Knowledge that Transforms

We examine the dynamic nature of the information content of aggregate earnings. Specifically, we examine how changes in supply elasticity affect the relation between aggregate earnings and future inflation. Using total capacity utilization to capture supply elasticity, we find that aggregate earnings are more informative about inflation when the supply is inelastic. This finding aligns with the investment demand hypothesis—higher aggregate earnings drive increased investment, pushing inflation higher, when supply is relatively inelastic. Furthermore, when we consider market outcomes such as three-month Treasury yields and aggregate stock returns, the role of supply elasticity pervades. That is, we find that aggregate earnings are more informative for market outcomes primarily when supply is inelastic. Finally, the relation between aggregate earnings and gross domestic product (GDP) also varies with the economy’s supply elasticity. Our findings highlight supply elasticity as a critical factor in interpreting the macroeconomic signals in aggregate earnings.

Abstract A primary argument against fair value measurement is the lack of verifiability, where verifiability is defined as consensus in measurement by independent parties. We evaluate this argument by investigating trends in the consensus of reported fair values. Our findings indicate that consensus increased between 2005 and 2019, as evidenced by reductions in the fair value range and standard deviation. Further analyses suggest that enhanced data availability—driven by public dissemination of trade information—serves as a mechanism for this trend. We also document that securities subject to testing by larger external auditors with more resources to take advantage of enhanced data availability are associated with a stronger trend in increasing consensus. Finally, this trend appears to be stronger in situations when management has a heightened opportunity to record a biased estimate. While conventional arguments express concern over management’s ability to manipulate fair values, our results demonstrate patterns consistent with improved verifiability.

Abstract We use unique disclosures in the insurance industry to examine whether client-engaged specialists (i.e., external actuaries) affect opportunism within the claim loss reserve. Using a fixed-effects approach, we find that external actuaries significantly affect the opportunism in the claim loss reserve, approaching half the effect of the auditor. With respect to actuary characteristics, we find a positive (negative) association between actuary permissiveness (actuary size) and opportunism in the claim loss reserve. In additional analyses, we find that the relation between actuary permissiveness and claim loss reserve opportunism is stronger when insurers have incentives to opportunistically manage the claim loss reserve. This relation continues to persist in the presence of high-quality auditors. Overall, we provide evidence suggesting that client-engaged external actuaries can be used to support opportunistic claim loss reserve estimates.

Abstract The Dodd-Frank Act expands bank managers’ reporting requirements to federal agencies, particularly relating to banks’ financial losses should common market and macroeconomic shocks occur. To comply with this regulation, bank managers have engaged in consulting arrangements (referred to as regulatory consulting). We examine the financial reporting quality implications associated with hiring external auditors for these services. We find banks with auditor-provided regulatory consulting, relative to banks without, have higher financial reporting quality as measured by loan loss provision validity. Consistent with knowledge spillover benefits accruing to financial audit teams, we find more pronounced effects in the fourth versus interim quarters and more frequent income-reducing Y9-C restatements. We also find auditor responsiveness to PCAOB inspections improves the effectiveness of regulatory consulting. Overall, our results suggest regulatory consulting improves the audits of estimates in judgmental financial statement accounts, despite regulatory concerns that these services may impair auditor independence.

Abstract We use publicly available information to estimate the country location of multinational firms’ cash holdings, examine why investors discount the value of cash held overseas, and examine whether that discount changes after the Tax Cuts and Jobs Act (TCJA) of 2017. We provide three main results. First, our firm-year foreign cash estimates are reasonably accurate, evidenced by high correlations with simulated data and proprietary country-level data, high adjusted R 2 when explaining a firm’s total cash holdings, and the ability to replicate prior findings. Second, we demonstrate that investors value foreign cash holdings more negatively than domestic cash holdings when the cash is held in high agency-cost countries. Finally, we find that investors no longer appear to discount foreign cash after the TCJA, when the U.S. moved from a worldwide to a quasi-territorial taxation system.

Abstract We examine whether variation in regulatory leniency is associated with the cost of deposits in the banking industry. We predict that lenient regulatory supervision allows for greater bank risk-taking due to delayed intervention, resulting in a higher cost of deposits. Our main finding is a positive association between banks’ cost of uninsured deposits and the leniency of their state regulators, incremental to observable measures of risk and performance. We further show that this result is stronger for riskier banks and when uninsured depositors have a greater ability or incentive to influence deposit rates. These findings suggest that the leniency of bank regulators is priced in uninsured deposit rates and further our understanding of the factors associated with regulatory leniency in the banking industry.

Abstract We examine whether and how language barriers influence a country’s decision to adopt International Financial Reporting Standards (IFRS). Our findings reveal that as the distance between a country’s official language and English (i.e., linguistic distance) increases, the likelihood and speed of a country adopting IFRS decrease. Our evidence is consistent with the notion that language barriers impose significant information costs on preparers and users of financial reporting, making IFRS costlier to adopt for countries with severe language barriers. In further analysis, we find that such information costs materialize when these countries eventually adopt IFRS. Specifically, firms in countries with the most severe language barriers experience a worsened post-adoption information environment, as evidenced by increased analyst forecast errors and widened bid-ask spreads. Overall our study suggests that language barriers impede achievement of international accounting harmonization by increasing the costs associated with adopting, understanding, and applying IFRS.

Abstract We study the dynamics of information demand and supply in capital markets, focusing on how firms’ disclosures align with analysts’ information needs. Using a novel dataset from Visible Alpha, we analyze granular data from analysts’ forecasting models to understand the breadth of information they seek and how firms meet these demands through mandatory and voluntary disclosures. We document significant variation in the complexity of analysts’ models and the extent of firms’ disclosures, leading to some items in analysts’ models remaining undisclosed. This unmet information demand gives rise to a novel concept we term “uncertainty about the past” ( UP ). We investigate its implications for key capital market outcomes, including analyst forecast dispersion, market reactions to earnings announcements, and stock market liquidity. Our results demonstrate that UP plays a significant role in shaping the information environment, challenging the assumption that earnings announcements fully resolve uncertainty about past performance.

Abstract How important is equal access to mandatory disclosures? We exploit the postal strike of 1970 that caused a delay in the delivery of annual reports via mail. This strike created unequal access because certain investors (e.g., institutions) had both the incentives and ability to obtain the annual reports by other means. Theory predicts that, when differential access exists, adverse selection problems intensify, causing a decline in stock trading. Our findings support this prediction: stock trading volume decreased by approximately 28% for firms unable to deliver the annual reports to shareholders during the strike, and this trading decline gradually dissipated afterward. Further tests confirm adverse selection as the primary mechanism. Overall, our paper underscores the importance of equal access to annual reports—a key mandated disclosure—and demonstrates the value of these reports to shareholders, as evidenced by their reluctance to trade absent this information.

Against the backdrop of an increasing threat of misinformation on social media, several countries have enacted regulations to curb the spread of misinformation. This study examines how corporate social media strategy responds to misinformation regulations. Using a large cross-country dataset of corporate tweets and a stacked regression analysis, we show that misinformation regulations lead to less corporate social media disclosure. This result suggests that, by deterring misinformation, these regulations reduce firms’ need to use social media to counteract its adverse effects. Additional analyses show that the effect strengthens among countries with higher social media usage and those with stronger investor protection but weakens for firms with stronger information environments. Finally, we provide direct evidence that firms post fewer tweets refuting misinformation about themselves following the enactment of these regulations.