Knowledge that Transforms

We examine the effect of personal taxes on CEOs’ decisions to sell their equity, controlling for diversification, managerial overconfidence, and other determinants. While CEOs frequently sell large amounts of their unrestricted firm equity, the tax burden associated with the sale significantly deters them from selling equity even after controlling for other determinants like diversification. We also find that both taxable institutional investors and CEOs respond to taxes in their selling of equity, although CEOs appear to be less tax-sensitive. Our findings underscore the importance of taxes in corporate and managerial decisions and they have implications for executive compensation policies.

Increasing the conformity between accounting earnings and taxable income has been proposed to improve financial reporting and curtail aggressive tax planning. We find, however, that increasing conformity results in earnings that are less informative. Our inquiry exploits a unique sample of firms forced to change from the cash method to the accrual method for tax purposes, thereby increasing their book-tax conformity. We find that these firms experienced a decrease in earnings informativeness compared to control firms unaffected by the change. To our knowledge, this is the first evidence of tax law changes affecting the informativeness of accounting earnings.

We find that relative to fundamentals, dual-class firms trade at lower prices than do single-class firms, both at the IPO and for at least the subsequent 5 years. The lower prices attached to duals do not foreshadow abnormally low stock or accounting returns. Moreover, some types of CEO turnover are less frequent among duals, and in general CEO turnover is sensitive to firm performance for singles but not for duals. Finally, when duals unify their share classes, statistically and economically significant value gains occur. Collectively, our results suggest that the governance associated with dual-class equity influences the pricing of duals.

This paper finds that compared with non-state-owned firms, Chinese state-owned enterprises controlled by province, city, and county governments (local SOEs) are more likely to hire small auditors within the same region (small local auditors). In regions with less developed institutions, SOEs controlled by central government (central SOEs) also have such a tendency. However, the tendency of local and central SOEs to hire small local auditors is attenuated as the institutions develop. This auditor choice pattern is likely to be explained by SOEs’ lack of demand for large or non-local auditors, small local auditors’ superior local knowledge, and SOEs’ collusion incentives.

This paper examines the effect of managerial legal liability coverage on earnings conservatism. Using directors’ and officers’ (D&O) liability insurance coverage and cash for indemnification as a proxy for managerial legal liability coverage, we find that the higher the managerial liability coverage, which reduces the expected legal liability of managers, the less conservative the firm's earnings. We also find that managerial legal liability coverage has a stronger influence on earnings conservatism in a legal regime with higher litigation risk. Our results are consistent with the threat of litigation conditioning managers to practice conservative accounting.

Utama and Cready [Utama, S., Cready, W.M., 1997. Institutional ownership, differential predisclosure precision and trading volume at announcement dates. Journal of Accounting and Economics 24, 129–150] use total institutional ownership to proxy for the proportion of better-informed traders, an important determinant of trading around earnings announcements. We argue that institutions holding small stakes cannot justify the fixed cost of developing private predisclosure information. Also, institutions with large stakes generally do not trade around earnings announcements since they are dedicated investors or face regulations that make informed trading difficult. However, institutions holding medium stakes have incentives to develop private predisclosure information and trade on it; we show that their ownership is a finer proxy for the proportion of better-informed traders at earnings announcements.

I explore which firm and loan characteristics decrease or exacerbate information asymmetry in the trading of private debt. I find that loans of public firms, loans with an available credit rating, loans of profit firms and loans syndicated by more reputable arrangers are traded at lower bid–ask spreads, while revolvers, distressed loans and loans issued by institutional investors are associated with higher information costs. I also find that timely loss recognition reduces the bid–ask spread. This finding suggests that conservative reporting decreases information asymmetry regarding a borrower and increases the efficiency of the secondary trading of debt securities.