Knowledge that Transforms

ABSTRACT In this study, we examine whether, for a sample of retail chains, high levels of employee compensation can deter employee theft, an increasingly common type of fraudulent behavior. Specifically, we examine the extent to which relative wages (i.e., employee wages relative to the wages paid to comparable employees in competing stores) affect employee theft as measured by inventory shrinkage and cash shortage. Using two store‐level data sets from the convenience store industry, we find that relative wages are negatively associated with employee theft after we control for each store's employee characteristics, monitoring environment, and socio‐economic environment. Moreover, we find that relatively higher wages also promote social norms such that coworkers are less (more) likely to collude to steal inventory from their company when relative wages are higher (lower). Our research contributes to an emerging literature in management control that explores the effect of efficiency wages on employee behavior and social norms.

ABSTRACT The SEC's emphasis on the use of plain English is designed to make disclosures more readable and more informative. Using an experiment, I find that more readable disclosures lead to stronger reactions from small investors, so that changes in valuation judgments are more positive when news is good and more negative when news is bad. Drawing on research in psychology to explain this result, I predict and find that processing fluency from a more readable disclosure acts as a subconscious heuristic cue and increases investors’ beliefs that they can rely on the disclosure. Although I do not find that more readable disclosures directly increase perceptions of management credibility, I do find evidence of an indirect effect operating through feelings of processing fluency. In supplemental analyses, I find that investors who receive more readable disclosures revise their valuation judgments to be less extreme when they are explicitly made aware of the potential for variation in readability. I discuss potential explanations for these revised valuation judgments.

We examine how the mandatory adoption of International Financial Reporting Standards (IFRS) in continental Europe affects the contractual usefulness of accounting information in executive compensation, as reflected in pay-performance sensitivity (PPS) and relative performance evaluation (RPE). The empirical evidence indicates a weak increase in accounting-based PPS in the post-adoption period, primarily driven by countries with large differences between IFRS and their previously adopted local accounting standards. We also document a significant increase in accounting-based RPE using foreign peers after the adoption. Additional analysis shows that the increase in RPE is greater for firms with more foreign sales, and for those with lower availability of domestic peers of comparable size. The overall results are consistent with the compensation committees in those countries perceiving earnings after IFRS adoption to be of higher quality and comparability. Our paper highlights an important benefit of IFRS largely ignored by the literature, that is, the higher earnings quality and comparability brought by the adoption of IFRS facilitate executive compensation contracting.

ABSTRACT To restore investors’ confidence in the reliability of corporate financial disclosures, the Sarbanes‐Oxley Act of 2002 mandated stricter regulations and arguably increased auditors’ liability. In this paper, we analyze the effects of increased auditor liability on the audit failure rate, the cost of capital, and the level of new investment. We focus on a setting in which, with imperfect auditing, a firm has better information than investors about its prospects and seeks to raise capital for new investments in a lemons market. The equilibrium analysis derives corporate reporting and investing choices by the firm, attestation opinions by the auditor, and valuation by rational investors. Three empirically testable predictions emerge: although increasing auditor liability decreases the audit failure rate and the cost of capital for new projects, it also decreases the level of new profitable investments.

ABSTRACT Recent evidence shows that option volatility skews and volatility spreads between call and put options predict equity returns. This study investigates whether such predictive ability is driven by option traders’ information advantage. We examine the predictive ability of volatility skews and volatility spreads around significant information events including earnings announcements, other firm‐specific information events, and events that trigger significant market reactions. Consistent with option traders having an information advantage relative to equity traders before information events, we find that the option measures immediately before these events have higher predictive ability for short‐term event returns than they do in a more dated window or before a randomly selected pseudo‐event. We also find that option measures have predictive ability after information events. However, this predictive ability holds only for unscheduled corporate announcements, which suggests that, relative to equity traders, option traders have superior ability to process less anticipated information.

ABSTRACT The objective of this study is to investigate factors that influence investor information demand around earnings announcements and to provide insights into how variation in information demand impacts the capital market response to earnings. The Internet is one channel through which public information is disseminated to investors and we propose that one way that investors express their demand for public information is via Google searches. We find that abnormal Google search increases about two weeks prior to the earnings announcement, spikes markedly at the announcement, and continues at high levels for a period after the announcement. This finding suggests that information diffusion is not instantaneous with the release of the earnings information, but rather is spread over a period surrounding the announcement. We also find that information demand is positively associated with media attention and news, and is negatively associated with investor distraction. When investors search for more information in the days just prior to the announcement, preannouncement price and volume changes reflect more of the upcoming earnings news and there is less of a price and volume response when the news is announced. This result suggests that, when investors demand more information about a firm, the information content of the earnings announcement is partially preempted.