Identifying productivity when it is a factor of production

Economists typically model a plant's productivity as an exogenous characteristic, but the people who run and work at manufacturing plants make choices, at a cost, that affect plant productivity. I develop a method to partially identify the productivity distribution when such choices determine productivity. The method uses a monotone comparative static result I prove in a general economic model. It does not require instruments or timing assumptions. I use the method to study the effect of implementing market-based pricing on productivity in the electricity generation industry.     

Short Selling Pressure,Stock Price Behavior,and Management Forecast Precision: Evidence from a Natural Experiment

Using a natural experiment (Regulation SHO), we show that short selling pressure and consequent stock price behavior have a causal effect on managers’ voluntary disclosure choices. Specifically, we find that managers respond to a positive exogenous shock to short selling pressure and price sensitivity to bad news by reducing the precision of bad news forecasts. This finding on management forecasts appears to be generalizable to other corporate disclosures. In particular, we find that, in response to increased short selling pressure, managers also reduce the readability (or increase the fuzziness) of bad news annual reports. Overall, our results suggest that maintaining the current level of stock prices is an important consideration in managers’ strategic disclosure decisions.     

Informal institutions and managers’ earnings management choices: Evidence from IFRS-adopting countries

In this study, we investigate the role of informal institutions (religiosity and culture) in determining managers’ choices of earnings management methods (accruals vs. real activities), after controlling for formal institutions (investor protection, enforcement quality and equity market development). Using an ethical perspective, we find that managers tend to choose an earnings management strategy that meets the prevailing social (informal) norms of the environment where the firm is headquartered. Specifically, our analysis shows that firms domiciled in countries with strong religious adherence and high-power-distance cultures prefer to manage their earnings ‘upwards’ through real activities rather than accruals. Overall, our results suggest that informal institutions determine managers’ earnings management choices at least as strongly as formal institutions do. It would therefore be misleading to analyze managers’ choices in managing earnings solely from the formal rules perspective without considering the role of informal constraints or vice versa.     

Disentangling Managers’ and Analysts’ Non‐GAAP Reporting

Researchers frequently proxy for managers’ non‐GAAP disclosures using performance metrics available through analyst forecast data providers (FDPs), such as I/B/E/S. The extent to which FDP‐provided earnings are a valid proxy for managers’ non‐GAAP reporting, however, has been debated extensively. We explore this important question by creating the first large‐sample data set of managers’ non‐GAAP earnings disclosures, which we directly compare to I/B/E/S data. Although we find a substantial overlap between the two data sets, we also find that they differ in systematic ways because I/B/E/S (1) excludes managers’ lower quality non‐GAAP numbers and (2) sometimes provides higher quality non‐GAAP measures that managers do not explicitly disclose. Our results indicate that using I/B/E/S to identify managers’ non‐GAAP disclosures significantly underestimates the aggressiveness of their reporting choices. We encourage researchers interested in managers’ non‐GAAP reporting to use our newly available data set of manager‐disclosed non‐GAAP metrics because it more accurately captures managers’ reporting choices.     

Financial Development,Credit, and Business Cycles

How does financial development affect the magnitude of the business cycles fluctuations? We examine this question in a general equilibrium model with heterogeneous agents and endogenous credit constraints based on Kiyotaki (1998). We show that there is a hump‐shaped relationship between the degree of financial frictions and the amplification of unexpected productivity shocks. This nonmonotonic relation is due to the fall in financial frictions having two opposite effects on the response of output. One effect is the reallocation of productive inputs between agent types, which, while active, increases with the fall in financial frictions. The other effect is the change in the demand of inputs, which decreases with the fall in financial frictions. At low levels of financial development, the reallocation effect dominates and a fall in financial frictions increases the amplification of productivity shocks. In contrast, at higher levels of financial development, a fall in financial frictions decreases the shock amplification because the reallocation effect disappears while the effect on the demand of inputs is still present.     

