Knowledge that Transforms

We investigate the consequences of public disclosure of information from company income tax returns filed in Australia. Supporters of more disclosure argue that increased transparency will improve tax compliance, while opponents argue that it will divulge sensitive information that is, in many cases, misunderstood. Our results show that in Australia large private companies experienced some consumer backlash and, perhaps partly in anticipation, some acted to avoid disclosure. We detect a small increase (decrease) in tax payments for private (public) firms subject to disclosure suggesting differential costs of disclosure across firms. Finally, we find that investors react negatively to anticipated and actual disclosure of tax information, most likely due to anticipated policy backlash rather than consumer backlash or the revelation of negative information about cash flows. These findings are important for both managers and policy makers, as the trend towards increased tax disclosure continues to rise globally.

We exploit the exogenous shock of a 2005 U.S. Supreme Court decision on securities class action loss causation requirements to examine two ways that firms bundle information with restatements: “positive bundling” of good news and “noise bundling” of additional bad news. We find that positive bundling offsets price declines and results in less litigation. In contrast, noise bundling magnifies price declines, but nevertheless deters litigation by confounding which bad news caused a decline. Non-bundled restatements are 5.94 times more likely to result in litigation. Bundled restatements have 8.17 times higher dismissal rates and 21.17 to 23.45 million lower settlement amounts.

We develop a Clawback Strength Index and show that while some firms adopt unambiguous and strong clawback provisions, others adopt weak ones. We find that strong clawback adopters experience improvements in financial reporting quality, fewer CEO turnovers, and lower CEO pay. We advance two possible explanations: First, clawback strength may be primarily responsible for the improvements in reporting quality. Second, strong clawbacks may yield benefits because they are part of a broader reform package. While our findings on reporting quality and CEO turnover are consistent with both explanations, our results on CEO pay support only the broader reform explanation.

Recent literature emphasizes the importance of a director's external network of social connections. I use a sample of closed-end funds to show that internal, within-board connections are also significant determinants of shareholder value. I find that boards with shared education, employment, and family backgrounds exhibit lower market values, higher expense ratios, higher director compensation levels, and an increased likelihood of financial misrepresentation. Director turnover is lower within these boards, and new director appointments are more likely to share connections with incumbent directors. I conclude that internal board networks negatively impact a firm's governance environment and overall monitoring quality.

The JOBS Act allows certain analysts to be more involved in the IPO process, but does not relax restrictions on analyst compensation structure. We find that these analysts initiate coverage that is more optimistically biased, less accurate, and generates smaller stock market reactions. Investors purchasing shares following these initiations lose over 3% of their investment by the firm's subsequent earnings release. By contrast, issuers, analysts, and investment banks appear to benefit from this increased bias, as optimism is more positively associated with proxies for firm visibility and investment banking revenues when analysts are involved in the IPO process.

Using hand-collected information, we find that analysts who own stock in a company they follow make more informative recommendations and exert more effort in covering the company. However, we also find that analysts with stock ownership issue more optimistic target price forecasts. These findings suggest that analysts’ stock ownership enhances the credibility of their recommendations by conveying their superior information, but also induces analysts to bias upwards their target price forecasts. Surprisingly, we find that 56% of analysts owning stock terminate their ownership while having a buy recommendation outstanding, suggesting a potentially widespread violation of the regulations on analysts’ research.

I examine the effects of proprietary information on corporate transparency and voluntary disclosure. To do so, I develop and validate two measures of firms’ reliance on trade secrecy: one based on 10-K disclosures and one based on subsequent litigation outcomes. I complement these measures by using the staggered passage of the Uniform Trade Secrets Act as a shock to trade secrecy. I find that firms that begin to rely more heavily on trade secrecy substitute increased voluntary disclosure of nonproprietary information for decreased disclosure of proprietary information. The total effect of trade secrecy is a decrease in corporate transparency.

We develop a measure to capture an audit firm's competitive position in a local audit market based on the transaction costs of changing audit firms included in DeAngelo's (1981) multi-period audit pricing model. Our competition measure reflects the size difference between the largest audit firm in a market specified by client industry at the city level and the other audit firms operating in that market. We find that audit fees of a client decrease as this size difference increases. This result suggests that smaller audit firms charge lower audit fees because of their competitive disadvantage to the local largest firm.

We use an experiment with experienced managers to provide more-direct evidence on how reporting goals and firm performance influence language choices. We find that bad news disclosures are less readable than good news, but only when managers have a stronger self-enhancement motive. Our results suggest that this difference is driven mainly by attempts to write more readable good news reports as opposed to intentional obfuscation of poor performance. In order to frame poor performance in a positive light, managers also focus more on the future, provide causal explanations for poor performance, and use more passive voice and fewer personal pronouns.

This study presents a field experiment in which media articles for a random sample of firms with earnings announcements are promoted to a one percent subset of Yahoo Finance users. Promoted firms have higher abnormal returns and some evidence of lower bid-ask spreads on the day of the earnings announcement. These results are more pronounced for less visible firms, negative earnings news, and on days with fewer promoted firms. These findings suggest that investor attention affects the pricing of earnings and that retail investors buy stocks that catch their attention, in a setting where attention is randomly assigned.