Knowledge that Transforms

ABSTRACT This paper studies shareholder derivative lawsuits related to CEO compensation. We document that compensation lawsuits are more likely to be filed against firms with higher CEO pay, especially in the presence of poor firm performance. Firms reduce the level of CEO compensation after lawsuits, which leads to CEO departures and declines in CEO effort provisions, and consequently, results in deteriorated firm performance. Interestingly, compensation lawsuits accompanied by low support in the preceding Say‐on‐Pay votes, which likely capture the quality of pay practices, are associated with even higher pay cuts, but do not harm firm performance or lead to departures of talented CEOs, supporting the idea that suboptimal pay and deteriorated performance after compensation lawsuits are driven by the lack of a sophisticated understanding of CEO pay by plaintiff shareholders.

ABSTRACT We assemble and describe a sample of 174,782 lawsuits filed against 218,437 public‐company lawsuit‐defendants in federal district court from 2006 to 2021. These lawsuits involve an array of allegations, including product liability, civil rights discrimination, contract breaches, improper compensation and labor practices, antitrust violations, corruption, securities violations, pollution, and intellectual property infringement. The sample exhibits rich variation across firms, industries, time, suit type, plaintiffs, and outcomes—reflecting not only firm activities but also social, political, and regulatory trends. Although many claims matter very little, some are important individually or in aggregate. We observe 23% of defendants experience a market value decline exceeding 10% of current assets around the lawsuit filing. Consistent with the notion that even low‐stakes claims, when numerous or persistent, can introduce frictions or reflect underlying issues, we find that aggregate legal exposure is associated with increased return volatility and decreased profitability. Subsequent tests indicate that materiality, public and private enforcement, and firms’ information environments (as well as other firm traits) are associated with managers’ decisions to disclose these claims. Collectively, our descriptive evidence establishes a foundation for further research into underexplored types of corporate litigation that represent a broad range of alleged wrongdoing and socially irresponsible behavior.

ABSTRACT This study examines the spillover effect of bank financial misconduct on the uninsured deposits of peer banks within local markets. We first validate that misconduct banks experience an increase in deposit spreads and a corresponding outflow of deposits following the misconduct. We then show local peer banks exhibit divergent deposit responses, contingent on how misconduct is perceived by information recipients in different economic contexts. During normal periods, depositors receiving a negative signal about bank misconduct reallocate their funds from misconduct banks to local peers, a local reallocation effect that decreases deposit spreads and increases deposit inflows for peer banks. Cross‐sectional analysis further reveals that this local reallocation effect is more pronounced for financially sophisticated depositors, amplified when peer banks have strong fundamentals, but attenuated when misconduct banks are financially sound. During financial crisis periods, however, bank misconduct leads to withdrawals from both misconduct banks and their peer banks, a local contagion effect whereby local peer banks face increased deposit spreads and deposit outflows following the misconduct.

ABSTRACT Complex accounting estimates are becoming increasingly important to financial statements. Yet, such estimates create ample opportunities for bias. Although both management and independent auditors are tasked with ensuring these estimates are free from error and bias, evaluating the appropriateness of these measures can be quite difficult. Drawing on unconscious thought theory, we predict and find across three experiments that engaging in unconscious thought can improve accounting practitioners’ evaluations of accounting estimates. In Experiment 1, we use practicing auditors as participants and find that unconscious thought improves less‐experienced auditors’ ability to recognize income‐decreasing patterns of bias. In contrast, more‐experienced auditors respond similarly to both incoming‐increasing and income‐decreasing bias, regardless of whether they use conscious or unconscious processing. In Experiments 2 and 3, we provide evidence that prompting managers to engage in unconscious thought also improves their recognition of patterns of bias within estimates. Overall, our findings demonstrate how unconscious processing can be intentionally prompted to improve accounting professionals’ ability to recognize subtle patterns of bias that they might otherwise overlook.