Make or buy new technology: The role of CEO compensation contract in a firm’s route to innovation

A firm’s board of directors, based on its risk tolerance or “appetite,” sets the corporate objectives. It is then the management’s job to meet the objectives by adopting appropriate strategies. However, the board can design compensation policies to encourage desired management strategy choices. This paper explores the extent to which management compensation policies are aligned with strategy choices for obtaining new technology. Firms obtain new technology either through internal R&D or through acquisitions, often labeled “make” and “buy” strategies, respectively. The “make” strategy is inherently more risky, with much of the high risk idiosyncratic. Furthermore, U.S. GAAP requires that R&D expenditures be expensed but allows capitalization of acquisition costs, thus a firm using the “make” as opposed to the “buy” strategy will experience a greater negative effect on accounting earnings. I hypothesize that these differences will lead risk-averse and utility-maximizing managers to implement the “buy” strategy if their compensation is heavily weighted on accounting-based performance measures. Conversely, managers with more stock-based compensation, especially stock options, are more likely to choose to develop new technology internally. Using data from U.S. high-tech industries and a simultaneous equations regression framework, I find evidence consistent with the above hypotheses.

Accounting information and managerial work

Despite calls to link management accounting more closely to management (Jonsson, 1998), much is still to be learned about the role of accounting information in managerial work. This lack of progress stems partly from a failure to incorporate in research efforts the findings regarding the nature of managerial work, as well as inadequate attention devoted to the detailed practices through which accounting information is actually used by managers in their work. In this paper I draw on prior research to develop a series of propositions focused on three primary insights into how and why managers use accounting information in their work. First, managers primarily use accounting information to develop knowledge of their work environment rather than as an input into specific decision-making scenarios. In this role, accounting information can help managers to develop knowledge to prepare for unknown future decisions and activities. Second, as accounting information is just one part of the wider information set that managers use to perform their work, it is imperative to consider its strengths and weaknesses not in isolation but relative to other sources of information at a manager’s disposal. Third, as managers interact with information and other managers utilising primarily verbal forms of communication, it is through talk rather than through written reports that accounting information becomes implicated in managerial work. These insights have important implications for how managers use accounting information, and, in particular, require reconsideration of the types accounting information that managers find, or could find, helpful. The paper also considers how existing experimental and field-based methods could fruitfully be adapted to focus on the detailed activities through which managers engage with accounting information.     

Determinants of accounting innovation implementation

Accounting innovations are often not successfully implemented or diffused throughout the organization. This study seeks to explain this phenomenon. One of the major impediments to the successful implementation of accounting innovation is that management accounting systems are generally used to serve the decision control needs of top management while at the same time purportedly supporting the decision management needs of lower level managers. To the extent that the accounting system is used for decision control, innovation creates the potential for wealth effects to occur. This prompts managers, whose wealth will be negatively affected, to resist accounting innovation. We present conditions where it is likely for negative wealth effects to occur. Under these conditions the system will fail to achieve its intended objectives. Our theoretical model examines how decentralization choices influence resistance to accounting innovation. We argue that delegation of decision rights can limit the potential for resistance in two ways—(a) by creating the environment which allows managers to ensure that their subunits are able to adapt to the new signals provided by accounting innovations and (b) by enabling subunit managers to become involved in the design of these systems. Our model also enables us to assess the consequences on organizational outcomes when subunit managers resist accounting innovations. Based on data collected from production managers, our results demonstrate the importance of decentralization choices on the effective implementation of accounting innovations.     

Disclosure Quality and Management Trading Incentives

This study examines whether managers strategically alter disclosure “quality” in response to personal incentives, specifically those derived from trading on their own account. Using changes in market liquidity to proxy for disclosure quality, I find that trading incentives are associated with disclosure quality choices. Tests are performed across three disclosure samples: management forecasts, conference calls, and press releases. Consistent with a desire to reduce the probability of litigation, I find evidence that managers provide higher quality disclosures before selling shares than they provide in the absence of trading. Consistent with a desire to maintain their information advantage, I find some, albeit weaker, evidence that managers provide lower quality disclosures prior to purchasing shares than they provide in the absence of trading.     

