Knowledge that Transforms

Dividends are a key mechanism for shareholders to discipline managers and mitigate agency conflicts. This study examines whether the volatility of tax payments is associated with dividend payouts. Consistent with the predictions, results suggest that firms with more volatile tax payments are less likely to pay dividends overall and their dividends are lower in magnitude when doing so. These effects are economically significant and incremental to a firm's operating risk. The link between volatile tax payments and the likelihood of dividend payouts is weaker for firms that distribute dividends to alleviate agency conflicts. Similarly, the link between volatile tax payments and the amount of dividend payouts is weaker for firms that hold more cash for tax reasons. Taken together, these findings add to our understanding of the economic consequences of volatile tax payments and the determinants of dividend payouts.

ABSTRACT We examine information quality and financial leverage when an entrepreneur needs financing to undertake a risky project and his effort input affects the project's outcome. We show that information quality and financial leverage interact to play active roles in both investment and effort decisions. Our analysis shows a positive association between leverage and optimal information quality—when leverage is low (high), low (high) information quality is optimal. This is because with low leverage, the entrepreneur is already motivated by his large share of the outcome to exert effort, and high information quality is not efficient as a precise bad signal discourages the entrepreneur's effort. In contrast, when leverage is high and thus the entrepreneur is less motivated by his residual cash flows, high information quality is optimal, because a precise good signal encourages the entrepreneur's effort. Our study highlights the joint effect of information quality and financial leverage on overall efficiency through firms' effort inputs as well as on defining investment efficiency.

Abstract We investigate the influence of peer quality on subjective performance evaluation using 75,413 ratings of 130 employees from 6,908 raters in a business school setting. We find that subjective performance ratings are lower for employees with higher quality peer groups in both randomized and nonrandomized settings. Using a novel long‐window setting, we observe peer effects persisting, but slowly decaying, for several months even when priming raters with the employees' previous performance information. We find that the strength of the peer effects is greater for focal employees with weaker performance, for the peers with higher attribute similarity, and when the performance of peers is more extreme. Overall, we find strong and persistent peer effects in subjective performance evaluation.

ABSTRACT We develop FinBERT, a state‐of‐the‐art large language model that adapts to the finance domain. We show that FinBERT incorporates finance knowledge and can better summarize contextual information in financial texts. Using a sample of researcher‐labeled sentences from analyst reports, we document that FinBERT substantially outperforms the Loughran and McDonald dictionary and other machine learning algorithms, including naïve Bayes, support vector machine, random forest, convolutional neural network, and long short‐term memory, in sentiment classification. Our results show that FinBERT excels in identifying the positive or negative sentiment of sentences that other algorithms mislabel as neutral, likely because it uses contextual information in financial text. We find that FinBERT's advantage over other algorithms, and Google's original bidirectional encoder representations from transformers model, is especially salient when the training sample size is small and in texts containing financial words not frequently used in general texts. FinBERT also outperforms other models in identifying discussions related to environment, social, and governance issues. Last, we show that other approaches underestimate the textual informativeness of earnings conference calls by at least 18% compared to FinBERT. Our results have implications for academic researchers, investment professionals, and financial market regulators.

Abstract This study develops several Google search‐based measures to test the relation between earnings‐week online search results and the speed of price discovery. These measures are based on searches using only a firm's ticker symbol in the search string. I collect the total number of search results (across all search result pages) as well as the type and content of search results on the first three pages of search results. I find that the quantity, quality, and content of search results have varying effects on the speed at which earnings news is impounded into stock price. I also find that effects are only observed for search results presented on the first page of a Google search. Overall, my results suggest that (1) increases in online information are associated with slower price discovery, and (2) the likely mechanism by which this association operates is through useful search results being crowded off the first page of results by more complex or irrelevant search results.

Abstract The literature on corporate social responsibility (CSR) disclosure focuses on its economic consequences, but little is known about motivations—especially CEO personal incentives—behind such disclosure. Using an array of CSR reporting measures, we find that career concerns of CEOs early in their tenure motivate them to use voluntary CSR reporting as a signaling mechanism. The negative association between CEO tenure and CSR reporting is more pronounced in firms with stronger information intermediaries—that is, a higher level of socially responsible investors, a higher number of analysts following, and a higher level of media coverage. We also find that CEOs early in their tenure receive more personal benefits after voluntary CSR reporting, in terms of higher total compensation, better reputation, and less turnover, than CEOs later in their tenure. Taken together, the findings of our study lend support to the conjecture that CEO career concerns early in their tenure can be an important determinant of firms' voluntary CSR reporting.

