We study the role of litigation risk in M&A valuations. Specifically, we hypothesize that litigation risk leads to strategic valuations in fairness opinions (FOs) obtained in M&A transactions. Employing a regulatory shock to merger litigation risk and focusing on the most common valuation techniques – peer firm comparables and DCF analysis – we find that target-sought FOs exhibit lower valuations when litigation risk is high. The effect is concentrated in deals with greater agency conflicts between target management and outside shareholders. Furthermore, downward-biased valuations reduce appraisal litigation but are also associated with lower premiums. In contrast to prior work suggesting that target-sought FOs are used to negotiate a higher takeover price, our findings imply that they are used, at least in part, to mitigate litigation risk and facilitate successful deal completion. Our findings are relevant to academics, practitioners, and regulators interested in M&A price formation, and highlight the role litigation plays therein

This study examines the capital-market effects of tipper-tippee insider trading laws. To do so, I exploit the unexpected decision issued by the Court of Appeals for the Second Circuit in U.S. v. Newman 773 F.3d 438, which reduced legal jeopardy for Second Circuit-based market participants prior to being overturned. Consistent with Newman constraining insider trading enforcement, I find strong evidence of plausible insider trading in the Second Circuit following the ruling. I also document a substantial reduction in general trading activity in Second Circuit stocks, as well as an increase in daily quoted spreads and the price impact of trading. These findings are consistent with unchecked insider trading increasing transaction costs and crowding-out investors. In total, my results show that tipper-tippee insider trading restrictions play an important role in bolstering market integrity, and that market participants can to some degree counteract insider trading when public regulation is constrained

Intermediaries play a significant role in capital markets by reducing disclosure processing costs to market participants. Yet, due to selection and other empirical challenges, the extent and mechanisms through which intermediaries influence firm disclosure are largely unknown. To address these challenges, I conduct a field experiment that randomizes coverage of a mandatory disclosure by two key intermediaries—non-governmental organizations and the media. I show that this coverage causes noncompliant firms to publish the disclosure and firms with low-quality disclosures to improve their existing disclosures. Surprisingly, new disclosures from previously noncompliant firms are on average low quality. Survey evidence and cross-sectional tests suggest the main effect may be driven by firms perceiving pressure from the regulator, whose processing costs may have been reduced. My results yield causal estimates of the effect of intermediary coverage on disclosure and shed light on the nature of the stakeholders that subsequently exert costs on firms

SEC confidential treatment (CT) orders are regulatory exemptions that enable firms to redact proprietary information from SEC filings if the disclosure would cause competitive harm and if the information is immaterial to investors. This study examines the role of firms' political connections in the SEC's decisions to approve versus reject CT requests before and after Congressional intervention and internal SEC scrutiny into the CT process. CT requests from politically connected firms are less likely to be rejected before Congressional intervention and internal SEC scrutiny and are more likely to be rejected following these events. When the SEC rejects CT requests, firms must disclose the contents of the unapproved redactions. These disclosures are informative to investors, on average, and are less informative following Congressional intervention and internal SEC scrutiny. Together, these findings contribute to the literature on political influence in SEC oversight and disclosure regulation and provide unique evidence on the role of Congressional intervention in SEC decision making

This study investigates the degree of concordance between fifteen measures of audit quality used in academia and two measures of audit process quality determined either by audit firms’ internal inspections or by Public Company Accounting Oversight Board inspections of individual engagements. Using two confidential datasets of these assessments of audit process quality, I find that three of the measures of audit quality used by academics have significant associations with both measures of audit process deficiencies used by auditors and regulators: (i) the propensity to restate financial statements, (ii) the propensity to meet or beat the zero earnings threshold, and (iii) audit fees. Seven academic proxies are significantly associated with only one audit process quality measure, and five have insignificant associations with both practitioner assessments. Overall, the significant associations indicate that practitioners and academics share common ground in identifying low-quality audits. These findings can provide guidance for future studies in selecting audit-quality proxies suitable for different research questions

