Firm Characteristics and Stock Price

This study examines the stock price reaction to the internal control reporting required under Section 404 of the Sarbanes‐Oxley Act of 2002 for three distinct groups of firms. After controlling for general stock price movements, we find that stock returns are most negative for firms that delay filing of their internal control reports, continue to be negative for firms with ineffective internal controls, and are positive for firms with effective internal controls. The decrease in stock prices of the first two groups is more pronounced for those with a lower return on assets, higher growth rate in sales, and no prior disclosure of their internal controls weaknesses. Our results indicate that market participants value the reliability of financial information ensuing from Section 404 compliance, irrespective of firm size and debt proportion. Thus, regulators and policymakers worldwide should consider mandating comparable SOX 404 compliance for all publicly held companies to improve the accuracy and reliability of financial reports.     

Advertising and Investor Recognition of Banking Firms: Evidence from Taiwan

This study examines the effect of advertising expenditure on strengthening a firm’s intangible capital and firm value by attracting the public on the firm’s visibility and then investigates the role of advertising expenditures on a banking firm’s market value, liquidity, and breadth of ownership. The empirical results find that the advertising has a significantly positive effect on banking firm’s share value, liquidity, and institutional holdings. Consequently, this study concludes that advertising benefits banking firms through increased investor perceptions of such firms. In particular, the findings provide additional support for the home bias phenomena, in which investors prefer to invest in familiar stocks.     

A study of firms surrounding the threshold of Sarbanes–Oxley Section 404 Compliance

This study examines whether firms surrounding the Sarbanes–Oxley Section 404 market value compliance threshold behave opportunistically to reduce their market value to avoid compliance with Section 404. We find evidence that those firms reduce their market value temporarily during threshold measurement quarters, whereas control firms experience increasing market value. We find strong evidence of dampened stock returns and some evidence of insider trading as means to reduce the float. Additionally, we find that downward earnings management is used as a mechanism to alter investors’ expectations of firm value in order to temporarily reduce stock prices. We consider this opportunistic evidence of regulatory avoidance. Finally, we find that the likelihood of avoidance increases with the power of the CEO and decreases with the strength of the monitoring of the CEO, which suggest that avoidance is more likely to happen in firms with poor corporate governance mechanisms.     

Product market advertising and corporate bonds

Research shows that by enhancing visibility, advertising improves stock liquidity and returns. Unlike stock holders, bond holders may view advertising skeptically. Without proven effectiveness in improving revenues, large pre-interest advertising expenditures can be seen as eroding a firm's ability to meet its debt service obligations. We find that although greater advertising by a firm improves liquidity of its bonds in the market, it does not lower the firm's cost of debt. However, firms with ineffective advertising experience reduced bond market liquidity and a higher cost of debt. Without a real positive economic impact, advertising has little or no value for bond investors.     

Internal control weaknesses and evidence of real activities manipulation

We examine whether US public firms that file internal control weakness (ICW) disclosure reports with the Securities and Exchange Commission, as part of the reporting requirements under Section 404 of the Sarbanes–Oxley (SOX) Act, exhibit higher levels of real activities manipulation (RM), compared to firms that do not file such reports. Using firm-level data for the post-SOX period, 2004–2010, we find a positive relationship between firms reporting internal control weaknesses and real activities manipulation. Further, those ICW-firms that use RM to beat earnings benchmarks have lower performance in the subsequent year. Our results also show that firms do not use discretionary accruals as a substitute for RM when they report internal control weaknesses. Overall, our findings suggest that ICW-firms are prone to using real activities manipulation as a form of earnings management. Our findings also have implications for audit quality as auditors need to gain a better understanding of how real activities manipulation influences the operations of the firm.     

