Knowledge that Transforms

ABSTRACT In the presence of business groups, the expropriation through related party transactions (RPTs) is common and costly to minority shareholders. Using the setting of India's RPT voting rule, I find that a majority‐of‐minority shareholder voting mechanism helps mitigate expropriation. Minority shareholders actively raise their voice against RPT resolutions. A difference‐in‐differences analysis reveals that shareholder voting has a significant deterrence effect on RPT volume. I also find that stock markets react positively to the voting rule's passage, and that the rule makes Indian firms more attractive to foreign institutional investors.

ABSTRACT This study investigates a communication game between a CEO and a board of directors where the CEO's career concerns can potentially impede value‐increasing informative communication. By adopting a policy of aggressive boards (excessive replacement), shareholders can facilitate communication between the CEO and the board. The results are in contrast to the multitude of models which generally find that management‐friendly boards improve communication, and help to explain empirical results concerning CEO turnover. The results also provide the following novel predictions concerning variation in CEO turnover: (1) there is greater CEO turnover in firms or industries where CEO performance is relatively more difficult to assess; (2) the board is more aggressive in their replacement of the CEO in industries or firms where the board's advisory role is more salient; and (3) there is comparatively less CEO turnover in firms or industries where the variance of CEO talent is high.

ABSTRACT Despite issuing extensive guidance related to the evaluation of accounting estimates, the PCAOB continues to identify deficiencies related to the audit of estimates through their inspections process. We examine whether PCAOB inspections lead to more accurate audited accounting estimates, defined as those that more closely match economic reality, by examining a significant estimate within the banking industry. We find that in contrast with the PCAOB's goal of more accurate and unbiased estimates, allowance for loan losses (ALL) estimates become less accurate and more conservative with higher levels of ALL‐related inspection findings for public company audits. We find no evidence of auditor response to PCAOB inspection findings for private‐company audits, which are not subject to PCAOB inspection. Overall, our findings cast doubt on the efficacy of PCAOB inspections in improving estimate accuracy and suggest that firms are managing inspection risk to the potential detriment of audit quality.

ABSTRACT This paper provides evidence that disclosing corporate bond investors' transaction costs (markups) affects the size of the markups. Until recently, markups were embedded in the reported transaction price and not explicitly disclosed. Without explicit disclosure, investors can estimate their markups using executed transaction prices. However, estimating markups imposes information processing costs on investors, potentially creating information asymmetry between unsophisticated investors and bond‐market professionals. We explore changes in markups after bond‐market professionals were required to explicitly disclose the markup on certain retail trade confirmations. We find that markups decline for trades that are subject to the disclosure requirement relative to those that are not. The findings are pronounced when constraints on investors' information processing capacity limit their ability to be informed about their markups without explicit disclosure.

ABSTRACT We examine how options trading affects voluntary corporate disclosure, so that we can shed light on whether managers’ potential learning from the options market induces them to withhold disclosure. We find that options trading reduces the likelihood and frequency of management earnings forecasts, suggesting that firms that have active options trading on their stock make fewer voluntary disclosures. This finding is in accordance with the theoretical prediction that managers strategically reduce disclosure to avoid crowding out informed trading, which can give them informative feedback for their decision making. In support of the managerial learning channel, we document a real effect of reduced disclosure: When managers disclose less, options trading has a stronger positive effect on firm investment efficiency. The more pronounced effect of options trading on management earnings forecasts when the need for managerial learning is higher further supports the learning channel.

