Knowledge that Transforms

ABSTRACT Whether the information environment affects the cost of capital is a fundamental question in accounting and finance research. Relying on theories about competition between informed investors as well as the pricing of information asymmetry, we hypothesize a cross-sectional variation in the pricing of information asymmetry that is conditional on competition. We develop and validate empirical proxies for competition using the number and concentration of institutional investor ownership. Using these proxies, we find a lower pricing of information asymmetry when there is more competition. Overall, our results suggest that competition between informed investors has an important effect on how the information environment affects the cost of capital. JEL Classifications: G12; G14.

ABSTRACT The role of disclosure in attenuating market inefficiencies has been the subject of extensive research. While costless, voluntary, and unverifiable disclosures are unlikely to be credible sources of information, prior research demonstrates that individuals' decisions can be influenced by uninformative content. I use a unique dataset from a peer-to-peer lending website, Prosper.com, to demonstrate an economically large effect of voluntary, unverifiable disclosures in reducing the cost of debt. My results show an additional unverifiable disclosure is associated with a 1.27 percentage point reduction in interest rate and an 8 percent increase in bidding activity. Data Availability: All data are publicly available from sources identified in the paper.

ABSTRACT To facilitate managers' decision-making, firms develop strategic performance measurement systems that translate strategy into performance measures. Ideally, managers see measures for what they are—imperfect proxies for intangible strategic constructs. However, managers may fail to fully appreciate the fact that measures are merely representations of the strategic constructs, and act as though the measures are the construct of interest—a phenomenon we label surrogation. In this paper, we investigate whether and how the use of strategically linked performance measures for compensation purposes affects managers' propensity to exhibit surrogation. In accordance with the attribute substitution framework (Kahneman and Frederick 2002), we predict incentive compensation exacerbates surrogation, and that this effect is more prevalent when managers are compensated on a single measure of a strategic construct than when managers are compensated on multiple measures of a strategic construct. Via two experiments, we find support for these hypotheses. Our paper contributes to the literature on strategic performance measurement systems by highlighting the tendency of managers to use measures as surrogates for strategy. More generally, we identify a by-product of contracting on imperfect performance measures not previously considered in extant literature, and establish when consideration of costs of this by-product are likely to be critical.

ABSTRACT This study addresses the two-way process in which a subordinate and a superior engage in influence activities (bottom-up) and favoritism (top-down) in subjective Performance Evaluation. The research context is the Chinese government's evaluation of Chinese state-owned enterprises (SOEs) by the State-Owned Assets Supervision and Administration Commission of China (SASAC). We analyze archival records of the government's evaluation scores, score adjustments, and evaluation ratings given to 63 SOEs between 2005 and 2007. These analyses are also interpreted based on insights gained from in-depth field interviews with SASAC officials and chief financial officers (CFOs) of SOEs. Results indicate that the political connection of SOE CFOs, the geographic proximity of SOE headquarters to the SASAC central office, and political rank of the firm affect the SASAC's evaluations. Data Availability: Data used in this study cannot be made public due to a confidentiality agreement.

ABSTRACT This study examines the effect on firm value of repealing the last-in, first-out (LIFO) inventory method for tax purposes. Our model extends prior literature by determining quantities and prices in equilibrium, rather than specifying them exogenously. We find that LIFO repeal could increase the future after-tax cash flows of firms that had used LIFO, because the higher tax costs associated with FIFO result in lower equilibrium quantities and higher equilibrium output prices, which increase pretax cash flows. We illustrate our model by examining inventory methods used by firms in the oil industry.

ABSTRACT Press releases accompanying earnings restatements attempt to minimize negative reactions by explaining the reasons for the restatement. Although text-based press releases have been the norm for years, firms have recently begun using online video for such announcements. We examine the implications of doing so, and find that when a CEO accepts responsibility by making an internal attribution for a restatement, investors viewing the announcement online via video recommend larger investments in the firm than do investors viewing the announcement online via text. In contrast, when the CEO denies responsibility by making an external attribution for the restatement, investors viewing the announcement online via video recommend smaller investments in the firm than do investors viewing the announcement online via text. Our results also reveal that investor trust mediates the effect of disclosure venue and attribution on investment recommendations. These findings are important given the economic significance and trust-damaging implications of restatements, as well as the increased use of online video to make important announcements. Data Availability: Contact the authors for data and video.

ABSTRACT This study investigates whether extensive disclosure reduces managerial expropriation of corporate resources by examining the potential effects of enhanced reporting on the values of cash assets and investment ventures, respectively. We uncover evidence that liquid asset holdings are valued at a discount by firms with fewer disclosure practices than their more transparent counterparts. Moreover, disclosure activity substantially improves the value of cash assets in excess of requirements for operations and investment. These findings suggest that detailed reporting facilitates the scrutiny and discipline of capital markets, thus preventing the diversion of cash reserves. In further support of the disciplinary power of greater disclosure, we find that value-destroying projects, through internal capital investment and external acquisitions, are concentrated in firms adopting opaque disclosure policies. Collectively, our results support the premise that extensive disclosure impairs insiders' abilities to utilize corporate resources in a self-serving manner. Data Availability: Data are available from public sources indicated in the text..

ABSTRACT We examine whether audit quality affects the trade-off between accrual-based and real earnings management. We hypothesize that firms motivated to manage earnings per share (EPS) to meet or beat consensus analysts' forecasts are more likely to engage in accretive stock repurchases (a form of real earnings management) when their ability to manage earnings through accruals is constrained by high audit quality. We find that firms with high audit quality are more likely to use accretive stock repurchases and less likely to use accrual-based earnings management to meet or beat consensus analysts' forecasts. Our results are robust to various controls for endogeneity concerns.

ABSTRACT We examine the relationship between disclosure of nonfinancial information and analyst forecast accuracy using firm-level data from 31 countries. We use the issuance of stand-alone corporate social responsibility (CSR) reports to proxy for disclosure of nonfinancial information. We find that the issuance of stand-alone CSR reports is associated with lower analyst forecast error. This relationship is stronger in countries that are more stakeholder-oriented—i.e., in countries where CSR performance is more likely to affect firm financial performance. The relationship is also stronger for firms and countries with more opaque financial disclosure, suggesting that issuance of stand-alone CSR reports plays a role complementary to financial disclosure. These results hold after we control for various factors related to firm financial transparency and other potentially confounding institutional factors. Collectively, our findings have important implications for academics and practitioners in understanding the function of CSR disclosure in financial markets. Data Availability: The data are publicly available from the sources identified in the paper.

This study examines whether disclosures of insider equity purchases on Securities and Exchange Commission (SEC) Form 4 resolve uncertainty regarding the valuation implications of reported earnings. Defining information uncertainty as ambiguity about firm value arising from low earnings precision, I predict and find that insider purchase filings trigger more positive market reactions in firms with greater information uncertainty (lower quality accruals). After controlling for future earnings changes, I further find that market reactions to purchase filings are predictably associated with prior earnings changes. The strength of this effect is increasing in the magnitude of insider purchases, as well as the level of information uncertainty. Overall, these findings suggest that, in addition to signaling future earnings information, Form 4 purchase filings help investors learn about the valuation implications of past earnings signals.