Knowledge that Transforms

ABSTRACT We investigate how activist short sellers (AShSs) expose publicly listed firms in an increasingly popular form of “research reports” openly denouncing alleged frauds, flawed business models, accounting irregularities, and wrongdoings. We focus on six AShSs that issued research reports that often led to a strong negative market reaction. Our empirical analysis exploits both qualitative and quantitative methods for a comprehensive data set of 383 research reports targeting 171 unique firms, and 3 firsthand interviews with AShSs. Drawing on Aristotle's rhetoric, we first examine how AShSs use narratives in striving to convince other investors that the target firms are overvalued. Specifically, we search the documents produced by AShSs for stylized narratives related to credibility‐based (ethos), emotions‐based (pathos), and logic‐based (logos) rhetorical strategies. To assess the impact of these strategies, we examine the extent to which the AShSs' rhetorical strategies resonate in 3,665 press articles. As expected, the press often refers to logos‐based arguments. Interestingly, the press also frequently brings up pathos‐based and ethos‐based statements. Considering the importance of the press in shaping investors' opinions, our study points to AShSs' narratives playing a major role in policing financial markets. Theoretically, we show that AShSs, as dissenting market participants, produce narratives that go beyond the language of formal rationality—as they strive to reveal new information and frame it persuasively, in order to destabilize the extent of trustworthiness surrounding target firms.

ABSTRACT A recent trend is that firms prefer to hire generalist CEOs with transferable skills (across firms or industries) over hiring specialist CEOs, but the consequences of this trend are unclear. In this study, we examine whether credit rating agencies consider a CEO's general skills as a credit risk factor when assessing an entity's overall creditworthiness. We predict and find that generalist CEOs are associated with lower credit ratings, suggesting that the presence of generalist CEOs is a significant credit rating factor. We also find that generalist CEOs are likely to take on more risks, which leads to more volatile performance ex post, and our path analyses confirm default risk is a significant mediator between credit ratings and CEOs' general skills. Our results hold in the presence of additional controls (e.g., CEO characteristics and corporate governance), when applying different fixed‐effect models and different matching methods, and for a subsample with forced CEO turnover. We also find that the negative relationship is attenuated for R&D‐intensive firms and firms in competitive industries. Last, we provide evidence that firms with generalist CEOs face higher borrowing costs, such as bond yields and syndicated loan spreads. Overall, our results contribute to a growing literature on the costs and benefits of hiring generalist CEOs, by providing a full picture of why hiring a generalist CEO may benefit shareholders but also cause misalignments with bondholders' interests.

ABSTRACT We hypothesize and find that financial reporting quality at the foreign subsidiaries of US multinational companies (MNCs) is higher when the MNC's principal auditor engages a component auditor to audit the foreign subsidiary on its behalf. An important innovation of this study is that we focus on comparing the financial reporting quality of equivalent subsidiaries with and without component auditor work. Our approach contrasts with extant studies that examine the consequences of variation in the total amount of component auditor work at the MNC level. Our results are important for two reasons. First, we provide an alternative view on the consequences of component auditor use compared to the emerging literature in this area, which typically finds a negative association between the extent of component auditor use and financial reporting quality at the MNC level. Thus, we show that a different research design, conducted at the level at which component auditors actually perform their work, yields different inferences. Second, we demonstrate that using component auditors on US MNC group audits is an avenue through which US auditing institutions can affect financial reporting quality in foreign locations. We also reconcile our subsidiary‐level results to the MNC level by introducing a new MNC‐level component auditor “coverage” variable. Overall, we highlight that the best way to audit a foreign subsidiary is likely to be with a component auditor in the local country, which informs the debate surrounding recently proposed PCAOB guidance.

