11 Financial: Disclosure
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ItemTone and the Accounting Narrative( 2018-09-01)Tone is a means by which narratives may be imbued with a desired connotation or affect through word choice. Like other elements of style, tone may be deployed to aid the dissemination of incrementally useful information or used to strategically influence perceptions. Much literature in accounting considers tone as a uni-dimensional construct. This exploratory study seeks to demonstrate that verbal tone is considerably more nuanced in nature. Using multi-year sample of listed companies, we examine dimensions of tone across multiple document types within the annual report and two components of CSR reports issued separately from the annual report. We first consider how dimensions of tone vary across different types of corporate narrative. Next, we determine whether dimensions of tone are associated with another important element of style, readability. Last, we consider the determinants of tone, including the possibility that tone may be used in impression management. The paper makes several important contributions to practice and theory.
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ItemMeasuring investment opportunities using financial statement text( 2018-09-01)We analyze 10-K texts from EDGAR during 1995-2009 to score firms’ investment opportunity sets on multiple dimensions. We identify 646 unique key words that predict future investments and group them into 62 factors. Industry-specific factors include Bio-Pharmaceutical, Banking, Information Technology, Oil & Gas and Semi-conductor, while more general factors include Impairment, Debt Intensity, Executive Employment, Preferred Stock Buyback and Capital Seeking. Our multi-dimensional measures of firms’ investment opportunities outperform Tobin’s Q and/or industry-fixed effects, in predicting out-of-sample future (2010-15) investments and related corporate policies, and even inform incrementally over lagged dependent variables.
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ItemRefinancing Risk and Disclosure of Corporate Investment( 2018-09-01)This paper investigates the relation between the refinancing risk of corporate debt and firms' decisions to issue capital expenditure forecast. Building on theories of financing frictions that predict a negative relation between refinancing risk and firm investment and theories of strategic voluntary disclosure where managers can withhold the unfavorable news of reduced investment, we find that an increase in refinancing risk is associated with both lower probability of disclosing capital expenditure forecasts and lower frequency of capital expenditure forecasts. Cross-sectional tests show that firms that are more exposed to refinancing risk and are less able to mitigate refinancing risk are more likely to reduce capital expenditure forecasts following an increase in refinancing risk. Our results suggest that capital structure can influence firm information environment through managers' disclosure incentives.
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ItemWhy can’t I trade? Exchange discretion in calling halts( 2018-09-01)Stock exchanges exercise discretion when calling individual stock trading halts though the decision making behind the halt remains a “mystery” (WSJ, 2018). Between 2012 and 2015 halts are associated with large price movements (on-average 11%) and occur frequently with 97% of trading days having five or more halts. Given their importance, we investigate how exchanges use this discretion and whether the use of discretion alters the effectiveness of the halts. Our findings suggest halts reflect the preferences of exchange constituents as opposed to simply the stated objectives of the exchanges (i.e., minimizing excess volatility and trades at off-equilibrium prices). Specifically, we find halts are less likely for (i) good news than bad, (ii) firms with opportunistic CEO traders, and (iii) firms with low short interests. We also find some evidence that CEO characteristics are associated with halt outcomes. Concerning halt effectiveness, we find the level of unexplained halt discretion is positively associated with both small halt returns and larger post-halt stock return reversals, suggesting halts with more discretion are less effective.
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ItemInformation Transparency and Profitability Convergence( 2018-08-31)We investigate the effect of information transparency on the competitive environment by examining whether information transparency at the industry level is associated with industry-level earnings persistence. Theory predicts that competition reduces the sustainability of abnormally high and abnormally low profits, thereby reducing overall earnings persistence. Therefore, if information transparency facilitates competition, we expect more transparent industries to have lower earnings persistence. We measure industry-level information transparency as the industry-level future earnings response coefficient. Consistent with our expectation, we find that transparency is associated with lower earnings persistence. This finding suggests that information transparency facilitates the competitive forces that lead profits to converge within an industry. We corroborate this interpretation by demonstrating that information transparency is positively associated with the degree to which competitors enter or exit an industry in anticipation of changes in the industry’s profitability outlook. Our study provides new and important evidence that information transparency facilitates product market competition.
