Knowledge that Transforms

This study investigates whether and how customer-base concentration affects supplier firm fundamentals and stock market valuation. I compile a comprehensive sample of supply chain relationships and develop a measure (CC) to capture the extent to which a supplier's customer base is concentrated. In contrast to the conventional view of customer-base concentration as an impediment to supplier firm performance, I document a positive contemporaneous association between CC and accounting rates of return, suggesting that efficiencies accrue to suppliers with concentrated customer bases. Consistent with a cause-and-effect link between customer-base concentration and supplier firm performance, analysis of intertemporal changes demonstrates that CC increases predict efficiency gains in the form of reduced operating expenses per dollar of sales and enhanced asset utilization. Using stock returns tests, I find that investors underreact to the implications of changes in customer-base concentration for future firm fundamentals when setting stock prices. A trading strategy that exploits investors' underreaction yields abnormal stock returns over the 30-year period studied. JEL Classifications: M41; L25; G14. Data Availability: Data are available from the sources indicated in the text.

This study examines the sources of credit risk associated with asset securitizations and whether credit-rating agencies and the bond market differ in their assessment of this risk. Measuring credit risk using credit ratings, we find the securitizing firm's credit risk is positively related to the firm's retained interest in the securitized assets and unrelated to the portion of the securitized assets not retained by the firm. Measuring credit risk using bond spreads, we find the securitizing firm's credit risk is positively related to both the firm's retained interest in the assets and the portion of the securitized assets not retained by the firm. Additionally, our findings indicate the bond market does not distinguish between the retained and non-retained portions of the securitized assets when assessing the credit risk of the securitizing firm. These different assessments of sources of credit risk associated with asset securitizations provide insight into ongoing controversies surrounding the financial reporting for asset securitizations and the efficacy of credit ratings.

I investigate the possibility that recent price movements include significantly larger speculative components than those observed historically, where speculation is defined as the component of price that does not co-move with fundamentals. Specifically, at the aggregate level, price and accounting fundamentals co-move historically (1979–1993) but do not co-move recently (1994–2008). The lack of co-movement in recent periods is accompanied by a significant reduction in the positive association between ratios of accounting fundamentals-to-price with future market returns. Changes in measurement error in accounting fundamentals do not appear to cause the lack of co-movement in recent periods, and risk- and growth-based explanations are not supported by the data. The results of this study provide evidence of a structural change in the long-run association between price and accounting fundamentals. Data Availability: Data are available from public sources identified in the study.

Evidence evaluation in accounting often involves both the assessment of evidence relevance and the combination of its relevance and source to assess overall strength. We decompose this strength-assessment judgment into its components—relevance assessment and source and relevance combination—and consider the effects of experience. Participants in our experiment assess the strength and relevance of tax authorities in relation to a client scenario. Contrary to prior research, we find that more-experienced participants exhibit greater use of analogical reasoning when evaluating tax-authority relevance than do less-experienced participants. We find a similar experience effect in the use of configural information processing to combine authority source and relevance, a judgment not previously considered in tax. The effects of experience are particularly important in the current environment as the tax function is a leading cause of material weaknesses and restatements under Sarbanes-Oxley and tax executives cite increasing difficulty in hiring and retaining qualified professionals. Data Availability: Data are available from the authors on request.

I study whether managers use real activities manipulation and accrual-based earnings management as substitutes in managing earnings. I find that managers trade off the two earnings management methods based on their relative costs and that managers adjust the level of accrual-based earnings management according to the level of real activities manipulation realized. Using an empirical model that incorporates the costs associated with the two earnings management methods and captures managers' sequential decisions, I document large-sample evidence consistent with managers using real activities manipulation and accrual-based earnings management as substitutes. Data Availability: Data are available from public sources indicated in the text.

Whether the information environment affects the cost of capital is a fundamental question in accounting and finance research. Relying on theories about competition between informed investors as well as the pricing of information asymmetry, we hypothesize a cross-sectional variation in the pricing of information asymmetry that is conditional on competition. We develop and validate empirical proxies for competition using the number and concentration of institutional investor ownership. Using these proxies, we find a lower pricing of information asymmetry when there is more competition. Overall, our results suggest that competition between informed investors has an important effect on how the information environment affects the cost of capital.

Press releases accompanying earnings restatements attempt to minimize negative reactions by explaining the reasons for the restatement. Although text-based press releases have been the norm for years, firms have recently begun using online video for such announcements. We examine the implications of doing so, and find that when a CEO accepts responsibility by making an internal attribution for a restatement, investors viewing the announcement online via video recommend larger investments in the firm than do investors viewing the announcement online via text. In contrast, when the CEO denies responsibility by making an external attribution for the restatement, investors viewing the announcement online via video recommend smaller investments in the firm than do investors viewing the announcement online via text. Our results also reveal that investor trust mediates the effect of disclosure venue and attribution on investment recommendations. These findings are important given the economic significance and trust-damaging implications of restatements, as well as the increased use of online video to make important announcements. Data Availability: Contact the authors for data and video.

This study examines whether the mandatory adoption of International Financial Reporting Standards (IFRS) in the European Union significantly improves information comparability in 17 European countries. We employ three proxies—the similarity of accounting functions that translate economic events into accounting data, the degree of information transfer, and the similarity of the information content of earnings and of the book value of equity—to measure information comparability. Our results suggest that mandatory IFRS adoption improves cross-country information comparability by making similar things look more alike without making different things look less different. Our results also suggest that both accounting convergence and higher quality information under IFRS are the likely drivers of the comparability improvement. In addition, we find some evidence that cross-country comparability improvement is affected by firms' institutional environment. Data Availability: Data are available from commercial providers (Worldscope, DataStream, and I/B/E/S).

Using path analysis, we investigate the direct and indirect links between three measures of earnings quality and the cost of equity. Our investigation is motivated by analytical models that specify both a direct link and an indirect link that is mediated by information asymmetry, but do not suggest which link would be more important empirically. We measure information asymmetry as both the adverse selection component of the bid-ask spread and the probability of informed trading (PIN). For a large sample of Value Line firms during 1993–2005, we find statistically reliable evidence of both a direct path from earnings quality to the cost of equity, and an indirect path that is mediated by information asymmetry, with the weight of the evidence favoring the direct path as the more important.

Gray markets arise when a manufacturer's products are sold outside of its authorized channels, for instance when goods designated by a multinational firm for sale in a foreign market are resold domestically. One method multinationals use to combat gray markets is to increase transfer prices to foreign subsidiaries in order to increase the gray market's cost base. We illustrate that, when a gray market competitor exists, the optimal transfer price to a foreign subsidiary exceeds marginal cost and is decreasing in the competitiveness of the domestic market. However, a multinational's discretion in setting transfer prices may be limited by mandatory arm's length transfer pricing rules. Provided gray markets exist, we characterize when mandating arm's length transfer pricing lowers domestic social welfare relative to unrestricted transfer pricing. We also demonstrate that gray markets can lead to higher domestic tax revenues, even when gray market firms do not pay taxes domestically.