Reassessing measures of sustainable firm performance: A consultant's guide to identifying hidden costs in corporate disclosures

Strategy, management, corporate social responsibility, critical accounting, and other business researchers frequently utilize financial metrics such as return on assets, return on equity, and return on sales as proxy measures for the financial performance of firms. Large data sets offer convenience but exclude the textual data of corporate disclosures that offers critical insight into specific executive actions and social and environmental outcomes. This study looks at the detrimental consequences of the prevalent practice of relying on macrofinancial metrics as measures of firm performance. Insight from the socioeconomic approach to management (SEAM) is then applied to help an external analyst develop the perspective of an internal consultant to identify hidden costs in corporate disclosures. An extensive case on former CEO Robert Nardelli's tenure at Home Depot is presented as an example of applied SEAM theory to explore how a causal network of dysfunctions can be traced through publicly available financial disclosures. The management discussion and analysis as well as the executive incentive compensation formulas serve as a roadmap to discover hidden costs. The study offers a critical perspective of financial disclosures to allow researchers to externally diagnose dysfunctions sooner rather than years later, an insight formerly only available to internal consultants.     

Credit Default Swaps and Managers’ Voluntary Disclosure

We investigate how the availability of traded credit default swaps (CDSs) affects the referenced firms’ voluntary disclosure choices. CDSs enable lenders to hedge their credit risk exposure, weakening their incentives to monitor borrowers. We predict that reduced lender monitoring in turn leads shareholders to intensify their monitoring and demand increased voluntary disclosure from managers. Consistent with this expectation, we find that managers are more likely to issue earnings forecasts and forecast more frequently when traded CDSs reference their firms. We further find a stronger impact of CDS availability on firm disclosure when (1) lenders have higher ability and propensity to hedge credit risk using CDSs, and (2) lender monitoring incentives and monitoring strength are weaker. Consistent with an increase in shareholder demand for public information disclosure induced by a reduction in lender monitoring, we find a stronger effect of CDSs on voluntary disclosure for firms with higher institutional ownership and stronger corporate governance. Overall, our findings suggest that firms with traded CDS contracts enhance their voluntary disclosure to offset the effect of reduced monitoring by CDS‐protected lenders.     

Corporate reporting of intellectual capital: Evidence from UK companies

This paper reports the results of an empirical investigation into the intellectual capital reporting practices of UK companies in four distinct sectors. It differs from prior intellectual capital reporting studies in that it analyses a wide range of corporate reports for their intellectual capital content. It finds major differences between the elements of intellectual capital reported in each sector studied. The study also finds that a range of different types of corporate reports were used for communicating intellectual capital information, and that the annual reports were not a good proxy for the proportion of disclosures across all corporate reports analysed in this study.     

Two sides of the same coin: Green Taxonomy alignment versus transition risk in financial portfolios

We develop the first top-down method to estimate the greenness of financial portfolios, in terms of alignment to the EU Taxonomy for sustainable activities. We also develop a method to estimate, at the same time, the portfolio exposure to climate transition risk. We provide sector-level, standardized and transparent coefficients for both estimates, based on definitions of greenness and transition risk that are applicable across countries. We analyse the portfolios of Euro Area investors in 2022, based on the confidential Securities Holdings Statistics of the European Central Bank. We find that, overall, the greenness of Euro Area investors’ portfolios is lower than their exposure to transition risk (2.8% vs. 11.7%).Across financial institutions, we estimate greenness and exposure to transition risk, respectively, at 3.2% and 12% for investment funds, at 0.8% and 5% for banks and at 4.8% and 15.1% for insurers. Our analysis also shows that investors with large amounts invested in green activities can have at the same time large exposures to transition risk.     

Bank Competition: Measurement,Decision‐Making,and Risk‐Taking

This paper investigates whether greater competition increases or decreases individual bank and banking system risk. Using a new text‐based measure of competition, and an instrumental variables analysis that exploits exogenous variation in bank deregulation, we provide robust evidence that greater competition increases both individual bank risk and a bank's contribution to system‐wide risk. Specifically, we find that higher competition is associated with lower underwriting standards, less timely loan loss recognition, and a shift toward noninterest revenue. Further, we find that higher competition is associated with higher stand‐alone risk of individual banks, greater sensitivity of a bank's downside equity risk to system‐wide distress, and a greater contribution by individual banks to downside risk of the banking sector.     

Does Accounting Conservatism Discipline Qualitative Disclosure? Evidence From Tone Management in the MD&A*

We investigate whether accounting conservatism, which has been found to be effective in constraining management opportunism in other settings, constrains upward tone management (UTM) in the Management's Discussion and Analysis (MD&A) portion of the 10-K filing. We hypothesize that conservatism makes it harder for managers to opportunistically downplay bad news and magnify good news when discussing current performance. Consistent with this hypothesis, we find that UTM is negatively associated with several accounting conservatism proxies. Additionally, we hypothesize and find that this association is stronger for firms where managers have higher incentives to manipulate tone. In supplemental analyses, we find evidence to suggest that our results are not due to an endogenous relationship between conservatism and UTM. We also find that conservatism neither encourages downward tone management (DTM) nor constrains managers from conveying real information about future good news. Together, our results suggest that accounting conservatism improves disclosure narratives.     

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.     

Do VC-backed IPOs manage tone?

ABSTRACT

This paper examines how and why VC-backed firms manage their tone during initial public offerings (IPO) and seasoned equity offerings (SEO). Analysis conducted using the Management Discussion and Analysis section of the prospectuses from 1997 to 2011 show that VC-funded firms are less optimistic in tone. VC-financed firms do so to reduce litigation risks and protect their reputational capital; the effect of conservative tone management is more pronounced when they hire large auditors, receive more analyst coverage, operate in high-tech sectors and in industries with high litigation risk. Further, tone is not related to the conveying of private information as IPO firms that received VC funding experience larger surprise unexpected returns and perform better than non-VC-backed offers in the long run.