Implied Equity Duration: A Measure of Pandemic Shutdown Risk

Implied equity duration was originally developed to analyze the sensitivity of equity prices to discount rate changes. We demonstrate that implied equity duration is also useful for analyzing the sensitivity of equity prices to pandemic shutdowns. Pandemic shutdowns primarily impact short‐term cash flows, thus they have a greater impact on low‐duration equities. We show that implied equity duration has a strong positive relation to U.S. equity returns and analyst forecast revisions during the onset of the 2020 COVID‐19 shutdown. Our analysis also demonstrates that the underperformance of “value” stocks during this period is a rational response to their lower durations.     

“Too‐Small‐To‐Survive” versus “Too‐Big‐To‐Fail” banks: The two sides of the same coin

In the recent crisis, the U.S. authorities bailed out numerous banks through TARP, whilst let many others to fail as going concern entities. Even though both interventions fully protect depositors, a bail out represents an implied subsidy to shareholders, which is not yet the case with closures where creditors are not subsidised. We investigate this non‐uniform policy, demonstrating that size and not performance is the decision variable that endogenously determines one threshold below which banks are treated as TSTS by regulators and another one above which are considered to be TBTF. We, hence, provide a pair of economic rather than regulatory cut‐offs for TBTF and TSTS banks. The shareholders and the other uninsured creditors of a distressed bank are not bailed out if the bank is considered to be TSTS. We further document that the less complex a bank is, the less likely is to be bailed out and, hence, to have all of its creditors protected.     

Exchange traded funds and asset return correlations

We provide novel evidence supporting the notion that arbitrageurs can contribute to return comovement via exchange trade funds (ETF) arbitrage. Using a large sample of US equity ETF holdings, we document the link between measures of ETF activity and return comovement at both the fund and the stock levels, after controlling for a host of variables and fixed effects and by exploiting the ‘discontinuity’ between stock indices. The effect is also stronger among small and illiquid stocks. An examination of ETF return autocorrelations and stock lagged beta provides evidence for price reversal, suggesting that some ETF‐driven return comovement may be excessive.     

Does Internal Corporate Governance Complement or Substitute for External Auditing? Evidence from China's Anti‐corruption Campaign

Two competing hypotheses have been developed for the relationship between internal corporate governance and external auditing. One proposes a complementary relationship, while the other suggests it is substitutable. This study takes advantage of China's recent anti‐corruption campaign as a quasi‐natural experiment to explore this relationship. Using a difference‐in‐differences approach, we find that, after the campaign, internal corporate governance improved more in SOEs (state‐owned enterprises) than in non‐SOEs. SOEs were less likely to choose Big 10 auditors after the campaign, while audit firms assigned less experienced auditors to their SOE client firms and charged lower audit fees. These effects were more pronounced in SOEs that exhibited greater improvement in corporate governance. Overall, we find the anti‐corruption campaign improved corporate governance in SOEs but, at the same time, reduced external audit quality, which supports the substitution view. We argue that this result might be driven by the fact that SOEs have limited demand for high‐quality accounting information because the Chinese government maintains strong control over the capital markets.     

Investment Horizon and Repo in the Over‐the‐Counter Market

This paper presents a three‐period model featuring a short‐term investor in the over‐the‐counter bond market. A short‐term investor stores cash because of a need to pay cash at some future date. If a short‐term investor buys bonds, then a deadline for retrieving cash lowers the resale price of bonds for the investor through bilateral bargaining in the bond market. Ex‐ante, this hold‐up problem explains the use of a repo by a short‐term investor, the existence of a haircut, and the vulnerability of a repo market to counterparty risk. This result holds without any uncertainty about bond returns or asymmetric information.     

Analysing the market–book value relation in large Australian and US firms: implications for fundamental analysis and the market–book ratio

This study compares the market–book relation of Australian and US firms using firm‐level dynamic analysis of using annual data for a long‐run period in error correction modelling. This paper contributes to a recent call for alternative ways of estimating Ohlson‐type linear valuation models (Ohlson and Kim, 2015). Log transformations of the data are used in this study to improve the statistical properties of the models. This study contributes to the findings on linear valuation model estimation for long‐run firms. Based on the returns model estimation, we find evidence of a higher level of co‐integration between market and book values for Australian firms.     

