Knowledge that Transforms

ABSTRACT This study investigates whether industrial diversification generally provides a tax advantage and how the convexity of the tax system contributes to this benefit. The main findings show that multi-industry operations lower a firm’s taxes and income volatility relative to single industry operations on average, but the benefit is not universal. Namely, there is no significant tax advantage when multi-industry firms have high crossindustry cash flow correlations or when limitations are placed on the convexity mechanism, such as when firms have recent diversifying acquisitions or a high degree of crossjurisdiction activity. To shed new light on the mechanism through which U.S. firms realize this benefit, I exploit two temporary policies expected to reduce tax convexity via extensions of loss carryback periods. I find these policies also mitigate the tax advantage. Taken together, the results underscore how context matters in determining whether a firm will realize a tax advantage from multi-industry operations. JEL Classifications: D23; G11; H25; M41.

ABSTRACT Using two natural field experiments, we examine how warning individual retail borrowers that their loan performance will be reported to a public credit registry before and after the loan take-up affects their borrowing behavior. We show that credit warnings reduce default rates by 3.7 to 7 percentage points and increase loan take-up rates by 4.1 percentage points, which suggests that credit warnings benefit both lenders and borrowers. The main drivers appear to be borrowers’ anticipation of a reduction in lenders’ informational rents and improved repayment incentives. Moreover, the reduction in default rates is comparable for borrowers who receive the credit warning before and after the loan take-up. As credit warnings received before but not after a loan take-up can affect the borrower pool, and thus the overall credit risk of the pool, the results suggest that credit warnings have little net effect on the pool’s credit risk due to selection. JEL Classifications: G10; G21; G23.

ABSTRACT I first distinguish the terms economic growth, economic development, and sustainable development. I then discuss the term ESG and why this term is used with respect to the corporation. I follow with a discussion of the shareholder primacy perspective and how this perspective plays a defining role in corporate law, corporate governance, and asset management. I argue that the shareholder primacy perspective is not appropriate for sustainability reporting because when a firm pollutes the environment, reduces biodiversity, or has inequitable social policies, it does not bear the full cost of its action; society and the planet does. Therefore, providing sustainability disclosures that are relevant to investors misses the point that sustainability disclosures are motivated by the desire of other stakeholders to learn about externalities. I discuss the different standard setters in the sustainability space and how accounting and measurement play key roles. I close with a discussion of research opportunities. Data Availability: Data are publicly available from sources indicated in the text. JEL Classifications: K22; L21; M41; M48; Q56; Q58.

ABSTRACT Data breach disclosure laws are state-level disclosure mandates intended to protect individuals from the consequences of identity theft. However, we argue that the laws help reduce shareholder risk by encouraging managers to take real actions to reduce firms’ exposure to cyber risk. Consistent with this argument, we find an on-average decrease in shareholder risk, proxied by cost of equity, after the staggered passage of these laws. We also find the effect is attenuated for firms that already took real actions to manage cyber risk before the laws. Further, after these laws, firms are more likely to increase cybersecurity investments and have a cybersecurity officer. Finally, we observe positive abnormal returns on key dates related to the passage of these laws. Our collective evidence suggests that consumer protection disclosure mandates can benefit shareholders and, specifically, that regulators can use disclosure mandates to incentivize managers to reduce firms’ exposure to cyber risk. Data Availability: All data used in this study are publicly available. JEL Classifications: G120; G340.

ABSTRACT We provide evidence that lenders with lower regulatory capital issue loans with lower financial covenant strictness, consistent with such lenders viewing borrower covenant violations as costlier. This is because a borrower covenant violation may lead the lender to downgrade the loan, which triggers accounting that further reduces regulatory capital. Because of regulatory scrutiny, this is true even if the lender waives the violation. We find that this association is concentrated in performance covenants rather than capital covenants. We also find that lenders with relatively low capital issue loans with lower amounts and shorter maturities, consistent with such lenders replacing covenant protection with stricter loan terms on other dimensions. Finally, we find that this form of lender capital management extends to loan syndicate participant lenders, in that participants with relatively low capital adequacy take smaller loan shares when the lead arranger sets high covenant strictness. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G21; M40; M41.

