Abstract This paper examines the security market response to the announcement of sell‐side analysts' decisions to initiate coverage of a firm. We examine the market reaction to the initiation announcement and the accompanying investment recommendation, by disaggregating our sample based on existing analyst coverage at the announcement date. We find, on average, a significantly larger, positive stock price reaction to buy recommendations conveyed in announcements of coverage initiation for firms with a small existing analyst following compared to such announcements for firms receiving no prior analyst coverage. Tests show that the relation between the extent of preexisting analyst coverage and market response is nonlinear and concave down in shape. Specifically we find that lightly followed firms, on average, experience larger price reactions to announcements of coverage initiations than either previously uncovered firms or more heavily followed firms. We test for and find that this result holds over a range of definitions of light coverage and is not attributable to the presence of an underwriting relationship existing between the analyst's employer and the firm receiving coverage. We do find that initiations by analysts named to Institutional Investor magazine's “All‐American Research Team” produce a significantly larger market reaction than do initiations by non‐All‐American security analysts. In addition, similar to the market response associated with other types of information events, we observe that proxies for the richness of the initiated firms' preannouncement information environment are associated with event‐day average abnormal returns.

Abstract. This study distinguishes between incremental and relative information content. Incremental comparisons ask whether one accounting measure provides information content beyond that provided by another, and apply when one measure is viewed as given and an assessment is desired regarding the incremental contribution of another (e.g., a supplemental disclosure). Relative comparisons ask which measure has greater information content, and apply when making mutually exclusive choices among alternatives, or when rankings by information content are desired (e.g., when comparing alternative disclosures). Questions of both incremental and relative information content arise frequently in accounting. However, few previous studies have examined questions of relative information content. Possible explanations include unfamiliarity with the relative versus incremental distinction, and the additional statistical complexity involved in testing for relative information content. First, we examine analytically the relation between incremental and relative information content, demonstrating that they address different research questions and require different tests for statistical significance. Second, we identify accounting research contexts in which questions of relative and incremental information content arise. Third, we propose a new regression‐based test for relative information content. This test applies to both returns and valuation studies, generalizes to any number of predictor variables, and can be used in conjunction with White's (1980) adjustment for heteroskedasticity. Fourth, we illustrate tests for relative and incremental information content in a familiar research setting that compares the information contents of net income, cash flows, and net sales in 40 industries. Résumé. Les auteurs établissent la distinction entre le contenu marginal et relatif en information. Les comparaisons du contenu marginal visent à déterminer si une mesure comptable livre un contenu en information supérieur à celui d'une autre, et elles s'appliquent dans les cas où une mesure est considérée comme étant donnée et où l'on souhaite évaluer la contribution marginale d'une autre mesure (par exemple, la présentation de renseignements complémentaires). Les comparaisons du contenu relatif visent à déterminer quelle mesure livre un contenu en information supérieur , et elles s'appliquent dans les cas où les choix entre différentes possibilités sont mutuellement exclusifs ou lorsqu'il s'agit d'établir des classifications selon le contenu en information (par exemple, dans la comparaison de différentes possibilités en ce qui a trait à la présentation d'information). La question du contenu marginal aussi bien que du contenu relatif en information se pose fréquemment en comptabilité. Dans les études réalisées jusqu'à maintenant, l'on s'est peu intéressé aux questions touchant le contenu relatif en information. Cette lacune pourrait s'expliquer, entre autres, par le caractère inusité de la distinction entre contenu relatif et contenu marginal en information et par la complexité statistique accrue que supposent des tests portant sur le contenu relatif en information. Selon un schéma analytique, les auteurs examinent en premier lieu la relation entre le contenu marginal et le contenu relatif en information, en démontrant que les mesures correspondantes se rapportent à des questions de recherche différentes et qu'elles exigent des tests de signification statistique différents. Ils déterminent en deuxième lieu quels sont les contextes de recherche comptable dans lesquels se posent les questions pertinentes au contenu relatif et marginal en information. Ils proposent, en troisième lieu, un test inédit fondé sur la régression et s'appliquant au contenu relatif en information. Ce test convient à la fois aux études de rendement et aux études d'évaluation, peut être généralisé à n'importe quel nombre de variables prédictives et peut être utilisé en association avec l'ajustement de White (1980) relatif à l'hétéroscédasticité. Ils illustrent, en quatrième lieu, l'application de tests du contenu relatif et marginal en information dans un contexte de recherche familier où le contenu informationnel du bénéfice net, des flux de trésorerie et du chiffre d'affaires net est comparé dans 40 entreprises.

