Knowledge that Transforms

ABSTRACT This study investigates whether the timely revelation of bad earnings news is associated with a lower incidence of litigation. The timeliness of earnings news is captured by a new measure based on the evolution of the consensus analyst earnings forecast. Holding total bad earnings news and other determinants of litigation constant, we find that earlier revelation of bad earnings news lowers the likelihood of litigation. This result holds for both settled and dismissed lawsuits. Further, we reconcile our findings with prior work that measures timeliness using managerial warnings via press releases. These tests suggest our findings are attributable to the ability of our timeliness measure to capture bad earning news revealed through disclosure channels beyond press releases. Data Availability: Data are available from public sources identified in the paper. JEL Classifications: K22; K41; M41.

ABSTRACT We examine the effect of more precise cost information on contract renegotiations between supply-chain parties. Specifically, we experimentally investigate the benefits of activity-based costing (ABC) information to address common supply-chain inefficiencies that are caused by the buyer or the seller, but have the same underlying costs. Results suggest that the impact of more precise cost information depends crucially on the cause of the inefficiency that parties need to address during the negotiation. ABC information increases the total joint profit in the supply chain. However, ABC information increases the seller's perceptions of the fairness of the buyer's arguments for contract changes only when the buyer causes the inefficiency but not when the seller causes the inefficiency. The combined effect of ABC information on joint profit and fairness perceptions thus increases the buyer's profit only when buyer causes the inefficiency but not when the seller causes the inefficiency. Data Availability: Data are available from the first author upon request.

ABSTRACT This study presents evidence that option expensing, whether voluntary under SFAS 123 or mandatory under SFAS 123(R), is associated with changes in CEO compensation that are beneficial to shareholders. I find that the reporting benefits of aggregate-employee option grants under SFAS 123 are associated with the change in the mix of CEO option grants and stock grants that occurs after SFAS 123(R), suggesting that reporting benefits of option grants may have influenced some CEO compensation decisions. Additionally, I find that the reduction in CEO pay after SFAS 123(R) is greater when shareholders have more power to act in their own best interest and when there is evidence of pre-expensing CEO compensation rents. The findings suggest that SFAS 123 may have encouraged inefficient, CEO-preferential pay practices and that SFAS 123(R) may have contributed to a reduction in CEO compensation inefficiencies. Data Availability: All data are publicly available.

ABSTRACT This study examines the effects of taxation on the incentives of multinational firms to develop and use intellectual property. We model optimal investment and production decisions by firms that engage in a patent race by making R&D investments. We investigate how taxes affect the level and efficiency of R&D investments, and how these effects depend on whether the winner of the patent race uses it by either producing in the country in which the patent was developed (the domestic country) or in a foreign country. A higher domestic tax rate decreases investment in R&D if production occurs in the domestic country, but increases investment in R&D if production occurs in the foreign country. The present value of domestic tax revenues is strictly positive if production occurs in the domestic country, but is weakly negative if production occurs in the foreign country.

ABSTRACT 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.

ABSTRACT We examine the actions and outcomes of investor relations (IR) programs in smaller, less-visible firms. Through interviews with IR professionals, we learn that IR strategies have a common goal of attracting institutional investors and that direct access to management, rather than increased disclosure, is viewed as the key driver of the strategy's success. We test for the effects of IR programs by examining small-cap companies that hired IR firms in a differences-in-differences research design with controls for changes in disclosure and determinants of the decision to initiate IR. Relative to a matched sample of control firms, we find that companies initiating IR programs exhibit greater increases in institutional investor ownership and a shift toward investors that normally would not follow the companies. We also find greater improvements in analyst following, media coverage, and the book-to-price ratio. Our results indicate that IR activities successfully improve visibility, investor following, and market value. Data Availability: All analyses are based on publicly available data.

ABSTRACT We investigate how the strictness of a requirement to consult on potential client fraud affects auditors' propensity to consult with firm experts. We consider two specific forms of guidance about fraud consultations: (1) strict, i.e., mandatory and binding; and (2) lenient, i.e., advisory and non-binding. We predict that a strict consultation requirement will lead to greater propensity to consult, particularly under certain client- and engagement-related conditions. Results from two experiments with 163 Dutch audit managers and partners demonstrate that consultation propensity is higher under a strict consultation requirement, but only when underlying fraud risk is high. The strictness effect is also greater under tight versus relaxed time pressure. Further, a strict standard increases auditors' perceived probability that a fraud indicator exists. Overall, we demonstrate that the formulation of a standard can have the desired effect on the judgments of auditors while also creating unexpected incentives that may influence auditor judgments. Data Availability: The data used in this study are available upon request from the authors.

ABSTRACT Prior research demonstrates that investors respond differently to earnings surprises that are part of a string of consecutive earnings increases or surprises than to those that are not. To shed light on who values these patterns, I compare trading responses of small and large traders to earnings surprises that occur during a series of positive or negative surprises. I find that the relative intensity of small traders' trading response (and, to a lesser extent, that of medium traders) to earnings surprises generally increases as a series progresses. Small traders respond more negatively to the second (third) negative surprise in a series than to the first (second), and more positively for the first three surprises in a positive series. Moreover, I find that announcement-period returns are related to the trading of small and medium traders. These results suggest that less sophisticated smaller traders, responding to earnings series, contribute to previously documented pricing patterns. Data Availability: All data used in this study, with the exception of data obtained from an anonymous discount brokerage firm, are publicly available from the sources indicated in the text.

ABSTRACT We propose that the value of the earnings reporting process as an information source lies in limiting delays in the release of bad news, either by inducing managers to disclose it voluntarily or by directly releasing the negative news that managers have incentives to withhold. We compare earnings informativeness in bad-news and good-news quarters. Using returns to measure news, we find, consistent with our prediction, that earnings informativeness relative to other sources is higher in bad-news quarters than in good-news quarters. Further, cross-sectional tests indicate that earnings differential informativeness in bad-news quarters is more pronounced when managers do not voluntarily disclose the news, information asymmetry is stronger, and managers are net sellers of stock. JEL Classifications: G3; M4; M40; M41; M48. Data Availability: Data are available from Compustat, CRSP, First Call, I/B/E/S, ISSM, TAQ, and Thompson Financial.

ABSTRACT Financial analysts' forecast dispersion has been used in a variety of contexts in accounting and finance studies. In this study, we provide large sample evidence on the cross-sectional determinants of forecast dispersion and examine to what extent analysts' strategic behavior biases the observed dispersion from the dispersion of unmanaged forecasts. We propose a method to estimate the dispersion bias for each sample observation. We find that observed dispersion, on average, understates dispersion of unmanaged forecasts by 53.4 percent and this downward bias varies considerably across firms. We further discuss the implications of the significant cross-sectional variation in the bias in observed dispersion for studies that rely on dispersion to estimate constructs such as consensus and information quality as well as those that use dispersion directly in research design. Data Availability: The data are publicly available for the sources indicated.