Asymmetrical return on equity mean reversion and catering

Using a momentum threshold autoregression model, we find evidence showing that there is an asymmetrical mean reversion behavior in return on equity (ROE). Results show that the speed of adjustment of ROE towards the long-term mean is slower in the ROE increasing regimes than in the ROE decreasing regimes. Additional results indicate that investor earnings optimism is significantly related to change in abnormal ROE. These results are consistent with predictions from catering theory.     

Ownership structure,corporate governance and analyst following: A study of French listed firms

This study investigates the effects of some characteristics of the French corporate governance model – deemed to foster entrenchment and facilitate private benefits extraction – on the extent of analyst following. The results show that analysts are more likely to follow firms both with high discrepancy level between ownership and control and those controlled through pyramiding. These findings provide empirical support to the argument that minority shareholders value private information on firms with high expropriation likelihood, asking thence for more analyst services. Additional findings show that analysts are reticent to follow firms managed by controlling family members. This is, in part, explained by these firms’ reliance on private communication channels rather than public disclosure, producing a poor informational environment.     

Family firms and crash risk: Alignment and entrenchment effects

Stock price crash risk could be lower in family firms because the controlling family investors have a longer-term interest, hold greater decision rights and are better informed than investors in diffusely owned firms (alignment effect). However, the agency costs between family and nonfamily investors (entrenchment effect) could affect crash risk in two opposing ways. Non-controlling investor skepticism about insider entrenchment limits overvaluation and reduces the crash risk. In contrast, entrenched insiders could hide bad news to exploit private benefits, which could increase the crash risk. We show that family firms exhibit a lower crash risk than similar nonfamily firms after controlling for lower overvaluation, which is consistent with the better alignment effect. Moreover, we show that better governance further reduces the crash risk, which indicates that the substitutive relationship between strong governance and family ownership shown in countries with low investor protection rights does not carry over to the U.S. where investor protection rights are strong.     

Order aggressiveness as a metric to assess the usefulness of accounting information

Motivated by the availability of high-frequency data on trading activity, this paper proposes the use of order aggressiveness as a metric to evaluate the usefulness of accounting information. I test, through an analysis of order aggressiveness, whether earnings announcements of firms listed on the Italian Stock Exchange limit order book have information content. I estimate an ordered probit relating order aggressiveness to unexpected earnings and to three market determinants of aggressiveness. Consistent with the theory on the choice between limit and market orders, I find that order aggressiveness increases with the absolute value of unexpected earnings. The results provide evidence on the extent to which the information contained in earnings is used by traders.     

Macro to micro: Country exposures,firm fundamentals and stock returns

We outline a systematic approach to incorporate macroeconomic information into firm level forecasting from the perspective of an equity investor. Using a global sample of 198,315 firm-years over the 1998–2010 time period, we find that combining firm level exposures to countries (via geographic segment data) with forecasts of country level performance, is able to generate superior forecasts for firm fundamentals. This result is particularly evident for purely domestic firms. We further find that this forecasting benefit is associated with future excess stock returns. These relations are stronger after periods of higher dispersion in expected country level performance.     

Information friction and investor home bias: A perspective on the effect of global IFRS adoption on the extent of equity home bias

This paper provides a perspective on the effect of IFRS adoption on the tendency of investors to under-invest in foreign equities. We consider explanations for the equity home bias described in prior research and discuss research relevant to the informational consequences of global adoption of IFRS. Specifically, we evaluate whether IFRS adoption reduces information processing costs or decreases investor uncertainty about either the quality of financial reporting or the distribution of future cash flows. We predict that the effect of any reduction in information processing costs from the adoption of IFRS is likely to be small relative to the effects of other determinants of home bias such as the strength of investor protection mechanisms in foreign countries, behavioral biases toward familiar equities, and informational advantages related to geographical proximity. We argue that the quality of the information that investors have (or perceive they have) decreases with distance, conclude that global IFRS adoption is unlikely to affect home bias, and propose avenues for future research.     

Foreign macroeconomic and industry-related information transfers around earnings announcements: Evidence from U.S.-listed non-U.S. firms

This study examines information transfer regarding how investors react to new foreign macroeconomic and industry-related information embedded in foreign firms' earnings releases. Using non-U.S. firms listed in the U.S. as our main setting, we find that U.S. investors react significantly to foreign macroeconomic information and to information generated by the interaction between macroeconomic and industry-related information. We also find that the benefits (costs) of processing earnings reports increase (decrease) both types of information transfers. In addition, we find macroeconomic information transfers in an international cross-listing setting and both types of information transfers in an international non-cross-listing setting.     

