Knowledge that Transforms

This paper examines how market participants trade on private information about firm fundamentals using the largest known case of informed trade of earnings announcements. From 2011 to 2015, a cartel of sophisticated traders illegally obtained early access to and traded on over 1,000 firm earnings announcements. Using this setting, I identify the information in earnings announcements that these market participants found most price relevant. The informed traders preferred announcements with larger earnings and sales surprises relative to forecasts, quantitative managerial guidance, and more extreme news sentiment. Despite their perfect foresight, the traders performed, perhaps surprisingly, poorly relative to hypothetical trading strategies based on comparable foresight. Frictions that limited their performance include price impact, risk aversion, and information processing costs. The trading performance of these informed traders implies that information about firm fundamentals explains little of the cross‐sectional variation in earnings announcement returns, even for sophisticated market participants.

We conduct an experiment to investigate the use of peer evaluations for compensation purposes. Although organizations often rely on peer evaluations for incentive compensation, it is not well understood how peer feedback should be used and designed to ensure non‐distorted evaluations and motivate effort provision. We study peer evaluations in form of bonus allocation proposals, thereby enabling a quantifiable test of our hypothesis. We distinguish between discretionary use (i.e., allocation by the manager) and formulaic use (i.e., allocation by the team via the average) of self‐including and self‐excluding proposals. We find that, relative to self‐including proposals, self‐excluding proposals are less distorted, irrespective of use, but lead to more effort provision only under formulaic use. Under discretionary use, the benefits of self‐excluding proposals are offset, as managerial biases enter bonus allocations. In sum, our findings illustrate benefits of delegating bonus allocations to teams through formulaic use of self‐excluding peer evaluations and extend the understanding of how organizations can effectively incorporate peer evaluations into incentive compensation.

We examine the effect of internal employee coordination on customer trust, focusing specifically on employees’ responsiveness to each other as an important, quantifiable, and objective aspect of internal coordination. Using proprietary data from a company with exogenous assignment of employees to teams that serve individual customers, we study how inter‐employee responsiveness influences customer trust. Each customer is served via an app‐based group chat by a randomly assigned team of employees. Our data include more than 2 million group chat messages with over 16 thousand customers. We find that inter‐employee responsiveness serves as a credible signal that helps build customer trust, as evidenced by their subsequent contracting choices. The effect is more pronounced when the signal is (1) more frequent and (2) more intense. Our findings highlight the novel value of internal employee responsiveness as a credible signal that helps build trust with external stakeholders.

Complexity in applying financial accounting standards can have real operational effects if firms alter their actions in response to increased reporting costs. We examine whether the introduction of ASU 2017‐12, designed to reduce compliance burden and better align hedge accounting rules with risk management practices, led to more effective hedging. Using detailed hedging disclosures, we show that firms that adopt the ASU expand the use of hedge‐accounted derivatives and reduce exposures to interest rate and foreign currency risks. ASU‐adopting firms also reduce cash flow volatility, increase their use of debt, invest more, and reduce information asymmetry in the equity market. Our analyses reveal that easing hedge effectiveness tests and reliefs targeting “cash flow hedges” and “net investment hedges of foreign operations” were the most influential of the ASU's reforms. Our study is the first to integrate the effects of hedge accounting frictions on firms’ risk management activities and resulting spillovers to debt financing and investments.

This paper investigates why commercial lenders make markets for the loans that they sell on the secondary market. Using loan‐level data, I find that origination lenders with extensive borrower relationships and more reputational capital at stake are more likely to serve as market makers. Greater participation of origination lenders as market makers is associated with lower trading costs for their borrowers' loans. This association remains even in conditions where origination lenders could exploit their information advantage for market making profits. Lenders benefit from being market makers by maintaining strong subsequent lending relationships with their borrowers. Collectively, this evidence is consistent with origination lenders' participation in the secondary market being motivated by reducing trading frictions rather than market making profits.

We examine whether U.S. immigration policy, specifically the H‐1B visa program, affects the likelihood of financial misconduct. We argue that employers have leverage over employees on H‐1B visas because such employees must maintain H‐1B–eligible employment to legally reside in the United States. We posit that companies relying on H‐1B visas to hire workers in accounting roles have an increased ability to misreport their financial statements due to the greater costs H‐1B employees face if they are unexpectedly fired for not following the demands of their bosses or for blowing the whistle on misconduct. Using the sharp reduction in the H‐1B visa cap in 2004 as a shock to such employment, we find that companies that relied on this visa program for accounting roles pre‐shock experience a 2.3 percentage point decline in accounting irregularities post‐shock. Cross‐sectional tests show that the reduction in irregularities is greater in companies where H‐1B employees have (1) a greater influence on financial reporting or (2) fewer job opportunities. In addition, the relation between H‐1B visa use and irregularities is stronger in companies whose investors are more focused on near‐term earnings targets. We corroborate our findings using the outcome of H‐1B visa lotteries as shocks to such employment.

Local-thinking bias, wherein agents overweight information that comes readily to mind, is a prominent finding in cognitive psychology. In this study, we investigate local-thinking bias in the context of sell-side analysts and measure each analyst’s “local” information as news stemming from their individual coverage portfolio. Tests examining multiple analysts forecasting on the same focal firm at the same time find that individual analysts overweight idiosyncratic local news and underweight news from economically linked firms that are not in their coverage portfolios. Market prices track the analyst bias from local news, leading to predictable and economically significant return reversal patterns in the future. A trading strategy that adjusts for analysts’ biases earns meaningful abnormal returns. We discuss the implications of these findings for three literatures: (1) cognitive psychology, (2) analyst behavior, and (3) behavioral asset pricing.

Following securities law violations, regulators can require firms to hire a corporate monitor to implement reforms that limit future misconduct and protect investors. We examine the determinants of including a corporate monitor as equitable relief in an enforcement action, as well as their effectiveness in promoting positive change at a firm. Using a structural equation model that jointly determines monetary and nonmonetary sanctions, we find that monitor assignments are related to the nature of the offense, violation severity, and investor harm. We also find that monitors with targeted accounting oversight responsibilities are associated with improved corporate culture, a higher likelihood of financial restatements during their tenure, and enhanced financial reporting credibility at the firms they oversee relative to enforcement firms without such monitors. Although corporate monitors can foster positive change, their impact depends on the scope of their responsibilities. Data Availability: Data are available from the public sources cited in the text.