Knowledge that Transforms

ABSTRACT We study the influence of supervisors on employee misconduct at branches of U.S. financial institutions. Individual supervisor fixed effects explain twice as much variation in branch misconduct as firm fixed effects. Supervisor influence is concentrated in firms that theory suggests are most likely to delegate authority—firms with complex operations, distant branches, and trustworthy supervisors. Supervisors affect misconduct through their personnel decisions, attention to employees with past misbehavior, and ethics and industry rules training. After major internal control improvements, supervisor influence declines. Our results illustrate how supervisors influence misconduct above and beyond firm-level factors. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: D21; D82; G20, L22; L23; M12; M40.

ABSTRACT Toward the goal of reconciling conflicting arguments on whether performance-based incentives facilitate or impede divergent thinking, we identify a feature common to prior demonstrations of negative incentive effects: they generally involve tasks with only one correct solution. Our first experiment replicates a negative incentive effect when insight problems require “bottom-up” divergent thinking from an unexpected resource to the problem it is uniquely equipped to solve, whereas our second experiment finds a positive incentive effect in the more general case of problems that enable “top-down” divergent thinking from a problem to multiple potential solutions. We also observe a positive incentive effect in a third experiment that measures the time needed to generate a solution to problems that have multiple potential solutions and in a fourth experiment in which participants design insight problems. Overall, our findings suggest that any harmful effects of performance-based incentives are likely restricted to highly constrained settings. Data Availability: Data are available from the authors upon request. JEL Classifications: J33; M14; M41; M52.

ABSTRACT We examine the impact of transparency on the convenience yield of AAA-rated asset-backed security (ABS) tranches. AAA tranches of ABS are commonly held by investors to manage financial liquidity and therefore enjoy a price premium beyond what is determined solely by the expected monetary payoff (i.e., convenience yield). The Securities and Exchange Commission (SEC) requires ABS issuers to provide monthly disclosures about the performance of the underlying individual loans for ABS issued after November 23, 2016 to improve transparency. We document that AAA tranches of ABS experience a significant increase in price volatility after the loan-level disclosure mandate. As a result, the use of these tranches as collateral for short-term funding and their convenience yield decrease significantly after the increased disclosure. Our collective evidence highlights an important unintended consequence of increased transparency in the ABS market; it diminishes the pledgeability of long-term safe assets. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G14; G23; M48.

ABSTRACT Boards of directors encourage risk-averse managers to take risky actions by providing stock options and severance pay. We demonstrate that the ability of these incentives to encourage risk-taking hinges on the level of uncertainty facing the manager. We confirm prior findings that stock option convexity encourages risk-taking but find that this relation only holds when market-wide uncertainty is low. We also confirm prior findings that severance pay encourages risk-taking but find that this relation only holds during high market-wide uncertainty and negative market-wide performance. Finally, we find that compensation committees respond to variation in uncertainty by adjusting the level of option grants. Our results suggest that the effectiveness of incentives to take risk varies with the market-wide uncertainty, and that boards consider this in annual compensation design. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G30; G34; K22; M40; M46.

ABSTRACT This paper examines the prevalence and benefits of upward social mobility in the early accountancy profession by analyzing the lifespan of chartered accountants admitted to membership in Scotland between 1853 and 1940. We find that 76 percent of the chartered accountants in our sample experienced upward social mobility, a greater percentage than found in previous studies. The chartered accountants in our sample experienced an average life expectancy premium of approximately three years over the general population, irrespective of social origins, and were less likely to die from most preventable causes than the general population. Upwardly mobile chartered accountants achieved lifespans consistent with their achieved professional status rather than their previous social class. While the findings confirm the existence of a social mortality gradient, the increase in longevity is likely attributable to the superior resources of higher social class and other factors affecting self-selection into the accountancy profession. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: I1; I3; M4; N3.

ABSTRACT I investigate whether algorithmic trading (AT) affects the provision of management guidance. Existing research finds that AT decreases fundamental information acquisition before earnings announcements and consequently reduces the informativeness of prices. To compensate for reduced information acquisition, I predict and find that managers at firms with more AT activity increase the quantity and quality of guidance issued at earnings announcements. Evidence is consistent with managers responding to reduced information acquisition, as opposed to changes in liquidity, and results suggest guidance in response to AT is effective at reducing information asymmetry. These findings identify a new channel through which AT affects stock price informativeness by documenting a link to managers’ disclosure decisions. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G14; G19; G10.

ABSTRACT Organizations invest heavily in supervision to increase the competitive advantage of their human capital. Although recent studies show that supervisors add value in general, it is not well understood what specific supervisory behaviors are relevant for employee career outcomes. To that end, this study explores the performance evaluation process and focuses on supervisors’ evaluation behavior. Interpreting a supervisor’s tendency to differentiate as a way of advancing employee development, I provide theory-consistent evidence revealing the relevance of differentiation for employee career outcomes. Using proprietary archival data, I demonstrate that differentiation relates positively to employees (1) performing more successfully in a new position upon promotion, (2) receiving a promotion to the next position, and (3) remaining in the organization. Therefore, this study presents novel and relevant evidence on the importance of specific supervisory behaviors in establishing effective human capital management practices.

ABSTRACT We study firms’ decisions to withhold loan covenant details by focusing on a unique disclosure-related cost. Prior research documents the prevalence of tight initial covenants that are selectively relaxed in future renegotiations. This uncertainty in renegotiation outcomes can generate a disclosure-related cost because disclosing a snapshot of initial covenants with a high likelihood of violation could lead to harmful outsider reactions (e.g., trade credit cuts) to violations that may be eventually cured. We hypothesize and find that, when firms are likely to face tighter initial covenants and more renegotiations, they are more likely to withhold covenant details, particularly when under pressure from trade creditors. Our inference is robust to controlling for firms’ obligation to disclose (i.e., contract materiality) and future performance. Prior research has found that the precise covenant details of many loans are not publicly available. We are the first to offer a systematic explanation related to disclosure costs. JEL Classifications: M41; D82; G21; L14.

ABSTRACT This study examines whether politicians exhibit hometown favoritism in assigning preferential corporate income tax rates. We find that firms with hometown connections to incumbent provincial leaders experience favorable tax treatment. This effect is more pronounced when those leaders have strong hometown preferences and weaker when they have a strong incentive to seek promotion, suggesting that social incentives are the primary drivers of the effects on corporate tax benefits of hometown favoritism by politicians. Moreover, this effect is intensified when members of senior management have personal connections with the provincial leader. The mechanism test reveals that the provincial governments tend to qualify connected firms for preferential tax policies under their jurisdictions. Overall, our results suggest that hometown favoritism by politicians promotes tax benefits for business entities. Data Availability: Data are available from the public sources cited in the text. JEL Classification: H26; H71; M48.

ABSTRACT We exploit a regulatory change to examine whether bank regulator strictness is affected when regulators no longer rely on external assurance. In the absence of external assurance, we find that banks report higher nonaccrual loans, higher troubled debt restructurings, and both a timelier loan loss provision and higher quality allowance for loan loss reserve. Further, regulators spend more days performing targeted bank examinations for banks affected by the regulatory change. We do not find evidence of operational deterioration, but rather the findings are consistent with increased regulator strictness over the reporting of problem assets, particularly during targeted examinations. Overall, our results suggest that regulators become stricter when they can no longer rely on the work of external auditors and that third-party assurance is an imperfect substitute for direct regulatory monitoring. Data Availability: Bank regulatory rating and examination dates are confidential and were obtained from the Federal Reserve Bank of St. Louis. All other data are available from the public sources cited in the text. JEL Classifications: G21; G28; M42.