Auditor reporting and earnings management: some additional evidence

This paper investigates the reasons that lead to modification of auditors’ opinions. We revisit the conclusions of prior US‐based research on whether a modification highlights likely earnings management activities. Extending this research, we consider an alternate explanation that managers adjust accruals to report earnings that better predict future firm performance, which has the side‐effect of placing them in conflict with their auditors. Our study sample comprises all firms listed on the Australian Stock Exchange over the period 1999–2003. Consistent with prior research, there is no evidence of earnings management leading to an audit opinion modification. However, we do show that firms receiving inherent uncertainty modifications (other than going concern) have greater persistence of earnings (accruals) relative to other firms. This is consistent with the proposition that managers have made policy choices in reporting current earnings, with which their auditors disagree, that will likely result in a greater ability to forecast the firm's future earnings.     

Relationships among budgetary leadership behavior, managerial budgeting games, and budgetary attitudes: Evidence from Taiwanese corporations

In this paper, we examine the relationship among leadership behavior (contingent reward vs. contingent punishment), managerial budgeting games (devious games vs. economic games), and attitudes towards the budgetary process. Relationships were tested using a structural equation model that was estimated on the basis of questionnaire data from 216 Taiwanese managers. The majority of respondents were accounting/finance managers employed by manufacturing firms. Results reveal that contingent-reward leadership behavior has a direct and positive effect on attitudes toward the budgetary process, and an indirect effect through economic games. On the other hand, we find evidence that contingent-punishment leadership behavior has only an indirect and negative effect on attitudes toward the budgetary process through devious games, especially for non-accounting/finance managers. Managers who play economic games tend to have positive attitudes towards the budgetary process, while those who play devious games do not. The findings should be useful to management in understanding what effective leadership behavior is in the budget-preparation process in Taiwan, and assessing how budgeting games are likely to be adopted by Taiwanese managers.     

Value Maximisation, Stakeholder Theory, and the Corporate Objective Function

This paper examines the role of the corporate objective function in corporate productivity and efficiency, social welfare, and the accountability of managers and directors. I argue that since it is logically impossible to maximise in more than one dimension, purposeful behaviour requires a single valued objective function. Two hundred years of work in economics and finance implies that in the absence of externalities and monopoly (and when all goods are priced), social welfare is maximised when each firm in an economy maximises its total market value. Total value is not just the value of the equity but also includes the market values of all other financial claims including debt, preferred stock, and warrants. In sharp contrast stakeholder theory, argues that managers should make decisions so as to take account of the interests of all stakeholders in a firm (including not only financial claimants, but also employees, customers, communities, governmental officials and under some interpretations the environment, terrorists and blackmailers). Because the advocates of stakeholder theory refuse to specify how to make the necessary tradeoffs among these competing interests they leave managers with a theory that makes it impossible for them to make purposeful decisions. With no way to keep score, stakeholder theory makes managers unaccountable for their actions. It seems clear that such a theory can be attractive to the self interest of managers and directors. Creating value takes more than acceptance of value maximisation as the organisational objective. As a statement of corporate purpose or vision, value maximisation is not likely to tap into the energy and enthusiasm of employees and managers to create value. Seen in this light, change in long‐term market value becomes the scorecard that managers, directors, and others use to assess success or failure of the organisation. The choice of value maximisation as the corporate scorecard must be complemented by a corporate vision, strategy and tactics that unite participants in the organisation in its struggle for dominance in its competitive arena. A firm cannot maximise value if it ignores the interest of its stakeholders. I offer a proposal to clarify what I believe is the proper relation between value maximisation and stakeholder theory. I call it enlightened value maximisation, and it is identical to what I call enlightened stakeholder theory. Enlightened value maximisation utilises much of the structure of stakeholder theory but accepts maximisation of the long run value of the firm as the criterion for making the requisite tradeoffs among its stakeholders. Managers, directors, strategists, and management scientists can benefit from enlightened stakeholder theory. Enlightened stakeholder theory specifies long‐term value maximisation or value seeking as the firm’s objective and therefore solves the problems that arise from the multiple objectives that accompany traditional stakeholder theory. I also discuss the Balanced Scorecard, the managerial equivalent of stakeholder theory. The same conclusions hold. Balanced Scorecard theory is flawed because it presents managers with a scorecard which gives no score—that is, no single‐valued measure of how they have performed. Thus managers evaluated with such a system (which can easily have two dozen measures and provides no information on the tradeoffs between them) have no way to make principled or purposeful decisions. The solution is to define a true (single dimensional) score for measuring performance for the organisation or division (and it must be consistent with the organisation’s strategy). Given this we then encourage managers to use measures of the drivers of performance to understand better how to maximise their score. And as long as their score is defined properly, (and for lower levels in the organisation it will generally not be value) this will enhance their contribution to the firm.     

