Fair Value Accounting and Debt Contracting: Evidence from Adoption of SFAS 159

We examine how fair value accounting affects debt contract design, specifically the use and definition of financial covenants in private loan contracts. Using SFAS 159 adoption as our setting, we find that a small but significant proportion of loans (14.5%) modify covenant definitions to exclude the effects of SFAS 159 fair values. Only a limited number of these modifications exclude assets elected at fair value (less than 7%), while all exclude liabilities elected at fair value. Notably, we document that covenant definition modification is unassociated with ex ante fair value elections. We find that covenant definition modification positively varies with common incentive problems attributed to fair value accounting and negatively varies with benefits attributed to fair value accounting. Our results suggest that fair value accounting is not uniformly detrimental for debt contracting and fair value adjustments are included when they are most likely to improve performance measurement.     

Institutional Differences and International Private Debt Markets: A Test Using Mandatory IFRS Adoption

Institutional differences between countries result in additional information risks between borrowers and lenders in cross‐border private loans. This study examines the effect of these information risks on the structure of optimal debt contracts in international (cross‐border) versus domestic private debt markets. Using mandatory IFRS adoption as an indicator for institutional changes that reduced differences between countries, I compare attributes of international versus domestic loans before and after IFRS adoption. I find that, in the pre‐IFRS period, international loans are associated with a higher credit spread, a weaker relationship between the bank and the borrower, a more diffuse loan syndicate, and less reliance on accounting‐based covenants than domestic loans. These results are consistent with incremental information risks in international debt markets that make it more costly for lenders to screen and monitor borrower credit quality, resulting in a more arm's‐length relationship between borrowers and lenders. Many of these associations attenuate after IFRS adoption, suggesting that the pre‐IFRS differences in contract terms are driven by incremental information risks related to institutional differences between countries. My findings imply that incremental information risks result in a different optimal contract in international debt contracts compared to domestic debt contracts.     

IFRS Adoption and the Choice Between Public and Private Debt: Evidence from South Korea

This article examines the association between mandatory International Financial Reporting Standards (IFRS) adoption and corporate choice between public debt and private debt. If IFRS adoption increases the quality of lenders’ information environment provided on financial statements, firms are more likely to access the public debt market. Using a sample of public and private debts financing firms from 2000 to 2014 in Korea, we find that firms that file financial reports under the IFRS are less likely to finance from public debt markets, implying that the mandatory IFRS adoption has exacerbated the information environment of the public debt market in Korea.     

Debt Financing and Voluntary Adoption of the International Financial Reporting Standards: Evidence from Korean Unlisted Firms

We investigate the effect of debt financing on the voluntary adoption of the International Financial Reporting Standards (IFRS) by unlisted firms and such adoption’s effect on bond credit rating. We find that unlisted firms with public debts are more likely to voluntarily adopt IFRS. Subsequent to the voluntary application of IFRS, the unlisted firms exhibit, on average, enhanced credit ratings. These findings suggest that the public debt market’s demand for high-quality financial reporting may drive those unlisted firms to voluntarily adopt IFRS. Furthermore, rating agencies seem to reward such firms by elevating their bond credit ratings.     

Voluntary Adoption of the IFRS and Industry-Level Comparability: Evidence from Korean Unlisted Firms

This study examines the role of industry-level comparability with regard to voluntary adoption of the international financial reporting standards (IFRS) by unlisted firms in Korea. Mandatory adoption of the IFRS for listed firms in 2011 inhibits financial statement comparability between listed and unlisted firms. Our empirical findings reveal that unlisted firms in industries with higher ratios of listed firms tend to adopt the IFRS voluntarily. After this adoption, such unlisted firms seem to attract greater investment in the public debt market.     

Accounting Information in Financial Contracting: The Incomplete Contract Theory Perspective

This paper reviews theoretical and empirical work on financial contracting that is relevant to accounting researchers. Its primary objective is to discuss how the use of accounting information in contracts enhances contracting efficiency and to suggest avenues for future research. We argue that incomplete contract theory broadens our understanding of both the role accounting information plays in contracting and the mechanisms through which efficiency gains are achieved. By discussing its rich theoretical implications, we expect incomplete contract theory to prove useful in motivating future research and in offering directions to advance our knowledge of how accounting information affects contract efficiency.     

Enforceability of non-compete covenants,discretionary investments,and financial reporting practices: Evidence from a natural experiment

Non-compete covenants are widely used in employment contracts to promote employee stability. Using legal amendments of non-compete enforceability as a natural experiment, we find that as non-compete enforceability increases, firms display an increased likelihood of meeting short-term earnings benchmarks, lower discretionary expenditures, and declining future performance. These effects are more pronounced when CEOs have lower ability or shorter tenures, and when firms have more growth opportunities or operate in localized industries. Our results suggest that managers actively adapt investment and financial reporting practices to the changing environment that affects their contractual relations with firms.     

