Do dividend changes predict the future profitability of firms?

Many previous studies have been conducted to test whether corporate dividend changes predict the future profitability of firms. While the debate continues, we assess the information content of dividends (ICD) hypothesis in the Korean market as it provides an interesting experimental setting for testing the hypothesis in the context of corporate governance. We find that it is difficult to support the ICD hypothesis if one accepts nonlinear patterns in earnings. However, when we divide the sample in terms of Chaebol vs. non‐Chaebol and high‐growth vs. low‐growth firms, we find that the ICD hypothesis becomes valid, especially for non‐Chaebol firms and for low‐growth firms. Therefore, we suggest that the validity of the ICD hypothesis may be dependent on firm characteristics such as the corporate governance structure and growth stage.     

Do seasoned industry specialists provide higher audit quality? A re-examination

The purpose of this paper is to re-examine the recent findings in Gaver and Utke (2019) (GU) who find that seasoned industry specialist auditors provide higher audit quality. We first illustrate how the magnitude of residuals from the accruals model can vary significantly by industry, thus highlighting the importance of including industry fixed effects when the dependent variable is discretionary accruals. We next replicate GU’s findings. We first attempt to replicate prior literature after including industry fixed effects in the audit quality (discretionary accruals) models. This is an important control, as the relevant benchmark for a firm with an industry specialist auditor is a peer firm in the same industry with a non-specialist auditor. We find that after including industry fixed effects, there is no association between seasoned industry specialist auditors and discretionary accruals. We also find that the association between industry specialization and discretionary accruals is very sensitive to the way in which the researcher calculates specialization. Our findings are informative for shareholders of public companies who vote on auditor ratification.     

Does the monitoring effect of Big 4 audit firms really prevail? Evidence from managerial expropriation of cash assets

Review of Quantitative Finance and Accounting - This study pins down the monitoring effect of Big 4 versus non-Big 4 audit firms on shareholder wealth by exploring the dollar equivalent of the...     

Do less regulated markets attract lower quality firms? Evidence from the London AIM market

The paper examines whether the moderately regulated London AIM market is at a disadvantage in attracting high quality firms. The results show that firms listed on AIM are of the same quality level as firms listed in the US and in Continental Europe, albeit smaller in size. Furthermore, the delisting and valuation pattern is the same across markets, whereas AIM listed firms raise relatively more capital. Thus, rather than catering to low quality firms seeking to conceal their type, the AIM market attracts small firms that – due to size – face disproportional regulatory costs, but are otherwise equivalent to firms listing in more regulated markets.     

Do powerful chief executives influence the financial performance of UK firms?

Drawing on a framework from agency theory, we examine the relation between the decision-making power of Chief Executive Officers (CEOs) and the financial performance of 468 United Kingdom (UK) publicly listed companies (plcs) using a dynamic panel data estimation method for the six years 2003–2008. We measure CEO power using a ‘power index’ which captures the extent to which the autonomy of the CEO to make unilateral decisions could influence firms' financial performance. To test for robustness, our analysis is conducted using different measures of financial performance. Our results reveal that, consistent with previous UK research, CEO power, as defined by CEO-Chair duality, CEO-tenure and CEO share ownership, is negatively related to financial performance. We also find that concentrated ownership is inversely related to the performance of UK plcs. CEO's compensation and board structure, however, do not appear to be related to the financial performance of the UK plcs.     