The Influence of Culture on Pension Plans

It is widely recognized that culture is a dimension affecting a vast array of management and social choices. However, we know little about the effect of culture on choices that combine both business and social issues in an accounting setting. Employee benefit choices by managers reflect both the business choices of a firm in the selection and retention of employees and social choices in the type and extent of benefits provided to employees. The objective of this study is to investigate the extent to which culture affects employee benefits as manifested in pension plans. In a comparison of plans that differ according to the home country of the parent firm and are offered in the regulated environment of the United States, results indicate an effect of culture on pension plan choices. In particular, culture plays a role in determining the funding level percentage of the plan, employer contributions receivable, and revenues received or receivable from employers.     

Interaction between securitization gains and abnormal loan loss provisions: Credit risk retention and fair value accounting

This study investigates whether managers use asset securitization gains to substitute loan loss provision (LLP) management for earnings management, and, if so, whether the percentage of credit risk retained affects such a relationship. The literature provides evidence that managers have used securitization transactions to boost earnings. Using 2001?2014 data for a sample of bank holding companies, I find that managers use securitization gains and LLPs as partial substitutes and that earnings management from securitization gains grows at an increasing rate to substitute income increasing LLP management as the level of risk retention increases. These findings are consistent with the argument that the higher the level of risk retention, the greater the potential impact on achieving earnings targets, given banks’ exercise of discretion over securitization gains through estimation of fair value of retained interest. In addition, I document that the substitution effect between the two tools is non‐existent in the post‐SFAS 166/167 period. Taken together, the findings have timely implications for accounting standards by informing the effect of risk retention that I measure through earnings management techniques. Moreover, my findings provide additional support for improved disclosures on assets‐backed securities.     

Cephalon, Inc. Taking risk management theory seriously

Cephalon Inc., a biotech firm, bought call options on its own stock to meet its conditional cash flow needs. We analyze this decision by using the cash flow hedging concepts of Froot et al., (1993. Journal of Finance 5, 1629–1658). We identify the managerial analyses necessary to apply this theory and discuss managerial considerations absent from the theory. We find that managers consider deadweight costs of risk management, which theory tends to ignore. Theory provides little guidance in how to measure these and other deadweight costs. Finally, uncertainty about the availability of external financing and accounting considerations are critical considerations by managers.     

When is good news really good news?

The impression management literature suggests that managers often resort to biased disclosures. However, there is little systematic evidence on what types of strategies management uses to achieve this bias. Do managers simply lie? Or, do they use more subtle ways of introducing positive bias into corporate narratives, such as selecting specific information items which result in a more positive impression (‘selectivity’) or by keeping their narratives vague and general (‘vagueness’)? In order to differentiate between the two scenarios, I re-examine the positive forward-looking statements examined by Schleicher and Walker (2010) and compare, across firms with improving and deteriorating financial performance, the managerial choices made in relation to eight forecast attributes.

