Knowledge that Transforms

ABSTRACT Motivated by the increasing influence of shareholder votes on corporate policies, we examine investors' perceptions of activism via voting. To identify instances of activism via voting, we focus on annual meetings with at least one ballot item where a substantial fraction of shareholders is expected to vote against management's voting recommendation, indicating an increase in their monitoring activity. We define such meetings as “contentious.” Using a sample of almost 28,000 meetings between 2003 and 2012, we examine stock returns over the period between the proxy filing and the annual meeting. This period captures when investors learn about the contentious nature of the upcoming meeting and form expectations about its likely impact on firms' policies. We find that abnormal stock returns prior to contentious meetings are significantly positive and higher than those prior to noncontentious meetings. These higher abnormal returns increase with the contentiousness of the meeting; are more pronounced in firms with poor past performance, which are more likely to respond to shareholder pressure; and persist after controlling for firm‐specific news and proxies for risk factors. Our results are consistent with investors' expecting activism via voting to have a positive impact on firm value, on average, and cast doubts on regulatory attempts to restrict the use of shareholder votes.

ABSTRACT Prior research has examined target setting in market‐driven companies but has not examined target setting in state‐run companies that also have social and political objectives. I examine how Chinese state‐owned enterprises (SOEs) set and revise performance targets to motivate a balanced effort allocation. Using data on financial performance (sales) targets set by SOEs and non‐SOEs during the period 2006–2016, I predict and find that the financial targets of SOEs are easier to achieve than those of non‐SOEs, and that SOEs with easier financial targets perform better regarding corporate social responsibility. I also predict and find that SOEs ratchet financial targets upward less than non‐SOEs to keep them easy to achieve and, as a consequence, SOE managers are less likely to game performance to avoid future target increases. The results are robust to alternative measures of state influence and alternative measures of financial targets. These findings suggest that firms balance their multiple objectives through strategically setting and revising financial targets. In doing so, this study provides a better understanding of target‐setting practices in organizations pursuing multiple, sometimes conflicting, objectives.

ABSTRACT This paper documents a differential role of R&D versus selling, general, and administrative expenses (SG&A) for real earnings management. The distinction of these two components is important because prior studies mostly examine their combined use, but firms could manipulate them differently given the differing valuation implications. Reduced SG&A is viewed positively by investors as evidence of cost reduction, while reduced R&D is viewed negatively by investors as such expenditures are critical signals of expected growth. I examine their use in the context of seasoned equity offerings (SEOs) as well as firms receiving accounting and auditing enforcement releases (AAERs). Although both groups face strong incentives to manage earnings upward by reducing expenses, I predict and find that firms will reduce SG&A but increase R&D. During the manipulation period, SEO and AAER firms exhibit lower discretionary SG&A and higher discretionary R&D, relative to control firms, and investors positively value low discretionary SG&A and high discretionary R&D. Overall, this study confirms the importance of distinguishing between R&D and SG&A in real earnings management contexts and suggests a complementary (substitutive) relation between cutting SG&A (R&D) and accruals management.

ABSTRACT We investigate the effect of mandatory IFRS adoption on trade credit. We document that firms in countries that adopt IFRS receive more trade credit from their suppliers, consistent with improved financial reporting quality and comparability playing a role in facilitating informal financing. This increase is larger for countries with a low level of societal trust, a poor pre‐IFRS‐adoption information environment, and stronger legal enforcement. These cross‐sectional results suggest that the conditions under which higher‐quality information is made publicly available affect suppliers' decisions to provide trade credit. This increase is also larger for firms with greater exposure to foreign markets, a finding that highlights the importance of more comparable international financial reporting standards in facilitating cross‐country trade credit. We also find that IFRS adoption has a stronger positive effect on trade credit for firms with greater liquidity needs. Finally, we find that firms in countries that adopt IFRS also extend more trade credit to their customers. Overall, our results support the notion that financial reporting can have a causal effect on trade credit.

ABSTRACT Prior research demonstrates that relative performance information affects effort and performance. However, little is known about the qualitative design parameters of these information systems. This study examines, via an experiment, how adding performance category labels to ranks (e.g., “good” ranking position and “poor” ranking position) affects effort and performance. Furthermore, we investigate the effort and performance effects of two design choices observed in practice: the type of performance category labels and the proportion of positively labeled ranks. We argue that performance category labels motivate greater effort and performance through competition for status, which varies with both the type of performance category labels and the proportion of positively labeled ranks. We find partial support for our hypothesis that adding performance category labels increases effort and performance. Specifically, we find positive effects if top ranks are positively labeled and bottom ranks are negatively labeled (combined labels) but not if only top ranks are labeled (positive‐only labels). We also find as predicted that the positive effects on effort resulting from using combined labels, instead of positive‐only labels, are stronger when the proportion of positively labeled ranks is larger. The results for performance are weaker. Our results shed new light on the usefulness of performance category labels and emphasize how firms can render relative performance information more effective.

