Knowledge that Transforms

We investigate whether the levels of social capital in U.S. counties, as captured by strength of civic norms and density of social networks in the counties, are systematically related to tax avoidance activities of corporations with headquarters located in the counties. We find strong negative associations between social capital and corporate tax avoidance, as captured by effective tax rates and book-tax differences. These results are incremental to the effects of local religiosity and firm culture toward socially irresponsible activities. They are robust to using organ donation as an alternative social capital proxy and fixed effect regressions. They extend to aggressive tax avoidance practices. Additionally, we provide corroborating evidence using firms with headquarters relocation that changes the exposure to social capital. We conclude that social capital surrounding corporate headquarters provides environmental influences constraining corporate tax avoidance.

ABSTRACT In 2013, a new law required Indian firms, which satisfy certain profitability, net worth, and size thresholds, to spend at least 2% of their net income on corporate social responsibility (CSR). We exploit this regulatory change to isolate the shareholder value implications of CSR activities. Using an event study approach coupled with a regression discontinuity design, we find that the law, on average, caused a 4.1% drop in the stock price of firms forced to spend money on CSR. However, firms that spend more on advertising are not negatively affected by the mandatory CSR rule. These results suggest that firms voluntarily choose CSR to maximize shareholder value. Therefore, forcing a firm to spend on CSR is likely to be sub‐optimal for the firm with a consequent negative impact on shareholder value.

ABSTRACT This manuscript proposes a theory of why and when organizations “support” their employees with resources, time, and freedom beyond what seems economically optimal. The idea is that support plays an information‐generating role in that it renders output more informative about employees' abilities. This effect reduces the need to gather additional information about ability via costly monitoring and commits the firm to make replacement/promotion decisions that are more sensitive to performance. Consequently, support indirectly strengthens employees' career concern incentives and reduces the pressure on costly bonus payments. I apply the model to tech companies, academia, and capital budgeting.

ABSTRACT This paper examines the relation between CEO inside debt holdings (pension benefits and deferred compensation) and corporate tax sheltering. Because inside debt holdings are generally unsecured and unfunded liabilities of the firm, CEOs are exposed to risk similar to that faced by outside creditors. As such, theory (Jensen and Meckling [1976]) suggests that inside debt holdings negatively impact CEO risk‐appetite. To the extent that corporate tax shelters are likely to result in high cash flow volatility in the future, we expect that inside debt holdings will curb CEOs from engaging in tax shelter transactions. Consistent with the prediction, we document a negative association between CEO inside debt holdings and tax sheltering. Additional analyses suggest that the effect of inside debt on tax sheltering is more (less) pronounced in the presence of high default risk and liquidity threats (cash‐out options in pension packages). Overall, our results highlight the importance of investigating the implication of CEO debt‐like compensation for corporate tax policies.

Standard setters explicitly state that disclosure should not substitute for recognition in financial reports. Consistent with this directive, prior research shows that investors find recognized values more pertinent than disclosed values. However, it remains unclear whether reporting items are recognized because they are more relevant for investing decisions, or whether requiring recognition itself prompts differing behavior on the part of firms and investors. Using the setting of subsequent events, I identify the differential effect of requiring disclosure versus recognition in a setting where the accounting treatment of an item is exogenously determined. For comparable events, I find a stronger initial market response for firms required to recognize relative to firms that must disclose, although the large magnitude of the identified effect calls into question whether this difference can be attributed to accounting treatments alone. In examining various reasons for the stronger market response to recognized values, I fail to find support for the hypothesis that this difference is due to differential reliability of disclosed and recognized values. I do find some evidence that investors underreact to disclosed events, consistent with investors incurring higher processing costs when using disclosed information.

It is conventionally perceived in the literature that weak analysts are likely to under weight their private information and strategically bias their announcements in the direction of the public beliefs to avoid scenarios where their private information turns out to be wrong, whereas strong analysts tend to adopt an opposite strategy of over weighting their private information and shifting their announcements away from the public beliefs in an attempt to stand out from the crowd. Analyzing a reporting game between two financial analysts, who are compensated based on their relative forecast accuracy, we demonstrate that it could be the other way around. An investigation of the equilibrium in our game suggests that, contrary to the common perception, analysts who benefit from information advantage may strategically choose to understate their exclusive private information and bias their announcements toward the public beliefs, while exhibiting the opposite behavior of overstating their private information when they estimate that their peers are likely to be equally informed.

I test whether the anticipation of earnings news stimulates acquisition of customer information and mitigates returns to the customer–supplier anomaly documented by Cohen and Frazzini (“Economic Links and Predictable Returns.” The Journal of Finance 63 (2008): 1977–2011). I find that attention to a firm's publicly disclosed customers increases shortly before the firm announces earnings, and that customer stock returns predict supplier stock returns shortly before, but not after, the supplier's earnings announcement. I further find some evidence that these predictable returns are increasing in the level of customer information acquisition. These results are unique to anticipated disclosure events and suggest that anticipation of supplier earnings announcements resolves investor limited attention to customer information and accelerates price discovery of customer news.

ABSTRACT We use a proprietary data set of financial statements collected by banks to examine whether economic growth is related to the use of financial statement verification in debt financing. Exploiting the distinct economic growth and contraction patterns of the construction industry over the years 2002–2011, our estimates reveal that banks reduced their collection of unqualified audited financial statements from construction firms at nearly twice the rate of firms in other industries during the housing boom period before 2008. This reduction was most severe in the regions that experienced the most significant construction growth. These trends reversed during the subsequent housing crisis in 2008–2011 when construction activity contracted. Moreover, using bank‐ and firm‐level data, we find a strong negative (positive) relation between audited financial statements during the growth period, and subsequent loan losses (construction firm survival) during the contraction period. Collectively, our results reveal that macroeconomic fluctuations produce temporal shifts in the overall level of financial statement verification and temporal shifts in verification are related to bank loan portfolio quality and borrower performance.

We investigate whether unpleasant environmental conditions affect stock market participants’ responses to information events. We draw from psychology research to develop a new prediction that weather-induced negative moods reduce market participants’ activity levels. Exploiting geographic variation in equity analysts’ locations, we find compelling evidence that analysts experiencing unpleasant weather are slower or less likely to respond to an earnings announcement relative to analysts responding to the same announcement but experiencing pleasant weather. Price association tests find evidence consistent with reduced activity due to weather-induced moods delaying equilibrium price adjustments following earnings announcements. We also use our analyst-based research design to re-examine an existing prediction that unpleasant weather induces investor pessimism, and find evidence of both analyst pessimism and reduced activity in the presence of unpleasant weather. Together, our study provides new evidence that both extends and reaffirms findings of a relation between unpleasant weather and market activities, and contributes to the broader psychology and economics literature on the impact of weather-induced mood on labor productivity.

This paper examines the relation between cognitive perceptions of management and firm valuation. We develop a composite measure of investor perception using 30-second content-filtered video clips of initial public offering (IPO) roadshow presentations. We show that this measure, designed to capture viewers’ overall perceptions of a CEO, is positively associated with pricing at all stages of the IPO (proposed price, offer price, and end of first day of trading). The result is robust to controls for traditional determinants of firm value. We also show that firms with highly perceived management are more likely to be matched to high-quality underwriters. In further exploratory analyses, we find the impact is greater for firms with more uncertain language in their written S-1. Taken together, our results provide evidence that investors’ instinctive perceptions of management are incorporated into their assessments of firm value.