Management’s personal ideology and financial reporting quality

Review of Quantitative Finance and Accounting - We investigate the relation between managers’ personal ideologies and financial reporting quality. We use Federal Elections Commission data to...     

Managerial labor mobility and banks’ financial reporting quality

This paper explores the relationship between managers’ labor mobility and the financial reporting quality of banks. Using the state-level adoption of the Inevitable Disclosure Doctrine (IDD) as an exogenous shock discouraging labor mobility, we show that adoption of the IDD is associated with a decline in financial reporting quality, as measured by discretionary loan loss provisions. The effect is larger for banks with managers who have limited outside job opportunities and smaller for banks with tight regulatory oversight. Our results support the view from the career concern hypothesis that bank managers facing restrictions on mobility have greater incentives to engage in discretionary accounting.     

Audit committees’ oversight of bank risk-taking

This study examines whether audit committee effectiveness affects bank risk-taking and risk management effectiveness. We find that banks with long board tenure audit committees have lower total risk and idiosyncratic risk, and banks with busy directors on their audit committees have higher total risk and idiosyncratic risk. These suggest that high audit committee effectiveness may constrain bank risk-taking activities. We also find that firm performance is more positively associated with bank risk for banks with long board tenure, more female audit committee members, or large size audit committees than for other banks, consistent with the notion that audit committee effectiveness may increase risk management effectiveness. However, this finding should be interpreted cautiously as it is contrary to the results on audit committee busyness.     

Are CFO debt-like compensation incentives associated with financial reporting quality?

We investigate whether CFO debt-like compensation incentives and their alignment with CEO debt-like compensation incentives are associated with financial reporting quality. He (2015) finds that CEO debt-like compensation incentives are associated with higher financial reporting quality. Consistent with agency theory, we extend He (2015) by considering CFO debt-like compensation incentives. Overall, we find that CFO debt-like compensation incentives are associated with better financial reporting quality while controlling for CEO debt-like compensation incentives. These effects are present when the CEO and CFO compensation incentives are aligned with the same party. Further, the CFO effect dominates that of the CEO when examining discretionary accruals, and complements the CEO effect for accrual quality. However, we are unable to find any evidence of an incremental joint effect from the alignment of the CEO and CFO debt-like compensation incentives.     

Is there a relation between audit fee cuts during the global financial crisis and banks’ financial reporting quality?

As a result of the global financial crisis (GFC), several audit clients were able to negotiate lower audit fees for the years 2008 and 2009. However, the PCAOB has expressed concern that lower audit fees might lead to lower audit effort and lower audit quality and financial reporting quality. This study examines the relation between audit fee cuts and banks’ financial reporting quality. Specifically, we focus on earnings management via loan loss provisions (LLP), the relation between current period LLP and future loan charge-offs, i.e., LLP validity, and the timely recognition of loan losses. For banks audited by Big 4 auditors, we find that income-increasing abnormal LLP are decreasing in audit fee cuts and LLP validity is increasing in audit fee cuts. For banks audited by non-Big 4 auditors, LLP validity is higher for banks that received a fee cut of more than 25% relative to other banks audited by non-Big 4 auditors. We do not observe an association between timely loan loss recognition and cuts in audit fees except for banks audited by non-Big 4 auditors and exempt from internal control audits where a fee cut of more than 25% is associated with less timely loan loss recognition. Overall, the findings suggest that Big 4 auditors constrained earnings management via LLP in banks that received cuts in audit fees. Our findings have important implications for regulators, investors, and others.     

Auditors’ going concern reporting accuracy during and after the global financial crisis

Motivated by concerns that one of the reasons for the Global Financial Crisis (GFC) is poor quality auditing, this study examines the accuracy of going concern modifications for a sample of United States (U.S.) companies in the pre-GFC (2005–2006), GFC (2007–2008), and post-GFC (2009–2010) periods. The results show that the type I misclassification is lower during the GFC but not different in the post-GFC period compared with the pre-GFC period. The type II misclassification is not significantly different in the GFC and post-GFC periods compared with the pre-GFC period. Additionally, the results suggest that non-Big 4 auditors, compared with Big 4 auditors, have become more conservative on clients’ going concern problems in the post-GFC period, which reduces their type II misclassification.     

Threat of entry and the use of discretion in banks’ financial reporting

This paper studies managers’ use of accounting discretion to deter entry. Using state-level changes in branching regulation under the Interstate Banking and Branching Efficiency Act, I find geographically-constrained community banks increased their loan loss provisions to appear less profitable when faced with the threat of entry by competitors. Additional tests rule out alternative explanations that firm economics or regulators drove the increase. I complement my analyses with survey-based evidence. Findings from the survey confirm that banks prefer to locate in markets where incumbents have high profitability and low credit losses, and that banks use competitors’ financial statements to analyze competition.     

Do management reports on internal control over financial reporting improve financial reporting?

Sections 404a and 404b of the Sarbanes–Oxley Act require management and external auditors, respectively, to report on the adequacy of a company’s internal control over financial reporting (ICFR). Larger public firms were first required to file a management report and have an external audit of ICFR in 2004. Smaller public firms were first required to file a management report on ICFR in 2007 but are exempt from the attestation requirement. We investigate the distinct effect of management reports on financial reporting quality. We find that management reports on ICFR improve reporting quality and demonstrate that there are financial reporting benefits from the management report requirement on its own without attestation.     

