The effect of disclosure committees on non-GAAP reporting quality

I examine whether company-implemented disclosure committees help to improve non-GAAP reporting quality. I find that firms with disclosure committees provide higher quality non-GAAP performance metrics and that the exclusions used to calculate their non-GAAP numbers are less persistent for future operating income and operating cash flows. Moreover, I find that firms with disclosure committees are less likely to receive SEC comment letters about non-GAAP disclosure. For firms that receive comment letters about non-GAAP reporting, disclosure committees can help to improve non-GAAP reporting quality. Comparing the influence of audit committees and disclosure committees, I find that audit committee financial experts have stronger monitoring effects than those on disclosure committees. Meanwhile, legal experts on disclosure committees provide similar monitoring compared to audit committees’ financial experts. Finally, the interaction between audit committee financial experts and disclosure committee legal experts produces the strongest effect on non-GAAP reporting quality. In sum, my analyses suggest that disclosure committees can provide important monitoring of non-GAAP reporting.     

Non-GAAP Earnings Disclosures on the Face of the Income Statement by UK Firms: The Effect on Market Liquidity

This study benefits by a special feature of the UK information environment which allows UK firms to disclose non-GAAP earnings on the face of the income statement to examine two interrelated questions. First, we ask whether the decision to disclose non-GAAP earnings on the face of the income statement is related to the firm's financial performance and corporate governance characteristics, and second, we investigate the effect of this disclosure decision on market liquidity. Using a dataset of 1227 hand-collected firm-year observations during the period 2006–2013, we show that better governed firms and firms with weaker financial performance are more likely to disclose non-GAAP earnings. Our evidence also suggests that this disclosure is associated with increased levels of market liquidity and the results hold after controlling for self-selection bias. We conclude that firms' decision to disclose non-GAAP earnings on the face of the income statement is more consistent with the incentive to provide information than to mislead the market.     

Policy implications of research on non-GAAP reporting

Over the past two decades, the regulatory landscape for non-GAAP reporting has evolved significantly. Despite a temporary decline in the frequency of non-GAAP reporting following Regulation G, the incidence of non-GAAP disclosure has continued to increase steadily, leading to a current all-time high in reporting activity. This proliferation of non-GAAP disclosure has captured the attention of standard setters and regulators in recent years. This paper provides an academic perspective on policy implications for both regulation and standard setting. We contend that current Compliance and Disclosure Interpretations (C&DIs) of the SEC staff may perhaps have gone too far in restricting certain types of non-GAAP disclosures. As a result, we advocate a slight relaxation of the current enforcement of Regulation G. We agree with FASB proposals for greater disaggregation in the income statement to allow for more transparency in non-GAAP reporting. Finally, we believe the PCAOB should consider requiring auditors to take a more direct role with respect to non-GAAP disclosures.     

Audit committees and earnings quality

This research investigates whether audit committees are associated with improved earnings quality for a sample of Australian listed companies prior to the introduction of mandatory audit committee requirements in 2003. Two measures of earnings quality are used based on models first developed by Jones (1991 ) and Dechow and Dichev (2002 ). Our results indicate that formation of an audit committee reduces intentional earnings management but not accrual estimation errors. We also find differences in the associations between audit committee accounting expertise and the two earnings quality measures. Other audit committee characteristics examined are not significantly related to either earnings quality measure.     

The unintended consequences of voluntary adoption of clawback provisions on managerial ability

I investigate the impact of the voluntary adoption of clawback provisions on managerial ability and predict that clawback provisions will motivate managers to exert more efforts following the adoption of clawback and these efforts will be in the form of an increased managerial efficiency. Using a propensity score matched sample of firms, I find a significant positive association between voluntary clawback adoption and the change in both rank and score of managerial ability. My study highlights the unintended consequences of clawback provisions on CEO's behavior and contributes to the on-going debate on the importance of proactively and carefully drafting clawback policies, further signifying the importance of the SEC's efforts (Rule 10D-1) to enforce clawback policies.     

The spillover effect of shareholder activism: Evidence on firm reporting

This study examines the spillover effect of shareholder activism against target firms on financial reporting by non-target firms in portfolios held by the same activist shareholders. We find that firms that are not the target of institutional shareholders’ activism campaigns report more positive abnormal accruals. Cross-sectional tests indicate that the effect is more pronounced i) for firms that have more opportunities to engage in upward earnings management, or for firms with less effective alternative monitoring forces, and ii) when investors are more sensitive to good news. We also find that the effect is stronger when activist shareholders are more experienced, are waging more confrontational campaigns against target firms, and have larger holdings in non-target firms. We further find that non-target firms tend to report lower magnitude of asset write-downs, are more likely to restate financial statements and meet or beat earnings benchmarks, and exhibit a more optimistic tone in their 10-K/10-Q filings. Overall, our findings suggest that firms tend to window-dress their mandatory reporting to preempt possible shareholder activism against them.     

