Investor Attention and Stock Mispricing

This study examines the relation between investor attention and stock mispricing of accruals in U.S. firms using the Limited Investor Attention Model of Hirshleifer and Teoh ( 2003 ). Consistent with the model's hypothesis that investor attention reduces stock mispricing of accruals, I document three key findings. First, I find a significant and negative correlation between stock mispricing of accruals and analyst following. Second, stock mispricing of accruals is negatively correlated with institutional ownership and, in particular, with the ownership of bank trusts and the ownership of pensions and endowments. Third, stock mispricing of accruals is negatively correlated with Big 4 auditor choice.     

Does investor protection regime affect the effectiveness of outside directorship on the board?

Since the Sarbanes-Oxley Act was enacted in U.S., there has been a general tendency to globally harmonize regulations and practices of board governance. The purpose of this study is to compare among countries how well the board of directors constrains earnings management. Using a sample of firms from 23 countries, we document some evidence that higher outside directorship on the board is associated with lower earnings management in the international context. We also find that there is no significant difference in the effectiveness of board outside directorship in constraining earnings management between high and low investor protection countries. Our findings mitigate a concern that harmonized corporate governance in low investor protection countries may not work.     

Does Investor Sentiment Affect Earnings Management?

I hypothesize and find that earnings management via accruals is driven partially by the prevailing market‐wide investor sentiment. Managers inflate earnings in periods of higher sentiment, but report more conservatively during periods of low sentiment. Moreover, the likelihood of income‐increasing earnings management to avoid negative earnings surprises is also positively associated with investor sentiment. These results are robust to: (i) controls for time‐varying firm characteristics such as growth, investment opportunity sets, future profitability, leverage and size; (ii) macroeconomic variables such as future inflation, GDP growth, and growth in industrial production; (iii) multiple proxies for investor sentiment; and (iv) discretionary revenues as alternative measure of earnings management. Cross‐sectional analyses reveal that firms whose stock returns co‐move more with investor sentiment are more (less) likely to manage earnings upward via abnormal accruals in quarters of higher (lower) sentiment. The findings of managers’ strategic use of abnormal accruals show the need for increased attention from boards of directors, auditors and regulators to heightened managerial incentives to overstate earnings and to report optimistic earnings numbers during periods of high investor sentiment.     

Investor sentiment and management earnings forecast bias

This study investigates whether investor sentiment is associated with behavioral bias in managers’ annual earnings forecasts that are generally issued early in the year when uncertainty is relatively high. I provide evidence that management earnings forecast optimism increases with investor sentiment. Furthermore, I find that managers’ annual earnings forecasts are more pessimistic during low‐sentiment periods than during normal‐sentiment periods. Since managers lack incentives to further deflate stock prices during a low‐sentiment period, this evidence indicates that sentiment‐related management earnings forecast bias is likely to be unintentional. In addition, I find that the relationship between management earnings forecast bias and investor sentiment is stronger for firms with higher uncertainty, consistent with investor sentiment having a greater influence on management earnings forecasts when uncertainty is higher.     

How Representative Are Firms That Are Cross‐Listed in the United States? An Analysis of Accounting Quality

We provide evidence on the characteristics of local generally accepted accounting principles (GAAP) earnings for firms cross‐listing on U.S. exchanges relative to a matched sample of foreign firms currently not cross‐listing in the United States to investigate whether U.S. listing is associated with differences in accounting data reported in local markets. We find that cross‐listed firms differ in terms of the time‐series properties of earnings and accruals, and the degree of association between accounting data and share prices. Cross‐listed firms appear to be less aggressive in terms of earnings management and report accounting data that are more conservative, take account of bad news in a more timely manner, and are more strongly associated with share price. Furthermore, the differences appear to result partially from changes around cross‐listing and partially from differences in accounting quality before listing. We do not observe a similar pattern for firms cross‐listed on other non‐U.S. exchanges or on the U.S. over‐the‐counter market, suggesting a unique quality to cross‐listing on U.S. exchanges.     

