Knowledge that Transforms

Compared to non-family firms, family firms face less severe agency problems due to the separation of ownership and management, but more severe agency problems that arise between controlling and non-controlling shareholders. These characteristics of family firms affect their corporate disclosure practices. For S&P 500 firms, we show that family firms report better quality earnings, are more likely to warn for a given magnitude of bad news, but make fewer disclosures about their corporate governance practices. Consistent with family firms making better financial disclosures, we find that family firms have larger analyst following, more informative analysts’ forecasts, and smaller bid-ask spreads.

A firm may prefer not to disclose its private information if it is uncertain of investor response. In the setting under consideration, a firm needs to acquire capital from an investor. The investor can choose to invest in the firm, the risk free asset or in some alternative risky investment opportunity. It is shown that in a partial disclosure equilibrium, the firm discloses average information and withholds bad and good information. Disclosure of average information arises to attract the investor's capital away from the risk free asset.

We investigate going-private decisions in response to the passage of the Sarbanes–Oxley Act of 2002 (SOX). We study firms that go private from 1998 to May 2005 and find: (1) the quarterly frequency of going-private transactions has increased after the passage of SOX, and (2) abnormal returns surrounding both the passage of SOX and the going-private announcement are significantly related to proxies for the costs and benefits of SOX and the net benefits of being a public firm. Our empirical evidence is broadly consistent with the notion that SOX has affected firms’ going-private decisions.

Previous findings that upward earnings management causes a kink in the distribution of annual earnings cannot be verified without a well-specified benchmark for pre-managed annual earnings. We model shifts in the cumulative earnings distribution during the fourth quarter to explain the kink's formation. Logistic regression results show that compared to a control group, a high proportion of firms with small cumulative profits or losses at the beginning of the fourth-quarter report small annual profits rather than small annual losses. This suggests that upward earnings management causes the kink and indicates which firms are likely to manage earnings upward.

Much of the production in firms takes place over time. This paper seeks to understand the value of interim performance information on long projects. In particular, the model explores the sorting effects of performance evaluations. Conducting an interim performance evaluation increases efficiency by providing the option to end projects with low early returns. The main result: It is efficient to allocate more resources towards the end of a project. This result holds under a variety of scenarios: when the worker has unknown ability, when the outside options vary with output, and even under an agency framework with a risk‐averse agent.

An important problem facing managers is how to enhance the credibility, or believability, of their earnings forecasts. In this paper, we experimentally test whether a characteristic of a management earnings forecast—namely, whether it is disaggregated—can affect its credibility. We also test whether disaggregation moderates the relation between managerial incentives and forecast credibility. Disaggregated forecasts include an earnings forecast as well as forecasts of other key line items comprising that earnings forecast. Our results indicate that disaggregated forecasts are judged to be more credible than aggregated ones and that disaggregation works to counteract the effect of high incentives. We also develop and test an original model that explains how disaggregation positively impacts three factors that, in turn, influence forecast credibility: perceived precision of management's beliefs, perceived clarity of the forecast, and perceived financial reporting quality. We show that forecast disaggregation works to remedy incentive problems only via its effect on perceived financial reporting quality. Overall, our study adds to our understanding of how managers can credibly communicate their expectations about the future to market participants.

We examine the determinants and the informativeness of financial analysts' risk ratings using a large sample of research reports issued by Salomon Smith Barney, now Citigroup, over the period 1997–2003. We find that the cross‐sectional variation in risk ratings is largely explained by variables commonly viewed as measures of risk, such as idiosyncratic risk, size, book‐to‐market, and leverage. In addition, earnings‐based measures of risk, such as earnings quality and accounting losses, also contribute to explaining the cross‐sectional variation in the risk ratings. Finally, we document that the risk ratings can be used to predict future return volatility after controlling for other predictors of future volatility. We conclude that analysts play an important role as providers of information about investment risk.

This study examines firm performance surrounding insiders' prepaid variable forward (PVF) transactions to infer insiders' information when they enter these off‐market contracts. PVFs allow insiders to hedge downside risk, share performance gains, and obtain immediate large‐sum cash payments for investment or consumption. On average, PVF transactions cover 30% of a sample insider's firm‐specific wealth ($22 million), which is substantially larger than a typical open‐market sale. PVFs systematically follow strong firm performance and precede degraded stock and earnings performance. PVFs also precede periods of negative abnormal returns relative to potential alternative investments. The documented association between PVFs and performance declines does not appear to result from the market's response to transaction disclosure, participant self‐selection, or general price reversals. Thus, evidence suggests that insiders use PVFs to diversify firm‐specific holdings in anticipation of performance declines.

This paper studies the incentive effects of a balanced scorecard within a multitask agency framework under both formal and relational contracts. First, the main characteristics of the balanced scorecard are analyzed with respect to performance measure congruity. It is shown that under complete verifiability, a properly designed balanced scorecard is capable of perfectly aligning the interests of owners and employees by means of an explicit contract. I then investigate whether subjective performance evaluation is beneficial when not all the scorecard measures are contractible. It emerges that congruity of the contractible scorecard measures constrains a purely implicit incentive contract, but the first‐best solution may still be obtained through a combination of formal and relational contracts. Furthermore, a purely explicit contract in most cases can be improved by incorporating subjective rewards.

Managers play earnings surprise games to avoid negative earnings surprises by managing earnings upward or by managing analysts' earnings expectations downward. We investigate the effectiveness of the financial reporting process at restraining earnings surprise games. Because the annual reporting process is subject to an independent audit and more rigorous expense recognition rules than interim reporting, it provides managers with fewer opportunities to manage earnings upward. We document that, relative to interim reporting, annual reporting reduces the likelihood of income‐increasing earnings management and, to a lesser extent, of negative surprise avoidance, but increases the magnitude of downward expectations management. Our findings suggest that regulatory attempts to monitor corporations' internal checks and balances are likely to be more effective at curbing upward earnings management than at mitigating negative surprise avoidance.