Fraudulent financial reporting in China: Evidence from corporate renaming

Using a sample of listed Chinese companies during 2010–2019, we examine whether corporate renaming is associated with fraudulent financial reporting. We find that companies that change their corporate names without making underlying changes to business fundamentals are more likely to commit financial reporting fraud. The positive association between corporate renaming and financial reporting fraud is more pronounced for non-state-owned enterprises and companies with a lower ownership concentration. There is further evidence that corporate renaming is more likely to be associated with disclosure-related fraud (e.g., failure to disclose or delayed disclosure) and that the likelihood of fraudulent behavior increases with the frequency of corporate renaming. Overall, the findings of this study provide evidence of a new red flag for regulators and investors investigating financial fraud. This study is timely and has policy implications for market regulators hoping to establish and improve emerging capital markets in which the information environment is generally considered weak and opaque.     

Effects of Increasing Enforcement on Financial Reporting Quality and Audit Quality

A widely held assumption in policy making and empirical research is that increasing the strength of public enforcement improves financial reporting quality and audit quality. This paper provides a more nuanced view. In a model with a manager who can manage earnings, a strategic auditor, and an enforcement institution, we show that enforcement and auditing are complements in a weak enforcement regime but can be substitutes in a strong regime. Although stronger enforcement always mitigates earnings management, the effects of different instruments of strengthening enforcement are ambiguous. We show that they can improve or impair financial reporting quality and audit quality, depending on production risk, accounting system characteristics, and the scope of auditing relative to enforcement.     

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.     

How do corporate political connections influence financial reporting? A synthesis of the literature

A large stream of research has analyzed the effects of corporate political connections (CPCs) on firms, including first evidence on their effects on financial reporting behavior. However, the evidence so far is inconclusive, and attempts to explain the causality of effects on reporting are limited. In this article, we present the results of a systematic review of the literature on CPCs. We draw on findings in the accounting, finance, and economics literature and derive a framework that identifies four channels through which CPCs affect financial reporting. Our review of the literature suggests that effects of political connections tend to be more ambiguous than suggested by individual studies that often offer directional hypotheses. We also identify eight distinct types of political connectedness and discuss their interrelations and the proxies used in the literature to measure them.     

Externalities of public firm presence: Evidence from private firms' investment decisions

Public firms provide a large amount of information through their disclosures. In addition, information intermediaries publicly analyze, discuss, and disseminate these disclosures. Thus, greater public firm presence in an industry should reduce uncertainty in that industry. Following the theoretical prediction of investment under uncertainty, we hypothesize and find that private firms are more responsive to their investment opportunities when they operate in industries with greater public firm presence. Further, we find that the effect of public firm presence is greater in industries with better information quality and in industries characterized by a greater degree of investment irreversibility. Our results suggest that public firms generate positive externalities by reducing industry uncertainty and facilitating more efficient private firm investment.     

Accounting conservatism and voluntary corporate governance mechanisms by Australian firms

This study examines the relationship between voluntary adoption of selected corporate governance mechanisms and accounting conservatism for a sample of firms listed on the Australian Securities Exchange (ASX) over the 11‐year period prior to the promulgation of the ASX Corporate Governance Council Good Governance Principles and Best Practice Recommendations in 2003. Using four accounting and market‐based accounting conservatism measures, our results provide evidence of both conditional and unconditional conservatism in accounting reporting for Australian firms. We find that voluntary audit committee formation, increasing board independence and decreasing board size are positively associated with unconditional accounting conservatism and negatively related to the degree of conditional conservatism. Our results support the contention that firms voluntarily adopting perceived best practice corporate governance mechanisms employ unconditional accounting conservatism as a complimentary agency control device and are consistent with the observed negative association between the unconditional and conditional forms of accounting conservatism practice.     

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.     

Bank earnings management and performance reporting of comprehensive income

FASB’s ASU 2011-05 mandated that comprehensive income (CI) and other comprehensive income (OCI) be reported in performance statements (a single income statement or a separate statement of CI) rather than equity statements. Employing a difference-in-differences research design with ASU 2011-05 as the treatment, I find that presenting accounting information in different statements affects bank earnings management, specifically, presenting CI and OCI in performance statements (especially in single-statements with net income) reduces earnings management through selective sales of available-for-sale (AFS) securities in the banking industry. I also find that the influence of ASU 2011-05 is primarily on banks with high equity incentives in the CEO’s compensation package or less CEO job security. Additional analyses suggest that performance reporting of CI and OCI increases the predictive ability of realized gains and losses of AFS securities; however, banks may manage loan loss provision as a substitute strategy when they have to decrease selective sales of AFS securities.     

