Research

(with D. Larcker, B. Lynch, and B. Tayan)

Investors rely on corporate disclosure to make informed decisions about the value of companies they invest in. The COVID-19 pandemic provides a unique opportunity to examine disclosure practices of companies relative to peers in real time about a somewhat unprecedented shock that impacted practically every publicly listed company in the U.S. We examine how companies respond to such a situation, the choices they make, and how disclosure varies across industries and companies. We ask: What motivates some companies to be forthcoming about what they are experiencing, while others remain silent? Do differences in disclosure reflect different degrees of certitude about how the virus would impact businesses, or differences in management perception of its obligations to shareholders?  What insights will companies learn to prepare for future outlier events? [download]

• Featured in Bloomberg Money Stuff; Cooley PubCo; Harvard Law School Forum on Corporate Governance and Financial Regulation; included in NIRI’s Covid-19 Crisis Response Library
• Private staff briefing to House Financial Services Committee
• Presented to the SEC’s Investor Advisory Committee, presentation covered in Law360

(with M. Barth and W. Landsman)

This study examines the effect of the Jumpstart Our Business Startups Act (JOBS Act) on information uncertainty in IPO firms. The JOBS Act creates a new category of issuer, the Emerging Growth Company (EGC), and exempts EGCs from several disclosures required for non-EGCs. Our findings are consistent with proprietary cost concerns motivating EGCs to eliminate some of the previously mandatory disclosures, which increases information uncertainty in the IPO market, attracts investors who rely more on private information, and leads EGCs to provide additional post-IPO disclosures to mitigate the increased information uncertainty. Our results also are consistent with agency explanations, whereby EGCs exploit the JOBS Act provisions to avoid compensation related disclosures, which results in larger IPO underpricing for such firms. Overall, we provide evidence on how reduced mandatory disclosure affects the IPO market. [download]

• Winner, AICPA Notable Contribution to Accounting Literature Award (2020)
• Cited in the SEC’s final ruling on amendments to Regulation A of the Securities Act, “Amendments for Small and Additional Issues Exemptions Under the Securities Act” SEC Release No. 33–9741, 34–74578
• Featured in Harvard Law School Forum on Corporate Governance and Financial Regulation; speech by SEC Commissioner Kara Stein; CFO; CPA Practice Advisor; MarketWatch; The Intercept; Accounting Today
• Altmetrics media influence score in the top 25% of all academic research, ranked in top 10% within journal.

(with D. Larcker and G. Ormazabal)

This paper investigates the market reaction to recent legislative and regulatory actions pertaining to corporate governance. The managerial power view of governance suggests that executive pay, the existing process of proxy access, and various governance provisions (e.g., staggered boards and CEO-chairman duality) are associated with managerial rent extraction. This perspective predicts that broad government actions that reduce executive pay, increase proxy access, and ban such governance provisions are value enhancing. In contrast, another view of governance suggests that observed governance choices are the result of value-maximizing contracts between shareholders and management. This perspective predicts that broad government actions that regulate such governance choices are value destroying. Consistent with the latter view, we find that the abnormal returns to recent events relating to corporate governance regulations are, on average, decreasing in CEO pay, decreasing in the number of large blockholders, decreasing in the ease by which small institutional investors can access the proxy process, and decreasing in presence of a staggered board. [download]

• Cited in the SEC’s final ruling on proxy access (SEC Rules 14a-8 and 14a-11), “Facilitating Shareholder Director Nominations” SEC Release No. 33-9136
• Synopses printed in CFA Digest
• Featured in Wall Street Journal; New York Times; Harvard Law School Forum on Corporate Governance and Financial Regulation; CFA Institute

(with B. Lynch)

In 2008, the SEC published guidance allowing firms to use corporate websites as an alternative disclosure channel to EDGAR. While the information content and market reaction to traditional disclosure channels such as EDGAR filings and press releases are well-documented, evidence on corporate websites as a disclosure channel is scarce. In this paper, we take the first step toward shedding light on corporate websites as an important but unregulated source of information to investors. We begin by developing a novel measure of corporate website content. We then identify large changes in corporate websites content that do not occur in close proximity to EDGAR filings and press releases and examine what effect, if any, these standalone changes in website content have on markets and information production by analysts and journalists. Using standard event study methods, we find that standalone changes in the corporate websites provide significant value-relevant information to investors, reduce information asymmetry, and precede significant revisions in analyst forecasts and increases in media coverage. Collectively, our findings indicate that corporate websites are an economically significant source of new information to markets and information intermediaries that supplements traditional disclosure channels considered in prior literature. [download]

