employees is difficult to measure directly. We hypothesize that external communication patterns reveal the location of knowledge within the management team. Using a large database of firm conference call transcripts, we find that CEOs speak less in settings where they are likely to be relatively less knowledgeable. CEOs who speak more are also paid more, and firms whose CEO pay is not commensurate with CEO speaking have a lower industry-adjusted Tobin's Q. Communication thus appears to reveal knowledge. [ABSTRACT FROM AUTHOR]

Large shareholders and disclosure strategies: Evidence from IPO lockup expirations

Ertimur, Yonca, Sletten, Ewa, Sunder, Jayanthi

Vol 58, Issue 1, 79-95 (2014)

We examine the effect of large shareholders' ex ante selling incentives on firms' voluntary disclosure choices in the setting of IPO lockup expirations. We find evidence that managers delay disclosures of bad news, not for their own benefit, but to enable influential pre-IPO shareholders to sell their shares at more favorable prices. Delays are more pronounced when aggregate selling incentives are greater, when uncertainty is high, and when venture capitalists, influential investors with strong selling incentives, own more shares. Simultaneously, managers' disclosure decisions reflect litigation concerns; no significant delays occur when litigation risk is high or when managers trade themselves. [ABSTRACT FROM AUTHOR]

Issues raised by studying DeFond and Zhang: What should audit researchers do?

Donovan, John, Frankel, Richard, Lee, Joshua, Martin, Xiumin, Seo, Hojun

Vol 58, Issue 2/3, 327-338 (2014)

We view audit-quality choice as one among many that managers make to maximize firm value. We question whether audit-quality differences among publicly traded companies are of significant interest to investors, clients, and auditors and ask for research on this topic. Relatedly, we ask for research on whether auditors and their clients show behavior consistent with regulated audit quality exceeding the audit quality level demanded absent regulation. We propose that researchers incorporate the competitive advantages of auditors and the institutional features of the audit process into the definition of audit quality. We propose that audit quality research test for externalities and inefficiencies to understand whether auditors and their clients are choosing the efficient level of audit quality. We note the legislative, judicial, and executive powers residing in the PCAOB. [ABSTRACT FROM AUTHOR]

A review of archival auditing research

DeFond, Mark, Zhang, Jieying

Vol 58, Issue 2/3, 275-326 (2014)

We define higher audit quality as greater assurance of high financial reporting quality. Researchers use many proxies for audit quality, with little guidance on choosing among them. We provide a framework for systematically evaluating their unique strengths and weaknesses. Because it is inextricably intertwined with financial reporting quality, audit quality also depends on firms' innate characteristics and financial reporting systems. Our review of the models commonly used to disentangle these constructs suggests the need for better conceptual guidance. Finally, we urge more research on the role of auditor and client competency in driving audit quality. [ABSTRACT FROM AUTHOR]

Political connections and SEC enforcement

Correia, Maria M.

Vol 57, Issue 2/3, 241-262 (2014)

Abstract: In this study, I examine whether firms and executives with long-term political connections through contributions and lobbying incur lower costs from the enforcement actions by the Securities and Exchange Commission (SEC). I find that politically connected firms on average are less likely to be involved in SEC enforcement actions and face lower penalties if they are prosecuted by the SEC. Contributions to politicians in a strong position to put pressure on the SEC are more effective than others at reducing the probability of enforcement and penalties imposed by an enforcement action. Moreover, the amounts paid to lobbyists with prior employment links to the SEC, and the amounts spent on lobbying the SEC directly, are more effective than other lobbying expenditures at reducing enforcement costs faced by firms. [Copyright &y& Elsevier]

Cash flow asymmetry: Causes and implications for conditional conservatism research

Collins, Daniel W., Hribar, Paul, Tian, Xiaoli

Vol 58, Issue 2/3, 173-200 (2014)