Internal control reporting and market liquidity

We investigate the impact of the Sarbanes-Oxley Act of 2002 (SOX) on information asymmetry by analyzing the relation between SOX Sections 302 and 404 control reports and market liquidity using bid-ask spreads. Lower market liquidity indicates higher levels of information asymmetry implying that market participants perceive financial statement misstatement risk is higher. If SOX disclosures contain relevant information, then one would expect firms reporting internal control material weaknesses to have lower market liquidity. Accordingly, we find that market liquidity is lower (i.e., bid-ask spreads are higher) for firms reporting ineffective control compared to firms reporting effective control using either annual SOX 404 internal control reports or quarterly SOX 302 disclosure control reports, which suggests that SOX 302 and 404 reports provide useful information for identifying firms with a higher risk of financial statement misstatement. However, we do not find consistent results using two alternative liquidity measures: trading volume and market quality indices. We then examine whether changes in control reports are associated with changes in market liquidity. We generally do not find that firms with improved (deteriorated) control reports experience a larger decrease (increase) in bid-ask spreads or larger increases (decreases) in trading volume and market quality indices compared to other firms, suggesting that market participants do not discern a change in information asymmetry when the effectiveness of internal controls over financial reporting changes.     

Cash holdings and real asset liquidity

This paper examines the relationship between the ability of a firm to sell its real assets and its cash holdings behavior. A substitution effect exists between the size of cash balances and the liquidity of a firm’s real assets when access to external capital markets is limited. Among financially constrained firms, higher asset liquidity is related to lower cash holdings. Additionally for financially constrained firms, the market value of cash is lower for firms with higher asset liquidity.     

Firm investment,finance constraint and voluntary asset sales: the evidence from Indian manufacturing firms

This paper examines the importance of finance constraints for firm investment expenditures by looking at the investment-asset sales sensitivity in financially healthy Indian manufacturing firms. Voluntary asset sales is a cleaner indicator of firms' liquidity than cash flows since it is unlikely to influence firms' growth opportunities unless they are financially constrained. We take care of the endogeneity and the implicit monotonicity problems, which are much debated in the literature, by using an endogenous regime switching regression model. We find that the investment-asset sales sensitivity is significantly greater for firms that are likely to be financially constraints.     

Intangible Assets and Corporate Signaling

Research and development (R&D) and advertising expenditures often result in patents, technologies and brand names which are difficult to accurately value. Under current generally accepted accounting principles (GAAP) these intangible assets are generally not recognized in the financial statements, but instead are expensed in the period that they occur. Prior studies note that the market-to-book ratios of firms with significant levels of R&D and advertising expenditures suggest that investors, at least partially, value these assets. Researchers and practitioners argue that current GAAP, by not recognizing these intangible assets, reduces the usefulness and relevance of accounting reports.We investigate whether companies with significant levels of intangible assets are more likely to emphasize dividend increases and stock repurchases (which are generally perceived as signaling favorable investment opportunities), instead of traditional accounting disclosures, as a means of overcoming adverse selection. Because these assets are difficult to measure, cash distributions may be viewed as a more credible means of signaling firm value to investors. Using analysts' ratings of firms' accounting disclosures, we find that companies with higher levels of R&D and advertising expenditures are less likely to provide extensive accounting disclosures and instead tend to employ dividend and stock repurchase signals. We obtain these results even after controlling for other firm attributes, such as size, stock returns performance, leverage, liquidity and investors' expectations of growth opportunities. We also find that the market reaction to dividend increase and stock repurchase announcements is greater for firms with higher levels of R&D and advertising expenditures, indicating that these announcements are more informative for such firms.     

Convertible Bonds and Stock Liquidity

This paper shows that the probability of exercise of convertible bonds issued against a firm’s stock directly affects the liquidity of the stock itself. Using the ratio of absolute stock return to its dollar volume as a proxy for stock liquidity I demonstrate that there is a direct and positive relationship between conversion probability and stock liquidity while controlling for firm size, book to market equity value and firm beta. I describe the effect of unlisted convertible debt on the liquidity of listed firms in the US, Korea and Singapore. The effects of conversion probability on stock liquidity are less pronounced for smaller firms, which helps explain time series variations in the liquidity premiums for smaller firms over time. The relationship between convertibles and stock liquidity is mainly attributed to the expected increase in the number of shares available for trade upon conversion and the expected change in the capital structure of the firm.     