Abstract Financial statements summarize a firm's fiscal position using only a limited number of accounts. Readers often interpret financial statements in conjunction with other information, some of which may be aggregated in a different way (or not at all). This paper exploits properties of the double‐entry accounting system to provide a systematic approach to reconciling diverse financial data. The key is the ability to represent the double‐entry system by network flows and, thereby, access well‐recognized network optimization techniques. Two specific uses are investigated: the reconciliation of audit evidence with management‐prepared financial statements, and the creation of transaction‐level financial ratios.

ABSTRACT We select a small set of recommendations that lie in the upper and lower tail of the empirical distribution of divergences between a recommendation, and the consensus over the window (−30, −1) days prior to that recommendation. We classify these extremely divergent recommendations as bold, and then subdivide them into informative bold recommendations that lead other analysts (leading‐bold) and those that are ignored by other analysts (contra‐bold) based on the consensus change in the 30 days after the announcement. We focus on the information conveyed to the market by these bold, leading‐bold, and contra‐bold recommendations through their effects on cumulative abnormal returns (CAR). We find that bold recommendations are not anticipated by market participants (CARs are negative before a bold buy and positive before a bold sell). The next finding is that the market responds strongly to both leading and contra‐bold recommendations over the (0, +4)‐day window and that these reactions are stronger than that to nonbold recommendations. In contrast, over the longer (0, +30)‐day window, leading‐bold recommendations earn additional returns whereas contra‐bold ones reverse significantly due to lack of confirmation. The overall pattern is one of rational market reaction both in the short and long windows. We support the rationality of the market reaction by showing that the percentage of leading‐bold recommendations exceeds that of contra‐bold recommendations, and that these two types of recommendations cannot be separated using observable analyst characteristics such as experience or brokerage size.

ABSTRACT Theory from organizations and economics research posits that in an inter‐organizational relationship, both parties invest in relationship‐specific knowledge, which in turn facilitates the effectiveness of the relationship while strengthening the attachment between the parties. In complex settings where there are more opportunities for knowledge creation, the investments will be larger and the attachment stronger. Because banks are complex institutions that present unique challenges to auditors, we suggest that effective audits critically depend on the accumulation of significant investments in client‐specific expertise through a long association with the client. We find a positive association between audit firm tenure and financial reporting quality, and this association is particularly strong in banks that are more complex. Also, contrary to recent research we find that benefits of audit firm tenure for complex banks accrue even for long tenure and are not limited to medium tenure. Our findings largely support the notion that a long relationship with the client reflects the underlying demand for expertise, which is critical for high‐quality audits of complex organizations. Imposing short‐term limits on audit firms would adversely affect the investments in client‐specific expertise especially in the cases where this expertise is needed the most. Our findings do not support calls for mandatory audit firm rotation for large complex institutions.

Considerable prior research investigates whether the extent of insider presence on corporate boards is detrimental. However, the majority of past research treats all inside directors as a homogenous group. This study considers that issue in the context of chief financial officers (CFO) serving on their own company's board. Our research is important because individuals in different executive roles bring different skills and knowledge to board interactions, highlighting the potential for differential contributions. As prior research does not specifically distinguish CFOs from other board insiders, the potential benefits of knowledge sharing due to increased communication with other board members may have been masked. Specifically, the CFO is directly responsible for the quality of the financial reporting process and can therefore be associated with specific outcome measures. Our results show that the percentage of CFOs serving on their own boards is not large, likely due to the perspective (consistent with agency theory and reflected in independence guidelines) that company insiders on boards could promote their own best interest at the expense of shareholders. Contrary to this perception, we find that companies whose CFO has a seat on the board are associated with higher financial reporting quality (i.e., a lower likelihood of reporting a material weaknesses in internal controls or having a financial restatement, and better accruals quality). Yet, we also find potential drawbacks in that CFOs with a board seat tend to have higher excess compensation and lower likelihood of termination following poor performance, signaling greater entrenchment. While our results provide information to companies considering appointing the CFO to the board, both costs and benefits are demonstrated, and thus we conclude that each board should consider this decision based on its own circumstances and composition.

