Knowledge that Transforms

We examine the role of firms’ internal information quality (IIQ) in designing executive incentive contracts. We find that higher IIQ is associated with a greater number of performance metrics and increased dissimilarity from peer firms’ contracts, particularly along non-financial dimensions. These relations hold when we examine changes in IIQ that are likely induced by plausibly exogenous shifts in two financial accounting standards. We further find that incorporating more numerous and more dissimilar non-financial metrics is positively associated with future profitability, but only when IIQ is high. Our results are consistent with the hypothesis that the quality of a firm’s internal information is a friction in performance metric selection.

This paper investigates the effect of frictions in consumption taxes on firms' product mix decisions. We use a stacked difference-indifferences approach that exploits the staggered transition from a sales tax with the risk of tax cascading to a value added tax (VAT) with credits on inputs across states in India, as well as detailed data on listed manufacturing firms' production decisions. We find that the switch to a VAT system induces affected firms to narrow their product scope and to reduce vertical integration. That is, firms cut the internal production of input goods and instead focus their production on their best-performing products. Firms affected by the switch to VAT reduce their firm size and are more likely to outsource production of input goods. We also show that this vertical disintegration results in lower manufacturing costs, higher profitability and firm value, and increased investment efficiency for affected firms. Overall, the paper shows that alleviating frictions in sales tax or VAT systems can reduce investment and productivity distortions and improve the allocation of capital across firms.

Do industries use advertising strategically when subject to the threat of political costs? Communication via advertising can assuage public concerns, which, in turn, reduces the incentives for elected officials to impose regulations on the industry. We identify expected political costs using cases of repeated industry testimony at congressional hearings. To disentangle strategic advertising in response to the threat of political costs from advertising for other reasons (e.g., reputation building or to generate sales), we exploit the fact that only politicians overseeing industry-relevant hearings can impose costs on a given industry. We find that subsequent to these hearings, affected industries increase their advertising by 132% more in the electorates of the politicians overseeing the hearings, relative to the increase in the electorates of other politicians. The strategic increase in advertising is magnified in the electorates served by the most senior politicians on the committees and those with the most politically engaged citizens. The increase is also pronounced in election years, when the hearings are longer, contain more negative language, or include a higher proportion of legislation-related words. Moreover, our results are not driven by politicians’ decisions to serve on committees relevant to their local-area firms. In sum, our findings provide novel evidence about corporate communication with non-investor stakeholders.