ABSTRACT Regulation Fair Disclosure (Reg FD) Form 8‐K filings provide a venue where managers release information to the market as a whole that they designate as being material . Using this setting, we study trading patterns immediately prior to the public disclosure of material information. We offer three main results. First, using both intraday and daily trading data, we find abnormal trading volume of 21 percent (13 percent) in the hour (day) prior to the public disclosure, respectively. Second, we find that this pre‐disclosure abnormal trading volume is concentrated in firms that are smaller, have more growth opportunities, issue fewer voluntary disclosures, and have weaker external monitoring. Finally, we find that this pre‐disclosure volume is concentrated in subsamples in which the information relates to a firm's material contracts, a firm holds investor/analyst conferences, and there is insider trading activity in a firm's shares. Our results do not concentrate in a small number of firms or industries, and do not appear to be explained by the form through which managers first release the material information (e.g., Form 8‐K, press release, website posting, or social media). Our results are also robust to controlling for the firm's other filings and peer filings that occur around the disclosure. Overall, the trading patterns we document may show that, inconsistent with the spirit of Reg FD, a subset of investors trade on information managers deem material prior to its broad, public release.

ABSTRACT The purpose of this paper is to increase our understanding of how enabling perceptions of new management controls (MCs) can be fostered. Prior research suggests that employees are more likely to use new MCs if they perceive them as enabling. However, rapid implementation of new MCs due to circumstances such as mergers and acquisitions can leave employees feeling coerced into using them, making it difficult to foster enabling perceptions. Based on a case study where an acquirer faces pressure to impose rigid controls on an acquired firm, we suggest factors contributing to enabling perceptions. Using interviews, observation, and document analysis, we find that positive relationships and mutual trust between the acquirer and the acquiree facilitated enabling perceptions of the MCs. We show that managers at the acquirer actively fostered trust using trust‐building activities and communicated their intentions underlying the implementation of new MCs. Doing so helped employees rationalize the controls as tools to help them do their work tasks. We also find that positive relationships reinforced by regular meetings were a way of providing assistance to employees in dealing with rigid MCs. This study contributes to the literature on enabling controls by developing a processual framework that suggests how trust can foster enabling perceptions from the intentions behind the implementation of new MCs, to their development process and daily use. In doing so, the study further develops our understanding of the relationship between enabling control and trust and helps in understanding how rigid controls can be implemented without generating mistrust.

ABSTRACT This study documents a spillover effect of accounting fraud by showing that after the revelation of accounting misconduct, there is an increase in financially motivated neighborhood crime (robberies, thefts, etc.) in the cities where these misconduct firms are located. We find that more visible accounting frauds (e.g., greater media attention and larger stock price declines) are more strongly associated with a future increase in financially motivated neighborhood crime. We also find that the association between fraud revelation and increased future financially motivated crime is strongest when local job markets are shallower and where local income inequality is high, consistent with adverse shocks from fraud putting pressure on local communities. Combined, our study provides evidence that the societal ramifications of corporate accounting misconduct extend beyond adversely impacting a firm's capital providers and industry peers to negatively influence the daily life of the residents in the firm's local community.

ABSTRACT We consider an investor's choice of conservative reporting, bonus payments, and investment decisions in the presence of the hidden‐information agency problem of a manager's productivity and the hidden‐action agency problem of a manager's diversion of resources. It is important to consider the hidden‐action and hidden‐information agency problems in isolation and their interaction to gain insights into the drivers of demand for conservatism. We show that the conservative (nonconservative) regime is optimal for the high‐productivity (low‐productivity) manager when both agency problems exist, even though the nonconservative regime is optimal for both the high‐ and low‐productivity managers when only the hidden‐action or the hidden‐information problem exists. Essentially, the low‐productivity manager can misrepresent as the high‐productivity manager to obtain high investment levels and divert resources only in the presence of both agency problems. This added layer of agency problem creates the demand for conservatism and highlights the importance of the interaction between the hidden‐action and hidden‐information agency problems. Furthermore, we show that as the conservatism level increases (i) the optimal investment level conditional on a good report for the high‐productivity manager increases and approaches the first‐best level (i.e., ex‐post investment efficiency increases); (ii) the expected optimal investment level for the high‐productivity manager decreases and diverges from the expected first‐best level (i.e., ex‐ante investment efficiency decreases); and (iii) the expected bonus payment to the high‐ and low‐productivity managers decreases. These findings provide insights into how the demand for conservatism arises in the presence of both hidden‐information and hidden‐action agency problems and provide empirical guidance relating conservatism to investment efficiency.