ABSTRACT During the COVID‐19 pandemic, states imposed restrictions intended to slow the spread of the virus. We investigate whether states' reliance on consumption tax revenue, relative to other tax revenue sources, is associated with the duration of COVID‐19 mobility restrictions. We find that states that are more dependent on consumption taxes experienced shorter durations of stay‐at‐home orders, restaurant closures, and bar closures. We conduct a series of analyses to mitigate concerns that state‐level political preferences and biases may be influencing our findings. Our findings suggest that anticipated shortfalls in consumption tax revenue may have shaped public health responses, consistent with tax system structures relating, unintentionally, to crisis management decisions.

Abstract We examine how progressive individual tax rates affect risk‐taking by pass‐through businesses (PTBs). PTBs generate over 60% of US business income and make up roughly 95% of business tax returns, yet there is limited research on how progressive tax rates affect project selection. We study PTBs using the setting of thoroughbred racing and examine how progressive tax rates affect the decision to enter a risky stakes race or a less risky allowance race. This setting provides a unique opportunity to observe the choice between two mutually exclusive projects that differ only in expected payoffs and risk. Using a difference‐in‐differences design surrounding the reduction in progressivity under the Tax Cuts and Jobs Act, we find that investment in stakes races increases in the United States relative to Canada. We find further evidence of a negative relation between progressive tax rates and risk‐taking using a plausibly exogenous shock in progressivity in California and exploiting cross‐sectional variation in the progressivity of state tax rates. Overall, our findings should be of interest to policy‐makers considering changes to progressive rates. Results indicate that increases to progressive tax rates may discourage risk‐taking by the small businesses that drive economic growth.

Abstract This study examines the effect of shareholder scrutiny of corporate tax avoidance behavior and its related financial reporting. Specifically, we explore the factors associated with shareholder tax litigation and its effect on the future tax behavior of the sued firm and its peers. We find that sued firms have lower cash and GAAP effective tax rates (ETRs) and engage in extreme tax avoidance before litigation. After litigation, they decrease tax avoidance activities, relative to matched control firms. Peer firms in the same industry as sued firms similarly reduce their level of tax avoidance and the likelihood of extreme tax avoidance after the litigation, relative to control firms. Additional analyses suggest that sued firms change their tax avoidance behavior, rather than merely their tax financial reporting. Finally, the spillover results are strongest for peer firms with the most tax avoidance (i.e., the lowest cash ETRs) when the sued firm's alleged misconduct is revealed.

Abstract We explore how securities litigation affects corporate reputation. Experts remain concerned that nonmeritorious securities class actions—those that will be dismissed or settled for nuisance amounts—cause reputational damage. Although several prior studies show reputational costs for nonmeritorious cases, they generally use indirect measures based on returns or total market losses, which are mechanically associated with securities litigation elements. In contrast, we use a relatively direct reputation measure from Fortune 's “Most Admired Companies” list. We find significant reputational damage after meritorious litigation, with the strongest cases having the largest effects. However, we find no evidence of reputational damage after nonmeritorious litigation. We also find that Fortune 's reputational damage measure is associated with more negative returns around the litigation filing date. We show possible mechanisms for our results, as initial legal filings contain information allowing market participants to assess case merits. Our results imply that reputational damage is primarily due to fraud, which securities litigation helps reveal to the market, rather than litigation itself. Thus, reputational damage is not an issue in over 70% of securities class actions due to the high frequency of nonmeritorious cases.