ABSTRACT This paper analyzes the impact of changes in regulatory priorities and resource allocation on criminal enforcement of white‐collar criminal activities. Using the 9/11 terrorist attacks as a shock to the FBI's priorities and allocation of investigative resources, as well as variation in the Muslim population in the United States, I examine whether prioritization of counterterrorism investigations after 9/11 is associated with weaker enforcement of laws targeting white‐collar crime. I then use a difference‐in‐differences estimation to study the magnitude of any increase in white‐collar crime resulting from reduced oversight. I find a significantly greater reduction in white‐collar criminal cases referred by FBI field offices that shifted more of their investigative focus away from white‐collar crime to counterterrorism. Further, geographic areas in the jurisdictions of FBI field offices with greater shifts in attention from white‐collar crime to counterterrorism experienced greater increases in wire fraud, illegal insider‐trading activities, and fraud within financial institutions.

ABSTRACT We examine how firms respond to the increased workplace transparency due to the coverage on Glassdoor.com, which collects and disseminates reviews on employee satisfaction. Leveraging the staggered timing of first‐time reviews on Glassdoor, we use a difference‐in‐differences design and find that after being reviewed on Glassdoor, firms improve their workplace practices, measured by corporate social responsibility scores on employee relations and diversity. Consistent with firms improving their workplace practices to remain competitive in the labor market, we find that such improvement concentrates in firms with negative initial reviews and with high labor intensity. We also find firms increase disclosures about workplace practices after being reviewed and the increase concentrates in firms with high institutional ownership, consistent with firms providing more disclosures to appease investors. Overall, our findings suggest that the increased workplace transparency through social media has a disciplinary effect on corporate policies.

ABSTRACT We construct a novel measure of disclosure choice by firms. Our measure is computed using linguistic analysis of conference calls to identify whether a manager's response to an analyst question is a “non‐answer.” Using our measure, about 11% of analyst questions elicit non‐answers from managers, a rate that is stable over time and similar across industries. A useful feature of our measure is that it enables an examination of disclosure choice within a call. Analyst questions with a negative tone, greater uncertainty, greater complexity, or requests for greater detail are more likely to trigger non‐answers. We find performance‐related questions tend to be associated with non‐answers, and this association is weaker when performance news is favorable. We also find analyst questions about proprietary information are associated with non‐answers, and this association is stronger when firm competition is more intense.

ABSTRACT Basu's [“The Conservatism Principle and the Asymmetric Timeliness of Earnings.” Journal of Accounting and Economics 24 (1997): 3–37] measurement of conditional conservatism as the asymmetric timeliness of earnings underlies hundreds of studies. However, many subsequent studies cast doubt on the extent to which Basu's measure captures conditional conservatism versus statistical biases or alternative constructs (collectively, “biases”), thereby questioning the validity of the inferences that empirical researchers draw from analyses using the measure. We modify Basu's measure in four simple ways to remove these biases. Our key modification is the inclusion of interactive controls for return variance, a volatility proxy that captures Patatoukas and Thomas’ [“More Evidence of Bias in Differential Timeliness Estimates of Conditional Conservatism.” The Accounting Review 86 (2011): 1765–1794] return variance effect and various sources of economic optionality and adjustment costs. This inclusion captures volatility‐related effects on both the level of earnings and the sensitivity of earnings to returns, and it allows the magnitudes of these effects to vary with the sign of returns. We conduct validation analyses using placebo‐dependent variables, synthetic returns, and nonconditionally conservative earnings components that show our modified Basu measure is largely free of known biases. We further show that our measure is associated with contracting and other economic variables as predicted by theory. Our findings suggest that researchers can rely on our modified Basu measure to identify the determinants and effects of conditional conservatism.

ABSTRACT We use novel satellite data that track the number of cars in the parking lots of 92,668 stores for 71 publicly listed U.S. retailers to study the local information advantage of institutional investors. We establish car counts as a timely measure of store‐level performance and find that institutional investors adjust their holdings in response to the performance of local stores, and that these trades are profitable on average. These results suggest that local investors have an advantage when processing information about nearby operations. However, some institutional investors do not adjust for the quality of their local information and continue to rely on local signals even when they are poor predictors of firm performance and returns. This overreliance on poor local information is reduced for institutional investors with greater industry expertise and those with greater incentives to maximize short‐term trading profits.