Knowledge that Transforms

This study identifies several interrelated reasons why firms’ depreciation method choice is likely to influence managers’ capital investment decisions. We find that firms that use accelerated depreciation make significantly larger capital investments than firms that use straight-line depreciation. Further, we find that there has been a migration away from accelerated depreciation to straight-line depreciation over the past two decades. Firms that make such accounting changes make smaller capital investments in the post-change periods than in the pre-change periods. These results suggest that a choice made for external financial reporting purposes influences managers’ capital investment decisions.

We study the optimal accounting policy of a financially constrained firm that pledges assets to raise debt capital for financing a risky project. The accounting system provides information about the value of the collateral. Absent accounting regulation, the optimal accounting system is conditionally conservative: it recognizes an impairment loss if the asset value is below a certain threshold, but never reports unrealized gains. We describe the optimal impairment rule and the optimal precision of the accounting information, and we provide comparative static results that lead to testable predictions on the determinants of impairment rules.

We rely on a unique dataset of 176 privatizations from 32 countries to extend recent research on the link between the political economy and accounting transparency by examining the importance of shareholders’ proportionate holdings to auditor choice. Consistent with our predictions on shareholders’ diverging interests in high-quality financial reporting that manifests in auditor choice, we report strong, robust evidence that privatized firms worldwide become less (more) likely to appoint a Big Four auditor with the extent of state (foreign) ownership. Moreover, we find that these relations between shareholders’ equity stakes and auditor choice strengthen when country-level governance institutions are weaker.

We study the determinants and market impact of sell-side debt research. Analyzing a sample of 5920 debt reports published by 15 brokerage firms from 1999 to 2004, we document that companies with a higher probability of financial distress, lower market-to-book ratio, larger debt, and higher leverage receive more debt research. In addition, we document higher frequency of debt reports around credit ratings downgrades and find that their publication impacts equity prices. The evidence enhances our understanding of the nature of the market forces shaping sell-side debt research and its effect on price formation.

We estimate a firm-year measure of accounting conservatism, examine its empirical properties as a metric, and illustrate applications by testing new hypotheses that shed further light on the nature and effects of conservatism. The results are consistent with the measure, C_Score, capturing variation in conservatism and also predicting asymmetric earnings timeliness at horizons of up to 3 years ahead. Cross-sectional hypothesis tests suggest firms with longer investment cycles, higher idiosyncratic uncertainty and higher information asymmetry have higher accounting conservatism. Event studies suggest increased conservatism is a response to increases in information asymmetry and idiosyncratic uncertainty.

In recent years, credit rating agencies have faced increased regulatory pressure and investor criticism for their ratings’ lack of timeliness. This study investigates whether and how rating agencies respond to such pressure and criticism. We find that the rating agencies not only improve rating timeliness, but also increase rating accuracy and reduce rating volatility. Our findings support the criticism that, in the past, rating agencies did not avail themselves of the best rating methodologies/efforts possible. When their market power is threatened by the possibility of increased regulatory intervention and/or reputation concerns, rating agencies respond by improving their credit analysis.