Mandatory disclosure and learning from external market participants: Evidence from the JOBS act

This paper examines whether mandatory disclosure affects the extent to which firms learn from external market participants. Conventional wisdom suggests that mandatory disclosure should increase the total amount of information in financial markets. However, disclosure can also reduce investors' incentives to acquire and produce information. Using the JOBS Act to identify variations in disclosure requirements, this paper finds that firms with reduced disclosure requirements attract more informed investors and learn more from financial markets than those with stricter disclosure requirements. This learning is concentrated among firms that attract sophisticated investors, particularly those with industry expertise, and weakens once firms are forced to disclose more information. Overall, the results suggest that one benefit from regulators’ recent efforts to reduce U.S. firm disclosure requirements is an increase in firm learning.     

The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research

This paper discusses the empirical literature on the economic consequences of disclosure and financial reporting regulation, drawing on U.S. and international evidence. Given the policy relevance of research on regulation, we highlight the challenges with (1) quantifying regulatory costs and benefits, (2) measuring disclosure and reporting outcomes, and (3) drawing causal inferences from regulatory studies. Next, we discuss empirical studies that link disclosure and reporting activities to firm‐specific and market‐wide economic outcomes. Understanding these links is important when evaluating regulation. We then synthesize the empirical evidence on the economic effects of disclosure regulation and reporting standards, including the evidence on International Financial Reporting Standards (IFRS) adoption. Several important conclusions emerge. We generally lack evidence on market‐wide effects and externalities from regulation, yet such evidence is central to the economic justification of regulation. Moreover, evidence on causal effects of disclosure and reporting regulation is still relatively rare. We also lack evidence on the real effects of such regulation. These limitations provide many research opportunities. We conclude with several specific suggestions for future research.     

Information Content of Internal Control Weaknesses: The Evidence from Japan

This paper investigates how capital markets in a code-law country, Japan, react to the disclosure of internal control weaknesses (ICW). The Japanese government attempted to implement a more concise, efficient, and, thus, less strict internal control reporting system than Section 404 of the US-SOX. In fact, for the first two years, the disclosure rate of ICW has been much lower in Japan than in the U.S. While market reactions to the disclosure of ICW are not significantly different from zero in our event study analysis, they become significantly negative after controlling for other information released around the disclosure date, audit quality, and other firm attributes. Our results are consistent with the notion that the disclosure of ICW is informative to the market because it is less frequent and exceptional in Japan.     

The Effect of Fair Value Adjustments on Dividend Policy Under Mandatory International Financial Reporting Standards Adoption: Australian Evidence

Using a sample of firms from the financial sector of the Australian Securities Exchange, we examine the effect of the fair value adjustments of financial instruments on firms’ dividend distributions in the context of mandatory International Financial Reporting Standards (IFRS) adoption. We find a positive relationship between the fair value adjustments of financial instruments and firms’ dividend payouts, suggesting that the frequent use of fair value adjustments of financial instruments by financial firms following mandatory IFRS adoption has the potential to increase the proportion of transitory earnings in reported earnings and cause changes in dividend policies. Our results add to the ongoing debate on the unintended economic consequences of fair value accounting (FVA) and provide empirical support for regulators’ concerns that unrealized FVA gains from asset revaluation during booms may encourage the distribution of those unrealized gains.     

Corporate Loan Securitization and the Standardization of Financial Covenants

We examine whether syndicated loans securitized through collateralized loan obligations (CLOs) have more standardized financial covenants. We proxy for the standardization of covenants using the textual similarity of their contractual definitions. We find that securitized loans are associated with higher covenant standardization than nonsecuritized institutional loans. In addition, we show that CLOs with more diverse or frequently rebalanced portfolios are more likely to purchase loans with standardized covenants, potentially because standardization alleviates information processing costs related to loan monitoring and screening. We also document that covenant standardization is associated with greater loan and CLO note rating agreement between credit rating agencies, further supporting the relation between lower information costs and covenant standardization. Overall, our study provides evidence that loan securitization is related to the design of standardized financial covenants.     

Mandatory IFRS adoption and management forecasts: The impact of enforcement changes

We examine how concurrent enforcement changes affect the positive relationship between mandatory IFRS adoption and firms’ voluntary disclosure. We show that the increase in the issuance of management forecasts after IFRS adoption is smaller for firms from IFRS-mandating countries with concurrent enforcement changes than for those from countries without such changes. We find no difference in the increase of forecast informativeness between firms from IFRS-mandating countries without concurrent enforcement changes and firms from non-IFRS-mandating countries; however, firms domiciled in IFRS-mandating countries with concurrent enforcement changes exhibit a significantly smaller increase in forecast informativeness. Our findings suggest that better IFRS enforcement distinctly weakens (strengthens) the positive effect of IFRS adoption on voluntary (mandatory) disclosure.     