Large shareholders’ power and the quality of corporate governance: An analysis of Brazilian firms

This paper analyzes the incentives of large shareholders to implement the corporate governance system that favors their interests within a framework of highly concentrated ownership and poor legal protection for investors. A metric for corporate governance based on the fulfillment of non-mandatory rules of good corporate governance is used. System GMM (Generalized Method of Moments) estimates for a balanced panel data of Brazilian firms reveal that the ownership concentration is detrimental to corporate governance quality and the quality of board composition. In accordance with the expropriation effect on principal-principal agency conflicts, by weakening the corporate governance system and board composition, large controlling shareholders may use private benefits of control. As proposed by the substitution effect, in a complementary way, controlling shareholders may renounce strong boards and directly perform management monitoring, mitigating agency conflicts with managers. Finally, the ability of large shareholders other than the main blockholder is not enough to contest his/her power to shape the corporate governance system. The work provides evidence of the prominence of the principal–principal agency problem in an emerging market, by analyzing the effect of ownership concentration over the quality of the corporate governance system, and also that other large non-controlling shareholders are not able to contest the power of the main blockholder.     

Where do firms incorporate? Deregulation and the cost of entry

We study how deregulation of corporate law affects the decision of entrepreneurs of where to incorporate. Recent rulings by the European Court of Justice (ECJ) have enabled entrepreneurs to select their country of incorporation independently of their real seat. We analyze foreign incorporations in the U.K., where incorporations of limited liability companies can be arranged at low cost. Using data for over 2 million companies from around the world incorporating in the U.K., we find a large increase in cross-country incorporations from E.U. Member States following the ECJ rulings. In line with regulatory cost theories, incorporations are primarily driven by minimum capital requirements and setup costs in home countries. We record widespread use of special incorporation agents to facilitate legal mobility across countries.     

Do stressed PE firms misbehave?

For private equity (PE) firms, follow-on funds provide additional streams of management fees for a considerable time. When prospective investors evaluate the performance of PE firms' latest funds, they have to rely on valuations reported by PE firms. The link between PE firms' fundraising and performance evaluation is thus an area susceptible to manipulation resulting in potentially high stakes. We examine the relationship between PE firms' fundraising pressure and earnings management in portfolio companies, along with heterogeneity in behaviour by reputation and dry powder. To proxy for the degree of fundraising pressure, we develop an index based on PE firms' affiliations, stage in the fundraising cycle, and fundraising frequency. Results suggest that the fundraising pressure leads to more earnings management in portfolio companies, regardless of PE firm reputation. While the reputational effect remains unchanged under a change in funding pressure, dry powder exhibits a strong moderating effect under extreme funding pressure. The results are robust to alternative proxies for earnings management, alternative fundraising indexes, and various controls for endogeneity concerns.     

Do peer firms influence innovation?

Using a large sample of 4,545 US firms over the period 1968–2018, we find robust and significant positive peer effects on corporate innovation. Consistent with the need to keep ahead or abreast of rivals, we document an increase in peer firms’ influence with product market competition. Our further analyses show interesting leader–follower interactions with firms following or adopting innovation policies of counterparts perceived or likely to have superior information. This finding supports the information-based motives of mimicking. More importantly, we show that adopting peers’ innovation policies is associated with improvements in long-term innovation outputs and product market performance. Our results suggest that peer effects are a critical determinant of corporate innovation in addition to other factors examined so far in the literature.     

Insider trading and share repurchases: Do insiders and firms trade in the same direction?

Signaling undervaluation is often considered a primary motive for repurchasing stock, but insider trading activity by repurchasing firms is not always consistent with undervaluation. Net insider buying and selling are both more frequent in quarters when firms are repurchasing non-trivial amounts of stock, with the odds of observing a repurchase the highest in quarters with net insider selling. In multinomial logit models, share repurchases associated with net insider selling are positively related to illiquidity, option exercises by insiders, and pre-repurchase returns and negatively correlated with industry-adjusted book to market ratios when compared to other repurchases. Hence, repurchases when insiders are selling stock are more likely done to support share prices or avoid dilution and are less likely undervaluation signals. We find that insider trades either validate or mitigate the undervaluation signal of the repurchase. Abnormal returns of repurchasing firms with net insider buying versus net insider selling in a given quarter are significantly higher for the quarter immediately after the repurchase and the three subsequent years. For repurchases accompanied by net insider selling, abnormal returns are negligible after only one year.     