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ItemDoes Compensation Disclosure Lead to Better Job Performance? Evidence from the Mandatory CFO Pay Disclosure( 2018-08-31)The 2006 SEC rule, by changing the definition of Named Executive Officers, for the first time mandated the disclosure of CFO compensation. We exploit this setting and use a difference-in-differences research design to study the impact of CFO compensation disclosure on CFO job performance. We hypothesize that the disclosure of CFO compensation information, by facilitating shareholder monitoring of the board and motivating the board to improve CFO compensation contract design, leads to better CFO job performance in providing high-quality financial reports. Analyses support our prediction: The treatment firms, which, under the 2006 rule, start to disclose CFO compensation information, compared to the control firms, which were already disclosing CFO compensation prior to 2006, experience a significant improvement in financial report quality as exhibited in the reduced frequency of both accounting restatements and internal control weaknesses, as well as improved accrual quality. Further strengthening our conclusion, the improvement in CFO performance in financial reporting for the treatment firms is more pronounced for firms with younger CFOs, firms with CFOs subject to weaker internal monitoring, and firms facing higher litigation risk. We contribute to the disclosure literature by showing a causal impact of compensation disclosure on job performance. Our findings also have regulatory implications.
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ItemDisclosure and Rollover Risk( 2018-08-31)This paper studies whether and to what extent transparent disclosure prevents inefficient liquidation arising from rollover risk. We model an illiquid but solvent borrower who can design a public signal about what creditors can recover from forcing liquidation, and what their claims would be worth if the firm survives. We find that the signal structure that minimizes rollover risk never identifies liquidation or continuation values, and that borrowers can commit to this structure. Moreover, if creditors can impose disclosure requirements, they may increase inefficient liquidation, in order to pool states to increase the amount they expect to recover from defaults.
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ItemProduct Market Effects of Customer Referencing( 2018-08-31)Customer referencing refers to the phenomenon that a firm intentionally reveals its connections to customers to raise its own reputation. In this paper, we rely on textual data about customer referencing in financial reports to examine the association between customer referencing and firms’ future product market performance. We first document that a substantial number of firms voluntarily reference customers in financial reports. We find that these firms have a better future performance, consistent with the notion that the customers being referenced certify product quality and enhance a firm’s reputation. We also find that the positive association is stronger for firms with a low reputation and those that are risky or facing high product market competition. These results further affirm the product quality certification and reputation enhancement roles of customer referencing. Our study provides new insight into how certification via inter-organizational relationships can be an intangible marketing asset.
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ItemWhen Do Associate Analysts Matter?( 2018-08-31)Sell-side equity analysts often work in hierarchical teams. Lead analysts manage a team of associate and junior analysts, who take part in the team’s tasks. We hypothesize a division of labor between lead and associate analysts where lead analysts focus on higher-importance tasks and delegate secondary tasks to their associates. We find that associate analyst fixed effects explain more of the variation in forecast accuracy than lead analyst fixed effects do. In contrast, lead analyst fixed effects explain more of the variation in forecast timeliness and in the stock price reaction to the analyst report. These results suggest that associate analysts have a significant role in forecasting while lead analysts are the main contributors to the qualitative information in the report. In cross-sectional tests, we find that lead analysts are more involved in the coverage of larger firms that likely generate more trading commissions to the brokerage house. We also document that lead analysts are more involved when more information processing is required and associate analysts are more involved as they gain experience. Overall, our study documents the division of labor between lead and associate analysts and the significant role of associate analysts in forecasting.
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ItemManagement Forecasts in Crowded Sectors( 2018-08-30)This paper documents a dual role for disclosure. In addition to the traditional role of alleviating information asymmetry, firms are motivated to disclose to attract investors’ limited resources and order flow away from other firms (Fishman and Hagerty, 1989). In periods when firms returns comove more with their sector's returns and thus face more competition for investors, they issue more guidance, especially capex guidance. The effect of firm-sector comovement ("sector crowdedness") on guidance increases with fiercer competition for investors. Guidance increases liquidity and price efficiency (measured as investment sensitivity to price), but the impact of guidance decreases in sector crowdedness, consistent with the proposition that more disclosure in the crowded sectors is investor-seeking rather than precision increasing. Although the impact of guidance on investment-price sensitivity is lower in more crowded sectors, the effect is still positive, suggesting that firms can improve price efficiency by issuing guidance to attract informed investors to the firm.