China-US trade dispute investigations and corporate earnings management strategy

This paper studies Chinese firms’ earnings management strategy in response to the trade dispute investigations initiated by the U.S. from 2001 to 2018. This topic is important given the increasingly severe international trade environment and the significant influence of macro economy on financial reporting. We find that firms affected by the U.S.-initiated trade dispute investigations engage in more upward earnings management. Additionally, the result is more pronounced in firms with a more negative market reaction around the announcement of the investigations. Cross-sectional tests provide evidence that the positive relation is stronger among firms whose U.S. operating revenue and management ownership is high, firms in provinces with weak investor protection, and firms that performed well one year after initiation of the investigations. Moreover, investors react positively to the earnings management by the affected firms. Our results are robust to a variety of sensitivity checks. Overall, our findings suggest that companies will manage their earnings upward to mitigate the negative impacts of the U.S.-initiated trade dispute investigations.     

Strategic Conservative Earnings Management of Technology Firms: Evidence from the IPO Market

In this paper, we investigate the conservative earnings management strategies of technology firms in the IPO market. We hypothesize that technology IPOs, due to their fewer tangible assets, more information asymmetry, and higher uncertainties of future cash flows, tend to have higher litigation risk. At equilibrium, technology firms are more motivated to strategically employ conservative earnings management during the IPO process, to mitigate their higher litigation risk. Using a sample of U.S. IPOs, we find that technology IPOs, on average, involve significantly more conservative earnings management, especially during the bubble periods. Our results also show that the conservative earnings management strategies of technology firms tends to have a greater impact on their underpricing than for non‐tech firms, and thus effectively reduce their risk of being a target in the securities class action lawsuits.     

XBRL and Accruals: Empirical Evidence from China

We examine whether XBRL adoption by publicly traded firms on the Shanghai Stock Exchange and Shenzhen Stock Exchange is related to the level of total accruals that firms report in the pre‐XBRL versus post‐XBRL periods. Our results indicate that the level of total accruals in the post‐XBRL period is lower relative to the pre‐XBRL period. This finding is robust to several controls for macroeconomic conditions and firm fundamentals. Moreover, we find this main effect is most prominent for firms that are most likely to benefit from greater transparency: high‐growth firms, small firms, and firms in high‐technology industries. One interpretation of our results is that XBRL implementation decreases investor’s information acquisition costs and thereby improves their ability to detect earnings management; managers in turn reduce accruals.     

Discretionary Loan Loss Provisions and Systemic Risk in the Banking Industry

This study examines the relation between earnings management through discretionary loan loss provisions (LLPs) and systemic risk in the U. S. banking sector using a large sample of commercial banks from 1996 to 2009. We find that earnings management increases a bank's contribution to systemic crash risk and systemic distress risk, consistent with the notion that earnings management increases information opacity, facilitates bad news hoarding, co‐moves with macroeconomic conditions, and exhibits cross‐sectional correlation and herding in earnings management. However, the effect of earnings management through discretionary LLPs on systemic risk disappears during the crisis period, consistent with weakened earnings management in crisis times. We also find that the same effect strengthens with bank uncertainty and homogenous loans, and weakens in the post‐SOX period, and when banks are audited by Big 4 auditors.     

Institutional investor distraction and earnings management

In this study, we explore the implications of institutional investor distraction for earnings management. Our identification approach relies on a firm-level measure of institutional investor distraction that exploits exogenous attention-grabbing shocks to unrelated parts of institutional investors' portfolios. We find that firms with distracted institutional shareholders engage more in both accrual-based and real earnings management. Further analyses show that the association between investor distraction and earnings management is stronger in firms with low analyst coverage and weak board monitoring, as well as in firms where managing earnings upward allows meeting or just beating their earnings target. Collectively, our results suggest that managers exploit the loosening in monitoring intensity resulting from investor distraction by engaging in earnings management. Even in the presence of institutional investors with superior monitoring abilities, limited attention may induce insufficient monitoring of earnings management practices.     

Accounting Choice, Home Bias, and U.S. Investment in Non-U.S. Firms

This paper examines the relation between accounting choice and U.S. institutional investor ownership in non‐U.S. firms. We predict that U.S. investors exhibit home bias in their preference for accounting methods conforming to U.S. Generally Accepted Accounting Principles (GAAP) because such methods are more familiar, reduce information processing costs, and are perceived as higher quality. We find that firms exhibiting higher levels (changes) of U.S. GAAP conformity have greater levels (changes) of U.S. institutional ownership. Lead‐lag regressions suggest that increases in U.S. GAAP conformity precede increases in U.S. investment, but changes in U.S. institutional holdings do not precede changes in accounting methods. We also find that the positive relation between U.S. GAAP conformity and U.S. investment holds regardless of a firm's visibility to U.S. investors (e.g., American Depositary Receipt listing, stock index membership, analyst following, firm size). However, we find that U.S. GAAP conformity has a significantly greater impact among firms already visible to U.S. investors.     