ABSTRACT The centrality of private information in the design of accounting institutions has been explored via agency models that address control concerns as well as disclosure models that amplify valuation issues. This paper derives disclosures by an entrepreneur‐owner when both control and valuation concerns are in play. In particular, the disclosures influence stock price not only via a direct impact on valuation of the firm's revenue but also via an indirect impact on the firm's cost of procuring inputs from a self‐interested and privately informed upstream supplier. In this setting, disclosures are judiciously designed to influence the supplier's decision to share cost information and to control information rents embedded in the procurement contract within the supply chain. Specifically, in order to convey that information rents are not in the offing and, thus, motivate information sharing by the supplier, the owner has incentives to convey a less “rosy” picture. In effect, when controlling supplier actions also becomes important, the owner discloses some unfavorable revenue news that she would have otherwise withheld and conceals some favorable revenue news that she would have otherwise revealed. Consequently, in our model, the disclosure region is either two‐tailed or intermediate, in contrast to the single‐tailed disclosure region implied by familiar valuation considerations alone.

ABSTRACT Incorporating the firm's corporate parent in a tax haven is a major decision that receives significant attention from many stakeholders, yet certain implications of this corporate strategy remain unclear. While tax haven incorporation offers tax savings, it also imposes risks that are potentially costly and hence important to consider. We predict and find a higher cost of equity capital in firms with parent companies that are incorporated in tax havens but that are primarily based in nonhaven countries. We also predict and find that the observed cost of equity premium is more pronounced in firms with greater tax risk, firm‐level information risk, and country‐level legal risk. We also employ corporate inversions in a difference‐in‐differences test and again find a positive relation between tax haven parent incorporation and the cost of capital. Our findings imply that an increased cost of capital is a material cost of tax haven parent incorporation. We contribute to the literatures on valuation of tax haven use, tax and nontax costs of corporate tax strategies, corporate inversions, and the relation between taxes and the cost of capital. Our study provides evidence on the tax and nontax risks of a uniquely observable tax strategy (i.e., tax haven parent incorporation) that could factor into firms' decisions about whether to incorporate in a tax haven and policymakers' efforts to deter such activity.

ABSTRACT Bolton, Scheinkman, and Xiong (2006) model a setting where investors disagree and short‐sales constraints cause pessimistic views of stock prices to be less influential, which leads to speculative stock prices. A theoretical implication of the model is that existing shareholders can exploit the speculative stock prices by (i) designing managerial compensation contracts that encourage short‐term performance, and (ii) subsequently selling their shares to more optimistic investors. We document empirical support for this theory by finding that an exogenous removal (Regulation SHO) of short‐sales constraints curbs the provision of short‐term incentives, an effect reflected in longer CEO compensation duration. The effect is concentrated among stocks with high investor disagreement and short‐term‐oriented institutional ownership. Consistent with prior work, we also find that longer CEO compensation duration leads to longer CEO investment horizons, less overinvestment, and less earnings management. Collectively, our results speak to the contributing role of speculative stock prices in corporate short‐termism. Finally, our study implies that effective policies to curb corporate short‐termism should address stock market speculation and promote mechanisms that tie executive compensation to longer‐term stock price performance.

ABSTRACT In this paper, we investigate how auditors respond to shareholder activism against their clients. Our study is important because activism may be viewed by auditors as a source of increased engagement risk, thereby impacting audit outcomes. The potential relationship between shareholder activism and audit outcomes leads us to predict that activism targets will pay higher audit fees and also will be more likely to receive adverse internal control opinions (ICOs) and first‐time going concern opinions (GCOs). Our results, which support all three predictions, suggest that the public scrutiny associated with activism campaigns heightens auditors' concerns about reputational damage and litigation risk. Consistent with this notion, we find that activism targets are more likely to experience accounting‐related lawsuits. We also find that the increased likelihood of adverse ICOs documented in our baseline tests reflects higher‐quality reporting rather than increased auditor conservatism. Overall, our findings suggest that activism campaigns spur auditor diligence while also increasing the possibility of negative outcomes that may not be fully anticipated by activist investors.

ABSTRACT Prior studies find that delayed earnings announcements tend to communicate unfavorable news, and investors react negatively when firms delay earnings announcements. However, these findings do not explain why investors discount delayed earnings, even after controlling for the earnings news, and why firms sometimes announce good news late. Motivated by theory from Trueman (1990) that attempts to explain these phenomena, we examine whether announcement delays indicate earnings management. We predict and find that good news firms with higher discretionary accruals are more likely to announce earnings late. Consistent with post fiscal year‐end activities driving announcement delays, we fail to find a relation between measures of real earnings management and late announcements. Using a last‐chance earnings management measure based on tax expense manipulation, we also predict and find strong evidence that good news firms engaging in last‐chance earnings management are more likely to delay earnings announcements. Consistent with Trueman's (1990) theory that earnings management explains why investors discount delayed earnings announcements, we find that, on average, earnings announcement returns are 1.4% lower for late announcers relying on last‐chance earnings management to report good news. Overall, our findings suggest that announcement delays provide information about not only the sign of the earnings news but also the potential for earnings management.