I make two observations. First, there are significant differences in the characteristics of good- and bad-news firms’ positive statements. In particular, bad-news firms’ positive statements involve more non-specific time horizons, more segmental forecasts, and more references to conditions and aims and objectives, but fewer directional forecasts, fewer numbers, and fewer reinforcing qualifiers. Second, the identified differences in good- and bad-news firms’ positive statements can be exploited for classification purposes: including into a classification model additional regressors that measure a positive forward-looking statement's level of selectivity and vagueness significantly increases the model's ability to separate firms with improving financial performance from firms with deteriorating financial performance. Overall, my results are consistent with (a) impression management operating predominantly through selectivity and vagueness and (b) selectivity and vagueness being an important signal for future financial performance.     

Private Interaction Between Firm Management and Sell‐Side Analysts

Although sell‐side analysts often privately interact with managers of publicly traded firms, the private nature of this contact has historically obscured direction examination. By examining a set of proprietary records compiled by a large‐cap NYSE‐traded firm, I offer insights into which analysts privately meet with management, when analysts privately interact with management, and why these interactions occur. I also compare private interaction to public interaction between analysts and managers on conference calls. The evidence suggests that private interaction with management is an important communication channel for analysts for reasons other than firm‐specific forecasting news.     

Leadership and control system design

Little attention has been given to the role of leadership characteristics in the organization design literature despite significant evidence of its importance in explaining firm behavior. This study develops and tests a model to assess the effects of leadership style on three control choices that are considered integral elements of a firm's management control system; namely the delegation choice, the use of planning and control systems and the performance measurement system. Our results, based on data collected from 128 profit center managers, indicate that leadership style is a significant predictor of senior management's use of the planning and control system and their use of the performance measurement system for rewarding lower-level managers. After controlling for operating contextual factors (namely, subunit interdependencies and knowledge asymmetries) we find no effect of leadership style on delegation choices but do find that leadership style influences the use of planning and control systems as predicted.     

Infrastructure, Externalities, and Economic Development: A Study of the Indian Manufacturing Industry

If infrastructure tends to generate spillover externalities,as has been the assumption in much of the development literature,one may reasonably look for evidence of such indirect effectsin the accounts of manufacturing industries. Empirical supportfor this assumption has so far been ambiguous. This analysisof Indian data, however, reveals substantial externality effectsfrom the states’ infrastructure to manufacturing productivity.The analysis separates the direct effects of roads and electricity,as mediated by the infrastructure services purchased by manufacturingindustries along with other intermediate inputs, from the indirecteffects, as measured by the impact of infrastructure capacityon the Solow productivity residual. In the 20 years from 1972to 1992, growth of road and electricity-generating capacityseems to have accounted for nearly half the growth of the productivityresidual of India’s registered manufacturing.     

Value Maximization,Stakeholder Theory,and the Corporate Objective Function

This paper examines the role of the corporate objective function in increasing corporate productivity, social welfare, and the accountability of managers and directors. Because it is logically impossible to maximize in more than one dimension, purposeful behavior requires a “single-valued” objective function. Two hundred years of work in economics and finance implies that, in the absence of externalities and monopoly, social welfare is maximized when each firm in an economy aims to maximize its total market value. The main contender to value maximization is stakeholder theory, which argues that managers should attempt to balance the interests of all corporate stakeholders, including not only financial claimants, but employees, customers, communities, and governmental officials. By refusing to specify how to make the necessary tradeoffs among these competing interests, the advocates of stakeholder theory leave managers with a theory that makes it impossible for them to make purposeful decisions. With no clear way to keep score, stakeholder theory effectively makes managers unaccountable for their actions (which helps explain the theory's popularity among many managers). But if value creation is the overarching corporate goal, the process of creating value involves much more than simply holding up value maximization as the organizational objective. As a statement of corporate purpose or vision, value maximization is not likely to tap into the energy and enthusiasm of employees and managers. Thus, in addition to setting up value maximization as the corporate scorecard, top management must provide a corporate vision, strategy, and tactics that will unite all the firm's constituencies in its efforts to compete and add value for investors.