Limits‐to‐arbitrage,investment frictions,and the investment effect: New evidence

This study comprehensively reexamines the debate over behavioral and rational explanations for the investment effect in an updated sample. We closely follow the previous literature and provide several differences. Our tests include five prominent measures of corporate investment and corporate profitability in q‐theory and recent investment‐based asset pricing models. Both classical and Bayesian inferences show that limits‐to‐arbitrage tend to be supported by more evidence than investment frictions for all investment measures. When idiosyncratic volatility and cash flow volatility are used in measuring investment frictions, the inference is more favorable for the rational explanation.     

Stock Return Predictability of Residual‐Income‐Based Valuation: Risk or Mispricing?

In an influential paper, Frankel and Lee (1998) conclude that the stock return predictability of the value‐to‐price ratio (V/P) results from market mispricing. This paper confirms whether the V/P reflects the rational risk premiums associated with the V/P factor or is better explained by market inefficiency. Following Daniel and Titman (1997), this paper examines whether the V/P characteristics or the V/P factor loadings predict stock returns. The findings show that the V/P loadings are positively associated with average returns even after controlling for the V/P characteristics in both time series and cross‐sectional tests. The overall results suggest that the mispricing explanation of the V/P effect is premature.     

Mind the gap: CEO–employee pay ratios and shareholder say‐on‐pay votes

We examine the Securities and Exchange Commission's assertion in the pay ratio disclosure rule that the ratio of Chief Executive Officer to employee pay is useful to shareholders for say‐on‐pay (SOP) voting decisions. Using an estimated pay ratio for a broad panel of commercial banks from 2010 to 2017, we find that voting dissent on SOP proposals is significantly higher in the top pay ratio decile, particularly when institutional ownership is high. Results are robust to controlling for a number of other determinants of voting dissent, including proxy advisor recommendations and executive compensation. Additionally, inferences using the first year of disclosed pay ratios in 2017 for S&P 1500 firms are consistent. However, we do not find similar results in the other deciles of the pay ratio in either sample, calling into question whether a cost‐benefit analysis would support the disclosure requirement imposed by Dodd‐Frank and implemented by the SEC.     

A new perspective on post‐earnings‐announcement‐drift: Using a relative drift measure

Prior research finds that there is a delayed reaction to both analyst‐based earnings surprises and random‐walk‐based earnings surprises. Focusing on the market reaction from the post‐announcement window, prior studies show that analyst‐based drift is larger than random walk‐based drift. This finding is counter‐intuitive if we believe large, sophisticated investors tend to trade on analysts’ forecast earnings news and thus react faster and more completely than smaller and less sophisticated investors react to random walk earnings news. In this study, we construct a relative measure of post‐earnings‐announcement drift (PEAD) (i.e., drift as a proportion of total market reaction to earnings news) which we refer to as the ‘drift ratio’, and we provide evidence, consistent with our intuition, that analyst‐based drift ratio is smaller (not greater) than random‐walk‐based drift ratio. We find that this difference is more pronounced in more recent periods and for firms with more sophisticated investors. Our approach to measure the PEAD is more intuitive than that in traditional PEAD literature. Our results thus complement existing research findings by utilizing the drift ratio measure to generate new insights about the drift phenomenon.     

Business as Usual? An Institutional View of the Relationship Between Management Control Systems and Strategy

The relationship between management control systems (MCS) and strategy has received considerable attention in the management control literature. Contingency‐based approaches, however, have traditionally dominated this research, with limited attention devoted specifically to how MCS and strategy may combine in organisations operating within highly institutionalised environments. Adopting an institutional perspective, the current study is based on interviews with CEOs and senior executives in 32 Australian Not‐for‐Profit organisations. Our findings indicate a tendency for these organisations to decouple informal control from MCS, producing a ‘business as usual’ mentality via the pervasive informal approach to control, supplanting contingency‐based predictions relating to MCS‐strategy relations.     

Product Market Competition,Information and Earnings Management

We study theoretically the effect of product market competition on the incentives to engage in earnings manipulation, and we show how manipulating earnings is particularly rewarding in more competitive markets since the boost in market value of reporting good earnings is especially important. Using a panel dataset of about 70,000 observations spanning the period 1989–2011, we document that the competitive environment is an important determinant of Jones type discretionary accruals and it also affects real earnings management. In additional analysis, we find that the effect of competition on earnings manipulation is particularly important for companies that seem to be underperforming their competitors and that the competition‐earnings management linkage is moderated by the degree of information visibility at the industry level.     

