This study investigates the spread of aggressive corporate tax reporting by modeling a firm’s decision to adopt the corporate-owned life insurance (COLI) shelter. Prior studies identify firm characteristics associated with aggressive tax reporting (Desai and Dharmapala 2006; Frank et al. 2009) and tax shelter participation (Wilson 2009; Lisowsky 2010). This study examines whether social environment factors explain the pattern of tax shelter adoption. Building on theory related to the diffusion of innovations and institutional isomorphism, I hypothesize direct and indirect ties between prior and potential shelter adopters influence the spread of shelter use. I find that network ties via board interlocks increase the likelihood of adopting the COLI shelter. I also find weak evidence that COLI use spreads geographically. However, I find no evidence that the spread of COLI use is concentrated among a particular set of audit firms or industries.

We examine the relation between disclosure tone and shareholder litigation to determine whether managers' use of optimistic language increases litigation risk. Using both general-purpose and context-specific text dictionaries to quantify tone, we find that plaintiffs target more optimistic statements in their lawsuits and that sued firms' earnings announcements are unusually optimistic relative to other firms experiencing similar economic circumstances. These findings are consistent with optimistic language increasing litigation risk. In addition, we find incrementally greater litigation risk when managers are both unusually optimistic and engage in abnormal selling. This finding suggests that firms can mitigate litigation risk by ensuring that optimistic statements are not contradicted by insider selling. Finally, we find that insider selling is associated with litigation risk only when contemporaneous disclosures are unusually optimistic. JEL Classifications: G38; K22; M41; M48. Data Availability: Data are available from sources indicated in the text.

We take advantage of the unique reporting requirements of nonprofit public housing authorities (PHAs) to study the effect of audits on financial information both generally and when there are management incentives to misreport financial data. There is little prior research on the effect of audit adjustments in nonprofit settings and conflicting research on how auditors react to management's incentives to misreport. We identify potential financial statement areas at risk of manipulation based on incentives specific to public housing authorities. Using pre- and post-audit financial data for almost 3,600 PHAs across seven years, we find that auditors make economically and statistically significant adjustments to PHA financial statements. In addition, we find evidence that audits appear to reduce potential management bias, particularly to reduce risks of overstatement. Overall, audits appear to matter in this nonprofit, low-litigation risk setting where there is a large concentration of non-Big 4 auditors.

This study jointly evaluates firm-level changes in investor composition and shareholder distributions following a 2003 reduction in the dividend and capital gains tax rates for individuals. We find that directors and officers, but not other individual investors, rebalanced their portfolios to maximize after-tax returns in light of the new tax rules. We also find that firms adjusted their distribution policy (specifically, dividends versus share repurchases) in a manner consistent with the altered tax incentives for individual investors. To our knowledge, this is the first study to employ simultaneous equations to estimate both shareholder and managerial responses to the 2003 rate reductions. We find that the generalized method of moments (GMM) estimates are substantially stronger than OLS estimates, consistent with our expectation that investor and manager responses are simultaneously determined. Failure to estimate systems of equations may account for some of the weak and conflicting results from prior studies of the 2003 rate reductions.

This study examines disaggregated management forecasts as a mechanism to reduce investors’ fixation on announced earnings. Our experimental results suggest that investors’ earnings fixation is reduced when they initially observe a disaggregated management forecast (earnings and its components) versus when they observe an aggregated forecast (earnings only). We also provide theory-consistent evidence that this reduction in earnings fixation is associated with investors interpreting the summary net income figure as one of several similarly important evaluation inputs rather than a substantially more important input (relative to its components). Finally, we provide evidence that suggests our results are not bounded by the level of emphasis on net income in the subsequent earnings announcement, and not fully explained by three plausible alternative explanations. Our study extends the voluntary disclosure literature by providing evidence that the form of management disclosures can influence investors’ interpretation of subsequently announced information, and contributes to practice by providing a potential alternative to stopping earnings guidance.

This study addresses whether firms’ share prices correctly reflect two accounting measures: dirty surplus and really dirty surplus. Dirty surplus is readily observable from the financial statements, but really dirty surplus, which arises from recognizing equity transactions such as employee stock option exercises at other than fair market value, is not. Findings show that dirty surplus and really dirty surplus are irrelevant for forecasting abnormal comprehensive income. However, findings also indicate that investors appear to undervalue really dirty surplus. Hedge returns are insignificant when portfolios are formed based on dirty surplus, but are significantly positive based on really dirty surplus. Really dirty surplus positive hedge returns are robust to a variety of sensitivity tests. Taken together, the findings are consistent with either investors over-valuing firms that have large negative really dirty surplus or really dirty surplus being correlated with an unmodeled risk factor.