This study exploits an exogenous change to audit committee policy in Canada and presents new evidence on how high-quality corporate governance mitigates managerial resource diversion and improves firm values. We first examine why some firms listed on the Toronto Venture Exchange (TSX Venture) voluntarily adopted the more stringent governance policy in 2004 that requires all audit committee members to be independent and financially literate. We develop a parsimonious analytical model that shows that both compliance costs and financing needs have an impact on firms' adoption decisions. Confirming the model's predictions, we find that TSX Venture firms with low compliance costs and greater future financing needs are more likely to adopt the new policy voluntarily. The analytical model also shows that high-quality audit committees enhance firm values by reducing the likelihood of managerial resource diversion. Consistent with the predictions of our analytical model, we find that the adoption decision has a positive impact on firm value and a negative impact on firms' cost of equity capital for both Toronto Stock Exchange (TSX) and TSX Venture firms. As corroborating evidence of the economic impact of the more stringent governance policy, we also show that both TSX and TSX Venture firms have improved investment efficiency following the adoption decisions. Data Availability: Data are available from public sources identified in the paper.

The objective of this study is to examine the market valuation of environmental capital expenditure investment related to pollution abatement in the pulp and paper industry. The total environmental capital expenditure of $8.7 billion by our sample firms during 1989–2000 supports the focus on this industry. In order to be capitalized, an asset should be associated with future economic benefits. The existing environmental literature suggests that investors condition their evaluation of the future economic benefits arising from environmental capital expenditure on an assessment of the firms' environmental performance. This literature predicts the emergence of two environmental stereotypes: low-polluting firms that overcomply with existing environmental regulations, and high-polluting firms that just meet minimal environmental requirements. Our valuation evidence indicates that there are incremental economic benefits associated with environmental capital expenditure investment by low-polluting firms but not high-polluting firms. We also find that investors use environmental performance information to assess unbooked environmental liabilities, which we interpret to represent the future abatement spending obligations of high-polluting firms in the pulp and paper industry. We estimate average unbooked liabilities of $560 million for high-polluting firms, or 16.6 percent of market capitalization.

We investigate the association between errors in management forecasts of subsequent year earnings and current year accruals. In an uncertain operating environment, managers' assessments of their firms' business prospects are imperfect. Since managers' imperfect business assessments influence both accruals generation and earnings projection, we hypothesize that management earnings forecasts exhibit greater optimism (pessimism) when accruals are relatively high (low). Consistent with this hypothesis, we find a positive association between management earnings forecast errors and accruals. This positive association is stronger for firms operating in a more uncertain business environment and for firms in industries exhibiting greater covariation between accruals and growth-related activities. Moreover, this positive association is significant when accruals likely reflect managers' true beliefs about firms' business prospects, but is nonexistent when accruals are likely manipulated to boost managers' trading gains. Supplementary analysis reveals that the presence of management earnings forecasts does not significantly reduce accrual mispricing.

This study examines the explicit use of relative performance evaluation (RPE) in executive compensation contracts and the selection of RPE peers. Using S&P 1500 firms’ first proxy disclosures under the SEC’s 2006 executive compensation disclosure rules, we find that about 25 percent of our sample firms explicitly use RPE in setting executive compensation. We demonstrate that a lack of knowledge of both actual peer-group composition and the link between RPE-based performance targets and future peer performance significantly hinder the traditional implicit test from detecting RPE use. We also find that firms consider both costs and benefits of RPE as an incentive mechanism when deciding to use RPE. Finally, both efficient contracting and rent extraction considerations influence RPE peer selection, with the relative importance of these competing considerations depending on RPE firms’ performance.