Predicting fraud by investment managers

We test the predictability of investment fraud using a panel of mandatory disclosures filed with the SEC. We find that disclosures related to past regulatory and legal violations, conflicts of interest, and monitoring have significant power to predict fraud. Avoiding the 5% of firms with the highest ex ante predicted fraud risk would allow an investor to avoid 29% of fraud cases and over 40% of the total dollar losses from fraud. We find no evidence that investors receive compensation for fraud risk through superior performance or lower fees. We examine the barriers to implementing fraud prediction models and suggest changes to the SEC's data access policies that could benefit investors.     

Booms, Busts, and Fraud

Firms sometimes commit fraud by altering publicly reported informationto be more favorable, and investors can monitor firms to obtainmore accurate information. We study equilibrium fraud and monitoringdecisions. Fraud is most likely to occur in relatively goodtimes, and the link between fraud and good times becomes strongeras monitoring costs decrease. Nevertheless, improving businessconditions may sometimes diminish fraud. We provide an explanationfor why fraud peaks towards the end of a boom and is then revealedin the ensuing bust. We also show that fraud can increase iffirms make more information available to the public.     

The spillover effect of fraudulent financial reporting on peer firms' investments

We investigate how high-profile accounting frauds affect peer firms' investment. We document that peers react to the fraudulent reports by increasing investment during fraud periods. We show that this finding is not driven by frauds that have a higher ex ante likelihood of detection or by an association between fraud and investment booms. In addition, we find that peers’ investments increase in fraudulent earnings overstatements, and in industries with higher investor sentiment, lower cost of capital and higher private benefits of control. We also find evidence consistent with equity analysts potentially facilitating the spillover effect.     

The effect of conference calls on equity incentives: An empirical investigation

Conference calls have become increasingly common in recent years, yet there is little empirical evidence regarding the effect of conference calls on executive compensation. In this study, we examine the effect of voluntary disclosures on equity incentives. We hypothesize that voluntary disclosures, as measured by conference calls, affect executive compensation contracts. Using a dataset of 6263 firm-year observations from both conference call and non-conference call firms, our results are consistent with the argument that the board of directors substitutes voluntary disclosures for more costly corporate governance mechanisms. Alternatively, in firms where CEOs have less equity incentives, the owners demand more voluntary disclosures. The results of this study should be of great importance to executives and capital market participants internationally, such as investors and analysts, since we provide evidence that conference calls affect incentive based compensation contracts, which were shown in prior studies to be value relevant.     

Is There a Link between Executive Equity Incentives and Accounting Fraud?

We compare executive equity incentives of firms accused of accounting fraud by the Securities and Exchange Commission (SEC) during the period 1996–2003 with two samples of firms not accused of fraud. We measure equity incentives in a variety of ways and employ a battery of empirical tests. We find no consistent evidence that executive equity incentives are associated with fraud. These results stand in contrast to assertions by policy makers that incentives from stock‐based compensation and the resulting equity holdings increase the likelihood of accounting fraud.     

Corporate Scandals and Household Stock Market Participation

We show that, after the revelation of corporate fraud in a state, household stock market participation in that state decreases. Households decrease holdings in fraudulent as well as nonfraudulent firms, even if they do not hold stocks in fraudulent firms. Within a state, households with more lifetime experience of corporate fraud hold less equity. Following the exogenous increase in fraud revelation due to Arthur Andersen's demise, states with more Arthur Andersen clients experience a larger decrease in stock market participation. We provide evidence that the documented effect is likely to reflect a loss of trust in the stock market.     

Insider Ownership,Risk, and Leverage in REITs

We investigate the relative importance of managerial entrenchment and incentive alignment as indicated by REIT risk-taking. The two theories make contradictory predictions about the sign of the relation between insider ownership and risk. We test for the possibility of diminishing entrenchment returns to insider ownership. Empirical results for equity and asset betas soundly reject linear models in favor of nonmonotonic relations with reversals at insider ownership of 36%. Up to that point, increasingly entrenched insiders mitigate their own risk aversion. Above 36%, incentive alignment emerges as managers become more substantial owners. Leverage declines at an accelerating rate above 20% insider ownership. Together these results suggest a shift in the composition of risk, from leverage risk to asset risk, reflecting comparative advantage and a crossover in the relative monitoring costs of debt and equity. Problematically for linear models, the coefficient of insider ownership is not significant for most risk measures, producing the misleading appearance of no relation between insider ownership and risk. Institutional ownership is significantly negatively related to leverage. Thus incentives are aligned between insiders and institutional owners at insider ownership above 20%.     

