08 Financial Accounting 2: Disclosure (FAR2)
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ItemWhat moves the market? Individual firms’ earnings announcements versus macro releases as drivers of index returns( 2021)In this paper, we characterize the relative importance of two sources of fundamental market-wide news—large firms’ earnings announcements and macroeconomic releases. Our investigation is motivated by growing concerns in the financial community about the increasing impact of individual firms’ news on the broad stock market indices and the disconnect between the stock market and the economy at large. We leverage the S&P500 index futures data and use narrow intraday and overnight windows to isolate the market-wide reactions to earnings and macro announcements. We find that earnings announcements represent an economically significant source of index-level market activity—an average earnings announcement experiences around 21% (47%) of abnormal volatility (trading volume) associated with an average macroeconomic release. The returns earned over earnings announcement windows serve as a significant driver of daily index price movement. Importantly, earnings announcements’ contribution to index-level volatility has been relatively stable over our sample period from 2004 to 2018, while we observe a drastic decrease in the volatility explained by macro announcements. The latter is consistent with a growing disconnect between the stock market and the broader macroeconomy.
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ItemHow Does Private Firm Disclosure Affect Demand for Public Firm Equity? Evidence from the Global Equity Market( 2021)We investigate the relationship between private firms’ disclosures and the demand for the equity of their publicly traded peers. Using data on the global movement of public equity, we find that a one standard deviation increase in private firm disclosure transparency – proxied by the number of disclosed private firms’ financial statement line items – reduces global investors’ demand for public equity by 11% to 12% or $174 million to $190 million in dollar terms. These findings are consistent with private firm disclosures generating negative pecuniary externalities – global investors reallocate their capital away from public firms to more transparent private firms – and less consistent with these disclosures creating positive information externalities that would benefit public firms. Consistent with this interpretation, we find that the reduction in demand for public equity is offset by a comparable increase in capital allocation to more transparent private firms. Using staggered openings of the Bureau van Dijk database offices and implementation of electronic business registers in investee countries as plausibly exogenous shocks to private firm transparency, we conclude that the negative relationship between private firm disclosures and public equity demand is likely causal.
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ItemFinancial Statement Information and the Market for Innovation( 2021)We examine the effect of innovation-relevant financial statement disclosures on the liquidity of the secondary patent market. Relative to equity markets, the secondary patent market is decentralized and rife with information frictions yet provides a potentially important tool to reallocate innovations to the most productive users. Using data on patent transactions, we find that a one standard deviation increase in innovation-related financial statement disclosures – proxied by the number of innovation-related phrases in relevant 10-K filings – is linked to a 32% increase (or 46 more patent sales) in a given technology class-year. These results are consistent with financial statement disclosures generating positive information externalities useful for trading patents in the secondary market. The positive link between financial statement disclosures and future patent sales is stronger where information asymmetry is likely greatest (transactions between public and private firms) and where information uncertainty likely prevails (transactions between private firms) relative to transactions less likely to suffer from informational frictions (transactions between public firms). Moreover, consistent with the notion that public firm disclosures provide information that facilitates patent transactions, we find patent sales are positively related to Edgar download activity. Our results speak to an important, but previously unexplored externality of financial statement disclosures – their contribution to a well-functioning secondary patent market.
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ItemThe Mitigating Effect of Pending Patent Disclosure on Myopic R&D Underinvestment( 2021)Guided by prior theoretical studies of real effects of disclosure, we investigate whether pending patent disclosure under the American Inventor’s Protection Act (AIPA) can mitigate managerial myopic underinvestment in R&D. When there is limited information on R&D payoff, investors tend to fixate on earnings when valuing firms, which motivates managers to underinvest in R&D myopically. The AIPA requires pending patent disclosure within 18 months of patent application. Such disclosure provides timely, detailed, and credible information on R&D payoff and can serve as an additional signal of firm value, reduce investors’ fixation on earnings, and mitigate R&D underinvestment. We find that pending patent disclosure under the AIPA significantly mitigates R&D underinvestment, especially for firms that face greater pressure to meet or beat earnings targets. We also find that the mitigating effect is stronger for firms with more analysts following, higher institutional ownership, and more unique technologies.
