Knowledge that Transforms

We study the impact of social connections between judges and executives on the outcomes of Securities Class Action Litigation (SCAL). Judges who are socially connected to a firm's executives are significantly more likely to dismiss lawsuits against the firm. There is also evidence of faster resolution and lower payout amounts in connected cases. The favorable outcomes cannot be explained by the lower severity of connected cases, or by court, judge, or firm characteristics. Our results are more pronounced when executives connected to the judge are named defendants in the lawsuits, when connected cases involve less visible lawsuits or firms, and when connections between judges and executives are likely more direct. Our evidence indicates that social connections influence judge impartiality and meaningfully alter SCAL outcomes.

This study examines whether the efficiency of federal district courts affects the likelihood of SEC enforcement. The results indicate that the SEC is less likely to initiate enforcement actions against firms in less efficient federal district courts. In addition, the study examines the implications of court efficiency for firms’ financial reporting quality (FRQ). The evidence suggests that firms residing in more efficient federal districts have higher FRQ and the effect is stronger in subsamples with weak private enforcement regimes. Additional analysis of the choice of venue suggests that the SEC's decision to file in the District Court for D.C. is not affected by local court efficiency. Collectively, this study highlights the importance of an efficient federal judicial system for public enforcement.

A significant portion of a merger's purchase price is allocated to goodwill. Currently, goodwill is not amortized but rather tested annually for impairment. When managers of acquiring firms care about earnings, goodwill's accounting treatment can have large effects on future earnings and may influence how much a manager will bid for a target company. We quantify the effects of goodwill accounting by estimating a structural model of corporate takeovers. Our estimates suggest accrual accounting increases buyout premia by an average of approximately 11 percentage points. If firms needed to amortize goodwill over 10 years, we estimate premia would reduce by 4.9 percentage points and M&A volume would shrink by 4.1% or $67 billion per year. Furthermore, the fraction of private equity acquirers would increase by 6.9 percentage points, shifting control over productive assets to the private and financial sector. Our results suggest the accounting treatment for goodwill has a meaningful effect on the market for corporate control.

Auditors frequently outsource audit work to offshore Shared Service Centers (SSCs) to reduce costs and ease the workload burdens of audit team members. However, concerns persist about whether these benefits come at the expense of audit quality. Using proprietary audit engagement‐level data, I evaluate whether greater SSC usage by Big 4 audit teams has an association with either, or both, audit quality and audit costs. I find that SSC usage is nearly universal in Big 4 audits, with the percentage of audit hours SSCs perform increasing in recent years. Consistent with the audit firm's objectives, evidence suggests that SSC usage is associated with fewer audit hours and lower audit fees. Importantly, I find no evidence that SSC usage is associated with lower audit quality. Overall, results suggest that SSCs have the intended effect of reducing audit costs without sacrificing audit quality.

This paper investigates how U.S. private firms communicate with investors around private securities offerings. Using multiple research methods including survey, interview, and archival analysis, I provide systematic evidence on private firms' public and private disclosure practices. I find that despite engaging in a low level of public disclosures, private firms actively communicate with investors through private communication channels, with notable variation across firms in terms of content and frequency. Consistent with managers providing relevant information, financial information is disclosed when it is particularly useful for investors' decision‐making. Furthermore, I explore the relation between private communication and public disclosure preferences and find a substitutive effect, suggesting that private firms may strategically manage communication channels to effectively engage with investors. This study contributes to the literature by describing the existing disclosure landscape of private firms.

Using a large sample of U.S. commercial banks from 1994 to 2019, we find that loan fair values are highly relevant for depositor decision making. A one‐standard‐deviation decrease in loan fair value performance is associated with more than 10% lower uninsured deposit flows than the sample average. Information in fair values about loan credit quality is quite limited and cannot account for the bulk of the relevance. Instead, consistent with models of bank fragility, the relevance seems to stem more from information on the decline in loan liquidation values, triggering panic‐based withdrawals motivated by (self‐fulfilling) expectations of withdrawals by other depositors. The findings inform the cost‐benefit tradeoff of reporting loan fair values.