Earnings asymmetric timeliness captures both accrual and operating cash flow (CFO) asymmetric timeliness. Because recognition of operating cash flows does not reflect differential verification thresholds for recognizing unrealized gains versus losses, CFO asymmetry adds noise or bias to tests of conditional conservatism. We show that CFO asymmetry is predictable in the cross-section, and varies systematically with life-cycle characteristics. Removing CFO from earnings and using accruals-based measures of asymmetric timeliness eliminates several biases that prior studies have attributed to other sources. Moreover, accrual asymmetric timeliness varies in the cross-section as theory predicts. Going forward, we recommend researchers use accruals-based asymmetric timeliness measures when testing for conditional conservatism. [ABSTRACT FROM AUTHOR]

Differences in the information environment prior to seasoned equity offerings under relaxed disclosure regulation

Clinton, Sarah B., White, Joshua T., Woidtke, Tracie

Vol 58, Issue 1, 59-78 (2014)

The SEC promulgated the Securities Offering Reform (SOR) in 2005 to ease disclosure restrictions prior to seasoned equity offerings (SEOs). The SEC argued that SOR would improve the information environment, but critics claimed it would allow firms to hype their stock. This paper is the first to examine the information environment at the time of capital formation under SOR. We find more frequent and accurate management earnings forecasts, more 8-K filings, greater absolute market-adjusted returns, and more positive stock returns leading up to the SEO issue date indicating a richer pre-SEO information environment with capital formation benefits after SOR. [ABSTRACT FROM AUTHOR]

Does freezing a defined benefit pension plan affect firm risk?

Choy, Helen, Lin, Juichia, Officer, Micah S.

Vol 57, Issue 1, 1-21 (2014)

Abstract: This paper examines the impact of a defined benefit (DB) pension plan freeze on the sponsoring firm's risk and risk-taking activities. Using a sample of firms declaring a hard freeze on their DB plans between 2002 and 2007, we observe an increase in total risk (proxied by the standard deviation of EBITDA and asset beta), equity risk (standard deviation of returns), and credit risk following a DB-plan freeze. The increase in credit risk is reflected in a decline in credit ratings and an increase in bond yields for freezing firms. When we examine investment strategies, we observe a shift in investment from capital expenditures before the freeze to more-risky R&D projects after the freeze, and an increase in leverage. These strategies (increased focus on R&D and higher leverage) increase the operating and financial risk the firm faces. Overall, we observe an increase in risk-taking following DB plan freezes, consistent with theories that DB plans act as "inside debt" that aligns managers' interests with bondholders'. [Copyright &y& Elsevier]

Have capital market anomalies attenuated in the recent era of high liquidity and trading activity?

Chordia, Tarun, Subrahmanyam, Avanidhar, Qing, Tong

Vol 58, Issue 1, 41-58 (2014)

We examine whether the recent regime of increased liquidity and trading activity is associated with attenuation of prominent equity return anomalies due to increased arbitrage. We find that the majority of the anomalies have attenuated and the average returns from a portfolio strategy based on prominent anomalies have approximately halved after decimalization. We provide evidence that hedge fund assets under management, short interest and aggregate share turnover have led to the decline in anomaly-based trading strategy profits in recent years. Overall, our work indicates that policies to stimulate liquidity and ameliorate trading costs improve capital market efficiency. [ABSTRACT FROM AUTHOR]

Thoughts on financial accounting and the banking industry

Bushman, Robert M.

Vol 58, Issue 2/3, 384-395 (2014)

I provide big picture comments on the review of the banking literature in accounting by Beatty and Liao (2014) . Beatty and Liao (2014) does a service to the accounting field by providing an intelligent, well organized and accessible point of entry to banking research in accounting. I complement Beatty and Liao by presenting my observations on the role of financial accounting in banking, focusing my discussion on real effects of accounting policy choices on individual bank risk taking and codependence of risk among banks. I also offer ideas on future research directions. [ABSTRACT FROM AUTHOR]

The impact of issuer-pay on corporate bond rating properties: Evidence from Moody׳s and S&P׳s initial adoptions

Bonsall, Samuel B.

