In this paper, I examine a new approach for measuring earnings quality, defined as the closeness of reported earnings to “permanent earnings,” based on firm decisions with regard to capital and labor investments. Specifically, I measure earnings quality as the contemporaneous association between changes in the levels of capital and labor investment and the change in reported earnings. This approach follows the reasoning that (1) firms make investment decisions based on the net present value (NPV) of investment projects and (2) reported earnings with higher quality should more closely associate with real investment decisions. I find that measures of earnings quality based on managerial labor and capital decisions correlate positively with earnings persistence and have incremental explanatory power relative to earnings-quality measures used in the accounting literature. Furthermore, investment-based earnings-quality measures are less informative when managers tend to overinvest.

We examine chief executive officer (CEO) compensation, CEO retention policies, and mergers and acquisition (M&A) decisions in firms in which founders serve as a director with a nonfounder CEO (founder-director firms). We find that founder-director firms offer a different mix of incentives to their CEOs than other firms. Pay-for-performance sensitivity for nonfounder CEOs in founder-director firms is higher and the level of pay is lower than that of other CEOs. CEO turnover sensitivity to firm performance is also significantly higher in founder-director firms compared with nonfounder firms. Overall, the evidence suggests that boards with founder-directors provide more high-powered incentives in the form of pay and retention policies than the average US board. Stock returns around M&A announcements and board attendance are also higher in founder-director firms compared with nonfounder firms.

ABSTRACT: This study examines the effect of the readability of firms’ written communication on the behavior of sell-side financial analysts. Using a measure of the readability of corporate 10-K filings, we document that analyst following, the amount of effort incurred to generate their reports, and the informativeness of their reports are greater for firms with less readable 10-Ks. Additionally, we find that less readable 10-Ks are associated with greater dispersion, lower accuracy, and greater overall uncertainty in analyst earnings forecasts. Overall, our results are consistent with the prediction of an increasing demand for analyst services for firms with less readable communication and a greater collective effort by analysts for firms with less readable disclosures. Our results contribute to the understanding of the role of analysts as information intermediaries for investors and the effect of the complexity of written financial communication on the usefulness of this information.