• Featured in 2021 NBER Big Data and Securities Markets Conference

(with B. Bushee and I. Gow)

Prior research generally interprets complex language in firms’ disclosures as indicative of managerial obfuscation. However, complex language can also reflect the provision of complex information, e.g., informative technical disclosure. As a consequence, linguistic complexity commingles two latent components — obfuscation and information — that are related to information asymmetry in opposite directions. We develop a novel empirical approach to estimate these two latent components within the context of quarterly earnings conference calls. We validate our estimates of these two latent components by examining their relation to information asymmetry. Consistent with our predictions, we find that our estimate of the information component is negatively associated with information asymmetry while our estimate of the obfuscation component is positively associated with information asymmetry. Our findings suggest that future research on linguistic complexity can construct more powerful tests by separately examining these two latent components of linguistic complexity. [download]

• Synopsis printed in CFA Digest
• The Perl command to calculate Fog Index, Lingua:EN:Fathom, was revised as a direct result of the computational errors identified in this paper (see v1.22 of this command)
• Top 5 most highly cited papers published in Journal of Accounting Research since 2018

(with W. Guay and D. Samuels)

A growing literature documents that complex financial statements negatively affect the information environment. In this paper, we examine whether managers use voluntary disclosure to mitigate these negative effects. Employing cross-sectional and within-firm designs, we find a robust positive relation between financial statement complexity and voluntary disclosure. This relation is stronger when liquidity decreases around the filing of the financial statements, is stronger when firms have more outside monitors, and is weaker when firms have poor performance and greater earnings management. We also examine the relation between financial statement complexity and voluntary disclosure using two quasi-natural experiments. Employing a generalized difference-in-differences design, we find firms affected by the adoption of complex accounting standards (e.g., SFAS 133 and SFAS 157) increase their voluntary disclosure to a greater extent than unaffected firms. Collectively, these findings suggest managers use voluntary disclosure to mitigate the negative effects of complex financial statements on the information environment. [download]

• Featured in Columbia Law School Blue Sky Blog
• Top 5 most highly cited papers in Journal of Accounting and Economics since 2016

(with C. Armstrong, J. Core, and R. Verrecchia)

This paper examines when information asymmetry among investors affects the cost of capital in excess of standard risk factors. When equity markets are perfectly competitive, information asymmetry has no separate effect on the cost of capital. When markets are imperfect, information asymmetry can have a separate effect on firms’ cost of capital. Consistent with our prediction, we find that information asymmetry has a positive relation with firms’ cost of capital in excess of standard risk factors when markets are imperfect and no relation when markets approximate perfect competition. Overall, our results show that the degree of market competition is an important conditioning variable to consider when examining the relation between information asymmetry and cost of capital. [download]

• Cited in the SEC’s proposed rule regarding mandatory clawbacks “Listing Standards for Recovery of Erroneously Awarded Compensation” SEC Release No. 33-9861, 34-75342
• Cited in the SEC’s proposed exemptions to Section 404(b) of SOX “Amendments to the Accelerated Filer and Large Accelerated Filer Definitions” SEC Release No. 34–85814

(with M. Barth and G. Ormazabal)

This study examines the sources of credit risk associated with asset securitizations and whether credit rating agencies and the bond market differ in their assessment of this risk. Measuring credit risk using credit ratings, we find the securitizing firm’s credit risk is positively related to the firm’s retained interest in the securitized assets and unrelated to the portion of the securitized assets not retained by the firm. Measuring credit risk using bond spreads, we find the securitizing firm’s credit risk is positively related to both the firm’s retained interest in the assets and the portion of the securitized assets not retained by the firm. Additionally, our findings indicate the bond market does not distinguish between the retained and non-retained portions of the securitized assets when assessing the credit risk of the securitizing firm. These different assessments of the sources of credit risk associated with asset securitizations provide insight into ongoing controversies surrounding the financial reporting for asset securitizations and the efficacy of credit ratings. [download]

(with M. Heinle and D. Samuels)