Vol 57, Issue 2/3, 89-109 (2014)

Abstract: This study examines whether and how the properties of corporate bond ratings change following Moody׳s and S&P׳s adoptions of the issuer-pay business model in the early 1970s. Regulators and debt market observers have criticized the issuer-pay model for creating an independence problem. However, the issuer-pay model allows for economic bonding between rating agencies and issuers through explicit contractual arrangements, which should improve the flow of nonpublic information. Using a difference-in-difference research design, I find that more optimistic ratings by issuer-pay rating agencies predict greater future profitability, differences between the ratings of issuer-pay and investor-pay rating agencies are associated with narrower secondary bond market bid-ask spreads, and that issuer-pay rating agencies become relatively more accurate and timely predictors of default compared to investor-pay agencies after the adoption of issuer-pay. These results reinterpret the recent findings of optimistic ratings by Jiang et al. (2012) as consistent with more informative bond ratings. [Copyright &y& Elsevier]

Financial accounting in the banking industry: A review of the empirical literature

Beatty, Anne, Liao, Scott

Vol 58, Issue 2/3, 339-383 (2014)

We survey research on banks׳ financial accounting. After providing a brief background of the theoretical models and accounting and regulatory institutions underlying the bank accounting literature, we review three streams of empirical research. Specifically we review studies associating bank financial reporting with the valuation and risk assessments, associating bank financial reporting discretion with regulatory capital and earnings management, and examining banks' economic decisions under differing accounting regimes. We discuss what we have already learned and about what else we would like to know. We also discuss methodological challenges associated with predicting the effects of alternative accounting and regulatory capital regimes. [ABSTRACT FROM AUTHOR]

Audit committee financial expertise and earnings management: The role of status

Badolato, Patrick G., Donelson, Dain C., Ege, Matthew

Vol 58, Issue 2/3, 208-230 (2014)

Regulatory pressure to increase both audit committee financial expertise and board independence has resulted in lower status for audit committees relative to management. This status differential is relevant because expertise and relative status are important determinants of each party׳s ability to influence outcomes, particularly when parties face conflicting goals. We find that audit committees with both financial expertise and high relative status are associated with lower levels of earnings management, as measured by accounting irregularities and abnormal accruals. These results speak to benefits and limitations of financial expertise, which have been the focus of considerable debate. [ABSTRACT FROM AUTHOR]

Industry concentration and corporate disclosure policy

Ali, Ashiq, Klasa, Sandy, Yeung, Eric

Vol 58, Issue 2/3, 240-264 (2014)

This study examines the association between U.S. Census industry concentration measures and the informativeness of corporate disclosure policy. We find that in more concentrated industries firms׳ management earnings forecasts are less frequent and have shorter horizons, their disclosure ratings by analysts are lower, and they have more opaque information environments, as measured by the properties of analysts׳ earnings forecasts. Also, when these firms raise funds they prefer private placements, which have minimal SEC-mandated disclosure requirements, over seasoned equity offerings. Overall, our findings suggest that firms in more concentrated industries disclose less and avoid certain financing decisions that have non-trivial disclosure implications, presumably due to proprietary costs of disclosure. [ABSTRACT FROM AUTHOR]

Market reaction to earnings news: A unified test of information risk and transaction costs

Zhang, Qi, Cai, Charlie X., Keasey, Kevin

Vol 56, Issue 2/3, 251-266 (2013)

Abstract: We examine how information risk and transaction costs influence the initial and subsequent market reaction to earnings news. We find that the initial market reaction is higher per unit of earnings surprise for higher information risk firms (information content effect). Furthermore, it is information risk that induces transaction costs that limit the initial market reaction and lead to higher subsequent drift (transaction costs effect). Information risk does not have an effect on drift beyond that achieved through transaction costs. Our findings highlight the importance of understanding the linkage between information risk and transaction costs in price discovery around public disclosure. [Copyright &y& Elsevier]

Creditor control rights, state of nature verification, and financial reporting conservatism

Tan, Liang

Vol 55, Issue 1, 1-22 (2013)

