Knowledge that Transforms

Abstract This study examines the impact of the presence of institutional dual‐holders, whose portfolios hold both loans and equity securities of the same firms, on those firms' voluntary disclosures. Using mergers between institutional shareholders and lenders to the same firms as exogenous shocks to identify firms with institutional dual‐holders that have high relative equity ownership, we document that such firms are less likely to provide management forecasts and disclose fewer voluntary 8‐K items. In cross‐sectional analyses, we find that the reduction in voluntary disclosures is more pronounced when institutional dual‐holders have higher board representation and when firms have lower litigation risk. In addition, we find that firms with institutional dual‐holders provide more private disclosures to their lenders via loan contract covenants. Additional analyses indicate that the impact of institutional dual‐holders on corporate disclosures is driven by both their monitoring and trading incentives.

Abstract Discretionary income smoothing has been argued to increase bank opacity and degrade financial system stability by making banks more difficult to monitor. However, no direct empirical association between discretionary smoothing and opacity has been established to date. We argue that smoothing could reflect either the opportunistic exercise of discretion that disconnects loan loss provisions (LLPs) from changes in underlying credit quality, consistent with smoothing increasing opacity, or an informative exercise of discretion to communicate forward‐looking information about loan losses. We examine the association between discretionary smoothing and the informativeness of LLPs for a sample of banks from 1994 to 2019 and find that discretionary smoothing is, on average, associated with more informative LLPs. However, this association is nuanced, with cross‐sectional differences and changes over time. We find evidence that an intervention by the SEC into bank LLP practices in the late 1990s curbed opportunistic smoothing via provisioning for homogeneous loans. Subsequently, smoothing is associated with more informative provisions, including for banks with both more homogeneous and more heterogeneous loan portfolios. Our findings are inconsistent with the notion that smoothing may be associated with greater opacity.

Abstract Statement of Financial Accounting Standards (SFAS) 141 (Accounting Standards Codification [ASC] 805) requires that firms record identifiable assets and liabilities acquired in business combinations at fair value. While the FASB argued that these fair values should provide users with incremental decision‐useful information, opponents have continuously argued that they are too difficult to reliably estimate and could be subject to managerial discretion. Using hand‐collected data from US mergers and acquisitions, we find that, on average, fair value adjustments predict future cash flows incrementally beyond pre‐deal book values and cash flows, goodwill, and other firm and deal characteristics. We also find that the relation between fair value adjustments and future cash flows varies predictably based on several factors that affect managers' ability and incentives to provide accurate estimates. Furthermore, despite prevailing concerns about their usefulness, we find that fair values for intangible assets predict future cash flows, on average. However, we find that this relation is driven primarily by the fair values of customer‐ and contract‐related intangible assets and that the fair values of other types of identifiable intangibles do not necessarily convey incremental decision‐useful information. Finally, we find that users appear to rely on the information conveyed by these disclosures, as evidenced by revisions to analysts' forecasts and changes in stock prices. Overall, our findings provide insight regarding the usefulness of current standards and users' reliance on fair values in business combinations.

Abstract Most fraud research in accounting has focused on controls rather than offenders' subjective experience, meaning that our understanding of motive in fraud (defined as linguistic devices employed to justify, interpret, or excuse actions) remains underexplored. This is particularly the case for employee fraud, which has been largely neglected relative to top management fraud or financial statement fraud. To provide a richer understanding of how fraud offenders make sense of their offending, we interviewed 30 serious employee fraud offenders to better investigate their typal vocabularies of motive. We focus on holistic narrative accounts to provide insights into the common justifications and excuses presented by employee fraud offenders. We develop a taxonomy of narrative constructions based on the explanatory locus of the accounts offered by offenders. We identify three common justifications, (1) inconsequentiality motives, (2) permission motives, and (3) unfair treatment motives, and three common excuses, (4) personal crisis motives, (5) addiction motives, and (6) appeasement motives. We draw implications for researching fraud, organizational control, and ethics in accounting education.

Abstract Lenders are reluctant to finance firms' innovation activities because such activities tend to be opaque, with a high likelihood of negative outcomes that could hamper loan repayment. We posit that public credit registries (PCRs), which play an important role in credit information sharing in many countries, can facilitate financing by reducing adverse selection and moral hazard and increasing bank competition. Using the staggered establishment of PCRs in different countries and an international firm–patent data set, we find that credit information sharing positively affects firm innovation, especially in firms that experience a larger increase in bank debt financing after the establishment of a PCR. This finding is consistent with the notion that credit information sharing promotes firm innovation by easing bank debt financing frictions. We also find a stronger effect in countries that experience a large increase in bank competition after the establishment of a PCR—consistent with increased bank competition serving as a channel through which credit information sharing facilitates bank debt financing, thereby generating a positive effect on firm innovation. The positive effect is more pronounced when the established PCR has features that promote credit information sharing. It is also more pronounced for opaque firms and firms in innovation‐intensive industries, indicating that credit information sharing helps to reduce financing frictions. Finally, we posit and find evidence that firm efficiency in transforming innovation inputs into outputs improves after the establishment of a PCR. Overall, our paper offers novel insights into how credit information sharing facilitates firm innovation.

Abstract Deferred compensation is often proposed as an instrument to prevent managerial myopia. However, empirical studies show that its practical use is limited when it comes to managerial retirement. We study the optimal design of accounting‐based deferred compensation for retiring managers. While deferred compensation is useful in establishing long‐term incentives, it causes contracting frictions in subsequent periods. Deferred bonuses of retiring managers imply inefficiently weak incentives for incoming managers. This down‐scaling effect renders deferred compensation less useful in providing long‐term incentives. We also find that the down‐scaling effect has implications for the desirability of accounting timeliness—that is, the timely recognition of future cash flows in current accounting earnings—from a stewardship perspective. If managers' long‐term actions are sufficiently important, higher timeliness can cause more myopic managerial incentives.

Abstract This study finds that accounting standards play an important role in cross‐border investor reactions to peer firm earnings. Specifically, we document that when international peer firms report under the same accounting standards, investors overreact to peer firms' earnings announcements. Using a sample of 35,116 firm‐pair‐years from 51 countries between 2000 and 2010, we show that heightened information transfers for international same‐standard firms are followed by predictable price reversals when investors observe own‐firm earnings. However, overreactions are not present for international firm‐pairs that follow different accounting standards. While we find that institutional investors learn over time, overreactions do not decline among retail investors. Additional tests suggest that overreactions cause significant excess volatility, which results in economically significant costs. Collectively, our findings document an unintended consequence of financial reporting harmonization in the form of increased investor overreactions.