Knowledge that Transforms

ABSTRACT We exploit a one-month period when SEC activity largely stopped during a U.S. government shutdown to examine whether variation in SEC scrutiny affects its ability to enforce insider trading. Difference-in-differences analyses suggest insiders earn abnormal profits during the shutdown, and the findings are robust to using different control periods and groups. We estimate that it takes roughly one week before the abnormally profitable trading begins, consistent with insiders updating their beliefs regarding the duration and disruption of the shutdown. Supporting the claim that SEC regulatory activity drops with the shutdown and does not fully recover afterward, we find a decline in the frequency of insider trading enforcement releases, investigations, and comment letter issuances after the SEC resumes operations. Our study speaks to the SEC insider trading enforcement literature and economic consequences of a regulatory discontinuity in a divisive political climate. Data Availability: All data are available from public sources. JEL Classifications: G14; G30; M41; M48.

ABSTRACT I examine how mandatory position disclosure of claimholders’ economic interests affects Chapter 11 bankruptcy outcomes. Exploiting a regulation that increased disclosure by creditors and equityholders on certain committees, I find that position disclosure is associated with a decrease in the length of bankruptcy cases, especially the duration of negotiations between claimholders across classes. Further, I show that position disclosure is associated with lower post-bankruptcy recidivism. Contrary to the concerns expressed by critics, I find little evidence that position disclosure reduced claimholders’ participation in committees or decreased trading in the market for bankruptcy claims. My findings highlight the overall benefits of position disclosure in facilitating negotiations during bankruptcy. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: D82; G33: G34; K22; M40.

ABSTRACT I use a unique setting in the municipal bond market to examine the impact of compliance auditing on bond yields. SEC Rule 15c2-12 requires bond issuers to provide annual financial and operating disclosures to investors over the life of the bonds. Due to concerns of noncompliance, Louisiana passed a state law requiring auditors to test for compliance with Rule 15c2-12. I find that bond yields in the municipal bond market decrease by 21 basis points after the audit law for previously noncompliant issuers in Louisiana. I find similar results when I separately examine the primary and secondary markets. I also find that previously noncompliant issuers file 75.2 percent more annual disclosures after the audit law, suggesting that the audit law improved compliance with Rule 15c2-12. Overall, my findings inform policymakers and regulators on the role of auditing over compliance with disclosure regulation as a mechanism to protect investors. JEL Classifications: G28; H74; K22; M42.

ABSTRACT Using a large sample of executive performance equity grants over 2006–2019, we provide a comprehensive representation of the single- and multi-metric vesting schemes used by U.S. public firms and investigate the incentives provided by alternative functional forms of vesting formulas that combine earnings with stock returns and other nonearnings targets. Our results indicate that, compared to earnings-vesting single- and multi-metric summative grants, binding schemes that require the contemporaneous achievement of both earnings and nonearnings targets for grant vesting limit executive fixation on earnings and the associated incentives to maximize grant payouts by managing earnings around the targets. The findings confirm the expectation of different incentive effects from alternative (linear versus nonlinear) aggregations of multiple performance targets in the grant vesting formulas, with binding schemes being more effective in mitigating the risk of executives prioritizing earnings relative to other targets in multi-metric grants. JEL Classifications: G34; J33.

ABSTRACT This study examines the impact of ex ante litigation risk on auditor hiring and retention. Using employee data from LinkedIn, we find ex ante accounting-related litigation risk is associated with fewer auditors joining and more auditors leaving an audit office, whereas we fail to find any impact of nonaccounting litigation risk. Moreover, ex ante accounting-related litigation risk is associated with audit firms' hiring less experienced and less educated auditors, suggesting ex ante litigation risk impacts the quality of auditing hires. We also find that the impact of ex ante litigation risk is concentrated in audit offices with more outside job opportunities and in those that are more susceptible to changes in litigation risk. Our results highlight the impact of ex ante litigation risk on audit labor supply, providing insights concerning the unintended consequences of increasing auditors' legal liability. Data Availability: All data used in this study are based on publicly available information obtained through the services or authors cited in the manuscript. JEL Classifications: M42.