The Disciplinary Role of Financial Statements: Evidence from Mergers and Acquisitions of Privately Held Targets

This study examines whether requiring the disclosure of audited financial statements disciplines managers’ mergers and acquisitions (M&As) decisions. When an M&A transaction meets certain disclosure thresholds, the Securities and Exchange Commission (SEC) requires the public acquirer to disclose the target's audited financial statements after the merger is completed. Using hand‐collected data, I find that the disclosure of private targets’ financial statements is associated with better acquisition decisions. Furthermore, I find that this disciplining effect of disclosure is more pronounced when monitoring by outside capital providers is more difficult and costly, and when other disciplining mechanisms are weaker. Finally, these findings are robust to several alternative explanations, such as monitoring from blockholders and voluntary disclosures. In sum, the evidence suggests that the ex post mandatory disclosure of private targets’ accounting information disciplines managers’ acquisition decisions and improves acquisition efficiency.     

Auditor reputation and earnings management: International evidence from the banking industry

We examine the relation between auditor reputation and earnings management in banks using a sample of banks from 29 countries. In particular, we examine the implications of two aspects of auditor reputation, auditor type and auditor industry specialization, for earnings management in banks. We find that both auditor type and auditor industry specialization moderate benchmark-beating (loss-avoidance and just-meeting-or-beating prior year’s earnings) behavior in banks. In addition, we find that once auditor type and auditor industry specialization are included in the same tests, only auditor industry specialization has a significant impact on constraining benchmark-beating behavior. In separate tests related to income-increasing abnormal loan loss provisions, we find that both auditor type and auditor expertise constrain income-increasing earnings management. Again, in joint tests, only auditor industry expertise has a significant impact on constraining income-increasing earnings management.     

Disclosure Versus Recognition: Inferences from Subsequent Events

Standard setters explicitly state that disclosure should not substitute for recognition in financial reports. Consistent with this directive, prior research shows that investors find recognized values more pertinent than disclosed values. However, it remains unclear whether reporting items are recognized because they are more relevant for investing decisions, or whether requiring recognition itself prompts differing behavior on the part of firms and investors. Using the setting of subsequent events, I identify the differential effect of requiring disclosure versus recognition in a setting where the accounting treatment of an item is exogenously determined. For comparable events, I find a stronger initial market response for firms required to recognize relative to firms that must disclose, although the large magnitude of the identified effect calls into question whether this difference can be attributed to accounting treatments alone. In examining various reasons for the stronger market response to recognized values, I fail to find support for the hypothesis that this difference is due to differential reliability of disclosed and recognized values. I do find some evidence that investors underreact to disclosed events, consistent with investors incurring higher processing costs when using disclosed information.     

Stock performance and the mispricing of accruals

I investigate the relationship between contemporaneous stock-price performance and the persistence of accrued earnings, and its impact on the accrual anomaly. I find that, in a fiscal year, accrued earnings for stocks that have performed poorly are less persistent in predicting future earnings than accrued earnings for stocks that have performed moderately. I further find that a hedge-strategy based on accruals earns greater abnormal returns following bad-news years. The results are consistent with conservative accounting causing accrued earnings to be even less persistent in bad-news years and investors failing to efficiently price this differential in persistence.     

Unintended consequences of the increased asset threshold for FDICIA internal controls: Evidence from U.S. private banks

We examine the unintended consequences of the 2005 increase from $500 million to $1 billion in the asset threshold for the Federal Deposit Insurance Corporation Improvement Act (FDICIA) internal control reporting requirements. We focus on a test sample of banks that increased their total assets from between $100 million and $500 million prior to the change in regulation to between $500 million and $1 billion within two years following the change. These “affected” banks are no longer subject to the internal control requirements but would have been had the regulation not been changed. We hypothesize that these affected banks are likely to make riskier loans, which will increase the likelihood of failure during the crisis period. We find evidence consistent with this hypothesis. Affected banks have higher likelihood of failure during the crisis period than banks from two different control samples. We also find that auditor reputation (i.e., whether the bank is audited by a Big 4 auditor or an industry specialist auditor) has a moderating effect on the likelihood of failure for these affected banks.     

Cooking the books: Recipes and costs of falsified financial statements in China

We examine the causes and consequences of falsified financial statements in China. Using bivariate probit regression analysis, we find that firms with high debt and that plan to make equity issues are more likely to manipulate their earnings and thus have to restate their financial reports in subsequent years. We also find that corporate governance structures have an effect on the occurrence and detection of financial fraud. There are significant negative consequences to fraudulent financial statements. Restating firms suffer negative abnormal stock returns, increases in their cost of capital, wider bid-ask spreads, a greater frequency of modified audit opinions, and greater CEO turnover. We also find that firms located in highly developed regions suffer more severe consequences when they manipulate their accounts.     