Abstract We study how corporate taxation interacts with intrafirm incentive conflicts between shareholders and managers and how this interaction impacts the firm's economic decisions and outcomes. In our model, investment under asymmetric information facilitates entrenchment and rent extraction by the privately informed manager. We show that when the future investment payoff is exogenous, a corporate tax cut increases managerial rents, reduces pre‐tax investment profitability, increases the firm's optimal investment hurdle rate, and reduces investment. When the manager can exert upfront project development effort to increase the expected investment payoff, a tax rate reduction not only encourages more effort but also leads the firm to increase the investment hurdle rate to curtail rents. In equilibrium, a lower tax rate always benefits the manager, but the sensitivity of the project's return to the manager's effort determines whether the firm will increase or decrease investment in response to a tax cut, and whether the firm's resulting pre‐tax profit will increase or decrease. Overall, our study shows that intrafirm incentive conflicts can be an important factor in the interplay between tax incidence and economic efficiency, two central themes in corporate tax policy debates.

Abstract An audit committee (AC) report is the primary channel through which investors learn about the responsibilities and activities of an AC. AC members may use personal language (“we”) or impersonal language (“the audit committee”) in an AC report. Psychology research suggests that personal (vs. impersonal) language signals that the language user has greater warmth and sense of communion (i.e., being part of a larger group). Applying this theory, we predict that an AC's use of personal (vs. impersonal) language leads investors to perceive a warmer and more communal AC, and that an AC's perceived warmth/communion (cued by personal language) positively impacts investor judgments. We further posit that the positive effect of personal language is stronger when AC compensation is largely short term than long term. This is because investors need more assurance of AC oversight effectiveness when AC compensation is short term, which makes investors rely more on heuristic cues such as AC language to make judgments. Consistent with this prediction, we find that when AC compensation is largely short term, nonprofessional investors (proxied by Master of Business Administration students) react more positively to an AC's use of personal language than impersonal language. The effect of AC language is insignificant when AC compensation is largely long term, as the long‐term compensation structure already provides assurance about the AC's oversight effectiveness, and thus, investors rely less on heuristic cues. Furthermore, we find that the perceived warmth of AC members explains the effect of AC language. Finally, our interviews with nonprofessional investors corroborate some of our main findings and validate their practice implications.

Abstract We examine whether managers' narcissism explains the difficulty of the performance targets that they set for their subordinate employees and the resulting dysfunctional behaviors of these employees. Utilizing a field‐based data set and a government policy change that imposes higher performance standards, we document both direct and indirect associations between manager narcissism and employee dysfunctional behavior. In particular, we find that managers with a higher degree of narcissism respond to the higher performance standards by setting more difficult targets for their subordinates, which in turn lead to more employee dysfunctional behaviors. Furthermore, after controlling for the effect of target difficulty, we find that manager narcissism also has a direct positive association with employee dysfunctional behavior. Our findings contribute to the management accounting literature by documenting that narcissism, a personality trait that is ubiquitous among managers, plays an important role in affecting managers' control choices and the dysfunctional behaviors of lower‐level employees.

ABSTRACT This study examines whether analysts have an industry‐level information advantage over managers when forecasting earnings. While analysts are often viewed as industry experts, prior research fails to document such an advantage. We predict that analysts' industry‐level information advantage is more likely to exist in industries where firm performance is more sensitive to industry‐level external economic forces. We find that for such firms, analysts provide relatively more accurate earnings forecasts compared to managers. Consistent with our predictions, we further find that managers of such firms provide fewer and less precise forecasts and that this association is more pronounced in firms with higher analyst following. Collectively, these findings suggest that analysts have an industry‐level information advantage over managers when forecasting earnings for firms in industries with high sensitivity to external forces, and that industry sensitivity risk is a distinct industry characteristic that affects firm‐level disclosure.