To gain insight into the impact of the Public Company Accounting Oversight Board’s (PCAOB) auditor inspection program, I examine the association between the PCAOB’s access to inspect auditors of foreign SEC registrants and audit quality. Although the PCAOB is mandated to inspect all auditors of SEC registrants, certain foreign governments prohibit PCAOB inspections of their domestic auditors, providing variation in PCAOB inspection access that is not available when studying a sample of US companies. I find that auditors subject to PCAOB inspection access provide higher quality audits as measured by more going concern opinions, more reported material weaknesses, and less earnings management, relative to auditors not subject to PCAOB inspection access. There is no observable difference between the two sets of auditors prior to the PCAOB inspection regime. The positive effect of PCAOB inspection access on audit quality is observed in jurisdictions with, and without, a local audit regulator. Overall, the results are consistent with PCAOB inspection access being positively associated with audit quality

Earnings distributions commonly exhibit statistically significant discontinuities at zero earnings, which are widely interpreted as evidence of earnings management to avoid a loss. In contrast, Durtschi and Easton, 2005, Durtschi and Easton, 2009 assert that discontinuities are instead explained by some combination of prior researchers׳ choice(s) of scaling and sample selection as well as a scaling-related effect due to a systematic relation between the sign of earnings and market prices. Resolution of the conflicting interpretations of discontinuities is important because (1) it affects how investors, regulators, and scholars view earnings management and (2) it demonstrates the importance of a close linkage between theory and research design choices. We point out that DE provide no evidence that scaling or selection create discontinuities, but only evidence showing that changes in scaling or selection eliminate discontinuities. We demonstrate why the research designs used by DE eliminate discontinuities and why alternative designs using the same data yield statistically significant discontinuities that cannot be attributed to either scaling or selection

This study examines whether and how the properties of corporate bond ratings change following Moody׳s and S&P׳s adoptions of the issuer-pay business model in the early 1970s. Regulators and debt market observers have criticized the issuer-pay model for creating an independence problem. However, the issuer-pay model allows for economic bonding between rating agencies and issuers through explicit contractual arrangements, which should improve the flow of nonpublic information. Using a difference-in-difference research design, I find that more optimistic ratings by issuer-pay rating agencies predict greater future profitability, differences between the ratings of issuer-pay and investor-pay rating agencies are associated with narrower secondary bond market bid-ask spreads, and that issuer-pay rating agencies become relatively more accurate and timely predictors of default compared to investor-pay agencies after the adoption of issuer-pay. These results reinterpret the recent findings of optimistic ratings by Jiang et al. (2012) as consistent with more informative bond ratings

This paper discusses evidence on the costs of the Sarbanes–Oxley Act (SOX) from stock returns and going-private decisions. Zhang, [2007. Economic consequences of the Sarbanes–Oxley Act of 2002. Journal of Accounting and Economics, doi:10.1016/j.jacceco.2006.07.002] analyzes returns around legislative events and concludes that SOX imposes significant costs on firms. Engel, et al. [2007. The Sarbanes–Oxley Act and firms’ going-private decisions. Journal of Accounting and Economics, doi:10.1016/j.jacceco.2007.02.002] examine going-private decisions and point to unintended consequences. Both studies are carefully conducted and deserve praise for tackling an important issue. However, as my discussion highlights, several key findings may not be attributable to SOX and we should exercise caution in interpreting the evidence. While it is not implausible that one-size-fits-all regulation imposes substantial costs on firms, we presently do not have much SOX-related evidence to support this conclusion

Until 1974, firms could choose, within GAAP, to capitalize or expense interest costs associated with capital expenditures. The predominant practice had been to treat interest as a period expense. However, in 1974, the Securities and Exchange Commission imposed a moratorium on further adoption of interest capitalization by non-regulated firms. This study empirically examines economic factors potentially influencing firms' decisions to expense or capitalize interest prior to the SEC moratorium. We hypothesize that the choice may be affected by (1) the existence of management compensation agreements tied to reported earnings, (2) debt covenant constraints, and (3) the political costs (for some firms) of reporting higher earnings. When compared to the control group, our findings are that (1) the frequency of explicit management compensation packages was not greater for the interest capitalization group, (2) firms with financial ratios closer to likely debt agreement constraints (on dividends, interest coverage, and leverage) tended to elect interest capitalization, and (3) other than the largest firms in the ‘politically sensitive’ petroleum refining industry, the larger firms were more likely to capitalize interest