09 Financial Accounting 3: Determinants and consequences of financial reporting attributes (FAR3)

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    Number of Numbers: Does Quantitative Disclosure Reduce Information Risk?
    ( 2021) Campbell, John ; Zheng, Xin ; Zhou, Dexin
    Theoretical research argues that numbers convey more precise information than words. Based on this work, we hypothesize that when managers provide disclosure with a greater proportion of quantitative information, information risk will decrease and firm value will increase. We offer three main findings. First, after controlling for the cash flow news in earnings conference calls, we find a positive association between the extent of hard information (i.e., numerical disclosure) and short-window stock returns around the call. This result suggests that information risk decreases when managers provide greater numerical disclosure. Second, we find that this positive association is larger when firms’ information environment is otherwise poor. Finally, we find that this positive association is larger when uncertainty about firm performance is higher (i.e., when the firm issues a negative earnings surprise). Overall, our results suggest that investors react to the extent of hard information (i.e., numerical disclosure) in earnings conference calls.
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    Does Lower Timely Loss Recognition Reflect Managers' Favorable Private Information?
    ( 2021) Feng, Ivy ; Kimbrough, Michael ; Cao, Yi
    A manager may choose not to record the full extent of bad economic news reflected in negative stock returns (i.e. a manager may exercise low timely loss recognition) if she believes she has private information that justifies a more favorable outlook than the stock market’s pessimistic outlook. Researchers often interpret the resulting deviations between earnings and stock returns as distortions in earnings. However, if managers' more favorable view is correct, earnings will more closely reflect the changes in fundamental value even as they become less aligned with stock returns. In other words, greater deviations between earnings and returns may actually be consistent with more rather than less transparent earnings. We test this possibility using a sample of firm years with negative annual returns. Using future returns as the proxy for the public revelation of managers’ favorable private information, we find that future returns offset current negative returns to a greater extent when managers exercise lower levels of timely loss recognition. Equivalently, we document a negative association between future returns and the portion of implied losses in current negative returns that managers do not recognize. This negative association is stronger when it is more likely that managers have private information. The association is also stronger when managers face higher disclosure costs that prevent full disclosure of their favorable private information. We also find that only a relatively small portion of unrecognized implied losses is recognized in earnings during the subsequent three years. These findings indicate that the traditional explanation for misalignments between earnings and negative stock returns as being due to delayed recognition of economic losses is only partial. Such misalignments are also due to managers’ use of appropriate discretion to include favorable private information in earnings.
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    Economic Consequences of Public Pension Underfunding Transparency: Evidence from Housing Market and Local Economics
    ( 2021) Fan, Haoqing Grace
    This paper sheds light on the mechanisms through which state pension underfunding influences local housing markets and economies. Using both a contiguous border-county approach and a single state study in California, I find that recent pension reporting regulation changes that enhance the transparency and salience of governments’ pension underfunding status led to lower growth in local housing prices. Such effect is stronger in states that are more strongly impacted by the regulation changes, and the media plays an important role in disseminating the information. Other local economic variables, including new building permits, business activities, and public employment outcomes, are also negatively impacted when pension underfunding is revealed.
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    The Role of Related Party Fundraising on the Relation Between Reporting Quality and Donations
    ( 2021) Balsam, Steven ; Harris, Erica ; Wong, Paul
    Prior research shows that donors discount program ratios when a nonprofit organization reports zero fundraising expense. In this paper, we show that a plausible reason for organizations reporting zero fundraising expenses is that a related party conducts fundraising on the organization’s behalf. Consistent with this interpretation, we find that nonprofits reporting a related fundraising entity are more likely to report zero fundraising expenses. We also find that related party fundraising moderates the impact of reporting zero fundraising expenses on donors use of the program ratio in their donation decisions.
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    Trade Credit in Distrust: Evidence from Financial Restatements
    ( 2021) Shou, Ming ; Liu, Qianqiu
    We argue that distrust significantly increases people's perceived information asymmetry and has important economic consequences. By using the occurrence of financial restatement as a proxy for significant trust reduction in financial information, we show that firms rely more on trade credit as an external financing choice after restatements because suppliers have an information advantage and better address information asymmetry problems. After comparing the predictability of sales by trade credit before and after restatements, we find that the informativeness of trade credit about firms' prospects changes during restatement periods. In the pre-restatement periods, firm sales monotonically increase with trade credit. In the post-restatement periods, firms with the most trade credit do not have the best future performance, while firms with the least trade credit experience the lowest subsequent sales. We also find that investors in the stock market do not realize such informativeness change and underreact to the valuable negative information from suppliers.
