Knowledge that Transforms

I study whether commercial banks' loan loss allowances were inadequate during the 2008 financial crisis because bank managers relied on low-quality information to estimate loan losses. To measure the quality of information collected on bank-held mortgages prior to the crisis, I create a bank exposure-to-mortgage fraud risk index (EFI) that captures overstatement of borrower income in mortgage applications. I find banks that originated more loans in high-risk neighborhoods had less adequate loan loss allowances during the crisis. My study is consistent with the hypothesis that fraudulent borrower information adversely affected banks’ loan loss provisioning.

We investigate the relationship between private firms' disclosures and the demand for the equity of their publicly traded peers. Using data on the global movement of portfolio investments in public equity, we find that a 10% increase in private firm disclosure transparency – proxied by the number of disclosed private firms' financial statement line items – reduces global investors’ demand for public equity by 4.3% or $358 million per investee country-industry. These findings are consistent with private firm disclosures generating negative pecuniary externalities – global investors reallocate their capital away from public firms to more transparent private firms – and less consistent with these disclosures creating positive information externalities that would benefit public firms. Consistent with this interpretation, we find that the reduction in demand for public equity is offset by a comparable increase in capital allocation to more transparent private firms. Using a simulated instruments approach and the staggered implementations of electronic business registers in investee countries in Europe as plausibly exogenous shocks to private firm transparency, we conclude that the negative relationship between private firm disclosures and public equity demand is likely causal.

This study explores whether NielsenIQ scanner data from U.S. retailers contain incremental information about the GAAP revenue of corresponding manufacturers. Using retail product/store/week data from 2006 to 2018, we construct a measure of aggregated consumer purchases at the manufacturer/quarter level, and find that it strongly predicts GAAP revenues. In addition, analyst forecasts of revenues have predictable errors, which implies that analysts do not fully incorporate the information in consumer purchases. Exploring investment implications, we find that hedge portfolios that buy (sell) stocks of firms with high (low) abnormal consumer purchases generate annualized returns on the magnitude of 14%–19%, depending on specification. Overall, these findings suggest that scanner data on consumer purchases provide an information edge over GAAP revenue, shedding light on the benefits of using transactional data.

Government subsidies allocated by politicians are ultimately funded by taxpayers, who care about how tax money is spent and demand transparency. I argue that subsidized firms, as beneficiaries of government subsidies, have incentives to provide more disclosures to help politicians achieve a reputation for transparency as well as to lower their own costs from public scrutiny. Using a novel dataset that tracks government subsidies, I provide the first large-sample evidence on the relation between government subsidies and firm disclosure. I find that relative to unsubsidized firms, subsidized firms provide more voluntary disclosures of general information about their business activities and profitability, as well as more disclosures of subsidy-goal-related information, such as job creation and capital investment. Further, these associations are stronger for firms operating in or obtaining subsidies from states whose politicians reveal a stronger preference for subsidy transparency, and for firms that are more likely to attract public scrutiny.

Armstrong et al. (2022) review the various econometric methods that have been used to draw causal inference in the accounting literature and offer an alternative method for conducting research when causal methods are not applicable. This discussion provides background for the emphasis on causal inference in accounting. It also draws parallels between the authors' proposed quasi-causal method and the structural estimation methods that have been used in finance and that are starting to be used in accounting.

We hypothesize that companies in the same product market avoid sharing the same audit partner when they are concerned about possible information spillovers. Consistent with our hypothesis, we find that product market rivals are less likely to share the same partner when they perceive that information spillovers are more costly. While concerns about information spillovers significantly reduce the likelihood of product market rivals sharing the same audit partner, we find that such concerns do not deter them from sharing the same audit office. Lastly, when companies are unconcerned with information spillovers, our results suggest that partner sharing can be beneficial because it can result in lower audit fees and fewer accounting misstatements.

I examine how banks change their risk management practices in response to the private disclosure of regulatory ratings that summarize bank risk-taking. Upon ratings disclosure, affected banks increase the timeliness of their loan loss provisioning. These effects are concentrated among banks that lie below key rating thresholds and those headquartered in states with low competition. After ratings disclosure, deficient banks decrease commercial lending while shifting assets into cash. Overall, my findings highlight how performance measures produced and privately disclosed by a third party can influence actions within a firm.

We argue that relative performance evaluation (RPE) contracts introduce a tournament among the focal firm and peer firms. We test whether a firm's riskiness is altered by its CEO's incentive to win the tournament. We find that a firm that performed poorly relative to its peers during an interim period takes more risk in the remainder of the evaluation period than a firm with better interim performance. This effect is stronger when the interim assessment date is closer to the end of the evaluation period and when winning the competition is more important to the CEO. Together, our results suggest that RPE contracts create tournament incentives for CEOs and significantly affect corporate risk taking.

The past 25 years have seen an exponential growth in the number of China studies in the leading accounting journals. The rise in China-related research mirrors the country's increased importance on the global stage and a growing appreciation of the economic importance of Chinese institutions. We organize our review of the China literature around three central themes: 1) political and regulatory institutions, 2) China's relationships with foreign investors, and 3) the availability of novel data and regulatory shocks. The former two themes address research questions that are more China-centric, while the third exploits the China setting to examine questions that are more universal. We highlight the contributions that China studies have made to the broader accounting literature, the limitations of the current literature, and we offer suggestions for future research directions.

We provide evidence that financial shocks to lenders influence the composition of financial covenants in debt contracts. Using two distinct measures of lender-specific shocks—defaults in a lender's corporate loan portfolio that occur outside the borrower's region and industry, and non-corporate loan delinquencies—we show that lenders respond to financial shocks by increasing the number and strictness of performance-based but not of capital-based covenants in debt contracts. We examine two possible channels for this result. We find evidence consistent with lenders using stricter control rights because of concerns about capital depletion (a capital channel) and because of new information about lenders' own screening ability (a learning channel). Our results indicate that lender preferences influence how accounting information is used in debt contracts.