Knowledge that Transforms

This study examines whether and how financial statement comparability facilitates the dissemination of innovative knowledge between firms and stimulates the creation of new knowledge. Using cross-patent citations to track interfirm knowledge transfers, we find that comparability increases firms' incentives to learn from peers and create new patents that cite their peers' existing patents. The investigation into the mechanism reveals that comparability improves firms’ ability to estimate the monetary value of peer knowledge and predict their own financial benefits from knowledge acquisition. The impact of comparability is more pronounced when peer knowledge is more publicly accessible or of higher monetary value. Consequently, the acquired knowledge fosters follow-on innovation, enabling firms to produce more patents with greater economic significance. Evidence from two quasi-natural experiments suggests that our findings are plausibly causal. Overall, our study highlights the important role of accounting comparability in facilitating knowledge dissemination.

Using a dataset covering 3 million commercial borrower financial statements, we document a substantial, nearly monotonic decline in banks’ use of attested financial statements (AFS) in lending over the past two decades. Two market forces help explain this trend. First, technological advances provide lenders with access to a growing array of borrower information sources that can substitute for AFS. Second, banks are increasingly competing with nonbank lenders that rely less on AFS in screening and monitoring. Our results illustrate how technology adoption and changes in credit market structure can render AFS less efficient than alternative information sources for screening and monitoring.

An important debate exists around the extent to which retail investors make sustainable investments and, if they do, why. We contribute to this debate by investigating the aggregate trading patterns of retail investors around a comprehensive sample of key environmental, social, and governance (ESG) news events for U.S. firms. We show that ESG news events appear to be an important factor in retail investors’ portfolio allocation decisions. Yet, inconsistent with arguments about retail investors’ nonpecuniary preferences, our evidence shows that retail investors mainly trade on this information when they deem it financially material to a company’s stock performance. We also find their net trading demand predicts abnormal returns in the subsample of financially material events, consistent with retail traders benefiting from incorporating ESG-related information into their decision-making when it influences firm value. Overall we conclude that the average U.S. retail investor cares about firms’ ESG activities but primarily to the extent these activities matter for company financial performance.

We survey corporate managers of both guiding and non-guiding firms. We find that managers of firms that provide guidance say that they: (1) primarily provide guidance to satisfy analyst and investor demands and manage analysts’ earnings expectations; (2) are relatively unconcerned about proprietary or litigation costs (managers of non-guiding firms are more likely to see litigation risk as a concern); (3) predominantly issue guidance that is conservative relative to their internal expectations; (4) are concerned that guidance induces analysts and investors to focus on the short-term but not that it induces managers themselves to make myopic decisions internally. We also find that managers are miscalibrated about the accuracy of their guidance and that significant quantities of guidance that managers say their firms issue are not captured by conventional sources. We offer several other new insights relevant to the voluntary disclosure literature.

We study the interaction between optimal financial reporting rules and managers' incentives to gather additional information about firm performance. Accounting-based covenants transfer control rights to lenders, allowing them to take corrective actions. After the accounting report is released, the manager can exert effort to uncover whether the report is a false alarm or unduly optimistic. The manager's incentive to gather information stems from optimal incentive contracts and private benefits of control that she loses when the project is liquidated. We derive conditions under which managerial information acquisition renders conservative reporting optimal for shareholders and show that these conditions relax when the manager derives greater private benefits from the project or the cost of information acquisition declines. Our model provides novel explanations for existing empirical findings and offers new predictions with respect to covenant waivers, debt contract renegotiations, and the frequency of corrective actions.

We examine whether performance reporting leads to inconsistent enforcement at the Securities and Exchange Commission (SEC). In a sample of over 13,000 SEC enforcement actions, we show that SEC staff respond to performance-reporting pressures and file more enforcement actions in September, the final month of the SEC's fiscal year, than in any other month. The increase in case volume in September is not fully explained by staff filing more procedural cases or accelerating case filings. Instead, SEC staff pursue less complex cases and agree to more lenient financial and non-financial sanctions to increase case volume in September. We attempt to rule out alternative explanations for our results, including natural SEC workflow and resource constraints. Overall, our findings suggest that performance reporting creates agency conflicts that lead to regulatory inconsistency within the fiscal year.

We examine how firms respond to requests for enhanced disclosure that we make on an online investor platform. Exploiting variation in firms' customer and supplier disclosures, we ask a randomized set of non-disclosing firms to provide information on their customers' and suppliers' identities. We find that the firms' probability of disclosure depends on the basis we give for the demand—requests appealing to disclosure's usefulness to investors lead to more frequent disclosure, while those appealing to regulators' preference for disclosure lead to less frequent disclosure. The requests we make on the platform lead to more frequent customer- and supplier-related inquiries from other platform users. We also find that the treatment firms' disclosure of customer and supplier information improves in the next period's regulatory filings. The findings suggest that investor platforms can enhance corporate transparency by increasing retail investors' ability to demand information.

We use a proprietary database with detailed, employee-specific compensation contract information for rank-and-file corporate accountants who are directly involved in the financial reporting process to assess their influence on their firms' financial reporting quality. Theory predicts that paying above-market wages can both attract employees with more human capital and subsequently encourage better performance. Consistent with audit committees structuring accountants' compensation to mitigate financial misreporting that might otherwise occur, we find that firms with relatively well-paid accountants tend to issue higher-quality financial reports. Moreover, this relationship is more pronounced when firms’ senior executives have stronger contractual incentives to misreport and when the audit committee is more independent from management.

In 2013, the U.S. Consumer Financial Protection Bureau released a database of consumer complaints filed against banks under its supervision (“CFPB banks”). We find that after the disclosure, rival banks exhibit a greater increase in mortgage approval rates in markets with more intensive mortgage complaints about CFPB banks. The effect is weaker when rivals have more expertise in the local market, are less concerned about credit risk due to mortgage sales, and locate in areas with more alternative information about the CFPB banks. The effect is concentrated in severe complaints and complaints related to loan underwriting practices. In addition to approving more loans, rivals also open more branches and are more likely to post a job opening in these markets. The findings suggest that these banks learn from the nonfinancial disclosures about operational deficiencies of peers (i.e., CFPB banks) in local markets, which alleviates their adverse selection concern about expanding.

This paper shows that mandating some firms to disclose more while leaving other firms disclosing voluntarily is less effective in improving and may even harm the overall information environment when firms' disclosures are endogenous. Although the regulated firms' increased disclosure directly reduces all firms' cost of capital, it crowds out the unregulated firms' voluntary disclosure and thus increases all firms’ cost of capital indirectly. Under certain circumstances, the negative indirect effect can outweigh the direct benefit. These results are consistent with the scant evidence on the cost-of-capital effect of mandatory disclosure. The model highlights the importance of the market-wide effects of disclosure regulation and facilitates quantitative cost-benefit analyses for specific regulatory proposals.