Knowledge that Transforms

Abstract In Gantler v. Stephens (2009), the Delaware Supreme Court makes explicit that corporate officers owe the same fiduciary duty to the firm and shareholders as do board members. The decision increased the risk of non‐board‐serving officers being added as named defendants to investor litigation but did not change the risk of corporate litigation. Analyzing the effect of the Gantler ruling on non‐board‐serving CFO s, we find a significant change in their behavior as well as in their firms’ disclosure and accounting choices. Specifically, speech tone during earnings calls of non‐board‐serving CFO s becomes more negative when compared to board‐serving CFO s and the firm's CEO , and non‐board‐serving CFO firms disclose bad news earlier and report more conservatively. Results are stronger for firms incorporated in Delaware. Our findings suggest that CFO s respond to personal litigation risk over and above corporate litigation risk.

ABSTRACT Many view large payments following mergers or acquisitions as excessive and evidence of rent extraction. Using additional disclosures required by the SEC since 2006, I hand‐collect details of preexisting change in control ( CIC ) provisions in employment agreements and CIC benefits granted to target CEO s during mergers. I find that CIC benefits are renegotiated in approximately 50 percent of my sample. I then investigate whether renegotiation of CIC benefits tends to be opportunistic, or, instead, evidence of efficient contracting. The overall evidence is more consistent with efficient contracting. This contrasts prior research that focuses solely on certain components of CIC benefits, such as employment in merged firms or merger bonuses. I find that changes in CIC benefits are positively associated with the CEO 's horizon, as would be predicted by efficient contracting, but only limited evidence that changes in CIC benefits are positively associated with proxies for CEO power, as would be predicted by rent extraction. Acquiring firm shareholders interpret increases in target CEO s' CIC benefits as evidence of rent extraction, although I find that the merged firm's post‐merger performance is positively associated with changes in CIC benefits. This result is more consistent with acquiring firms providing target CEO s increased CIC benefits to complete mergers and realize synergies than with value‐reducing rent extraction.

ABSTRACT We develop a mixed‐duopoly model in which a private firm competes against a state‐owned enterprise (SOE) who cares about social welfare and is privately informed about market demand. When the SOE's social concerns are sufficiently important and when the market competitiveness is sufficiently low, the SOE commits to fully disclose its private information. Otherwise, the SOE commits to withhold its private information. When the disclosure equilibrium prevails, the private firm can be more profitable competing against an SOE than against another private firm. In this mixed‐duopoly setting, the equilibrium social welfare is maximized when the SOE puts a positive weight on both social welfare and its own profit. Our analysis has further implications for both mandatory disclosure and market entry.

ABSTRACT The increase in investor diversity over the last 35–40 years prompted us to revisit trading volume reactions to earnings announcements and how these reactions vary with firm size. We argue that this increase in investor diversity would likely increase differences in the precision of pre‐announcement information around earnings announcements, particularly for large firms. This suggests that the role of earnings announcements in resolving investor disagreement, as reflected in trading volume reactions, has increased. Over the 35‐year period 1977–2011, we find a dramatic increase in the magnitude and frequency of volume reactions to earnings announcements, particularly for large firms. The increase in large firms’ trading volume reactions is so pronounced that the relation between volume reactions and firm size has turned positive in recent years, reversing Bamber's ( , ) previously documented negative relation. We provide intuition and empirical evidence that our results are attributable to the resolution of differential prior precision among increasingly diverse investors following large firms.

Abstract A basic tenet of microeconomics is that for a competitive industry in equilibrium the market price of a product will be equal to its marginal cost. This paper develops a model framework and a corresponding empirical inference procedure for estimating long‐run marginal cost in industries where production costs decline over time. In the context of the solar photovoltaic (PV) module industry, we rely primarily on firm‐level financial accounting data to estimate the long‐run marginal cost of PV modules for the years 2008–2013. During those years, the industry experienced both unprecedented price declines and significant expansions of manufacturing capacity. We compare the trajectory of average sales prices with the estimated long‐run marginal costs in order to quantify the extent to which actual price declines were attributable to reductions in production costs. The trajectory of estimated product costs is then extrapolated to forecast an equilibrium trend line for future PV module prices.

ABSTRACT This paper examines whether ties to politicians by corporate boards of directors weaken the effectiveness of tax authorities in constraining tax avoidance in China. We use a unique data set to measure geographic time‐variant tax enforcement, including the probability of income tax audit, the expertise of tax officers, and the consequences of underreporting tax liabilities. Based on a sample of 11,121 firm‐years from 2003 to 2013, we find that the deterrent effect of the probability that a firm's taxable income understatement will be detected and lead to heavy penalties is significantly undermined if the board is politically connected. To enhance our analysis, we use opportunities for income shifting, the most likely mechanism through which Chinese firms avoid taxes on an ongoing basis, to illustrate how connected boards exert power to unwind the constraining effect of tax enforcement. Overall, our results suggest that a board's ties to politicians can be a significant challenge to the effective enforcement of tax compliance in a politically controlled economy.

Abstract How do management control practices structure other organizational practices? This paper proposes a theory of practice hierarchies. The key idea is that organizations possess constitutive rules that define their character. They are enacted by the practices at the top of the hierarchy. These “anchor practices” contain objectives and established ways of doing things that control, or structure, subsidiary practices. They do so by defining key social relationships in the organization, often ones that are antagonistic. The paper uses illustrations from a longitudinal field study of a retail bank and draws on insights from cultural sociology.

Abstract This study examines the effect of auditors’ collaboration in joint audit engagements on knowledge transfer, auditor expertise, and audit outcomes. I employ a unique sample of Italian private companies whose financial statements are jointly audited by three individual auditors and use measures from the network literature to capture the intensity of interactions between these auditors. I find a positive association between several audit quality proxies and auditors’ collaboration in multiple joint engagements. My results suggest that auditors develop knowledge and contacts through collaboration which potentially leads to higher audit quality. Overall, my findings suggest that joint engagements facilitate knowledge transfer and increase auditor expertise.

Abstract We study labor unions, an important stakeholder group that has not been a focus of the earnings smoothing literature. We posit that managers strike a balance between sheltering resources from employees’ profit sharing demands and catering to employees’ aversion to downside risk by smoothing earnings. We then hypothesize that a strong labor union would intensify managerial incentives to smooth earnings. Consistent with our hypothesis, we find that union strength is positively associated with earnings smoothing activities through management of both accruals and R&D expenditures.

ABSTRACT This article examines whether ties to portfolio firms’ management via pension business relationships provide mutual funds with an informational advantage. Funds become related to portfolio companies when fund families serve as trustees for firms’ employee pension plans. Selling by related funds is more likely to be motivated by an information advantage than their buying, because the latter is heavily influenced by the desire to secure pension inflows. We find that stocks with larger net sales by related funds experience lower future returns. Information appears related to firm fundamentals, as the return predictability of related funds’ selling concentrates in stocks with negative future earnings surprises. Consistent with an information‐based explanation, the predictive power of related funds’ selling for future returns is more pronounced when information uncertainty about the stock is higher. Our results contribute to a growing literature that shows the sources of informed trading by institutions.