Do foreign investors insulate firms from local shocks? Evidence from the response of investable firms to monetary policy

Extant research shows that stock returns of investable firms are highly sensitive to foreign market and global information shocks, suggesting that having foreign investors might insulate investable firms from shocks to local fundamentals. Examining 24 emerging markets, we find that both investable and non-investable firms are sensitive to local monetary policy shocks. This allays the concern that emerging-market opening reduces the efficacy of local monetary policy. We also find that in 11 countries (46% of our country-sample), investable firms are more sensitive to local shocks than non-investable firms. Differences in leverage, stock liquidity, size, domestic product-market exposure, or industry cyclicality do not drive this finding.     

Do post-restatement firms care about financial credibility? Evidence from the pre- and post-SOX eras

This study examines whether negative-market-reaction firms in the year following restatement announcements adopt more conservative financial reporting to respond to their financial reporting credibility crisis, especially in the post-SOX era. Using Basu’s (1997) measure of conservatism, we find that negative-market-reaction firms in the year following restatement announcements report their financial statements more conservatively in the post-SOX era, as the market reaction following restatement announcements becomes more severe. We also find that as the negative market restatement reaction becomes more severe, negative-market-reaction firms using a Big N auditor in the year following financial restatements report their financial statements more conservatively in the post-SOX era.     

Do firms use the trade credit channel to manage growth?

While many theories of accounts payable and receivable are related to firm performance, there has not been a direct test whether firms actively use them to manage their growth. We argue that it is not just the accounts payable but also the accounts receivable that matter. While the former help to alleviate imperfections in the financial market, the latter do so in the product market. Using over 2.5 million observations for 600.000 firms in 8 euro area countries in the period 1993–2009, we show that firms use the trade credit channel to manage growth. In countries where the trade credit channel is more present, the marginal impact is lower, but the total impact is still higher. Further, firms that are more vulnerable to financial market imperfections, rely more on the trade credit channel to manage growth. Finally, we show that also the overall conditions of the financial market matter for the importance of the trade credit channel for growth.     

The global financial crisis and the capital structure of firms: Was the impact more severe among SMEs and non-listed firms?

Using a dataset covering about 276,998 firms across 75 countries over the period 2004–2011, this paper examines the short-run evolution of firms' capital structures following the start of the global financial crisis and its immediate aftermath, comparing the experience of already levered SMEs, large non-listed firms, and listed companies. We find that firm leverage and debt maturity declined both in advanced economies and in developing countries, even in those that did not experience a crisis. The deleveraging and maturity reduction were particularly significant for non-listed firms, including both SMEs as well as large non-listed companies. For SMEs, these effects were larger in countries with less efficient legal systems, weaker information sharing mechanisms, less developed financial sectors, and with more restrictions on bank entry. In contrast, there is weaker evidence of a significant decline in leverage and debt maturity among listed companies which are typically much larger than other firms and likely to benefit from the “spare tire” of easier access to capital market financing. Though our results are robust to many changes in sample and specification, we cannot rule out that survivorship bias and attrition could affect our estimates to some degree.     

Do ETFs provide effective international diversification?

Global investments have been a hot issue for years. Investors can diversify risks and obtain benefits from foreign markets by investing directly in the foreign security market or indirectly in Exchange-Trade Funds (ETFs). Because direct investments are not always feasible, we investigate whether indirect investments can replace direct investments. We create different regional optimal portfolios containing ETFs and ensure optimal asset portfolio allocation. In addition to mean-variance approach, the Sharpe index, we also adopt the Campbell et al. (2001) method to have the efficient frontier under control risks, the Value at Risk. We apply both normal and non-normal distributions for comparisons and find that different assumptions of return distributions affect the results of efficient frontier. The results show that international diversification is a reasonable strategy. In addition, when comparing ETFs and target market index portfolios, ETFs have higher Sharpe measures than target market indices especially in the emerging markets. However, there are no significant performance differences between direct and indirect methods even if we use different performance measures. We also find that the diversification benefits are the same before and after the Subprime crisis. We conclude that it is effective for investors to use indirect methods to create internationally diversified portfolios.     

