Knowledge that Transforms

Abstract We examine whether a firm's corporate social responsibility (CSR) actions that benefit external parties can cause the firm's employees to reduce their effort. We expect employees will reduce their effort in response to their firm's external CSR actions when they perceive that they are treated poorly by the firm and that the firm's external CSR actions use resources that could have been readily transferred toward improving employee treatment. We expect that, when employees hold both of these perceptions, they will react negatively to the firm's CSR actions due to heightened feelings of unfairness. Results support our expectations and theory. We find that employees respond negatively to CSR only when they perceive that they are treated poorly by their firm and that CSR uses transferable resources. Further, we find these effects are driven by employees' perceptions of the fairness of their firm's actions toward employees. Our study suggests that firms should consider how employees perceive their treatment by the firm and the transferability of the resources used for CSR actions that benefit external parties.

Abstract We examine the economic determinants and informational effects of credit rating affirmations (i.e., the reiteration of past credit ratings) for a sample of US public firms from 1995 to 2020. We find that credit rating affirmations typically follow major corporate events and changes in firm fundamentals that increase information uncertainty about a firm's creditworthiness, suggesting that affirmations reduce uncertainty. We further document that rating affirmations provide value‐relevant information to equity and debt investors. Using a short‐window event study method, we show that equity investors react positively to rating affirmations and that information uncertainty around affirmations diminishes. These findings are more pronounced for firms with non‐investment‐grade ratings. We further show that our results strengthen for firms with greater pre‐affirmation information uncertainty. Finally, consistent with our information uncertainty reduction results from the stock market, we report that bond yield spreads decrease for affirmed firms. Again, the effect is more pronounced for firms with non‐investment‐grade ratings. In summary, we highlight the significant capital markets' effects of credit rating affirmations, an area that the literature has largely ignored.

Abstract This paper presents new evidence on the economic benefits arising from common institutional ownership. We find a negative and significant effect of common institutional ownership on stock price crash risk. This effect is robust to a battery of robustness checks and is causal according to some identification tests, including difference‐in‐differences analyses on financial institution mergers. We find evidence that the negative effect is attributable to the monitoring role of common institutional owners—a role that is enabled by common owners' lower information processing cost and greater monitoring incentives owing to governance externalities. We also find that common owners negatively influence crash risk through constraining bad news hoarding and that common owners are more likely to force CEO turnover when a firm has higher crash risk. Overall, our results suggest that common institutional shareholders play a unique and effective monitoring role that fends off stock price crashes.

Abstract In empirically estimating the relation between CEO compensation and accounting‐based firm and peer performance, researchers often define the performance variables net of CEO compensation expense. We analytically show that a researcher's use of CEO compensation as a regression's dependent variable and as an expense in defining a regression's independent variables representing accounting‐based firm and peer performance will bias the researcher's pay‐for‐performance and relative performance evaluation (RPE) regression coefficients. In a panel estimation of CEO compensation, we document an attenuation bias in the coefficients on net firm and net peer performance. This evidence may partially explain inferences of weak CEO incentives and limited usage of RPE in prior work. Our results imply that in CEO compensation regressions, a researcher can remove biases in inferring CEO incentives and RPE usage by using gross rather than net accounting performance variables—that is, by adding back CEO compensation expense to net accounting measures.

Abstract We investigate whether a larger CEO employment network provides access to information that improves firms' earnings forecasts and find a significantly positive relation between CEO employment network size and management earnings forecast accuracy. Our results suggest that firms use information obtained from CEO contacts to increase the accuracy of their earnings forecasts. Our conclusion is further supported by evidence of positive associations between CEO employment network size and the likelihood, frequency, and precision of management earnings forecasts. We also find that CEO employment network size is positively related to analysts' reactions to the forecast news and the accuracy of management earnings forecasts relative to analyst forecasts. Overall, our results are consistent with a larger CEO employment network generating external information that increases the accuracy of firms' earnings forecasts.