The effect of banks’ financial reporting on syndicated-loan structures

We explore how an accounting measure of information asymmetry between lead and participating lenders influences syndication structures by examining whether lead lenders’ commercial and industrial (C&I) loan-loss provision validity affects the fraction of loans they retain. We first conduct multiple tests showing that C&I provision validity reflects banks’ underlying screening and monitoring effectiveness. We then find lead lenders’ loan share decreases with C&I provision validity, but not with non-C&I provision validity. Consistent with an information effect, we further find this association is attenuated by (i) alternative information sources about the borrowers and (ii) previous lead/participant relationships and participant/borrower relationships.     

Does order backlog matter for financial reporting quality? Evidence from revenue restatements

In this study, we investigate the relationship between revenue recognition restatements and order backlog. Order backlog, a leading indicator of future earnings, is defined as the monetary value of unfilled orders at year-end. The presence of an order backlog can be economically significant and can have positive or negative implications. However, it is not clear whether there is an association between order backlog and financial reporting quality and, if there is, whether the relationship is negative or positive. Our results suggest that revenue recognition restatements are more likely to occur when order backlogs or changes in order backlogs are significant. Additionally, firms just meeting an earnings target when they have greater order backlog changes, and firms with a higher deferred-revenue-to-order-backlog ratio, are more likely to restate revenue. Finally, audit firms with more experience auditing companies with average backlogs above the median mitigate the association between backlogs and revenue restatements. Hence, financial statement users and auditors should use more skepticism in reviewing financial statements when firms have order backlogs.     

Does mutual fund ownership affect financial reporting quality for Chinese privately-owned enterprises?

This paper examines the role of mutual funds in enhancing financial reporting quality in China. Mutual funds are more sophisticated and influential than individual investors. Therefore, they are expected to be more effective at preventing executives from expropriating investors and manipulating earnings as a cover-up, which in turn would reduce the incidence of modified audit opinions (MAOs). Our results, based on the Chinese listed firms from 2003 to 2008, confirm this prediction. More importantly, the effects of mutual fund ownership in reducing the incidence of MAOs are greater among privately owned enterprises (POEs), and especially those with higher growth. This is because POEs rely more heavily on the capital market for financing than do state-owned enterprises (SOEs), and because growth opportunities need to be funded by additional external capital. This finding implies that mutual funds form an important part of the external governance mechanism in emerging countries, but this effect is moderated by state control and ownership.     

Is export tax rebate a quality signal to determine firms’ capital structure? A financial intermediation perspective

This paper empirically examines the casual effect of export tax rebates (ETRs) on firm capital structure. The results of analyzing large panel data on Chinese manufacturing firms from 2007 to 2015 suggest that firms that obtain ETRs are more likely to access leverage. Moreover, ETRs affect the leverage ratio through funding fixed assets investments, smoothing financial costs, and alleviating for internal financing. In addition, ETRs are positively associated with leverage through improvements in firm performance, including firms’ total factor productivity, profitability, and labor productivity. Additionally, the effect of ETRs on leverage plays a stronger role in private firms than in state-owned or foreign firms.     

Serving the truth: Do directors with media background improve financial reporting quality?

This study examines whether and how independent directors with media background affect financial reporting quality. Using a proprietary dataset of independent directors' backgrounds, we find that firms with media backgrounds directors sitting on the board have lower absolute discretionary accruals. Besides, the effect is more pronounced when media background independent directors are from a news agency, or the directors bear higher reputation cost. Furthermore, media independent directors play a monitoring role by saying “no” at the board meeting and increasing the probability of exposure to financial frauds to reduce discretionary accruals. Overall, our evidence suggests that media independent directors with higher integrity and reputation concerns could improve firms' financial quality.     

Does economic policy uncertainty matter for financial reporting quality? Evidence from the United States

Review of Quantitative Finance and Accounting - We examine the effect of economic policy uncertainty (EPU) on the financial reporting quality of US firms over 1999–2015. We use accruals-based...     

Entry and capital structure mimicking in concentrated markets: The role of incumbents’ financial disclosures

We examine whether the public availability of product market incumbents' financial disclosures leads to greater capital structure mimicking of incumbents by entrants. Exploiting a change in disclosure enforcement for German private firms in the mid-2000s, we find entrant-incumbent mimicking rises substantially in concentrated markets once incumbents' financial statements are publicly available. Additional tests exploring potential mechanisms are more consistent with interfirm learning underlying the effect than alternative channels. Our findings shed light on the effects of competitor financial statement disclosure on private firms’ initial financing decisions and highlight how capital structure dependencies among peer firms arise.     

Management earnings forecasts and the quality of analysts’ forecasts: The moderating effect of audit committees

This study investigates whether effective audit committees influence the association between management earnings forecasts and the properties of analysts’ forecasts. We posit that this influence on the part of an audit committee would likely result from increased responsibility for monitoring voluntary disclosure. Using the four attributes that the Blue Ribbon Committee (1999) and prior research suggest as being indicative of audit committee effectiveness, we find that analysts’ forecasts exhibit higher accuracy and lower dispersion with the issuance of management forecasts for those firms employing audit committees that are composed exclusively of independent directors, include an accounting expert, and act with due diligence. We also find that effective audit committees strengthen the association between management and analyst forecast accuracy. Our evidence, therefore, supports the notion that effective corporate governance influences the reliability of voluntary disclosure, and thereby benefits the users of financial information.