Private Control Benefits and Earnings Management: Evidence from Insider Controlled Firms

We examine earnings management practices of insider controlled firms across 22 countries to shed light on the link between consumption of private benefits and earnings management. Insider controlled firms are associated with more earnings management than noninsider controlled firms in weak investor protection countries. Consistent with the private benefits motive, insider controlled firms with greater divergence between cash‐flow rights and control rights are associated with more earnings management in these countries. Growth opportunities attenuate the association between insider control and earnings management even in weak investor protection countries. We also find some weak evidence that insider controlled firms are associated with less earnings management in strong investor protection countries. Overall, our results highlight a strong link between private benefits consumption and earnings management.     

Non-audit services, auditor quality and the value relevance of earnings

This paper tests the hypothesis that there is an inverse relation between non‐audit services (NAS) provided by a firm auditor and the value relevance of earnings (measured as the earnings response coefficient) and that this relation is weaker for firms with Big 6 auditors. The hypothesis is based on anecdotal evidence and previous research that suggests that the provision of NAS by the external auditor is likely to adversely affect investors’ perceptions of the credibility of financial reports, and that Big 6 auditors, because of reputational capital and litigation costs, are likely to mitigate the adverse effects of NAS. Results using 840 firm‐year observations of Australian companies document a statistically significant inverse relationship between NAS and the value relevance of earnings, and this inverse relationship is weaker for Big 6 auditors, therefore supporting the hypothesis.     

Note on Self‐Selection of Auditors in the Municipal Sector*

The objective of this article is to revisit the literature on Big‐N audit fee premiums in the municipal setting using a methodology that controls for self‐selection bias. Because auditor choices can be predicted based on certain client characteristics, using standard one‐stage ordinary least squares regressions to draw inferences about the presence or absence of such a premium in the extant public‐sector audit fee studies may not be appropriate. Results indicate that, after controlling for a self‐selection bias, Big‐6 (non‐Big‐6) municipal clients on average pay a fee premium, compared to the case if they were to retain a non‐Big‐6 (Big‐6) auditor. Results continue to hold when we conduct further analyses on a subset of municipalities with access to both Big‐6 and non‐Big‐6 auditors in a local market defined by a 60‐km radius, rather than over a province‐wide audit market. The existence of non‐Big‐6 audit fee premiums has not been documented previously in the private‐ or public‐sector audit fee literature. We surmise that it may be caused by the dominance (79.4 percent) of non‐Big‐6 auditors in the Ontario municipal market, compared to most private‐sector audit markets where their market share generally does not exceed 20 percent. The strong market position of non‐Big‐6 firms in turn may have allowed these auditors to command a fee premium for the subset of municipalities that self‐selects to be audited by them. An implication from our study is that Ontario municipalities often choose to be audited by more costly auditors, even though they could have paid lower audit fees by switching to an alternative auditor type. These results do not support those reported by Chaney et al. (2004) , who find that U.K. private firms are audited by the least costly auditor type. The conflicting findings may be attributable to the fact that the Ontario municipal audit market is subject to regulation by not just the audit profession but also the Ontario government and that, unlike business corporations, municipalities receive funding from provincial governments to fulfil much of their financial requirements. Thus, municipal clients may be relatively more willing to accept higher audit fees provided their chosen auditor (or auditor type) matches their needs.     

Cross‐firm return predictability and accounting quality

We test the hypothesis that if poor accounting quality (AQ) is associated with poor investor understanding of firms’ revenue and cost structures, then poor AQ stocks likely respond more slowly than good AQ stocks to new non‐idiosyncratic information that affects both sets of firms. Consistent with this, results indicate that stock returns of good AQ firms significantly positively predict one‐month‐ahead stock returns to industry‐ and size‐matched poor AQ firms. In testing a delayed‐information‐processing mechanism behind the cross‐firm return predictability, we find that: (i) analyst earnings forecast revisions (FR) mimic the return patterns, as FR of good AQ firms significantly positively predict one‐month‐ahead FR of matched poor AQ firms; (ii) cross‐firm return predictability is concentrated in months with substantial news arrival, including months with Federal Open Market Committee (FOMC) rate announcements, but not in no‐news months; (iii) cross‐firm return predictability is stronger when the good AQ predictor firms have a richer information environment than poor AQ firms as proxied by analyst following, institutional ownership, and the presence of a Big 4 auditor. Collectively, the results uncover a new relation between accounting quality and stock return dynamics.     