The Effect of SOX Section 404: Costs,Earnings Quality,and Stock Prices

This paper exploits a natural quasi‐experiment to isolate the effects that were uniquely due to the Sarbanes–Oxley Act (SOX): U.S. firms with a public float under $75 million could delay Section 404 compliance, and foreign firms under $700 million could delay the auditor's attestation requirement. As designed, Section 404 led to conservative reported earnings, but also imposed real costs. On net, SOX compliance reduced the market value of small firms.     

Does the investment horizon of institutional investors matter for stock liquidity?

This paper examines the role of the investment horizon of institutional investors on stock liquidity of firms. We show that an increase in long-term institutional ownership is negatively associated with firm liquidity, while an increase in short-term ownership is positively related to a firm's stock liquidity. We identify the ownership-liquidity relationship by examining two major channels: the trading activity channel and the informational friction channel. Long-term investors reduce stock liquidity through low frequency trading and access to value-enhancing and private information, which induces adverse selection bias. In contrast, short-term investors improve liquidity through trading activity and competition with other investors, which lowers transaction costs. Our findings further suggest that the effects of an increase in long-term (short-term) institutional investors on liquidity weaken (strengthen) when a firm has more publicly available information. Finally, we show that the positive impact of an increase in long-term ownership on valuation is more pronounced for firms with higher liquidity and the valuation effect is persistent.     

Founders,heirs, and corporate opacity in the United States

We argue that information about firm activities can vary substantially in the presence of founder or heir ownership, thereby influencing the risks borne by minority investors. We explore two hypotheses with regard to these controlling shareholders and corporate transparency, focusing on their role as monitor in-place and their potential to exploit firm opacity to accrue private benefits of control. To test these notions, we create an opacity index that ranks the relative transparency of the two thousand largest industrial US firms and find founder and heir ownership in 22% and 25% of these firms, respectively. Our analysis indicates that, in large, publicly traded companies, both founder and heir firms are significantly more opaque than diffuse shareholder firms. We also find that founder and heir-controlled firms exhibit a negative relation to performance in all but the most transparent firms. Surprisingly, additional tests reveal that concerns about divergences in ownership versus control (management type, dual class shares, and board influence) appear to be substantially less important than corporate opacity in explaining the performance impacts of founder and heir control. Finally, we decompose corporate opacity into disclosure and market scrutiny components, finding that the disclosure quality component appears to be of greater importance to investors. However, irrespective of whether these controlling shareholders create or stay in the firm because of corporate opacity, our analysis suggests that founders and heirs in large, publicly traded firms exploit opacity to extract private benefits at the expense of minority investors.     

Advertising, Breadth of Ownership, and Liquidity

We provide empirical evidence that a firm's overall visibilitywith investors, as measured by its product market advertising,has important consequences for the stock market. Specificallywe show that firms with greater advertising expenditures, ceterisparibus, have a larger number of both individual and institutionalinvestors, and better liquidity of their common stock. Our findingsare robust to a variety of methodological approaches and tovarious measures of liquidity. These results suggest that theinvestors' degree of familiarity with a firm may affect itscost of capital and consequently its value.     

The Interaction of Solvency with Liquidity and its Association with Bankruptcy Emergence

Prior research has shown that accounting information available prior to a bankruptcy is associated with the likelihood of bankruptcy. We show that additionally, the accounting information available prior to bankruptcy is associated with whether or not a firm will emerge from bankruptcy. We predict that firms that exhibit low solvency risk and high liquidity risk are most likely to emerge from bankruptcy. Firms that exhibit high solvency risk and high liquidity risk are predicted to be least likely to emerge from bankruptcy. Cross–sectionally, our results support these predictions, but our findings differ across large and small firms.     

