Knowledge that Transforms

We investigate the relationship between insider horizon and disclosure policy. First, we develop and analyze a rational expectations model assuming insiders are able to commit to a disclosure policy. Insiders with a short horizon prefer more disclosure and are willing to bear costs of disclosure to reduce information asymmetries among capital market participants. We then empirically test our predictions in the setting of newly public firms and firms where the CEO is approaching retirement. We find that firms with insiders that have a shorter horizon disclose more and experience lower information asymmetry. Our study contributes to the understanding of firms’ disclosure choices by suggesting that the horizon of insiders shapes a firm’s disclosure policy.

This study uses difference-in-differences (DiD) analyses to examine the consequences of adopting the U.S. critical audit matter (CAM) disclosure requirement for preparers and users of financial reports. The CAM requirement is one of the largest expansions of the U.S. audit report since the 1940s. We document significant changes to financial statement footnotes referenced by CAMs, which suggests an indirect consequence where management disclosure changes in areas that are expected to be scrutinized following auditor-provided disclosure. Results also suggest that, on average, CAM disclosures do not provide incremental information to the market. To further examine market reaction, we develop well-specified prediction models for the expected number and subject areas of CAMs. We find limited initial evidence that the market reacts negatively when unexpected CAMs are disclosed. Overall, our findings provide insights on the new CAM standard and particularly demonstrate its relevance to management disclosure decisions and to the market.

We examine whether cost structure influences tax-motivated income shifting. We predict and find that U.S. multinational corporations (MNCs) with a less rigid cost structure engage in greater levels of tax-motivated income shifting relative to MNCs with a more rigid cost structure. This result is consistent with a less rigid cost structure providing greater flexibility to enable MNCs to take advantage of income-shifting opportunities. Further, we find that this relation is more pronounced when firms face greater costs in adjusting their operations, have less transfer pricing flexibility, and operate in a more uncertain environment. These results suggest that firms with less rigid cost structures possess the strategic operating and accounting flexibility necessary to take advantage of income-shifting opportunities. We provide evidence suggesting that a firm’s cost structure, a fundamental attribute of a firm’s business model, is a distinct and incrementally important determinant of tax-motivated income shifting. Data Availability: All data used in this study are publicly available.

We study the economic impacts of adopting harmonized accounting standards when firms’ investments exhibit beauty contest features. We model harmonized accounting standards as common/correlated noises in firms’ accounting reports. We show that while more harmonized accounting standards have ambiguous effects on the reports’ informativeness in representing firms’ underlying fundamentals, they always reduce their usefulness in forecasting aggregate investments. Therefore, the stronger the beauty contest features, the more important the forecasts about the aggregate investment, thus calling for less harmonized accounting standards. We also find that, absent beauty contest features, mandatory adoption of harmonized accounting standards can be unnecessary; however, such a mandate is warranted when beauty contest features are strong as firms, when left on their own, would not voluntarily do so. Taken together, our results provide both a justification for and identification of an unintended consequence of the recent mandates toward adopting harmonized accounting standards.

This study examines how information spillovers from equity to debt markets (“equity spillovers”) affect sell-side debt analysts’ activities and the informativeness of their reports. To explore this relation, I compare debt analyst reports for firms without equity spillovers (private firms) to firms with equity spillovers (public firms). I find that, absent equity spillovers, analysts rely more on mandatory SEC filings to fill the information gap for private firms. This additional effort, however, reduces debt analysts’ coverage of private firms overall. Conditional on coverage, the content of debt analyst reports is remarkably similar across private and public firms. Finally, I find that debt analyst reports are more informative for private firms than for public firms. Collectively, my findings shed light on the externalities created by equity spillovers and how debt market intermediaries contribute to the price discovery process.

We study the profit effects and interplay of two core accounting practices in a field experiment in a large retail chain. In a 2 × 2 factorial design, we vary (1) whether store managers obtain decision-facilitating information on a profit metric and (2) whether they receive performance pay based on the same metric. We find that both practices increase profits significantly. In contrast to reasoning based on standard economic theory, we do not find complementarity between both interventions. Rather, we detect evidence in line with an attention-directing role of both practices: the introduction of each raises attention to the underlying objective, which induces a countervailing substitution effect.

In three experiments, I investigate how supervisors’ task performance in lower-level jobs prior to being promoted to the supervisory level influences the targets they set for employees. I propose that supervisors show an “experience bias” by which they overemphasize their own experiences when setting targets for employees. As such, supervisors who achieved high performance before being promoted set higher targets than low-performing supervisors, despite having the same information about the employee’s potential. In line with my prediction, I find that supervisors exhibit this bias if they have worked on the employees’ task but that this bias is absent when they previously did a different task. I also show that this bias comes from a limited awareness that own experiences are not generalizable and it likely prevails in many managerial situations. The biased targets also lead to negative employee reactions. This study contributes to the understanding of supervisor target setting.

I predict that relative performance evaluation (RPE) CEOs avoid strategic differentiation and increase the correlation of their firms’ returns with that of their peers. This prediction follows from a moral hazard model integrating strategic differentiation decisions: Differentiation enhances performance but exposes firms to risks not shared with peers, and the weakening RPE’s risk-shielding effect. Consistent with my prediction, I find evidence that changes in peer-group correlation are higher for RPE than non-RPE firms. This effect is more pronounced if benefits from differentiation are low, RPE benchmarks are industry specific, or RPE grants are large. Additional analyses provide direct evidence that RPE CEOs differentiate strategies less from industry-common strategies than non-RPE CEOs. To address endogeneity concerns, I present a two-stage least-squares approach exploiting variance in RPE usage induced by compensation consultants’ distinct styles. My analyses suggest strategic differentiation decisions to help explain why many boards do not completely filter peer performance from CEO compensation. Data Availability: All data are obtained from commercially available databases, including Compustat, CRSP, Execucomp, I/B/E/S, and ISS Incentive Lab.

We study firms’ decisions to provide non-GAAP income statements and the information environment consequences of Securities and Exchange Commission (SEC) comment letters directing them to stop disclosing such statements. We find firms voluntarily disclose non-GAAP income statements when firm and disclosure complexity, analyst following, and institutional ownership are higher. Using a difference-in-differences design, we find that, after firms stop disclosing full non-GAAP income statements at the direction of the SEC, the informativeness of non-GAAP earnings and overall earnings announcements decreases, information asymmetry increases, and analyst forecasts become less accurate and more disperse. We also find that firms not receiving a comment letter are more likely to stop providing non-GAAP income statements after an industry peer receives a non-GAAP income statement comment letter. Overall, our evidence suggests SEC comment letters about non-GAAP income statements appear to worsen the information environment for firms previously providing those statements. Data Availability: Data are available from the public sources cited in the text.

Staff at the U.S. Securities and Exchange Commission (SEC) conduct recurring reviews of firms’ filings to deter misconduct and facilitate investor access to high-quality information. We identify the names of SEC staff who work on a comment letter and examine whether their prior involvement (i.e., continuity) is associated with comment letter quality. Our results are consistent with continuity leading to lower-quality comment letters. Continuity is associated with fewer substantive comments, agreed-upon disclosure changes, and greater similarity between consecutive comment letter reviews. These results are consistent with continuity increasing staffs’ tendency to focus on familiar issues and overlook other areas of potential deficiencies. Time, changes in firms’ operations, and increasing staffs’ feelings of accountability can mitigate the negative effect of continuity on comment letter quality. Our study suggests benefits to a fresh perspective in regulatory monitoring.