Knowledge that Transforms

We exploit a regulatory change to examine whether bank regulator strictness is affected when regulators no longer rely on external assurance. In the absence of external assurance, we find that banks report higher nonaccrual loans, higher troubled debt restructurings, and both a timelier loan loss provision and higher quality allowance for loan loss reserve. Further, regulators spend more days performing targeted bank examinations for banks affected by the regulatory change. We do not find evidence of operational deterioration, but rather the findings are consistent with increased regulator strictness over the reporting of problem assets, particularly during targeted examinations. Overall, our results suggest that regulators become stricter when they can no longer rely on the work of external auditors and that third-party assurance is an imperfect substitute for direct regulatory monitoring. Data Availability: Bank regulatory rating and examination dates are confidential and were obtained from the Federal Reserve Bank of St. Louis. All other data are available from the public sources cited in the text.

I use a novel decomposition to estimate information and bias components from the returns implied by analyst price targets and provide evidence that prices simultaneously under-react to information and over-react to bias. Price reactions to information are permanent, and prices drift in the direction of their initial reaction for up to 12 months. Price reactions to bias are transitory, and prices reverse their initial reaction after about three months. Price reactions are relatively efficient. Approximately 85 percent of the total price reaction to information occurs during price target announcement months. Market participants are able to mostly (but not fully) debias analyst-expected returns before incorporating them into prices, with the announcement-month reaction to bias being relatively weak at about 15 percent of its reaction to information. A trading strategy analysis implies that mispricing induced by bias is only about one-third of that implied by prior research.

To what extent do U.S. consumers change their purchase behavior or, in the extreme, boycott companies based on negative information about corporate tax activities? Practitioner publications and academic research identify consumers as a key corporate tax stakeholder. But we have limited empirical evidence whether information about corporate tax activities influences consumer actions. We undertake a comprehensive study of this question, triangulating across several settings. First, a representative sample of consumers suggests they rarely boycott in response to corporate tax activities. Next, an analysis of granular retail scanner data fails to provide compelling evidence of consumer purchase responses to negative tax news. An analysis of individual foot traffic at retail establishments around negative tax news again fails to suggest U.S. consumers change their shopping activities in response to negative tax news. The combined evidence suggests consumers do not meaningfully alter their purchase behavior in response to negative tax news.

This study examines whether crowdsourced forecasts of earnings and revenues help investors unravel bias in earnings announcement news, which is commonly derived from analyst forecasts. Our results suggest that investors, on average, understand and price the predictive signals reflected in crowdsourced forecasts about the bias in analyst-based earnings and revenue surprises. Using the staggered addition of firms to the Estimize platform, we find that crowdsourced coverage is associated with reductions in the mispricing of forecast bias and declines in earnings announcement premia. We further find some evidence that managers use income-increasing accruals to meet the crowdsourced forecast benchmark and that they respond to crowdsourced coverage through increased downward earnings and revenue guidance. Overall, we conclude that user-generated content on crowdsourced financial information platforms helps investors discount biases in traditional equity research and thereby better process the news in earnings announcements.

This study offers solutions to help address practical issues researchers generally overlook when assessing gains from a trading signal. Specifically, the methodologies used in previous research generally ignore investor risk aversion when forming portfolios, do not update portfolios as signals arrive, exploit look-ahead biases, do not assess the incremental gains of a new signal, and do not consider market frictions. We examine trading signals based on post-earnings announcement drift (PEAD), the earnings announcement premium (EAP), and earnings announcement rescheduling (RES). Using our proposed approach, we find that portfolios that incorporate the individual signals produce higher Sharpe ratios than equal-weighted portfolios; however, the gains for each signal are concentrated to a few days around the announcement. The EAP and RES signals do not provide incremental portfolio gains over the PEAD signal. After considering market frictions, portfolio performance rapidly attenuates and becomes similar to the SPY ETF as the portfolio size increases.

This study examines the risk taking properties associated with incentive plans that use relative performance evaluation, with a focus on the form of payout, whether in cash or shares. By analyzing determinants and consequences of payout form choice, I find that share-based plans offer risk-averse managers weaker incentives to pursue projects with idiosyncratic risk compared with cash plans. This occurs because share plans—unlike cash plans—expose managers to systematic performance trends, as payout values are linked to stock prices. Additionally, I document that the variation in risk taking incentives depends on expected relative performance and the strength of the incentives. Overall, this study’s findings suggest that commonly used share-based relative performance plans might not always motivate managers to pursue innovative projects with high idiosyncratic risk when projects with systematic risk are available. Data Availability: All data are available from the sources identified in the text.

This paper examines investment responses to emission taxes and the role of tax incidence in passing on tax burdens. Using private firms from Spain and the introduction of an emission tax in 2013 in the Autonomous Community Valenciana, we show that investments decline in response to the emission tax. Importantly, this investment decline does not depend on the level of pollution but on economic factors related to tax incidence. Investments in firms operating in highly competitive markets, firms with low pricing power, and firms with low financial flexibility are the most affected by environmental taxes. We generalize the investment findings using the introduction of carbon taxes in France and Ireland in a stacked difference-in-differences design. Overall, our results indicate that emission taxes affect not only polluters but also other firms and stakeholders such as suppliers, customers, and consumers depending on the relative elasticities of supply and demand. Data Availability: Data are available from the sources cited in the text.

This paper examines whether analysts and investors efficiently incorporate the informational signals from managerial linguistic complexity (e.g., Fog) into their forecasts and trading decisions. We predict that a manager’s Fog during a conference call provides a signal of their private information through their willingness to engage with analyst questions. We find that informative (obfuscatory) managerial Fog provides a positive (negative) signal of future earnings growth. We also find that analysts efficiently revise their forecasts to both positive and negative signals, whereas investors only correctly interpret obfuscation during the call; there is a delayed price reaction to informative Fog. However, when buy-side investors ask questions during a call, we find an efficient price reaction to informative Fog. Our findings highlight an important benefit of two-way interactive disclosures and underline the importance of active call participation for efficiently incorporating linguistic signals of managers’ private information. Data Availability: Data are available from the public sources cited in the text.

We study a model in which financial reports are used in labor markets to learn about managerial talent. A manager manipulates reports to influence the labor market assessment of his talent. If investors are uncertain about the manager’s incentives, manipulation introduces noise into the report and reduces its usefulness for the capital market. We consider price informativeness and expected reporting bias as measures of capital market efficiency and develop novel empirical predictions. We show that higher uncertainty about the manager’s contribution to firm value can decrease price informativeness and earnings response coefficients. Intuitively, supplemental disclosures about managerial talent can mitigate the detrimental consequences of uncertain labor market incentives. Perhaps surprisingly, we show that the usefulness of such supplemental disclosures may increase in their susceptibility to manipulation.

We examine whether the design of a firm’s internal management accounting system is associated with GAAP earnings management. We exploit the fact that ASC 280 mandates a “management approach” requiring multisegment firms to disclose their segment earnings as defined internally by their management accounting system. We posit that the less these segment earnings are decoupled from GAAP earnings, the higher are the costs of earnings management because earnings management spills over to segment earnings and distorts information used for internal decision-making. Thus, we predict that firms with more decoupled segment earnings engage in more earnings management. Using a large sample of U.S. firms from 1998 to 2020, we find support for this prediction. We also find that the decision usefulness of segment earnings for segment investment purposes decreases as earnings management increases, with this association being more pronounced for firms with less decoupled segment earnings measures. Data Availability: Data are available from the public sources cited in the text.