Knowledge that Transforms

In a cross-country setting we show the probability of a forced CEO turnover in large banks is positively associated with idiosyncratic tail risk. This finding is strengthened the greater the competition in the banking industry and when stakeholders have more to lose in the case of distress. Overall, the exposure to idiosyncratic tail risk offers valuable signals to bank boards on the quality of the choices made by CEOs. In contrast, systematic tail risk becomes important for forced CEO turnovers only in the presence of a major variation in the costs this risk generates for shareholders and the organization.

We examine whether managerial sentiment is associated with errors in accrual estimates. Using public banks we find (1) managerial sentiment is negatively associated with loan loss provision estimates, (2) future charge-offs per dollar of provision are positively associated with sentiment when the provision is estimated, and (3) the effects of sentiment are greater for firms with more uncertain charge-offs. Results are similar for private banks, suggesting accrual manipulation related to capital market incentives is unlikely to explain the results. Although economic fundamentals explain most of the variation in the provision, we find sentiment has an incremental and economically meaningful effect.

We investigate whether geographic proximity between corporate headquarters and IRS regional offices affects corporate tax avoidance and the likelihood and productivity of IRS examinations. Using geographic distance to represent information asymmetry, we find that corporations avoid more tax when located closer to the IRS unless they are close to an IRS industry specialist. This finding is consistent with taxpayers believing proximity provides them with an information advantage over the IRS. From the perspective of the IRS, we find that the Service is more likely to audit nearby companies and to assess more tax per hour from nearby taxpayers, except during constrained budget years. IRS audit likelihood and productivity are unaffected by the presence of nearby industry specialists, consistent with industry specialist proximity already constraining avoidance. Our tax compliance setting provides dual-party evidence on the proximity-information asymmetry hypothesis.

We examine whether analysts’ prior industry experience influences their ability to serve as effective external firm monitors. Our analyses of firms’ financial disclosure quality, executive compensation and CEO turnover decisions portray a consistent picture that related pre-analyst industry experience is of critical importance for analysts to play an effective monitoring role. Coverage by analysts with such experience is associated with reduced earnings management, lower probability of committing financial misrepresentation, less CEO excess compensation, and higher performance sensitivity of CEO turnover. We also provide evidence on several plausible mechanisms through which industry expert analysts exert monitoring efforts and limit managerial opportunism.

We hypothesize and find evidence consistent with foreign firms being tax-favored acquirers of U.S. targets with greater locked-out earnings because they can avoid the U.S. tax on repatriations. This effect is economically significant; a standard deviation increase in lockout is associated with a 12% relative increase in the likelihood that an acquirer is foreign. We also find evidence that foreign acquirers of the target firms are more likely to be residents of countries that use territorial tax systems, as the tax advantages for a foreign firm acquiring a U.S. target with locked-out earnings are even greater for these acquirers.

We document marked trends in 10-K disclosure over the period 1996–2013, with increases in length, boilerplate, stickiness, and redundancy and decreases in specificity, readability, and the relative amount of hard information. We use Latent Dirichlet Allocation (LDA) to examine specific topics and find that new FASB and SEC requirements explain most of the increase in length and that 3 of the 150 topics—fair value, internal controls, and risk factor disclosures—account for virtually all of the increase. These three disclosures also play a major role in explaining the trends in the remaining textual characteristics.

We examine the relation between workplace safety and managers’ attempts to meet earnings expectations. Using establishment-level data on workplace safety from the Occupational Safety and Health Administration, we document significantly higher injury/illness rates in firms that meet or just beat analyst forecasts compared to firms that miss or comfortably beat analyst forecasts. The higher injury/illness rates in firms that meet or just beat analyst forecasts are associated with both increases in employee workloads and in abnormal reductions of discretionary expenses. The relation between benchmark beating and workplace safety is stronger when there is less union presence, when workers’ compensation premiums are less sensitive to injury claims, and among firms with less government business. Our findings highlight a specific consequence of managers’ attempts to meet earnings expectations through real activities management.

SEC oversight of publicly listed firms ranges from comment letter (CL) reviews of firms’ reporting compliance to pursuing enforcement actions against violators. Prior literature finds that firm political connections (PC) negatively predict enforcement actions, inferring SEC capture. We present new evidence that firm PC positively predict CL reviews and substantive characteristics of such reviews, including the number of issues evaluated and the seniority of SEC staff involved. These results, robust to identification concerns, are inconsistent with SEC capture and indicate a more nuanced relation between firm PC and SEC oversight than previously suggested.

We quantify measurable benefits and costs of exempting firms from auditor oversight of internal control effectiveness disclosures. We measure the benefit of exemption as an aggregate 388 million in audit fee savings from 2007–2014. The costs stem from internal control misreporting: an aggregate 719 million of lower operating performance due to non-remediation and a $935 million delay in aggregate market value decline due to the failure to disclose ineffective internal controls. The audit fee savings benefit shareholders of all exempt firms, whereas the costs are borne by shareholders of only a fraction of exempt firms (the internal control misreporters).

We identify covenants in commercial loan contracts that require public borrowers to periodically disclose two types of accounting-related private information to lenders: projected financial statements for future periods and monthly historical financial statements. We hypothesize and provide evidence that: (1) loan contracts include these covenants in settings where they enhance lenders’ loan contract monitoring; (2) the covenants are positively associated with the frequency of loan contract amendments; and (3) lenders trade on the borrower private information they receive in secondary loan markets. We further show that the two types of covenants have predictably different determinants and effects.