ABSTRACT Revenue-sharing contracts allow firms that are distant from their target markets to leverage sellers' local expertise. Although these contracts align incentives in operational decisions, they also introduce the potential for sellers to underreport revenues. We analyze film-level box office data from 7,309 Chinese cinemas and find that cinemas report significantly lower revenues for foreign films than for comparable domestic films, consistent with foreign producers being less able to monitor reported revenues due to geographic distance. The underreporting of foreign films is lower in cities with widespread mobile payments, in multi-unit cinemas, and when foreign films have more predictable revenues, suggesting institutional factors that increase detection likelihood can mitigate underreporting. Further tests indicate the lower reported box office revenues of foreign films is not due to government intervention. Our findings provide novel evidence of product-level misreporting under revenue-sharing contracts and offer insights on mitigating these risks in international markets. Data availability: Data are available via the sources specified in the paper. The authors greatly appreciate the data supplied by EntGroup (http://english.entgroup.com.cn/enbase.html) but are not able to share the data based on the agreement with Entgroup. JEL Classifications: F00; L82; M40.

ABSTRACT Firms are facing increasing pressure to provide information about their Corporate Social Responsibility (CSR) commitment. Firms however differ in the quality of how they communicate CSR-related efforts to stakeholders as well as in the intensity of their CSR contracting. We examine the relationship between CSR disclosures and contracting and argue that the designs of the two practices are complements in signaling a CSR commitment. Using hand-collected data to capture disclosure quality of CSR reports and intensity of CSR contracting (i.e., scope, importance, and degree to which CSR metrics are incorporated) for S&P 500 firms, we show that firms indeed align the design choices of the two practices. In addition, firms using both practices intensively are associated with a stronger CSR commitment and more credible CSR disclosures. Finally, we document that firms that face higher credibility concerns show stronger complementarity between the design of these two practices. Data Availability: All data are available from public sources mentioned in the text. JEL Classifications: M14; M40.

ABSTRACT Accounting misstatements are often detected with substantial delays, leading to “look-ahead bias” in model predictions if the detection lag is not considered. Moreover, the misstatement data-generating process is evolving due to regulatory regime shifts, further complicating the evaluation of model predictions. We design an approach that accounts for detection lags and continuously updates models to adapt to the changing data-generating process. By comparing with the conventional approach that ignores detection lags, we show that the look-ahead bias can substantially inflate prediction performance. We also demonstrate that although leaving a temporal gap between training and test samples can mitigate the look-ahead bias, it sacrifices the model’s predictive power by disconnecting the dynamic data-generating process between training and test periods. We further implement a trading strategy to evaluate the practical utility of the continuously updating approach. Our study presents a new conceptual lens for understanding and evaluating misstatement prediction models. Data Availability: Data are available from the public sources identified in the study. JEL Classifications: C53; G32; G38; M41.

ABSTRACT Pay gaps, like gender or racial gaps, violate the widely held belief that employees should receive equal pay for equal work. This study examines whether a common control choice—framing pay raise budgets in percentages—contributes to perpetuating pay gaps. We predict that when the pay raise budget is framed as a percentage (the percentage frame), it inadvertently nudges managers to anchor individual raises on that budget percentage, thereby impounding prior salaries, and thus, existing inequities, into pay raises. We further predict that framing the pay raise budget as an absolute amount (the dollar frame) can un-nudge this behavior. As expected, we find in two experiments that the dollar frame perpetuates pay gaps less than the percentage frame, and that this difference is robust to varying levels of ambiguity about the source of salary differences. Our study examines a simple, cost-effective way to limit the perpetuation of pay gaps. Data Availability: Contact the authors. JEL Classifications: D91; J16; J31; J71; M40; M52.

ABSTRACT Governments implement wealth transfers with different policy goals and distribution methods. Prior research examines the timing (lump sum/periodic) of transfers but fails to simultaneously consider payment delivery method (standalone/combined with other income). Based on the behavioral life-cycle model, we predict payment timing influences how recipients spend government transfers, but that this effect is muted when the transfer payment is combined with other income. In contrast to prior research, our experimental findings provide theory-consistent results and suggest recipients of a periodic transfer spend more of the transfer than recipients of a lump sum transfer, but only when the transfer is standalone and not combined. Our findings help to explain theory-inconsistent results of prior research and extend the literature on the behavioral life-cycle model and mental budgeting. Moreover, our results suggest policymakers can intentionally structure the distribution of government transfers to encourage household spending or saving consistent with policy goals.