Investor communication and the benefits of cross-listing

While studies have sought to explain the benefits of cross-listing, little attention has been paid to the role of communication between managers and investors during this process. In this paper, I investigate whether managers change communication policies around U.S. cross-listings. I document significant increases in communication when firms cross-list. I then test whether these investor communication practices around cross-listing are associated with capital market benefits. I find that cross-listed firms that communicate more with investors experience greater and longer lasting cross-listing benefits. Lastly, I explore two potential reasons that may lead managers to choose higher levels of communication: to support an increase in investor recognition and to facilitate monitoring. I find results consistent with communication increasing visibility and scrutiny, suggesting that communication functions as a supporting tool to achieve managers’ cross-listing goals.     

Forecasts in IPO Prospectuses: The Effect of Corporate Governance on Earnings Management

Prior research suggests that managers may use earnings management to meet voluntary earnings forecasts. We document the extent of earnings management undertaken within Canadian Initial Public Offerings (IPOs) and study the extent to which companies with better corporate governance systems are less likely to use earnings management to achieve their earnings forecasts. In addition, we test other factors that differentiate forecasting from non‐forecasting firms, and assess the impact of forecasting and corporate governance on future cash flow prediction. We find that firms with better corporate governance are less likely to include a voluntary earnings forecast in their IPO prospectus. In addition, we find that while IPO firms use accruals management to meet forecasts; the informativeness of the discretionary accruals depends on whether or not the firm would have missed its forecast without the use of discretionary accruals.     

Earnings management and stock price crashes post U.S. cross-delistings

We examine whether cross-delisted firms from the major U.S. stock exchanges experience an increase in crash risk associated with earnings management. Consistent with our prediction, we find that earnings management has a greater positive impact on stock price crash risk post cross-delisting when compared to a control group of firms that remain cross-listed. More importantly, we find that this effect is more pronounced for cross-delisted firms from countries with weaker investor protection, poorer quality of their information environment and less conservative accounting practices. Our findings are robust to the potential endogenous nature of the cross-delisting decision, alternative measures of stock price crash risk and information asymmetry. We interpret our results as evidence of a “reverse bonding effect” following cross-delistings from U.S. stock exchanges.     

The value of Big 4 audits in Australia

Research suggests that equity markets value Big N audits over non‐Big N audits. Explanations include the information quality hypothesis, whereby Big N auditors increase information quality, and the insurance hypothesis, whereby investors value the deeper pockets of Big N auditors. Using client firms’ex ante cost of capital as the dependent variable, we investigate whether capital market participants differentially value Big 4 versus non‐Big 4 audits in Australia and whether the value of Big 4 audits in Australia changed as a result of the audit failures of 2001–2002. We find that Big 4 audits reduce the ex ante cost of equity capital until 2001, but not after 2001. We cannot dismiss the insurance hypothesis for the persistence of the loss beyond 2003 because of the establishment of liability caps, but the demise of the Big 4 audit value for 2001–2003 is consistent with the information quality hypothesis and does not support the insurance hypothesis.     

Outside Directors,Litigation Environment,and Management Earnings Forecasts

This study examines whether outside directors factor in litigation costs for the firm while monitoring optimal disclosure policy. It investigates the association of management earnings forecast disclosure and the proportion of outside directors across two regimes with unequal litigation costs, the United States and Canada. I find that the positive association between forecast frequency/ precision and the proportion of outside directors is stronger in Canada. This suggests that outside directors are more likely to encourage disclosure in less litigious Canada. I also find that firm‐level governance mechanisms such as outside directors and country‐level litigation environment act as governance substitutes in determining unbiased forecasts. Specifically, the negative association between forecast bias and the proportion of outside directors is stronger in Canada. I also revisit the effect of legal regime on forecast disclosure in a non‐U.S. context. Recent legislation has increased the likelihood of class‐action lawsuits in Canada. The passage of these laws has decreased the precision in forecasts by Canadian firms.