ABSTRACT We investigate whether Article 11 pro forma financial information assists investors in valuing IPOs. While the SEC expects it to be helpful in assisting investment decisions, Article 11 pro forma financial information is based on registrants' understanding and assumptions, and registrants can exercise their own judgment when preparing pro forma financial statements. It is therefore an empirical question whether the information contained in pro forma financial statements is useful to investors. We examine the association between pro forma adjustments of earnings and book value of equity and the IPO offer value and find asymmetric results. While positive pro forma adjustments of earnings and book value of equity are positively associated with the IPO offer value, negative pro forma adjustments of earnings and book value of equity are negatively associated with the IPO offer value, suggesting that negative pro forma adjustments are priced as growth opportunities. Additional analyses reveal that the association between pro forma adjustments of book value of equity and the IPO offer value varies across different time periods and industries and that pro forma adjustments of book value of equity are initially mispriced by investors. In contrast, we do not find similar results for pro forma adjustments of earnings. Further empirical tests show that the asymmetric results of mispricing of pro forma adjustments of earnings and book value of equity may be explained by the requirements of Article 11 of Regulation S‐X for pro forma adjustments dictating that adjustments to earnings reflect only recurring items while adjustments to book value reflect both recurring and nonrecurring items.

ABSTRACT Bundling managerial earnings guidance with quarterly earnings announcements (EAs) has become an increasingly common practice. This study investigates the impact of bundled guidance on analysts' forecast revisions. Our findings indicate that analysts respond more to bundled guidance than non‐bundled guidance. This effect increases with analysts' time pressure and cognitive constraints around the EA. Analysts' revisions also incorporate more of the bundled management guidance when accompanied by additional information, such as conference calls. We further find that analysts revise their forecasts more quickly following bundled guidance than non‐bundled guidance. Together, these findings are consistent with the notion that analysts place more weight on bundled guidance than on non‐bundled guidance in their forecast revisions as bundled guidance facilities analysts' timely forecast revisions following EAs. Finally, we find that analysts' forecast revisions following bundled guidance generate significant market reactions. Our findings enhance our understanding of analysts' information processing and shed light on why bundling can be an effective guidance strategy.

ABSTRACT We provide the first direct analysis of the magnitude of unreliable quantitative information disclosed in corporate social responsibility (CSR) reports. CSR report reliability is of particular interest to fund managers for investment decisions as well as to policymakers for regulating and monitoring purposes. However, surprisingly little is known about CSR reporting reliability despite concerns raised in the prior literature. We examine how often CSR reports for the Global Fortune 250 (G250) are restated, the magnitude of restatements, and factors associated with restatements during the period 2006 to 2013. During this sample period, the occurrence of restatements increased monotonically, with 39% of G250 CSR reports including one or more line‐item restatements. The magnitude of the line‐item restatements is quite high, with a median restatement of about 10%. We also find evidence of bias in the revised items toward overstatement. We find that restatements occur more frequently in firms that have reported a high level of social performance and that have environmental targets. The occurrence of restatement is also positively associated with firms residing in strong law countries and having their CSR reports audited. Our analysis of reporting bias indicates a negative association between use of Global Reporting Initiative (GRI) reporting guidelines and the likelihood of an overstatement. We also find a positive association between having the CSR report audited and the likelihood of revisions associated with overstatements. Together, our exploratory results indicate that CSR information may be unreliable and firms that face pressure to perform well have more restatements. However, our evidence is consistent with the restatements resulting from improvements in information systems over time rather than intentional bias. Our findings will help investors and fund managers better judge the reliability of CSR disclosures, and inform regulators and standard setters on ways to enhance the reliability of CSR reporting. Finally, we contribute to the audit literature examining sustainability assurance.