Earnings quality effect of state antitakeover statutes

Existing theories suggest two opposite effects that antitakeover protection may have on earnings management: the exacerbating effect and the mitigating effect. We use the introduction of state antitakeover laws during the mid- to late-1980s as a natural experiment to test the relationship between antitakeover protection and earnings quality. The results show that firms incorporated in states that passed the laws have lower magnitudes of abnormal accruals and higher levels of earnings informativeness in the post-passage periods, suggesting that antitakeover protection mitigates earnings management and enhances earnings quality. Further evidence shows that reductions in earnings management are concentrated in firms with low firm-level antitakeover protection and in firms with serious agency problems, and that the earnings management effect of state antitakeover laws is likely to be of short-term duration.     

Direct and substitution effects of regulations impacting the scope for classification shifting

We exploit two historic changes to Australian accounting standards to examine the direct and substitution effects of regulations impacting the scope for classification shifting. First, we consider whether reforms to the standard prescribing the format of the income statement (AASB 1018) introduced during 2001/02 reduced the extent to which core expenses were opportunistically misclassified as ‘abnormal’ in an attempt to boost ‘core earnings’ (the ‘direct effect’), and whether any reduction in classification shifting behavior induced greater use of accrual-based earnings management (the ‘substitution effect’). We then examine the impact of the introduction of AASB 101 in 2005, which effectively reversed the constraints on classification shifting introduced in 2001/02. We find that classification shifting using abnormal items was significantly reduced following the 2001/02 reform. However, this reform also appears to have induced an increased use of accruals management to manipulate core earnings, thus potentially impairing earnings quality. We find some weak evidence of an increase in classification shifting behavior following the adoption of AASB 101, but no evidence of any substitution effects involving accrual-based earnings management.     

The Informational Role of Short Sellers: The Evidence from Short Sellers’ Reports on US‐Listed Chinese Firms

Using US‐listed Chinese firms as the setting, this paper studies a novel channel through which investors can acquire information about firms’ financial reporting quality, that is, the reports published voluntarily by short sellers. I find that short sellers tend to target firms that have financial reporting red flags and that exhibit ‘good’ operating performance and stock valuations. Targeted firms experience an average three‐day cumulative abnormal return (CAR) of ?6.4%, and ?13.6% for initial coverage of the firm, and the CARs are more negative when the reports allege more severe misconduct of the firms. Non‐targeted firms also experience losses in value following short seller reports, especially when they hire the same non‐Big 4 auditors as targeted firms and when their earnings quality is poor. In comparison, analysts fail to perform proper due diligence and are much less effective than short sellers in exposing misreporting risk in Chinese firms.     

The effects of firm-initiated clawback provisions on bank loan contracting

Although firm-initiated clawbacks reduce accounting manipulation, they also induce managers to engage in suboptimal activities (e.g., reduce research and development (R&D) expenses) to achieve earnings targets. To assess the effectiveness of clawback provisions, we examine their impact from debtholders' point of view. We find that banks use more financial covenants and performance pricing provisions in the loan contracts and decrease interest rates after firms initiate clawbacks. Moreover, we also find that loan maturity increases and loan collateral decreases subsequent to clawback adoption. Taken together, our findings indicate that firm-initiated clawback provisions enhance financial reporting quality, thereby reducing the information uncertainty that financing providers face.     

Female tainted directors,financial reporting quality and audit fees

This paper examines the association between the presence of female tainted directors on corporate boards and audit committees and (1) financial reporting quality and (2) audit fees. Female tainted directors are defined as female directors who have been directors of the firms that have previously been involved in financial failures and integrity indiscretions. Using real earnings management and audit fees as proxies for effective governance and board reputation, we find that firms with female tainted directors have higher real earnings management and higher audit fees. However, since prior literature has demonstrated that audit fees are higher for firms with female directors because female directors demand better auditing, we corroborate a supply-side effect of auditors charging higher audit fees when female tainted directors exist. We demonstrate this by showing that while there is an association between audit fee and real earnings management, this association is higher for firms with female tainted directors. Arguably, the governance and reputational benefits of female directors on boards are negated if such directors have tarnished professional reputations.