This study develops and tests a simple model of voluntary disclosure where managers can choose to withhold (i.e., redact) certain elements from mandatory disclosure. We consider a setting where mandatory disclosure is a disaggregated disclosure (e.g., a financial statement), voluntary disclosure is an aggregate disclosure (e.g., an earnings forecast), and the costs of each type of disclosure are distinct. In this setting, we show that managers endogenously substitute between the two types of disclosure—managers that chose to withhold information from mandatory disclosure are more likely to provide voluntary disclosure. We test our predictions using a comprehensive sample of mandatory disclosures where the SEC allows the firm to redact information that would otherwise jeopardize its competitive position. Consistent with our predictions, we find strong evidence that redacted mandatory disclosure is associated with greater voluntary disclosure. [download]

(with C. Ittner and D. Larcker)

A numberof recent marketing studies examinethe stock market’s response tothe releaseof AmericanCustomer Satisfaction Index (ACSI) scores.The broad purposeofthese studies is to investigatethe stock market’s valuationof customer satisfaction. However, a key focus is on whethercustomer satisfaction information predicts long-run returns. We provide evidence onthe market’s pricing of ACSI information using a more comprehensive setof well-established tests fromthe accounting and finance literatures. We find that ACSI scores provide some incremental information on future operating income and thatthe market quickly responds tothe releaseof information on large increases in satisfaction. However, we find no evidence that ACSI predicts long-run returns.These results suggest thatcustomer satisfaction information is value-relevant, but are also consistent with Jacobson and Mizik’s (2009) conclusion that mispricing of ACSI information, if present at all, is limited. [download]

(with C. Armstrong and R. Verrecchia)

We extend the CAPM to a setting where a firm reports earnings prior to selling shares to investors. We show that an entrepreneur, as representative of a firm's initial owners, will choose to report earnings that asymmetrically reflect future cash flow. In modeling the entrepreneur's reporting choice, we deliberately abstract away from the stewardship role of accounting. In our model, the sole purpose of reported earnings is to facilitate valuation by the firm's equity investors. Nevertheless, we show that a firm's earnings will reflect future cash flow to a greater (lesser) extent in bad states (good states) –– when that cash flow is anticipated to be low (high). Importantly, we also show that the asymmetry in reporting generates asymmetry in the firm's systematic risk. When a firm's earnings reflect future cash flow to a greater extent in bad states, the firm's covariance with the market portfolio will be lower in bad states. [download]

(with J.M. Kim and R. Verrecchia)

Classical models of voluntary disclosure feature two economic forces: the existence of an adverse selection problem (e.g., a manager possesses some private information) and the cost of ameliorating the problem (e.g., costs associated with disclosure). Traditionally these forces are modelled independently. In this paper, we use a simple model to motivate empirical predictions in a setting where these forces are jointly determined––where greater adverse selection entails greater costs of disclosure. We show that joint determination of these forces generates a pronounced non-linearity in the probability of voluntary disclosure. We find that this non-linearity is empirically descriptive of multiple measures of voluntary disclosure in two distinct empirical settings that are commonly thought to feature both private information and proprietary costs: capital investments and sales to major customers. [download]

(with M. Heinle, C. Kim, and F. Zhou)

Several recent empirical papers assert that the decision to disclose an earnings forecast shortly before the actual earnings announcement reveals only short-term information and is therefore unlikely to entail proprietary costs. Using a simple dynamic model of voluntary disclosure, we show that the decision to disclose a short-term earnings forecast reveals managers’ private information about long-term future performance. We test the predictions of the model empirically and find that the decision to disclose a short-term earnings forecast predicts earnings three years beyond the forecasted period, and that the predictive ability is incremental to short-term earnings itself. Consistent with the predictions of our model, we find that the predictive ability of the short-term forecast decision for long-term performance is higher when short-term performance is poor; is lower when managers have short horizons; and is lower when proprietary costs of revealing long-term performance is high. Our analysis suggests that – despite its short horizon – the decision to provide a short-term earnings forecast contains significant information about long-term performance and thus can entail significant proprietary costs. [download]

(with R. Verrecchia)

We extend a standard, rational expectation model of trade to incorporate the possibility of individual investors delegating their trades to an informed financial intermediary. In the presence of delegated trade, we show that a firm's risk premium is a function of both the firm's exposure to a common risk factor and idiosyncratic characteristics of the firm's information environment. We show that even in a large economy, priced risks can manifest in the form of both idiosyncratic firm characteristics and common risk factors; as a consequence, factor-based asset pricing tests cannot rule out that a particular risk is priced. [download]