Corporate tax avoidance and stock price crash risk: Firm-level analysis

Using a large sample of U.S. firms for the period 1995–2008, we provide strong and robust evidence that corporate tax avoidance is positively associated with firm-specific stock price crash risk. This finding is consistent with the following view: Tax avoidance facilitates managerial rent extraction and bad news hoarding activities for extended periods by providing tools, masks, and justifications for these opportunistic behaviors. The hoarding and accumulation of bad news for extended periods lead to stock price crashes when the accumulated hidden bad news crosses a tipping point, and thus comes out all at once. Moreover, we show that the positive relation between tax avoidance and crash risk is attenuated when firms have strong external monitoring mechanisms such as high institutional ownership, high analyst coverage, and greater takeover threat from corporate control markets.     

Mandatory disclosure and learning from external market participants: Evidence from the JOBS act

This paper examines whether mandatory disclosure affects the extent to which firms learn from external market participants. Conventional wisdom suggests that mandatory disclosure should increase the total amount of information in financial markets. However, disclosure can also reduce investors' incentives to acquire and produce information. Using the JOBS Act to identify variations in disclosure requirements, this paper finds that firms with reduced disclosure requirements attract more informed investors and learn more from financial markets than those with stricter disclosure requirements. This learning is concentrated among firms that attract sophisticated investors, particularly those with industry expertise, and weakens once firms are forced to disclose more information. Overall, the results suggest that one benefit from regulators’ recent efforts to reduce U.S. firm disclosure requirements is an increase in firm learning.     

The Role of Social Media in the Capital Market: Evidence from Consumer Product Recalls

We examine how corporate social media affects the capital market consequences of firms’ disclosure in the context of consumer product recalls. Product recalls constitute a “product crisis” exposing the firm to reputational damage, loss of future sales, and legal liability. During such a crisis it is crucial for the firm to quickly and directly communicate its intended message to a wide network of stakeholders, which, in turn, renders corporate social media a potentially useful channel of disclosure. While we document that corporate social media, on average, attenuates the negative price reaction to recall announcements, the attenuation benefits of corporate social media vary with the level of control the firm has over its social media content. In particular, with the arrival of Facebook and Twitter, firms relinquished complete control over their social media content, and the attenuation benefits of corporate social media, while still significant, lessened. Detailed Twitter analysis confirms that the moderating effect of social media varies with the level of firm involvement and with the amount of control exerted by other users: the negative price reaction to a recall is attenuated by the frequency of tweets by the firm, while exacerbated by the frequency of tweets by other users.     

News-driven return reversals: Liquidity provision ahead of earnings announcements

This study documents a six-fold increase in short-term return reversals during earnings announcements relative to non-announcement periods. Following prior research, we use reversals as a proxy for expected returns market makers demand for providing liquidity. Our findings highlight significant time-series variation in the magnitude of short-term return reversals and suggest that market makers demand higher expected returns prior to earnings announcements because of increased inventory risks that stem from holding net positions through the release of anticipated earnings news. Collectively, our findings suggest that uncertainty regarding anticipated information events elicits predictable increases in the compensation demanded for providing liquidity and that these increases significantly affect the dynamics and information content of market prices.     

Accountability of independent directors: Evidence from firms subject to securities litigation

We examine which independent directors are held accountable when investors sue firms for financial and disclosure-related fraud. Investors can name independent directors as defendants in lawsuits, and they can vote against their reelection to express displeasure over the directors’ ineffectiveness at monitoring managers. In a sample of securities class action lawsuits from 1996 to 2010, about 11% of independent directors are named as defendants. The likelihood of being named is greater for audit committee members and directors who sell stock during the class period. Named directors receive more negative recommendations from Institutional Shareholder Services, a proxy advisory firm, and significantly more negative votes from shareholders than directors in a benchmark sample. They are also more likely than other independent directors to leave sued firms. Overall, shareholders use litigation along with director elections and director retention to hold some independent directors more accountable than others when firms experience financial fraud.     

CDS trading and analyst optimism

This paper investigates whether and how the initiation of Credit Default Swaps (CDS) trading affects analyst forecast optimism. First, we document that the initiation of CDS trading curbs analyst forecasts optimism. Second, we find that the dampening effect of CDS on analyst optimism is stronger for firms with negative news and for firms with poorer financial performance or higher leverage, supporting a “correction effect” of CDS on non-strategic optimism. Moreover, we find that CDS also has a “disciplining effect” on strategic optimism that arises from incentives to cultivate relation with management or to please institutional investors. Overall, our evidence shows that the CDS market not only provides important information for analysts, but also alters analysts’ reporting incentives and enhances their objectivity. Additional analysis shows that this effect has disappeared after the Dodd-Frank Act.