Abstract: I examine the impact of state-contingent allocation of creditor control rights on financial reporting. Using a discontinuity analysis, I find that firms'' financial reporting becomes more conservative immediately after covenant violations and this effect persists for at least eight quarters. The conservatism effect is more pronounced when creditors possess greater bargaining power, when firms'' operations are more volatile, and when creditors put Chief Restructuring Officers in place. My findings identify a specific channel through which debt financing shapes corporate financial reporting and provide direct evidence supporting the debt contracting explanation for conservatism posited in Watts (2003). [Copyright &y& Elsevier]

Internal control over financial reporting and managerial rent extraction: Evidence from the profitability of insider trading

Skaife, Hollis A., Veenman, David, Wangerin, Daniel

Vol 55, Issue 1, 91-110 (2013)

Abstract: This paper examines the association between ineffective internal control over financial reporting and the profitability of insider trading. We predict and find that the profitability of insider trading is significantly greater in firms disclosing material weaknesses in internal control relative to firms with effective control. The positive association is present in the years leading up to the disclosure of material weaknesses, but disappears after remediation of the internal control problems. We find insider trading profitability is even greater when insiders are more likely to act in their own self-interest as indicated by auditors' weak "tone at the top" adverse internal control opinions and this incremental profitability is driven by insider selling. Our research identifies a new setting where shareholders are most at risk for wealth transfers via insider trading and highlights market consequences of weak "tone at the top". [Copyright &y& Elsevier]

Bundled forecasts in empirical accounting research

Rogers, Jonathan L., Van Buskirk, Andrew

Vol 55, Issue 1, 43-65 (2013)

Abstract: This paper examines "bundled" forecasts, or management earnings forecasts issued concurrently with earnings announcements, which have evolved to become the most common type of management forecast. We describe the econometric problems associated with measuring bundled forecast news and, in particular, provide evidence that the measurement error in the traditional calculation of forecast news is material and is systematically associated with variables frequently studied in forecast-related research. We illustrate an application of conditional expectations to overcome these problems. Finally, we offer guidance and caveats to researchers considering the use of this method in the future. [Copyright &y& Elsevier]

Individual investors and financial disclosure

Lawrence, Alastair

Vol 56, Issue 1, 130-147 (2013)

Abstract: Using detailed data of individual investors, this study shows that, on average, individuals invest more in firms with clear and concise financial disclosures. The results indicate this relation is less pronounced for high frequency trading and financially-literate individuals. The study also shows that individuals' returns are increasing with clearer and more concise disclosures, implying such disclosures reduce individuals' relative information disadvantage. Together, the findings suggest improved corporate disclosure practices benefit individual investors, in particular buy-and-hold investors. [Copyright &y& Elsevier]

Boardroom centrality and firm performance

Larcker, David F., So, Eric C., Wang, Charles C. Y.

Vol 55, Issue 2/3, 225-250 (2013)

Abstract: Firms with central boards of directors earn superior risk-adjusted stock returns. A long (short) position in the most (least) central firms earns average annual returns of 4.68%. Firms with central boards also experience higher future return-on-assets growth and more positive analyst forecast errors. Return prediction, return-on-assets growth, and analyst errors are concentrated among high growth opportunity firms or firms confronting adverse circumstances, consistent with boardroom connections mattering most for firms standing to benefit most from information and resources exchanged through boardroom networks. Overall, our results suggest that director networks provide economic benefits that are not immediately reflected in stock prices. [Copyright &y& Elsevier]

Proxy advisory firms and stock option repricing

Larcker, David F., McCall, Allan L., Ormazabal, Gaizka

Vol 56, Issue 2/3, 149-169 (2013)

Abstract: This paper examines the economic consequences associated with the board of director's choice of whether to adhere to proxy advisory firm policies in the design of stock option repricing programs. Proxy advisors provide research and voting recommendations to institutional investors on issues subject to a shareholder vote. Since many institutional investors follow the recommendations of proxy advisors in their voting, proxy advisor policies are an important consideration for corporate boards in the development of programs that require shareholder approval such as stock option repricing programs. Using a comprehensive sample of stock option repricings announced between 2004 and 2009, we find that repricing firms following the restrictive policies of proxy advisors exhibit statistically lower market reactions to the repricing, lower operating performance, and higher employee turnover. These results are consistent with the conclusion that proxy advisory firm recommendations regarding stock option repricings are not value increasing for shareholders. [Copyright &y& Elsevier]

