Knowledge that Transforms

ABSTRACT To shed light on the role that academic research plays in Securities and Exchange Commission (SEC) rulemaking, this paper examines the SEC's patterns of consumption of academic research from 2007 through 2017. We show how the Business Roundtable v. SEC ruling in 2011 increased consideration given to academic research during SEC rulemaking. We find that after the ruling, the SEC cites more papers in its proposed rules and, in particular, more papers that illustrate the costs of regulation. This change in academic citations results in fewer negative comment letters on proposed SEC regulations. We survey academics whose research was cited by the SEC, and the majority respond that the SEC's description of their work is completely or mostly accurate. When we survey general academics, their average rating of the SEC's accuracy is lower, although the rating improves regarding specific SEC quotes citing academic research. Although there is still room for a more substantive discussion of research, having a higher standard of cost‐benefit analysis leads to a more balanced discussion of academic research.

ABSTRACT Consensus estimates, formed by taking an average of analyst forecasts, play an important role in capital markets (e.g., provide investors with a proxy for earnings expectations). We show I/B/E/S, a prominent information intermediary, removes 6% of one‐quarter‐ahead earnings forecasts before calculating the consensus, and among the 23% of firm‐quarters with at least one forecast removed, this figure rises to 16%. We provide evidence suggesting that I/B/E/S subjectively applies policies that govern its removal decisions and accepts feedback from firms that contributes to this subjectivity. Specifically, we find optimistic forecasts are removed more frequently than pessimistic forecasts, and such asymmetry increases further when removals allow firms to meet or beat the consensus. Furthermore, we find that these effects are more pronounced when managers’ incentives to just meet or beat the consensus are stronger (i.e., higher subsequent insider sales or higher compensation delta), or managers have greater ability to influence I/B/E/S. Lastly, we demonstrate that these subjective removals benefit I/B/E/S by improving consensus accuracy, explaining why I/B/E/S is willing to be influenced by firms.

ABSTRACT Economic downturns create uncertainty about a firm's operations and make it disproportionately harder for outside market participants to assess the firm's prospects. We posit that in this environment, management earnings forecasts will be more informative to investors and analysts. Consistent with this prediction, we find larger stock price reactions and analyst forecast revisions to news in management forecasts during downturns. Holding the amount of news in forecasts constant, stock price reactions to management forecasts are also greater than those to analyst forecasts. We also find that relative to analyst forecasts, management forecast accuracy increases during downturns, suggesting that investors justifiably assess management forecasts as more informative. Overall, we document that macroeconomic conditions create time‐series variation in the informativeness of different sources of information to outside market participants.

ABSTRACT We hypothesize that, in weak‐institution countries, firms adjust the ‘timing’ of dividend payments by committing to distribute a percentage of current earnings as dividends, revealing the extent of firm‐level agency conflicts to future investors and facilitating the raising of external capital. Consistent with this hypothesis, we find that, on average, firms in weak‐institution countries have a higher speed of adjustment ( SOA ) to their target payout ratio, pay dividends earlier in the life cycle, and are more likely to disclose a dividend policy committing to pay a minimum percentage of earnings. Within‐country tests show that, in weak‐institution countries, the firms with the highest SOA dividend policies have fewer agency problems and an increased ability to raise external capital. Finally, returns tests around earnings announcements show that high‐ SOA dividend policies are associated with larger market reactions to earnings in weak‐institution countries. Collectively, our findings suggest that dividend policy helps to alleviate agency conflicts in weak‐institution countries between firms and (future) investors.

ABSTRACT Recent corporate governance scandals have been attributed to a lack of board independence because of the influence CEOs have over their boards. However, CEOs can also affect board efficacy without compromising its independence by strategically choosing directors. We offer a theoretical framework to examine how CEOs can strategically choose director characteristics (such as expertise and skill set) to influence the inner workings of the board. We examine how director expertise affects the board's equilibrium voting strategies and show that some “passivity” on the part of directors can in fact be desirable equilibrium behavior. More importantly, we show that managers can strategically appoint independent outside directors to influence board voting in their favor. Surprisingly, contrary to what we might expect, we find that opportunistic (principled) managers may not always appoint the least (most) able directors to the board. We also examine whether CEOs would prefer a “captured” board (i.e., an insider‐dominated board) and show that the value of director input (i.e., the board's advising role) and the financial markets can discourage CEOs from pursuing such appointments.

ABSTRACT In early 2017, the Public Company Accounting Oversight Board (PCAOB) mandated the disclosure of audit participants, including the lead audit partner and other audit firms participating in the audit (“component auditors”). In this study, we examine whether investors use these disclosures in a way that influences their investment decisions, a primary goal of the PCAOB. Using trading volume, absolute abnormal returns, and bid–ask spreads, we find little evidence of a significant investor response following the disclosure of partner identity or component auditor participation in the first three years of the requirement. We also examine instances where these disclosures are most likely to be informative (e.g., partners associated with restatements or component auditors with PCAOB deficiencies) and find no significant investor response. Taken together, we find little evidence that capital markets respond to partner and component auditor identity in the United States.

ABSTRACT This study provides evidence on the role of public firms’ financial reports in the state‐bond secondary market. I investigate the informational role of corporate earnings announcements and find that public firms’ monthly earnings signals aggregated to the state level are positively associated with contemporaneous state‐bond returns. Further analyses reveal that public firms’ earnings announcements predict traditional economic indicators and contain incremental information that is independent of the traditional economic indicators. In cross‐sectional analyses, I show that the earnings–returns relation is especially pronounced when bondholders face longer investment horizons and higher credit risks. Taken together, the evidence indicates a positive externality of corporate financial reports in alleviating the opacity in the municipal bond secondary market.

ABSTRACT Implied equity duration was originally developed to analyze the sensitivity of equity prices to discount rate changes. We demonstrate that implied equity duration is also useful for analyzing the sensitivity of equity prices to pandemic shutdowns. Pandemic shutdowns primarily impact short‐term cash flows, thus they have a greater impact on low‐duration equities. We show that implied equity duration has a strong positive relation to U.S. equity returns and analyst forecast revisions during the onset of the 2020 COVID‐19 shutdown. Our analysis also demonstrates that the underperformance of “value” stocks during this period is a rational response to their lower durations.

Abstract Most firms covary more positively with downmarkets than upmarkets—a phenomenon I refer to as “risk asymmetry.” I predict and find that risk asymmetry is caused, at least in part, by a firm's ability to selectively obfuscate poor performance. Risk asymmetry decreases significantly when firms are required to adhere to the more stringent auditing standards mandated under Section 404 of the Sarbanes‐Oxley Act, however this decrease is more muted for firms with weak internal controls. Consistent with my predictions, these patterns are stronger for more market‐sensitive firms and weaker for firms that include relative performance evaluation in their CEOs' pay packages. Taken together with prior literature (which documents that risk asymmetry is priced), my results suggest that a firm can lower its cost of capital by credibly reducing its ability to obfuscate value‐relevant information.

ABSTRACT We document that stocks that have optimistic (pessimistic) consensus recommendations and are currently held by many short‐term institutions exhibit large stock‐return reversals: Their large past outperformance (underperformance) is followed by large negative (positive) future alphas. The predictable return reversals originate from overreaction to past recommendation releases and the correction of these overreactions around future releases. Results are stronger when earnings news is released and at firms with higher fundamental uncertainty. Further, firms with more short‐term institutions show stronger announcement returns and price drift after recommendation changes. Our results are consistent with models of higher order beliefs where short‐term institutions coordinate trading around public signals.