The IPO and first seasoned equity sale: Issue proceeds,owner/managers' wealth,and the underpricing signal

Recent models of IPO underpricing suggest that high-quality firms underprice their IPOs to differentiate themselves from low-quality firms and, thus, receive a more favorable market response to subsequent equity offerings. We test this suggestion for 172 industrial firms that made an initial public offering during 1987–1991 and made a subsequent seasoned equity offering within three years of their IPO. We examine two measures of the impact of the hypothesized underpricing signal net of the cost of employing that signal. Inconsistent with the underpricing signal hypothesis, we find no evidence that firms recover the cost of an underpriced IPO in either higher issue proceeds or in greater wealth for the firm's initial owners.     

Articulation-based accruals

We build an articulating financial statements model in which the beginning and ending balance sheet amounts are explicitly linked to accruals. We distinguish accruals based on the source financial statement of the accruals, either the cash flow statement, balance sheet, or statement of owners’ equity. We then examine how the accrual-generating source affects the relations between accruals and future earnings and stock returns. While prior studies document a negative association between accruals and future earnings and returns, we find accruals relating to the current operating section of the balance sheet are positively associated with future earnings. Further, accruals originating from net financial asset via the statement of owners’ equity are positively associated with future returns. We also show that equity investment and discontinued asset accruals differ from operating asset accruals in their association with future earnings.     

Disclosure of Intended Use of Proceeds and Underpricing in Initial Public Offerings

We use the context of a company's initial public offering (IPO) of equity securities as a capital‐markets setting to empirically study the economic consequences of endogenous disclosure. In particular, we examine the relation between the extent of dollar detail an IPO issuer provides regarding their intended use of proceeds and first‐day underpricing. We document substantial variation in the specificity of this disclosure and find that an increase in such specificity is associated with lower IPO underpricing. Overall, our results suggest that IPOs that provide specific use‐of‐proceeds disclosures have less ex ante uncertainty, in the sense that these disclosures help investors estimate the dispersion of secondary market values. Our paper contributes to the empirical accounting literature by documenting an association between voluntary disclosure and what is arguably the foremost cost of raising initial equity capital (i.e., IPO underpricing).     

BEYOND THE NUMBERS: MINING THE ANNUAL REPORTS FOR HIDDEN CUES INDICATIVE OF FINANCIAL STATEMENT FRAUD

Unlike previous fraud detection research, a vast majority of which has focused primarily on the use of quantitative financial information to predict fraud, in this study we examine qualitative textual content in annual reports to predict fraud and see whether there are discernible differences in the writing and presentation style between companies that committed fraud and those that did not. We believe that while numeric financial information in the annual reports can hide details of fraud, textual information relating to writing and presentation styles in such reports provides valuable clues pertaining to the existence of fraud. In this study we use the chi‐square test to analyse our data and test hypotheses about predictors of fraud that may explain linguistic feature variations in fraudulent and nonfraudulent annual reports. We provide new results on the usefulness of the qualitative content of annual reports in detecting fraud. Copyright © 2012 John Wiley & Sons, Ltd.     

The diversification cost of large,concentrated equity stakes. How big is it? Is it justified?

While the hypothesis that ownership concentration can affect the value of a company has seen a lot of empirical study, little light has been shed on a complementary problem, that these concentrated owners have a cost of their position due to an undiversified portfolio. Using a unique data set of the actual diversification of all Norwegian equity owners, we show that the largest owners of a corporation in fact have very undiversified equity portfolios, and that such owners have significant costs to their concentrated portfolios. At the level of risk of a benchmark portfolio, if they were to move from their present portfolio composition in risky assets to a well diversified portfolio, their returns would have increased by about 13 percentage points in annual terms. We ask whether this cost can be explained by estimated benefits of ownership concentration (private benefits), and show that extant estimates of private benefits are too low to offset our cost estimates.     

Corporate Fraud and Business Conditions: Evidence from IPOs

We examine how a firm's incentive to commit fraud when going public varies with investor beliefs about industry business conditions. Fraud propensity increases with the level of investor beliefs about industry prospects but decreases when beliefs are extremely high. We find that two mechanisms are at work: monitoring by investors and short‐term executive compensation, both of which vary with investor beliefs about industry prospects. We also find that monitoring incentives of investors and underwriters differ. Our results are consistent with models of investor beliefs and corporate fraud, and suggest that regulators and auditors should be vigilant for fraud during booms.     

Do Family Firms Provide More or Less Voluntary Disclosure?