How Effective Is Internal Control Reporting under SOX 404? Determinants of the (Non‐)Disclosure of Existing Material Weaknesses

We study determinants of internal control reporting decisions under Section 404 of the Sarbanes‐Oxley Act (SOX 404) using a sample of restating firms whose original misstatements are linked to underlying control weaknesses. We find that only a minority of these firms acknowledge their existing control weaknesses during their misstatement periods, and that this proportion has declined over time. Further, the probability of reporting existing weaknesses is negatively associated with external capital needs, firm size, non‐audit fees, and the presence of a large audit firm; it is positively associated with financial distress, auditor effort, previously reported control weaknesses and restatements, and recent auditor and management changes. These results provide evidence that detection and disclosure incentives play a role in whether existing material weaknesses are reported, which has implications for the effectiveness of SOX 404 in providing investors with advance warning of potential accounting problems.     

Liquidity and firm investment: Evidence for Latin America

This paper explores the relationship between firms' investment and stock market liquidity. Using a panel of Latin American firms, I find evidence that a higher trading volume and a higher industry-adjusted trading volume are associated with higher firm investment (PPE, Total Assets, and Inventory). This relationship is higher in episodes where the firm decides to issue shares, and it is also greater for firms with tighter financial constraints and better investment opportunities. This evidence is consistent with a mispricing channel, where firms issue and invest the proceeds to take advantage of low cost of capital, or with a cost channel, where liquidity is associated with lower issuance costs. Also, it is less related with an informational channel, where a liquid market helps a manager to take more efficient decisions, since this channel does not necessarily predict an increase in investment, but only more efficient investment.     

Liquidity management,operating performance,and corporate value: evidence from Japan and Taiwan

This study examines the relationship between liquidity management and operating performance, and that between liquidity management and corporate value for firms in Japan and Taiwan. We observe that the cash conversion cycle (CCC)–returns on assets (ROA) and CCC–returns on equity (ROE) relationships are commonly negative and sensitive to industry factors. Both Japanese and Taiwanese firms with q>1 have significantly lower CCC than firms with q⩽1. In addition, Japanese firms with q>1 have significantly higher ROA and ROE than firms with q⩽1. Overall, the findings indicate that aggressive liquidity management enhances operating performance and is usually associated with higher corporate values for both countries in spite of differences in structural characteristics or in financial system of a firm.     

The impact of geographic diversification on firm performance

This paper empirically examines the economic effects of both corporate industrial and geographic diversifications. Using a sample of 28,050 firm-year observations from 1990 to 1998, we find that industrial and geographic diversifications are associated with firm value decrease. Consistent with Denis et al. [Denis, D. J., Denis, D. K., and Yost, K. (2002). Global diversification, industrial diversification, and firm value. Journal of Finance, 57, 1951-1979], the costs of corporate diversification may outweigh the benefits of diversification. We find that geographically diversified firms have higher R&D expenditures, advertising expenses, operating income, ROE and ROA than industrially diversified firms. In addition, higher R&D expenditures create value for multi-segment global firms, but not for single-segment global firms. This result implies that there exists an interaction effect between industrial and geographic diversification. We also examine the effects of agency cost issues, as characterized by the diversification discount, on both industrial and geographic diversification. Consistent with the agency explanation, firms with high equity-based compensation are associated with higher firm value than firms with low equity-based compensation. Also, we find that firms with a higher insider ownership percentage are associated with higher excess value.     

Stock liquidity and dividend policy: Evidence from an imputation tax environment

This paper investigates the impact of stock market liquidity on firms' dividend payout policy in the Australian market. The finding suggests that stock liquidity positively relates to firm dividend payouts. The result holds after controlling for different model estimations and different measures of stock liquidity/dividend. To address endogeneity issue, I use the removal of broker identities by the ASX in 2005 as an exogenous shock to stock liquidity. The result suggests that there is an increase in stock liquidity around this shock, leading to an increase in firm dividend, suggesting a causal effect of stock liquidity on firm dividend. I further document that stock liquidity enhances firm dividend through reducing cash-flow volatility and the effect of stock liquidity on firm dividend is weaker for firms reporting imputation tax credit.