ABSTRACT We explore whether managers’ strong desire for good performance distorts their expectations and, consequently, corporate investment efficiency. We find that managers overweight favorable information and underweight unfavorable information, resulting in optimistic earnings guidance. We construct an ex ante measure of optimism and show that greater optimism is associated with a lower inventory investment efficiency: Managers overinvest in inventory, resulting in lower inventory turnover and increased incidence and severity of inventory writedowns. We also find motivational optimism influences firms’ financial reporting and is associated with an increased incidence of financial misreporting. Our results are consistent with the psychology theory of motivated reasoning, which emphasizes the distortive effects of preferences on beliefs and judgments. JEL Classifications: M41; D91; G41; G31.

ABSTRACT This paper examines voluntary disclosure in the context of shareholder scrutiny of executive compensation contracts. We find that firms voluntarily increase discussion of their performance within their CD&A disclosures when peer-benchmarked compensation relative to performance is high. In contrast, we do not find a similar increase in performance discussion in the corresponding MD&A disclosures, which suggests that the effect is not driven by firms’ general disclosure practices. We also find that the relation between relatively high compensation and CD&A performance disclosure strengthens following the implementation of mandatory Say-on-Pay, which increased costs associated with investor criticism of pay. These disclosures appear to be used effectively to avoid negative compensation assessments, in that they are associated with higher levels of shareholder and proxy advisor approval. Altogether, our findings suggest that CD&A performance disclosures allow firms to communicate the context of their compensation choices to improve shareholder opinions of pay. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: D22; J33; M41.

ABSTRACT Prior research finds that clients of high-quality auditors report higher-quality GAAP earnings. We extend this research to investigate whether auditor quality is associated with the quality of voluntarily disclosed non-GAAP earnings measures. Using a sample of Australian firms disclosing annual non-GAAP metrics, we find that clients of high-quality auditors are more likely to voluntarily disclose non-GAAP earnings numbers. However, clients of high-quality auditors make adjustments in calculating non-GAAP earnings (non-GAAP exclusions) that are less predictive of future earnings and less value relevant than those of other firms. These results indicate that their adjustments are of higher quality. We also find similar results for U.S. firms using a sample of quarterly non-GAAP earnings disclosures. Overall, our evidence indicates that commonly used indicators of audit quality for GAAP reporting are positively associated with the quality of voluntarily disclosed non-GAAP earnings measures. JEL Classifications: J33; M41.

ABSTRACT We present theory and empirical evidence that greater financial reporting quality can incentivize myopic investments. In the model, greater financial reporting quality increases investor response to earnings, elevating the manager’s incentive to invest myopically to improve earnings. Using the setting of Big N auditors’ acquisitions of non-Big Ns, which increased investor response to earnings for the acquired client firms, we find evidence supporting myopic investments. Specifically, acquired clients decrease intangible investments, particularly when (1) the increase in investor response to earnings is larger and (2) the horizon of shareholders is shorter. The investment decrease is inefficient, as evidenced by reduced profitability, fewer exploratory innovations, and other measures. JEL Classifications: G14; G34; M41; M42; O31; O34; N22.

ABSTRACT We provide evidence on effort coordination and information sharing between audit committees and external auditors. We use four effort measures: the risk areas reported by both the auditor and committee, auditor-reported materiality, and committee meetings. We find that the number of risks reported by the auditor (committee) is positively related to the number of risks reported by the committee (auditor) and that lower materiality is associated with more risks that the committee discloses. The evidence also suggests that although risk areas are “sticky,” the committee identifies new risks faster, whereas the auditor focuses on shared risks. Next, our analysis indicates that audit process standardization influences reporting quality in a nonlinear manner. Finally, although audit fees tend to rise with auditor effort, they are unrelated to the committee’s effort. Our findings endorse the service perspective on auditing by emphasizing the collaborative nature of the audit process over individual actors’ self-interests. Data Availability: Data are available from public sources cited in the text. JEL Classifications: M41; M42; G38.