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ItemCSR Goal Disclosures and Regulatory Mandates: The Role of Investors’ Perceptions of Greenwashing( 2021)As stakeholder demand for CSR information continues to grow, regulators are considering ways to improve the consistency, comparability, and reliability of corporate CSR disclosures. Utilizing an experiment, we examine how disclosure of CSR goals influences investors’ responses to subsequent CSR performance disclosures under different regulatory regimes. We find evidence that the type of CSR goal disclosure causes investors to react differently to identical CSR performance information, and that this effect is moderated by the regulatory reporting regime. Although high quantitative CSR goals are frequently encouraged to incent higher CSR performance, we find that investors’ perceptions of greenwashing are higher, and in turn, their investment willingness is lower after viewing identical CSR performance information for a company that initially issues a relatively high quantitative goal compared to a relatively low quantitative goal or qualitative goal. We also find that the observed effects of quantitative CSR goals are magnified by mandatory (compared to voluntary) regulatory reporting regimes. Our findings have important implications for investors, managers, as well as to regulators who are currently considering changes to CSR disclosure requirements.
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ItemThe Feedback Effect of Social Media on Corporate Investment: Evidence from Twitter Presence and Follower Engagement( 2021)Social media presence and follower engagement have a feedback effect on corporate investment through the learning channel and the disciplining effect. Utilizing 366 million posts for 2,065 firms on Twitter, we find that investment is less sensitive to stock prices for firms with Twitter presence and with more engaged followers. Managers forecast sales more accurately with Twitter presence and revise forecasts upwards (downwards) in response to improving (deteriorating) follower engagement, suggesting that managers learn new insights from social media. Interestingly, we find a greater responsiveness of investment to declining opportunities. The asymmetric effect suggests that social media disciplines managers.
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ItemShareholder Litigation Risk and Managers’ Private Disclosure of Earnings Warnings( 2021)This paper examines managers’ use of a private disclosure channel to provide early earnings warnings and therefore reduce bad news shocks around public announcements. I ask whether firms are more likely to provide private earnings warnings to analysts when expected shareholder litigation risk increases. To identify private communication, I measure variation in firms' propensity to privately disclose earnings warnings using the difference between analysts' and a selected group of benchmark forecasters' revisions of short-term earnings forecasts around earnings announcements. Using plausibly exogenous variation in expected shareholder litigation risk based on judge ideology, I find that managers are more likely to leak bad news privately when shareholder litigation risk increases. This effect is concentrated among large firms that are more likely the target of shareholder lawsuits. I conclude that firms react to the legal system by disclosing private earnings warnings to ensure stock prices incorporate this information in a timely manner.
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ItemMonitoring Effects of Foreign Internal Capital Disclosure on Foreign Investment and Operating Profitability( 2021)As firms’ internal capital increases to record amounts, the monitoring of related agency problems only becomes more important. This paper finds that disclosing disaggregated information about internal capital improves the monitoring of firms’ accumulation and deployment of internal capital. Using the Securities and Exchange Commission (SEC)’s introduction of disclosure requirements for foreign internal capital (FIC), I identify the causal effects of FIC disclosure on firms’ capital management decisions. I find that FIC disclosure reduces the accumulation of capital in foreign countries and the expansion of foreign operations through M&A. These decreases in FIC and foreign M&As are more significant when firms’ CEOs are more entrenched, suggesting that FIC disclosure mitigates existing agency problems associated with the use of internal capital across countries. I also find that foreign profit margin increases after FIC disclosure. This paper highlights that disclosure requirements improve monitoring and alter firms’ real activity decisions.
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ItemJust Friends? Managers’ Connections to Judges( 2021)Abstract: We study the impact of social connections between judges and executives on the outcomes of Securities Class Action Litigation (SCAL). Judges who share a social network with a firm’s executives are more likely to dismiss lawsuits against the firm. These connected cases are also resolved much faster and settled for significantly lower amounts. The favorable outcomes cannot be explained by the lower severity of connected cases, or by court, judge, or firm characteristics. Our results are robust to using new judge appointments as a source of exogenous variation in “connectedness”. The expectation of more favorable litigation outcomes has an ex ante effect on connected managers’ disclosure decisions. Connected managers issue more voluntary forecasts that walk up prevailing earnings expectations, particularly over the long term and also those that walk them down over the short term. Our evidence indicates that social connections influence judge impartiality and meaningfully alter litigation outcomes, as well as managers’ disclosure decisions.
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ItemUsing Machine Learning to Measure Conservatism( 2021)Using a neural network, we develop novel measures of conservatism that fits non-linearities and interactions absent in prior literature. The machine-learning measures exhibit (i) fewer economically anomalous observations, (ii) economic associations consistent with existing studies, (iii) less unexplained year-over-year instability, and (iv) higher economic magnitudes consistent with reduced attenuation bias. The measure further reveals intuitive trends toward a secular decline in conservatism in the US. In simulations, linear models perform honorably even in the presence of a complex data-generating process but causal inference based on machine learning is the most robust to misspecification. The approach offers the promise of reducing noise in measurements and designs more powerful tests to assess theories of conservatism.