Knowledge that Transforms

We examine how exposure to international tax competition affects domestic firms’ employment. Consistent with prior work, we find evidence that reductions in foreign tax rates affect the domestic competitive environment via increases in import competition and investment in foreign-owned subsidiaries. We posit that these changes in the domestic competitive environment can cause managers to reduce their firms’ employment levels. Consistent with our expectation, we find that relative decreases in foreign tax rates negatively affect total labor compensation at domestic firms ex ante exposed to import competition and competition from foreign-owned peers. The effect of exposure to tax competition is greater for firms more exposed to product-market competition and those that are less able to expand investment without also increasing employment levels. Taken together, our results suggest that foreign tax rate changes can affect managers’ domestic employment decisions by changing the domestic competitive environment.

This study examines the informational value of local news outlets and how they affect insider trading. We hypothesize that local news coverage is a critical channel through which outsiders acquire local information, which restricts insiders’ ability to profit from their information advantage. We argue that a loss of local news coverage increases information opacity faced by outsiders, while making it easier for insiders to seize profitable trading opportunities. Exploring the staggered shutdown of local newspapers, our difference-in-differences estimation presents novel evidence that insiders from closure counties trade more profitably after local newspaper closures, particularly in small firms that lack alternative news sources. Further analyses reaffirm that the post-closure increase in trading profits is unlikely to be wholly driven by regional economic conditions and is likely driven by increased information costs. Our results highlight that local newspapers play a meaningful role in mitigating information asymmetry between insiders and outsiders. Data Availability: Data used in this study are available from the sources identified in the paper.

This study examines the effect of banking market consolidations via mergers and acquisitions (M&As) on the role of banks in intermediating corporate tax planning through offshore tax haven operations. We find that bank clients significantly increase their tax haven operations after their banks are merged with others. In addition, such an increase is greater when a commercial bank merges with an investment bank and when the clients have greater tax planning opportunities. We also employ network analyses to show that the propensity for a client to expand its operations into a new tax haven country increases significantly when its relationship bank enters into this country through an M&A. Collectively, our findings reveal that bank M&As enhance banks’ tax intermediation capability.

A longstanding literature suggests that earnings provide the market with relevant information about firm performance, but one often overlooked benefit is their role in disciplining market expectations. This study examines the role of earnings announcements in constraining potential mispricing associated with firm-specific media sentiment. We show that media sentiment-driven quarterly returns (orthogonal to risk factors and fundamental news) largely reverse when public earnings are released. Our results suggest that quarterly earnings announcements play an important role in reducing media sentiment-related mispricing. Data Availability: Data are available from the public sources cited in the text.

I examine whether audit committees (ACs) improve financial reporting reliability by utilizing an internal audit function (IAF) as a resource and use semistructured interviews with chief audit executives and AC chairs to develop an understanding of the nature of AC-IAF relations. Using AC charters, I measure AC interaction with IAFs, finding improvement in financial reporting reliability for firms that introduce a new IAF under a New York Stock Exchange (NYSE) mandate. This improvement is limited to firms with significant interaction between ACs and new IAFs. Using detailed hand-coded data, I investigate the different kinds of interactions between ACs and IAFs, finding evidence of the importance of private meetings to review the IAF's scope, findings, and recommendations. The value of the IAF as a resource to the AC is greater when the AC ensures free and open communication, promotes IAF independence, and stands in greater ex ante need of monitoring assistance.

Auditor knowledge is a key element in explaining the supply of audit quality, yet understanding of the drivers of this knowledge in the archival literature is limited. This study uses an archival approach to examine whether the sharing of auditors among firms in banking relationships results in information transfers that improve audit quality. I find that audit quality improves for both borrowers and lenders who share the same auditor office. Specifically, lenders who share an auditor office with their borrowers have more accurate loan-loss provisions, especially lenders with smaller commercial loan portfolios. Borrowers who share an auditor office with their lender are less likely to receive a clean audit opinion just prior to bankruptcy. Overall, these findings are consistent with shared auditors in banking relationships developing client specific knowledge that is transferable across clients and industries.

Corporate managers are often better informed than outside investors about the uncertain future benefits of investments. However, information about investment prospects is not verifiable and therefore not amenable to direct disclosure, but instead inferred by investors from other accounting disclosures. Given this situation, we study the normative question of how the market’s perceptions of uncertainty and its beliefs about the expected level of future benefits of investment should factor into mandatory financial reports of investment expenditures. We establish a threshold of uncertainty in future benefits beyond which it is better to aggregate investment expenditures with cash flow from ongoing operations, rather than measuring and reporting the two separately. We obtain the surprising result that the higher the expectation of future benefits, the lower this uncertainty threshold should be.

Corporate managers often express concern about accounting-induced volatility in financial statements. Accounting regulators, however, argue that the volatility in financial statements merely increases transparency by shining a light on risks that are inherent to the firm’s business. We show that in many situations managerial concerns about volatility are justified because the information that is being provided actually magnifies rather than merely reflects the volatility in a firm’s fundamentals. Corporate managers anticipate the magnified volatility and take preemptive actions to decrease the firm’s exposure to the accounting treatment that induces volatility. These actions may not be in the best interests of external stakeholders, making disclosure costly, while at the same time improving the decisions of external stakeholders. We develop and study the resultant tradeoff that accounting regulators should consider in setting accounting standards.

This study assesses the impact of minority shareholder empowerment via lower defeat thresholds in “say-on-pay” votes on CEO compensation and career prospects for directors. We exploit the adoption of the Australian “two-strikes” rule as a quasi-exogenous shock, which empowers shareholders to vote on board dismissal if a firm’s remuneration report receives 25 percent or more dissent votes for two consecutive years. Using a difference-in-differences methodology, we find that firms respond to a “strike” by curbing excessive CEO pay. Under the two-strikes regime, independent directors are held more accountable for poor oversight and experience significant reputational penalties in terms of turnover and the loss of outside directorships subsequent to receiving a strike. The results are mainly driven by firms receiving a nonmajority strike, indicating that the effectiveness of the two-strikes regime stems largely from the lower defeat threshold. Data Availability: Data are available from the public sources cited in the text.

We examine the evolution of accounting regulation by linking disclosure policies and investments in a dynamic voting model. The disclosure policies are the outcome of voting by entrepreneurs, whose preferences are influenced by their investments. The investments are in turn endogenously determined by current and future disclosure policies. Absent external influences, accounting regimes are stable. A disclosure regime of high (low) quality and a strong (weak) economy coexist and reinforce each other. However, regulatory interventions can result in regime changes by changing the entrepreneurs’ expectations, even without direct enforcement. Unexpected shocks could also result in regime changes by impacting economic conditions and hence voter composition. Our analysis provides a framework to study the interaction between accounting regulation and firms’ economic decisions.