We examine the voluntary disclosure practices of family firms. We find that, compared to nonfamily firms, family firms provide fewer earnings forecasts and conference calls, but more earnings warnings. Whereas the former is consistent with family owners having a longer investment horizon, better monitoring of management, and lower information asymmetry between owners and managers, the higher likelihood of earnings warnings is consistent with family owners having greater litigation and reputation cost concerns. We also document that family ownership dominates nonfamily insider ownership and concentrated institutional ownership in explaining the likelihood of voluntary disclosure. Using alternative proxies for the founding family's presence in the firm leads to similar results.     

Surety bonds and moral hazard in banking

We examine a policy in which owners of banks provide funds in the form of a surety bond in addition to equity capital. This policy would require banks to provide the regulator with funds that could be invested in marketable securities. Investors in the bank receive the income from the surety bond as long as the bank is in business. The capital value could be used by bank regulators to pay off the banks’ liabilities in case of bank failure. After paying depositors, investors would receive the remaining funds, if any. Analytically, this instrument is a way of creating charter value but, as opposed to Keeley (1990) and Hellman, Murdock and Stiglitz (2000), restrictions on competition are not necessary to generate positive rents. We demonstrate that capital requirements alone cannot prevent the moral hazard problem arising from deposit insurance.     

The Role of Investment,Financing and Dividend Decisions in Explaining Corporate Ownership Structure: Empirical Evidence from Spain

This paper analyses the determinants of ownership structure by focusing on the role played by investment, financing and dividend decisions. The use of the Generalised Method of Moments allows us to provide new evidence on this important corporate governance topic, since it controls for the endogeneity problem. Our most relevant findings show that: i) increases in debt lead insiders to limit the risk they bear by reducing their holdings; ii) monitoring by large outside owners substitutes for the disciplinary role of debt; and iii) both inside and outside owners are encouraged to increase their stakes in the firm in view of higher dividends. Our results hold after controlling for equity issues and share repurchases.     

Partial Price Adjustments and Equity Carve‐Outs

We examine the extent to which market‐adjusted ex date returns reflect public information for 271 equity carve‐outs in 1988–2006. Although prior studies focus on ex post determinants of equity carve‐out and initial public offering returns, our study is the first to explore ex ante predictors of equity carve‐out returns. We use three primary variables: filing range adjustments, the percentage of the offering used to retire subsidiary debt or to pay dividends, and the CBOE Volatility Index (VXO) to predict initial returns. We show that 11–35% of the variation in market‐adjusted equity carve‐out returns can be predicted using public information known prior to the offer date.     

The effect of securities litigation on external financing

Using a comprehensive sample of securities litigation, we examine the effect of financial fraud on the subsequent use of external financing. We find that firms with a recent history of securities litigation, particularly more severe litigation, are less likely to seek external debt and equity financing. This negative relationship between prior litigation and external financing is stronger for firms with high information asymmetry. Furthermore, firms significantly reduce their investments in capital expenditures and research and development during the three years following a litigation filing. Thus, the reduction in the availability of external financing due to allegations of financial fraud can have a tangible impact upon the investment opportunities of the firm.     

高管连锁、同业监督与公司违规

本文选取2011—2018年度A股上市公司为研究样本,以具有竞争关系的同业公司间的高管连锁作为同业监督的渠道,检验了同业监督对目标公司违规的影响。研究发现:(1)同业监督能有效抑制目标公司违规倾向,且这一影响当且仅当连锁公司是同业公司时存在;(2)同业竞争是同业监督的基础,在行业集中度低和行业增长率低的行业中,同业监督对目标公司违规的抑制作用更强;(3)目标公司的政治关联会瓦解同业监督对公司违规的抑制作用;(4)区分违规行为类型后发现,同业监督对经营违规的抑制作用最强,对信息披露违规次之,对领导人违规几乎没有效果。本研究丰富了公司违规监督机制的内容,也提供了辩证看待高管同业兼任的新视角。     

A TEST OF THE TWO-TIER CORPORATE GOVERNANCE STRUCTURE: THE CASE OF JAPANESE KEIRETSU

We examine the effect of corporate governance structure on the relation between ownership structure and financial leverage among Japanese firms. Under normal conditions, we find no significant relation between ownership variables and financial leverage. When firms signal financial difficulties, however, keiretsu financial institution equity owners intervene to moderate the use of debt. This evidence reveals the existence of a keiretsu two-tier corporate governance system. In the first stage, the unique corporate cross-shareholding allows mutual monitoring under normal circumstances. In the second stage, when firms get into financial trouble, keiretsu financial institutions assume control by reducing debt levels. The results highlight differences between keiretsu and independent corporate governance structures.