Abstract The general anti‐avoidance rule, or GAAR, is an enforcement mechanism that gives a country's taxing authority broad power to deny a taxpayer tax benefits associated with any transaction. Although GAARs are becoming increasingly common, the presence of a GAAR is generally overlooked by researchers and thus has been left unstudied. In this paper, we provide an initial investigation by studying the effect of GAARs on firm‐level corporate tax avoidance behaviors. Using an indicator for the enactment or strengthening of a GAAR within a country in a stacked difference‐in‐differences design, we find GAAR enactment is associated with a statistically and economically significant decrease in firm‐level tax avoidance. Additional cross‐sectional analyses show that the decline in tax avoidance occurs for conventional GAARs and economic substance‐type rules, original and strengthened GAARs, and domestic and multinational firms. Results also show that the effect is strongest for firms with higher levels of pre‐GAAR‐enactment tax avoidance and for firms incorporated in countries where the burden of proof lies with the taxpayer.

Abstract Using a sample of 30,270 forecasts by 2,280 analysts under a stacked difference‐in‐differences framework involving 22 major climatic disasters in the United States, we examine the effect of climatic disasters on information production by security analysts, who play a crucial role in the financial market as information intermediaries. We find that earnings forecasts by analysts who experienced a major climatic disaster become less accurate than those by unaffected analysts within 3 months after the disaster, due to distracted attention. Disaster‐zone analysts are more likely to allocate their attention to firms of greater importance or salience, and they tend to reiterate their previous forecasts to maintain the quantity and timeliness of their forecasts. Overall, we document the real impact of cognitive bias on financial professionals' performance.

Abstract This study investigates the effects of audit committee financial expertise on the timeliness of banks' loan loss provisions. I employ two regulatory shocks that mandated audit committee expertise—the Federal Deposit Insurance Corporation Improvement Act in 1991 (FDICIA) and a modified listing standard for NYSE and NASDAQ firms in 1999—as quasi‐exogenous settings to investigate the effects of audit committee financial expertise on the timeliness of loan loss provisioning. Using a difference‐in‐differences research design, I find that the timeliness of loan loss provisions increases with audit committee financial expertise both for the FDICIA treatment group, which had larger banks than the control group, and for the NYSE and NASDAQ exchange treatment group, which had smaller banks than the control group. Further, I find that the results are stronger for banks that have lower regulatory scrutiny, are audited by Big 4 auditors, and do not have staggered boards. Finally, I find that audit committee financial expertise decreases discretionary loan loss provisions and financial restatements. Overall, these findings suggest the importance of audit committee financial expertise in loan‐related matters, which is particularly relevant in the context of the recent Current Expected Credit Losses implementation.

Abstract Drawing on Robert Michels's “iron law” of oligarchy, this study examines a governance crisis that unfolded at one of the world's largest professional accounting bodies (PABs)—CPA Australia. We leverage Michels's century‐old contribution to the social sciences to explore how this crisis sheds light on the challenges that PAB governance arrangements can pose when PAB leadership and membership priorities conflict. By applying Michels's seminal work to theorize the origins, escalation, leadership collapse, and eventual resolution of this PAB governance crisis, we illuminate how governance arrangements fueled conflict and fostered a democratic deficit that frustrated sections of the membership in their attempts to debate issues, exercise accountability on leadership matters, and become involved in governance reform. Overall, our analysis reveals that despite espoused principles of equity and participation, PABs are vulnerable to oligarchy impacting how their leaders relate to the interests of their members. Implications for the capacity of PABs to accommodate member conflict and for member participation in the current‐day professional context are discussed.

Abstract This paper examines how relative timing affects the quality of financial reports in a staggered reporting system in which some firms report earlier than others. We show that the audit quality of the leading firm exceeds that of the lagger. Investment efficiency also differs systematically across firms, depending on the relative reporting timing as well as the audit market structure. Audit regulations mitigate the misalignment of interests between auditors and investors but limit the effect of information spillovers. We characterize the socially optimal auditing standards and show how and why imposing minimum audit quality requirements complements and/or substitutes for adjusting auditors' legal liability. Overall, we show that a staggered reporting system dominates a simultaneous reporting system in enhancing audit quality and investment efficiency through regulation.