Financial Reporting Quality,Debt Maturity,and the Cost of Debt: Evidence from China

This paper investigates the influence of different financing channels—bond issuance or bank loans—as well as debt maturity and the quality of financial reporting on the cost of debt in China. The authors find that conservative accounting is an important characteristic of high-quality financial reporting that can reduce the cost of longer maturity debt such as bank loans and bonds. Even state-owned enterprises, which have fewer financial constraints than non-state-owned enterprises, benefit from accounting conservatism's ability to reduce financial costs. Moreover, the findings indicate that bond investors are concerned about the issuer's fundamentals, while banks are more likely to focus on the operation and bankruptcy risk of borrowers.     

Segment Disclosure Transparency and Internal Capital Market Efficiency: Evidence from SFAS No. 131

Using the adoption of SFAS 131, I examine the effect of segment disclosure transparency on internal capital market efficiency. SFAS 131 requires firms to define segments as internally viewed by managers, thereby improving the transparency of managerial actions in internal capital allocation. I find that diversified firms that improved segment disclosure transparency by changing segment definitions upon adoption of SFAS 131 experienced an improvement in capital allocation efficiency in internal capital markets after the adoption of SFAS 131. In addition, I find that the improvement in internal capital market efficiency was greater for firms that suffered more severe agency problems before the adoption of SFAS 131 and also for firms whose managers faced stronger incentives to improve efficiency after the adoption of SFAS 131. My results suggest that more transparent segment information can help resolve agency conflicts in the internal capital markets of diversified firms, thus improving investment efficiency.     

Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans

Using a data set that records banks’ ongoing requests of information from small commercial borrowers, we examine when banks use financial statements to monitor borrowers after loan origination. We find that banks request financial statements for half the loans and this variation is related to borrower credit risk, relationship length, collateral, and the provision of business tax returns, but in complex ways. The relation between borrower risk and financial statement requests has an inverted U‐shape; and tax returns can be both substitutes and complements to financial statements, conditional on borrower characteristics and the degree of bank–borrower information asymmetry. Frequent financial reporting is used to monitor collateral, but only for non–real estate loans and only when the collateral is easily accessible to lenders. Collectively, our results provide novel evidence of a fundamental information demand for financial reporting in monitoring small commercial borrowers and a specific channel through which banks fulfill their role as delegated monitors.     

The Disciplinary Role of Financial Statements: Evidence from Mergers and Acquisitions of Privately Held Targets

This study examines whether requiring the disclosure of audited financial statements disciplines managers’ mergers and acquisitions (M&As) decisions. When an M&A transaction meets certain disclosure thresholds, the Securities and Exchange Commission (SEC) requires the public acquirer to disclose the target's audited financial statements after the merger is completed. Using hand‐collected data, I find that the disclosure of private targets’ financial statements is associated with better acquisition decisions. Furthermore, I find that this disciplining effect of disclosure is more pronounced when monitoring by outside capital providers is more difficult and costly, and when other disciplining mechanisms are weaker. Finally, these findings are robust to several alternative explanations, such as monitoring from blockholders and voluntary disclosures. In sum, the evidence suggests that the ex post mandatory disclosure of private targets’ accounting information disciplines managers’ acquisition decisions and improves acquisition efficiency.     

Taxes and Financial Constraints: Evidence from Linguistic Cues

Using a new measure of financial constraints based on firms’ qualitative disclosures, we find that financially constrained firms—firms that use more negative words in their annual reports—pursue more aggressive tax planning strategies as evidenced by: (1) higher current and future unrecognized tax benefits, (2) lower short‐ and long‐run current and future effective tax rates, (3) increase in tax haven usage for their material operations, and (4) higher proposed audit adjustments from the Internal Revenue Service. We exploit the unexpected closures of local banks as exogenous liquidity shocks to show that firms’ external financial constraints affect their tax avoidance strategies. Overall, the linguistic cues in firms’ qualitative disclosures provide incremental information beyond traditional accounting variables or commonly used effective tax rates to reveal and predict tax aggressiveness, both contemporaneously and in the future.     

Mobile Communication and Local Information Flow: Evidence from Distracted Driving Laws

We examine the influence of mobile communication on local information flow and local investor activity using the enforcement of statewide distracted driving restrictions, which are exogenous events that constrain mobile communication while driving. By restricting mobile communication across a potentially sizable set of local individuals, these restrictions could inhibit local information flow and, in turn, the market activity of stocks headquartered in enforcement states. We first document a decline in Google search activity for local stocks when restrictions take effect, suggesting that constraints on mobile communication significantly affect individuals’ information search activity. We further find significant declines in local trading volume when restrictions are enforced. This drop in liquidity is (1) attenuated when laws provide substitutive means of mobile communication and (2) magnified when locals have long car commutes and when their daily commutes overlap with regular exchange hours. Moreover, trading volume suffers the most for local stocks with lower institutional ownership, less analyst coverage, and more intangible information. Additional analyses show lower intraday volume during local commute times when mobile connectivity is constrained. Together, our results suggest that local information and local investors matter in stock markets and that mobile communication is an important mechanism through which these elements operate to affect liquidity and price discovery.