Reversal and momentum patterns in weekly stock returns: European evidence

We analyze short‐term reversal and medium‐term momentum patterns in weekly stock returns in Europe. Focusing on raw and stock‐specific returns, our empirical results show for both return specifications (a) a negative relation between weekly past returns and future returns in the short run and (b) a positive relation in the medium run. However, returns from reversal and momentum strategies based on stock‐specific returns are less volatile. In further analyses, we find short‐term reversal and medium‐term momentum patterns to be connected to stock characteristics. Looking at the potential causes of these effects, our results do not support the idea that short‐term reversal in weekly stock returns is due to an over‐ or underreaction to firm‐specific news nor that it is mainly driven by illiquidity. Medium‐term momentum in weekly stock returns, on the other hand, can be connected to behavioral biases. Our concluding tests confirm that our findings are robust among industries, in subperiods, for the January effect and in varying market states. Finally, while medium‐term momentum strategies remain profitable after accounting for transaction costs, short‐term reversal strategies can be mainly explained by transaction costs due to their high turnover.     

Using Four‐Moment Tail Risk to Examine Financial and Commodity Instrument Diversification

We consider the effect of higher moments on diversification, since most assets possess a potential for tail losses. In particular, we examine higher‐moment Value‐at‐Risk measures for individual instruments and diversified portfolios. We find that a naïve futures portfolio is consistently superior to common stock indexes. As few as ten randomly chosen instruments diversify away 85% of the unsystematic four‐moment tail risk. We also compare the two‐ and four‐moment tail risks for different size portfolios. Finally, the tail risk for naïve portfolios varies much less over time than other portfolios.     

Does Accrual Management Impair the Performance of Earnings‐Based Valuation Models?

This study examines how accrual manipulations affect firm valuation in the years surrounding the passage of the Sarbanes‐Oxley Act (SOX). We compare the absolute percentage pricing errors of RIM and DCF valuation models for a group of US firms suspected to have engaged in accrual manipulations to avoid a small loss or a small earnings decline vs. ‘Normal’ firms matched on industry, year and size. We find that RIM can better estimate intrinsic value than DCF for the matched Normal firms in the pre‐SOX period, but not so for accrual manipulators, and that SOX mitigates the harmful effect of accrual manipulations, completely eliminating the difference in RIM's accuracy advantage over DCF between Normal firms and accrual manipulators. As a further analysis, we redefine Suspect firms as real‐activity manipulators and find a significant across‐group difference in accuracy wedge in both sample periods, implying that SOX has prompted firms to favor real‐activity manipulations over accrual manipulations.     

If Only We Had Listened to Ross Skinner!*

Ross Skinner built his intimate knowledge of the intricacies of the art of accounting through a very long and rich career as an “accounting philosopher". This allowed him to both observe, and be part of, the formalization of today's GAAP. The duration and timing of Skinner's career also allowed him to experience directly the gradual evolution of our accounting model from an approach based largely on principles to one based increasingly on rules. The objective of this paper is to look behind accounting figures, which are the product of varying combinations of rules and judgment, and to discuss some recent events that have rocked the auditing and accounting profession. Our comments are presented in the context of views expressed by Skinner in his 1995 “Judgment in Jeopardy” article. Skinner had a keen interest in accounting history. Therefore, we begin our paper by referring to Paciol's notion of “venture accounting". We use this notion to introduce our discussion of financial reporting, which has become an important instrument of resource allocation and a challenge for professional judgment. This leads us to describe some of the ideas Skinner presented in his article on accounting judgment as “visionary". Had we listened to him, perhaps we could have avoided some of the costly changes and additions recently imposed on our governance system, such as the creation of the Canadian Public Accountability Board and the tightening of several laws and regulations.     

Objective estimation versus subjective perceptions of earnings patterns and post‐earnings‐announcement drift

We investigate how the market's subjective estimates of autocorrelation in quarterly earnings vary with objective time‐series estimates. Our results suggest that investors increasingly underestimate the correlation as the autocorrelation level increases, and as a result, the post‐earnings‐announcement drift (PEAD) increases with the level of autocorrelation. We further show that the ability of autocorrelation to explain variation in the PEAD is robust to alternative explanations based on risk and institutional factors. Additional analysis indicates that the market's inefficiency in assessing the existence and magnitude of autocorrelation (and the related impact on PEAD) is inversely related to the richness of the information environment.     

Media heterogeneity and post‐earnings announcement drift: evidence from China

This paper examines how the Chinese stock market acts differently towards state‐controlled and market‐oriented media coverage. Using a setting of post‐earnings announcement drift, we find that information from state‐controlled media enters the stock price in a timelier manner, while the message from market‐oriented media needs more time to get a response from investors. The effect is also influenced by whether the type of news coverage is good or bad. Our findings suggest that the capital market underreacts when good news is reported by the market‐oriented media.