ABSTRACT This paper examines investors’ perceptions of auditor involvement in non‐GAAP reporting as captured by non‐GAAP disclosures in 10‐K filings. We find that firm‐years with auditor involvement in non‐GAAP reporting have higher CARs, lower bid–ask spreads, lower stock volatility, and lower abnormal trading volume on 10‐K filing dates. To sharpen identification of auditor involvement, we hand‐collect non‐GAAP measures and reconciliations for S&P 500 firms and identify which exclusions reconcile directly to the audited financial statements. As the percentage of exclusions that reconcile directly to the audited financial statements increases, bid–ask spreads and stock volatility on 10‐K filing dates decrease. We find that the results are not driven by strategic reporting or managers’ responses to perceived litigation risk. This study provides new insights into non‐GAAP disclosures outside of earnings announcements, which have been largely ignored in prior literature. Collectively, our results suggest investors value auditor involvement in non‐GAAP reporting and inform policymakers and standard setters considering the usefulness of assurance over non‐GAAP measures.

ABSTRACT This paper hypothesizes that information flows from target firms to large shareholders during activist campaigns and that these flows have governance consequences. Focusing on actively managed mutual fund families, we find that informed trading by large‐holding fund families increases during activist campaigns relative to smaller‐holding fund families invested in the same firms. The effect is stronger for firms that attend more invitation‐only investor events, face greater threats from activist campaigns, and are harder to value. Consistent with information flowing from management to large‐holding fund families, the effect strengthens when Regulation Fair Disclosure enforcement is lax and when the information is favorable to the firm. Furthermore, the increased information advantage is associated with more management‐friendly voting behavior by these investors and a higher likelihood of target firms winning activist campaigns and retaining board seats. Overall, our findings are consistent with a potential quid pro quo in which investors’ access to information from management is associated with more pro‐management behavior.

ABSTRACT We investigate the monitoring quality of accountants with ties to the Mafia in their role as auditors for “clean” firms—those with no known ties to organized crime. Using a proprietary government database, we identify Italian firms with alleged ties to the Mafia through their executives, directors, or shareholders. We define “suspect accountants” as those who serve as auditors for these Mafia‐connected firms, acknowledging their potential associations with criminal entities. We predict and find evidence that “clean” clients (treatment group) monitored by suspect accountants are more likely to engage in earnings management practices that reduce taxable income, compared with a control sample of “clean” firms monitored by accountants with no known Mafia ties (control group). Our findings suggest that accountants with ties to the Mafia act as low‐quality monitors in the “clean” economy.

ABSTRACT This paper explores the influence of two fixed payment arrangements—time‐based and output‐based wages—on worker behavior and performance in a multidimensional task setting. We examine how these wages affect the time workers spend on individual units of a task and their work quality. We contend that fixed compensation schemes can implicitly communicate standards of acceptable work. Our empirical evidence from MTurk experiments and a laboratory experiment indicates that workers on output‐based wages deliver higher quality and spend more time on individual units than their time‐based counterparts. These findings are consistent with output‐based wages, implying a standard of acceptable quality—without a conflicting standard of speed—to which workers respond. Our results emphasize the power of implicit cues from fixed compensation schemes and offer insights for employers, suggesting the choice between output‐ and time‐based wages should be informed by whether quality or turnaround time is valued more.

ABSTRACT This study examines how the subjectivity in measuring fair values of assets without readily observable market prices affects investment efficiency and shareholder value. When fair values are objective measures of asset value, they facilitate efficient investment decisions that align with shareholder interests. In contrast, firms' reliance on subjective valuation inputs causes underinvestment in long‐term projects. If fair values are highly subjective, they may lead firms to favor less profitable short‐term projects with objectively measurable fair values. When project returns are positively correlated, subjectivity in valuing long‐term projects induces overinvestment in short‐term projects with objective fair values. Regardless of these distortions, fair value measurement can add shareholder value. Not measuring fair values altogether leads to underinvestment, which moderately subjective fair values can alleviate.