Knowledge that Transforms

Exploiting detailed disclosures mandated by Accounting Standard Codification (ASC) 820, we provide evidence for the return relevance of Level 3 fair value remeasurements for a comprehensive sample of U.S. listed banks. We find that Level 3 remeasurements recognized in earnings are more return relevant than those recognized in other comprehensive income (OCI). Our results suggest that Level 3 remeasurements in OCI partially reflect transitory illiquidity discounts that are less relevant when banks have the ability to hold the underlying assets. The regulatory capital treatment of OCI also affects the return relevance of Level 3 remeasurements in OCI. Importantly, we find no differences in the return relevance of realized versus unrealized Level 3 remeasurements in earnings, allaying concerns that investors perceive unrealized Level 3 remeasurements of lesser quality. Overall, our findings support the usefulness of the segregated disclosures of Level 3 fair value remeasurements. Data Availability: Data are available from the public sources cited in the text.

Firms supply accounting conservatism in response to debt/equity contracting, litigation, political costs, and taxation demand from stakeholders. I examine whether political connections between U.S. firms and politicians moderate and/or intensify the impact of these demands on the supply of conditional and unconditional conservatism. I measure political connections based on the association between firms' campaign contributions and equity ownership in firms by U.S. House and Senate representatives. I measure conditional conservatism using an earnings-return model and unconditional conservatism using a persistent negative accruals proxy. I find that political connections moderate the effect of the debt contracting (litigation) demand for conditional (unconditional) conservatism. My results demonstrate whether and how political connections of U.S. firms can affect the four demands for and the supply of the two forms of conservatism. The collective evidence suggests that political connections serve as an alternative channel to reduce stakeholders' debt contracting and litigation demand for accounting conservatism.

In order to deter aggressive tax planning, the Australian government mandated public disclosure of three line items from large corporations' tax returns. However, there is no evidence that the mandated disclosure led public firms to pay more taxes (Hoopes, Robinson, and Slemrod 2018). Instead, I find that firms strategically offset expected reputational costs by voluntarily issuing supplemental information. Specifically, when managers expect new reputational costs from the mandated tax return disclosure (wherein the disclosure reveals an unexpectedly low tax liability) and low proprietary costs from a supplemental voluntary disclosure (wherein the firm discloses its nonaggressive tax planning), firms are likely to voluntarily disclose information that both preempts and supplements the government's mandatory disclosure. Thus, when mandatory disclosures are incomplete, firms will voluntarily issue additional information to remain in control of their disclosure environments.

This study provides the first large-scale study of the performance of expected-return proxies (ERPs) internationally. Analyst-forecast-based ICCs are sparsely populated and not robustly associated with future returns. Earnings-model-forecast-based ICCs are well-populated, but are unreliable outside the U.S. We adapt and extend the log-linear and present-value (LPV) framework—combining an accounting valuation anchor, its expected growth, and market prices—for estimating ERPs internationally, and implement a correction for the use of stale accounting data. An LPV ERP anchored on the book value of equity is positively associated with future returns in 26 of 29 equity markets, and largely subsumes the predictive ability of a broad set of firm characteristics previously shown to be associated with expected returns.

Auditor credibility is important in the banking industry due to the opacity of bank assets and the use of financial statements by external parties to facilitate monitoring. Depositors monitor and discipline bank behavior, but they can also contribute to the spread of shocks from one bank to another. We argue that depositors perceive bank failure as an audit failure, which reduces their assessment of auditor credibility. We document that exposure to failure through the audit firm is associated with lower uninsured deposit growth following the failure, consistent with depositors perceiving failures as a negative signal of auditor credibility. We further document that this association is stronger when depositors perceive connection to failure to reflect a pervasive issue within the audit firm. Collectively, our results suggest that depositors consider accounting signals at other banks in assessing financial reporting credibility.

I examine whether directors' superior access to information through their board network improves the accuracy of firms' forecasting. Managers may benefit from well-connected directors (i.e., board centrality) as they may have limited insight into market developments or decision-making processes of other firms beyond knowledge specific to their firm. Employing a sample of U.S.-listed companies, I separately examine the effect of within-firm variation in direct and indirect board connections on management earnings forecast accuracy. The study contributes by showing that higher-degree connections can have an economically significant effect on the accuracy of management forecasts, regardless of firms' board interlocks. Further analyses point toward well-connected directors' ability to provide managers with valuable advice in a forecasting context, which complements directors' more extensively studied role in preventing managerial expropriation. Data Availability: Data are available from the public sources cited in the text.

This study examines whether firms' political activism induces bias in the media coverage of earnings announcements and how such coverage impacts markets. We infer firm political ideology based on employee political contributions and identify firm and manager characteristics associated with distinct ideologies. We find that media outlets negatively slant their coverage of earnings announcements when the political leanings of the outlet are incongruent with the political ideology of the firm. Consistent with slanted coverage affecting market outcomes, we provide evidence that the price reaction to good (bad) earnings news is decreasing (increasing) in the percent of incongruent media outlets covering the earnings announcement. In addition, trading volume and returns volatility are decreasing for good earnings news with the percent of incongruent media outlets. Our results suggest that the prevalent bias across some media outlets in their coverage of political news also affects their coverage of corporate financial events.

The new accounting standard requires that financial institutions estimate expected credit losses on their loan portfolios. The predictability of long-term losses, however, remains an open question. We develop a model that predicts long-term loan losses and incorporates adjustments for macroeconomic forecasts. The model combines cross-sectional predictions with a high-dimensional dynamic factor model that tracks aggregate losses over the business cycle. The model predicts long-term losses out-of-sample with significantly greater accuracy than the Harris et al. (2018) model and several other alternatives. It is also more effective at detecting bank failures. We use the model to estimate the present value of expected losses and the expected loss overhang for a given bank-quarter. The estimated present values subsume information in reported allowances and in fair value disclosures about long-term losses; the evidence is also consistent with loss overhang distorting banks' decisions. The model provides a useful benchmark to study loan loss provisioning.

This paper studies the effects of allocating control rights to lenders via debt covenants when managers can sometimes misreport the accounting information on which the covenants are based. When contract renegotiation is exogenously prohibited, including a covenant in the contract is ex ante optimal because it increases both the probability that poor projects are liquidated and the manager's effort incentive. When the parties can renegotiate the contract, the results can flip: granting the lender more control can lead to less frequent liquidations of low-quality projects and lower managerial effort incentives and thereby reduce the manager's ex ante payoff. The key behind these results is not the manager's incentive to misreport per se, but her desire to take subsequent actions that conceal the misreporting. The model generates predictions regarding the determinants of accounting-based covenants, and the effects of covenants on misreporting, managerial effort, the frequency of liquidations, and firm value.

This study investigates the value of auditor industry specialization. In the first step, we use a discrete choice model to derive the first-order demand for auditor industry specialization. Our results reveal that clients have a general preference for auditor industry specialization, relating to both audit firm and audit office specialization. We observe that specializations at the audit firm and audit office level are substitutes. We also find that larger, more complex clients have a stronger demand for industry specialization at the audit office level. In the second step, we use the results from the discrete choice model to quantify the value of auditor industry specialists for clients. We find the overall value of industry specialization aggregated across all clients is 5.2 million USD (0.36 percent of audit fees) and that industry specialization at the firm (office) level is decisive for auditor choice in 4 percent (6 percent) of all cases.