Debt, equity, and capital investment

Jackson, Scott B., Keune, Timothy M., Salzsieder, Leigh

Vol 56, Issue 2/3, 291-310 (2013)

Abstract: Theory suggests that debt financing, relative to equity financing, makes managers reluctant to part with assets. Our evidence supports this theoretical prediction, revealing that the reluctance to part with a debt financed asset causes two decision errors--(1) participants forego investments that increase firm value and (2) participants accept investments that decrease firm value. When the source of finance is equity, participants are less likely to make either of these costly decision errors. Further, we find that higher unpaid principal accentuates participants' reluctance to part with debt financed assets. Finally, the decision errors stem, in part, from the perception that an asset having a large unpaid principal balance has provided lower past benefits than an otherwise identical asset. [Copyright &y& Elsevier]

Does information risk affect the implied cost of equity capital? An analysis of PIN and adjusted PIN

Hwang, Lee-Seok, Lee, Woo-Jong, Lim, Seung-Yeon, Park, Kyung-Ho

Vol 55, Issue 2/3, 148-167 (2013)

Abstract: Using a unique dataset of Korean listed companies for which trade initiators are correctly identifiable, we estimate bias-free PIN (probability of informed trading) that is no longer subject to the trade misspecification problem and test whether it is related to expected returns. Unlike prior studies, we find that bias-free AdjPIN, the adjusted PIN purged of a liquidity component, is positively related to implied cost of equity. Our findings suggest that the errors in PIN variables hamper a proper identification of PIN pricing in prior studies. [Copyright &y& Elsevier]

Tax avoidance and geographic earnings disclosure

Hope, Ole-Kristian, Ma, Mark, Thomas, Wayne B.

Vol 56, Issue 2/3, 170-189 (2013)

Abstract: This study tests the relation between corporate tax avoidance and disclosure of geographic earnings for U.S. multinational companies. We find that after the adoption of Statement of Financial Accounting Standards No. 131 in 1998, firms opting to discontinue disclosure of geographic earnings in their financial reports have lower worldwide effective tax rates. These results are consistent with managers perceiving that non-disclosure of geographic earnings helps mask tax avoidance behavior. However, the relation between tax avoidance and non-disclosure reduces after implementation of Schedule M-3 in the annual corporate tax filing beginning in 2004. Schedule M-3 requires a detailed reconciliation of book income to tax income and aims to make firms' tax avoidance activities associated with shifting profits to lower-tax foreign jurisdictions more apparent to the IRS. This study contributes to our understanding of the relation between financial reporting behavior and tax reporting behavior. [Copyright &y& Elsevier]

Performance shocks and misreporting

Gerakos, Joseph, Kovrijnykh, Andrei

Vol 56, Issue 1, 57-72 (2013)

Abstract: We propose a parsimonious stochastic model of reported earnings that links misreporting to performance shocks. Our main analytical prediction is that misreporting leads to a negative second-order autocorrelation in the residuals from a regression of current earnings on lagged earnings. We also propose a stylized dynamic model of earnings manipulation and demonstrate that both earnings smoothing and target-beating considerations result in the same predictions of negative second-order autocorrelations. Empirically, we find that the distribution of this measure is asymmetric around zero with 27% of the firms having significantly negative estimates. Using this measure, we specify a methodology to estimate the intensity of misreporting and to create estimates of unmanipulated earnings. Our estimates of unmanipulated earnings are more correlated with contemporaneous returns and have higher volatility than reported earnings. With respect to economic magnitude, we find that, in absolute terms, median misreporting is 0.7% of total assets. Moreover, firms in our sample subject to SEC AAERs have significantly higher estimates of manipulation intensity. [Copyright &y& Elsevier]



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