We introduce the idea of cross‐regulatory disclosure avoidance, whereby firms attempt to counteract expansions of disclosure under one regulation through actions that reduce disclosure under a different one. We study whether firms redact information from material contracts when they face new rules to disclose segment information. Using SFAS No. 131 as a plausibly exogenous shock to segment disclosure, we find that firms increasing the number of reported segments after the rule change exhibit a greater increase in redaction than firms maintaining the same number of segments. Consistent with proprietary cost motives, the increases are concentrated among firms with greater divergence in profitability across segments, higher abnormal segment profitability, and more negative abnormal stock returns in response to the finalization of the rule. Also, treated firms that redact after the rule change have abnormally profitable segments that they previously did not disclose. Firms that observables predict would increase redaction but did not experience declines in sales growth and profit margin. We find no evidence that agency cost motives drive the increases in redaction or, more generally, nondisclosure of segment performance before SFAS No. 131.

We examine the effect of the Securities and Exchange Commission's (SEC) regulatory oversight on private debt contracting outcomes, using the signing of the multilateral memorandum of understanding (MMoU) as a natural experiment. The MMoU enables the SEC to take stricter punitive actions against wealth expropriation by cross‐listed firms’ insiders and enforce better compliance with applicable rules and regulations. We find that enhanced SEC oversight in the post‐MMoU regime lowers loan spreads by 36 basis points, thus saving an average cross‐listed firm approximately $9 million in direct loan costs over the life of a bank loan. Cross‐sectional analyses show that the effect is more pronounced for borrowers from countries with weaker institutions, borrowers with greater accounting discretion, and for loans arranged by top lenders or loans not secured by collateral. Conversely, the effect is less pronounced for borrowers who use IFRS or when the SEC faces greater budgetary constraints. Enhanced SEC oversight also leads to an increase in loan maturity and a decrease in financial covenants. Our evidence suggests that while the SEC's primary mandate is to protect public equity and bond investors, its supervision yields substantial borrowing cost savings and more lenient nonprice loan terms in the private debt markets as well.

Audit theory and regulation assumes that auditors’ commercial motivation threatens audit quality. In this registered report, we use data from two Big Four firms in the Netherlands and provide empirical evidence on the relation between auditors’ commercial motivation and (1) compensation, (2) total audit effort, and (3) audit quality. We proxy commercial motivation as the time that individual auditors report allocating to commercial activities. We hypothesize that auditors’ commercial effort is positively related to compensation and we find mixed support. Next, we hypothesize that auditors’ commercial effort is negatively related to the audit effort but we find no support. Turning to audit quality, we hypothesize a negative direct relation between auditors’ commercial effort and audit quality but we find no support. We also predict a positive indirect relation in which auditors’ commercial effort increases quality control reliance leading to higher audit quality. We find some support for this hypothesis but only when we use technical consultations to proxy for quality control. Auditors with greater commercial effort maintain quality because they rely more on technical consultations. In sum, our study challenges the assumption that auditors’ commercial effort threatens audit quality and questions the need for additional regulation to constrain commercial motivation.

We examine the impact of technological competition on voluntary innovation disclosure around the enactment of the Leahy–Smith America Invents Act of 2011 (“AIA”). The AIA moves the US patent system from the first‐to‐invent to first‐inventor‐to‐file system and induces a patent race that increases technological competition. Firms that are slow to file a patent are disadvantaged in this race. We find that focal firms with lagging patent classes strategically increase scientific publications in their lagging technology areas in an attempt to block competitors from obtaining a patent. This effect is more pronounced in technology areas where the firm has better information about their relative competitive position (proxied by greater inventor mobility), in technology classes with constraints on increasing patent filing timeliness (proxied by fewer experienced attorneys), and areas characterized by more intense competition. We find that the peers of firms with lagging classes experience greater patent filing rejections for lack of novelty and obviousness reasons after the AIA, suggesting that strategic scientific disclosure is effective.