Knowledge that Transforms

We examine the economic determinants of short-sale supply, and its consequences for future stock returns. Lendable supply increases with expected borrowing costs and decreases with financial statement constructs that indicate overvaluation. Although rising loan fees help ease supply constraints, we find shares are still least available when they are most attractive to short sellers. Using a number of firm characteristics, we derive useful instruments for real-time loan supply and demand conditions in the lending market. Further, we show that (1) when lendable supply is binding (non-binding), short-sale supply (demand) is the main predictor of future stock returns, (2) abnormal returns to the short-side of nine well-known market anomalies are attributable solely to “special” stocks, and (3) loan fees significantly reduce the profitability of the short side and several of these anomalies cease to be profitable. Overall our evidence highlights the central role played by the supply of lendable shares in equity price formation and returns prediction.

We examine the link between corporate governance, managerial incentives, and corporate tax avoidance. Similar to other investment opportunities that involve risky expected cash flows, unresolved agency problems may lead managers to engage in more or less corporate tax avoidance than shareholders would otherwise prefer. Consistent with the mixed results reported in prior studies, we find no relation between various corporate governance mechanisms and tax avoidance at the conditional mean and median of the tax avoidance distribution. However, using quantile regression, we find a positive relation between board independence and financial sophistication for low levels of tax avoidance, but a negative relation for high levels of tax avoidance. These results indicate that these governance attributes have a stronger relation with more extreme levels of tax avoidance, which are more likely to be symptomatic of over- and under-investment by managers.

Recent research shows that high return dispersion (RD) is associated with economic conditions characterized by high discount rates, which are not conducive to growth and investment. We propose that RD risk can explain the accrual and investment anomalies. We conduct asset-pricing tests that include RD as a potential risk factor and show that low-accrual and low-investment firms have significantly higher exposure to the risk captured by RD. RD significantly explains future returns and the excess returns to accrual and investment hedge portfolios shrink in magnitude and become insignificant during periods of low RD. We conclude that risk explains the accrual and investment anomalies.

Discontinuities in earnings distributions at zero have been widely cited as evidence of earnings management but not without controversy. Recent research suggests discontinuities may be mere artifacts of certain research design choices. We find that the well-known zero-earnings discontinuity disappears soon after passage of the Sarbanes–Oxley Act (SOX) and has not returned. We also find that neither the discontinuity nor its disappearance require the effects of widely cited alternative (non-earnings management) explanations for the zero-earnings discontinuity.

We show that firms׳ ability to avoid taxes is affected by the quality of their internal information environment, with lower effective tax rates (ETRs) for firms that have high internal information quality. The effect of internal information quality on tax avoidance is stronger for firms in which information is likely to play a more important role. For example, firms with greater coordination needs because of a dispersed geographical presence benefit more from high internal information quality. Similarly, firms operating in a more uncertain environment benefit more from the quality of their internal information in helping them to reduce ETRs. In addition, we provide evidence that high internal information quality allows firms to achieve lower ETRs without increasing the risk of their tax strategies (as measured by ETR volatility). Overall, our study contributes to the literature on tax avoidance by providing evidence that the internal information environment of the firm is important for understanding its tax avoidance outcomes.

Recent research finds that many analyst recommendation revisions take place shortly after earnings announcements. Altinkilic and Hansen (2009) attribute the clustering of recommendations to analysts strategically piggybacking on earnings information to improve the perceived performance of their recommendations. This study proposes an alternative view: I find that analysts issue recommendations when they face greater demand from investors, when the relative supply of information available on earnings announcements is higher and when they detect mispricings. These results are consistent with analysts striving to meet the demands of investors by providing useful recommendations after earnings announcements.

In contrast to theoretical and empirical evidence linking disclosure to information environment benefits, recent research concludes that guidance increases volatility, but leaves open the question of whether volatility plays a role in prompting the issuance of guidance. Consistent with the notion that managers react to rising volatility by providing guidance, we document a link between abnormal run-ups in volatility and the decision to issue a forecast after controlling for the market’s ability to anticipate the guidance. Upon disentangling pre-guidance volatility changes from post-guidance volatility changes, we find no evidence that guidance increases volatility. Indeed, our evidence consistently supports the view that managers seek to and do mitigate share price volatility with guidance.

This paper examines the demand for disclosure rules by informed managers interested in increasing the market price of their firms. Within a model of political influence, a majority of managers chooses disclosure rules with which all firms must comply. In equilibrium, disclosure rules are asymmetric with greater levels of disclosure over adverse events. This asymmetry is positively associated with the informativeness of the measurement and increasing in the level of verifiability and ex-ante uncertainty of the information. The theory also offers implications about the relation between mandatory and voluntary disclosure, when both channels are endogenous.

One key challenge for the short selling literature is to identify the incremental contribution of various measures of short sale constraints. Although variables such as loan fee, loan supply and short interest are determined simultaneously in the market for borrowing stock, new incremental information may be found in each variable examined. Papers such as Beneish et al. (2015) attempt to disentangle the effect of one particular variable, and attempt to shed light on the parallel challenge faced by investors in determining which variables will make the most impact on returns as well as trading costs. We discuss a number of practical approaches to this challenge, and we also consider a potentially new take that considers accounting-data-driven anomalies as one of the possible exogenously determined variables in the equilibrium of the equity loan market.

We examine annual report text for over 15,000 non-US companies from 42 countries over the period 1998–2011, focusing on the length of disclosure, presence of boilerplate, comparability with US and non-US firms, and complexity. We find that textual attributes are predictably associated with regulation and incentives for more transparent disclosure and are correlated with economic outcomes such as liquidity, institutional ownership, and analyst following. Using mandatory IFRS adoption as an exogenous shock, annual report disclosure improved in the sense that quantity of disclosure increased, boilerplate was reduced, and comparability increased relative to both US and non-US firms. Firms with the greatest improvements in financial reporting experienced the greatest improvements in economic outcomes around IFRS adoption.