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    Investment, Inflation, and the Role of Internal Information Systems as a Transmission Channel
    ( 2021) Binz, Oliver ; Ferracuti, Elia ; Joos, Peter
    We examine whether the quality of firms’ internal information systems influences the relation between inflation Shocks and corporate investment, as posited by imperfect information models. We first document a positive relation between inflation Shock and investment, consistent with nominal rigidity breaking the classical dichotomy, i.e., the prediction that nominal variables, such as inflation, do not affect real variables, such as corporate investment. Next, we use responses to the World Management Survey to construct a direct measure of firms’ internal information system quality and find that higher quality mitigates this positive relation. This result suggests that internal accounting quality serves as a transmission channel through which aggregate nominal variables affect real variables at the firm level.
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    Did the FASB Codification Reduce the Complexity of Applying US GAAP?
    ( 2021) Binz, Oliver ; Kubic, Matthew ; Hills, Robert
    We examine whether the Financial Accounting Standards Board (FASB) can reduce financial reporting complexity without changing the underlying accounting guidance. We test whether the launch of the FASB Codification made it easier for preparers to locate the relevant accounting guidance. We find that areas of U.S. GAAP with more dispersed and voluminous guidance before the Codification experience a larger post-Codification reduction in restatements. We find a similar decline in SEC comment letter questions referencing areas of U.S. GAAP with more difficult-to-locate guidance. Our results suggest that, prior to the Codification, preparers had difficulty in locating the appropriate accounting guidance and that the Codification mitigated this difficulty.
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    Does Financial Statement Comparability Facilitate SEC Oversight?
    ( 2021) Nam, Jonathan ; Thompson, Rachel
    This study examines the impact of cross-firm financial statement comparability on regulatory oversight of accounting quality. Consistent with the notion that comparable accounting systems enhance regulators’ ability to identify accounting deviations from financial reporting, we find that the likelihood that the SEC issues a comment letter on 10-K filings that have poor accounting quality increases with financial statement comparability. Further analysis reveals that the regulatory benefits from financial statement comparability are more salient when the SEC faces higher monitoring constraints in filing reviews. Overall, we provide novel evidence suggesting that higher financial statement comparability improves the efficacy of the SEC’s oversight of accounting quality by reducing the information costs associated with cross-firm comparisons.
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    You Don't Know What You Don't Know: Improvements in Investment Efficiency Prior to a Mandated Accounting Change
    ( 2021) Christensen, Derek ; Lynch, Daniel ; Partridge, Clay
    Theory suggests mandated changes in accounting standards can increase investment efficiency through two mechanisms: (1) increases in internal information quality (IIQ), and/or (2) increases in external information quality (EIQ). We leverage the transition period of the new lease accounting standard, where EIQ is unlikely to change, to isolate the effect of increases in IIQ on investment efficiency. Using a difference-in-differences design, we find that firms affected by the new lease standard experience improvements in investment efficiency in the year immediately preceding the standard’s implementation. Cross-sectional tests suggest the investment efficiency gains are driven by IIQ reducing internal moral hazard risk. We contribute to the investment efficiency literature by isolating the effect of increases in IIQ on investment behavior and identifying a specific channel through which IIQ affects investment efficiency. Further, we document that preparing to comply with an accounting standard change improves managerial decision-making, which may be of use to the FASB as part of their post-implementation review of the lease accounting standard.
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    Earnings Verifiability
    ( 2021) Sarath, Bharat ; Palmon, Dan ; Chen, Yu-An
    Under Statement of Financial Accounting Concepts No. 8 in the US, verifiability is one of the decision-enhancing characteristics of financial information. Verifiability is also a key contention in the long-lasting debate on fair value accounting. Nevertheless, there is relatively little archival research on verifiability, probably due to the lack of an acceptable empirical construct to measure verifiability. We propose a new measure of earnings verifiability and find empirical evidence that higher verifiability enhances earnings relevancy. Although more verifiable earnings do not imply that these earnings measures are more faithfully represented, they do lead to better decisions by users of financial statements. Interestingly, the prevalence of fair values on firms’ financial statements is associated with lower earnings verifiability.