Knowledge that Transforms

This paper investigates whether foreign institutional investors affect the global convergence of financial reporting practices. Using several measures of reporting convergence, we show that U.S. institutional ownership is positively associated with subsequent changes in emerging market firms’ accounting comparability to their U.S. industry peers. We identify this association using an instrumental variable approach that exploits exogenous variation in U.S. institutional investment generated by the JGTRRA Act of 2003. Further, we provide evidence of a specific mechanism—the switch to a Big Four audit firm—through which U.S. institutional investors affect reporting convergence. Finally, we show that, for emerging market firms, an increase in comparability to U.S. firms is associated with an improvement in the properties of foreign analysts’ forecasts.

Prior research has documented that arbitrage activity significantly reduces or eliminates stock market anomalies. However, if anomalies arise due to unsophisticated investors’ behavioral biases, then these same biases can also apply to unsophisticated arbitrageurs and thereby disrupt the arbitrage process. Consistent with a disruption in the arbitrage process for the post‐earnings announcement drift anomaly, I document that the historically positive autocorrelation in firms’ earnings announcement news has become significantly negative for firms with active exchange‐traded options. For these easy‐to‐arbitrage firms, the firms in the highest decile of prior earnings announcement abnormal return (prior earnings surprise), on average, underperform the firms in the lowest decile by 1.59% (1.43%) at their next earnings announcement. Additional analyses are consistent with investors learning about the post‐earnings announcement drift anomaly and overcompensating. This study suggests that unsophisticated attempts to profit from a well‐known anomaly can significantly reverse a previously documented stock return pattern.

We examine whether and how an exogenous shock to the information environment changes insiders’ ability to learn from outsiders. We document three main findings. First, we find an increase in investment‐to‐price sensitivity following the adoption of International Financial Reporting Standards (IFRS). Second, we show that the relation between the market reaction to M&A deal announcements and the likelihood of deal completion becomes stronger after IFRS adoption. Third, we find significant improvements in post‐acquisition operating and stock return performance post‐IFRS adoption. These results are more pronounced for firms that experienced significant increases in foreign institutional ownership around IFRS adoption, especially when these foreign investors are from countries that matter for the firm’s growth opportunities. Taken together, our findings suggest that insiders’ ability to learn from outsiders improves post‐IFRS, and this improved ability to learn from outsiders leads to real economic gains.

Using the adoption of SFAS 131, I examine the effect of segment disclosure transparency on internal capital market efficiency. SFAS 131 requires firms to define segments as internally viewed by managers, thereby improving the transparency of managerial actions in internal capital allocation. I find that diversified firms that improved segment disclosure transparency by changing segment definitions upon adoption of SFAS 131 experienced an improvement in capital allocation efficiency in internal capital markets after the adoption of SFAS 131. In addition, I find that the improvement in internal capital market efficiency was greater for firms that suffered more severe agency problems before the adoption of SFAS 131 and also for firms whose managers faced stronger incentives to improve efficiency after the adoption of SFAS 131. My results suggest that more transparent segment information can help resolve agency conflicts in the internal capital markets of diversified firms, thus improving investment efficiency.

We study the relation between issuer operating performance and initial public offering (IPO) price formation from the initial price range to the offer price to the closing price on the first trading day. For a post‐bubble sample of 2001–2013 IPOs, we find that pre‐IPO net income and, in particular, operating cash flow are strongly, positively associated with the revision from the mid‐point of the initial price range to the offer price and that the “partial adjustment phenomenon” concentrates among issuers with the strongest operating performance. As for why publicly observable information helps predict changes in valuation from when the initial price range is set to when the offer price is set, our findings suggest that strong‐performing issuers, especially those offering small slices of ownership, have lower bargaining incentives and are susceptible to the underwriter(s) low‐balling the price range. Overall, our results suggest an important role for accounting information in understanding the pricing of book‐built IPOs and are consistent with the presence of agency problems between issuers and underwriters.

We investigate whether the media plays a role in corporate governance by disseminating news. Using a comprehensive data set of corporate and insider news coverage for the 2001–2012 period, we show that the media reduces insiders’ future trading profits by disseminating news on prior insiders’ trades available from regulatory filings. We find support for three economic mechanisms underlying the disciplining effect of news dissemination: the reduction of information asymmetry, concerns regarding litigation risk, and the impact on insiders’ personal wealth and reputation. Our findings provide new insights into the real effect of news dissemination.

We examine tone dispersion, or the degree to which tone words are spread evenly within a narrative, to evaluate whether narrative structure provides insight into managers’ voluntary disclosures and users’ responses to those disclosures. We find that tone dispersion is associated with current aggregate and disaggregated performance and future performance, managers’ financial reporting decisions, and managers’ incentives and actions to manage perceptions. Furthermore, we find that tone dispersion is associated with analysts’ and investors’ responses to conference call narratives. Our results suggest that tone dispersion both reflects and affects the information that managers convey through their narratives.

There is a debate in the literature as to whether employee selection is a substitute or complement to incentive contracting. We argue that incentive contracts and selection can be both complements and substitutes conditional on the contracting difficulty faced by the firm. We examine these control choices in a setting where contracting difficulties arise due to the firm's choice of strategy and from the volatility created by the firm's external environment. We select a firm's commitment to organizational learning (OL) as our strategic choice variable as this provides a useful proxy for identifying settings where explicit incentive contracting is difficult. The results show that, as firms become increasingly committed to OL, incentive contracts and employee selection operate as complements. However, with a high commitment to OL and an increasing level of external volatility, contracting on performance measures will become less effective. In this context, our results indicate that there is a substitution effect toward employee selection.

Our objective is to penetrate the “black box” of sell‐side financial analysts by providing new insights into the inputs analysts use and the incentives they face. We survey 365 analysts and conduct 18 follow‐up interviews covering a wide range of topics, including the inputs to analysts’ earnings forecasts and stock recommendations, the value of their industry knowledge, the determinants of their compensation, the career benefits of Institutional Investor All‐Star status, and the factors they consider indicative of high‐quality earnings. One important finding is that private communication with management is a more useful input to analysts’ earnings forecasts and stock recommendations than their own primary research, recent earnings performance, and recent 10‐K and 10‐Q reports. Another notable finding is that issuing earnings forecasts and stock recommendations that are well below the consensus often leads to an increase in analysts’ credibility with their investing clients. We conduct cross‐sectional analyses that highlight the impact of analyst and brokerage characteristics on analysts’ inputs and incentives. Our findings are relevant to investors, managers, analysts, and academic researchers.

Are there times when durable spending is less responsive to economic stimulus? We argue that aggregate durable expenditures respond more sluggishly to economic shocks during recessions because microeconomic frictions lead to declines in the frequency of households' durable adjustment. We show this by first using indirect inference to estimate a heterogeneous agent incomplete markets model with fixed costs of durable adjustment to match consumption dynamics in PSID microdata. We then show that aggregating this model delivers an extremely procyclical Impulse Response Function (IRF) of durable spending to aggregate shocks. For example, the response of durable spending to an income shock in 1999 is estimated to be almost twice as large as if it occurred in 2009. This procyclical IRF holds in response to standard business cycle shocks as well as in response to various policy shocks, and it is robust to general equilibrium. After estimating this robust theoretical implication of micro frictions, we provide additional direct empirical evidence for its importance using both cross-sectional and time-series data.