Do women managers keep firms out of trouble? Evidence from corporate litigation and policies

We find that firms where women have more power in the top management team, measured by female executives’ plurality and pay slice, face fewer operations-related lawsuits. This effect is robust to several treatments of endogeneity and does not appear to be driven by female executives' greater willingness to settle the cases. Evidence from a simultaneous equations approach suggests that firms where women executives have more power avoid lawsuits partly by avoiding some risky but value-increasing firm policies, such as more aggressive R&D, intensive advertising, and policies inimical to other parties.     

Do improvements in government quality necessarily reduce the incidence of costly sudden stops?

Sudden stops have been linked to a number of financial crises in emerging market countries. While a large literature has developed emphasizing the importance of institutions and governance in reducing economic volatility, this paper finds that the effect of government quality on the incidence of sudden stops is non-linear. Initial improvements in governance actually increase the incidence of costly sudden stops. A possible explanation is that improved governance encourages capital inflows that can overwhelm banking systems in countries with weak institutions. What is striking is that this result holds for a large number of countries including those with average levels of institutional quality that already receive considerable inflows. Eventually, however, improving institutions does reduce the frequency of sudden stops, allowing countries to enjoy the benefits of financial globalization with fewer risks.     

Do investors perceive a change in audit quality following the rotation of the engagement partner?

Though Section 203 of the Sarbanes-Oxley Act (SOX) calls for the rotation of the audit partner every five years, we do not know whether investors value audit partner rotation. This is an important issue since many in the auditing profession believe that mandatory rotation of the audit partner is unnecessary and may in fact impair audit quality. We identify a sample of firms that disclosed changes in the engagement partner in the proxy statement and examine whether equity investors perceive a change in audit quality following the partner rotation. We find a significant increase in earnings informativeness following audit partner rotation. We also find that short sellers regard earnings in the post-rotation to be of higher quality than earnings prior to the rotation. Finally, cost of equity capital is lower following partner rotation. Our findings have important implications for the regulators, auditors, and investors.     

Does corporate social responsibility help the survivorship of SMEs and large firms?

Using a sample of 2480 firms from 51 countries covering the period 2010–2015, we find that firms with more effective corporate governance mechanisms are more likely to be more engaged in CSR. Consistent with the stakeholder theory and the conflict resolution model, this result suggests that managers adopt effective governance mechanisms together with CSR engagement in an attempt to mitigate conflicts among stakeholders. Moreover, after controlling for endogeneity and simultaneity issues, we find that both CSR engagement and corporate governance mechanisms have a significantly negative influence on the firms' risk of financial distress measured by the Altman et al. model (1995). Our results also show that the favorable influence of CSR on the firms' capability of survivorship is more pronounced in SMEs than in large firms.     

Group audits: Are audit quality and price associated with the Lead auditor’s decision to accept responsibility?

Lead auditors frequently rely on work performed by Other auditors, especially when auditing clients with operations in multiple countries. The PCAOB has expressed concern that the quality of such group audits may differ depending on whether the Lead auditor accepts or declines responsibility for work done by Other auditors. The PCAOB also has been concerned with the venue through which Lead auditors and Other auditors disclose their participation in group audits, including disclosure of whether Lead auditors accept or decline responsibility. To investigate these issues, we employ a sample consisting entirely of group audit engagements. We identify Lead auditors taking responsibility from PCAOB Form 2, filed by Other auditors of U.S. registrants for fiscal years 2009 to 2017. We identify Lead auditors not accepting responsibility from audit report disclosures during the same period. The results suggest that Lead auditors accepting responsibility charge higher audit fees but provide audits of no higher quality, and possibly of even lower quality. These results are robust to various additional analyses. Our research contributes to the ongoing debate over how the participation of Other auditors affects audit quality.