13 Financial Accounting 8: Investor relations/Regulations /IPO/M&As/ Pension accounting (FAR8)

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    Economic Consequences of the Holding Foreign Companies Accountable Act
    ( 2022) Chen, Bingyi ; Conaway, Jenelle
    This paper investigates the initial economic consequences of the Holding Foreign Companies Accountable Act (HFCAA or the Act). While the Act applies to all U.S.-listed foreign companies, it impacts Chinese companies in particular. HFCAA seeks to address restrictions China has placed on the PCAOB’s ability to inspect or investigate auditors of U.S.-listed Chinese companies by imposing strict penalties, such as delisting from U.S. exchanges, on non-compliant firms. The Act may be a double-edged sword. While it seeks to even the playing field and improve the financial reporting quality of U.S.-listed Chinese companies, it can also make Chinese companies choose to forgo a U.S. listing entirely, thus creating barriers that prevent U.S. investors from access to the world’s second-largest economy. It remains unclear how investors will react to the Act. We begin by examining market reactions to related HFCAA legislative events. Our results show significantly negative three-day cumulative abnormal returns around five events leading up to the passage of HFCAA, consistent with investors’ concerns of the Act’s compliance and opportunity costs outweighing its intended benefits. Cross-sectional results reveal stronger negative reactions for state-owned enterprises that are less likely to comply with the requirement and thus more likely to forgo their U.S. listing, and for companies structured as variable interest entities since investors of those companies are particularly vulnerable to losing their investments in case of a delisting. We also find an attenuated reaction for firms with a secondary listing elsewhere that could offer an exit strategy for U.S. investors. We further document that institutional holdings in U.S.-listed Chinese companies consistently decline after the Act’s enactment, particularly for large-cap stocks such as Alibaba and Baidu, providing corroborating evidence that institutions also perceive the Act as net costly. Finally, our auditor analysis shows that some Chinese companies choose to comply with the HFCAA by subsequently switching to a U.S.-based auditor, suggesting the Act is achieving its intent to strengthen the financial oversight of U.S.-listed Chinese companies at least in part.
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    Once Bitten, Twice Shy: Learning from Corporate Fraud
    ( 2022) Nguyen, Trung
    This paper finds that investors learn from their experience with corporate fraud and financial misconduct and modify their investment behavior to avoid suspicious firms and increase corporate governance efforts. More specifically, mutual funds that experienced corporate fraud at one of their portfolio firms subsequently chose firms with lower probabilities of fraud and financial misconduct, compared to otherwise similar funds that did not experience any corporate malfeasance incidents. Furthermore, mutual funds that experienced corporate fraud intensify their corporate governance activities and vote significantly more against management at other firms in their portfolios, compared to the voting behavior at the same firms by otherwise similar funds but that did not experience any fraud, especially on issues related to director election, audit, and financial statement. I find that fraud-experienced investors are significantly less likely to vote for problematic directors. Finally, I find that firms held by more fraud-experienced investors observe a significant drop in the propensity to get an accounting fraud sanction in subsequent years. Taken together, my results show that learning and experience play a critical role in corporate governance spillovers, fraud detection, and deterrence.
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    Municipal Bond Market Effects of Credit Rating Dissemination
    ( 2022) Basu, Riddha ; Chen, Xiangpei ; Naughton, James
    We examine the effect of dissemination on transaction costs in the municipal bond market by exploiting a regulatory change that made municipal credit rating information prepared by two of the three major credit rating agencies freely and publicly available on the Electronic Municipal Market Access (EMMA) database. We use a difference-in-differences framework that compares subsequent trading in bonds issued before the regulatory change, where the difference is whether rating information is provided on EMMA or not. We find that the dissemination of credit ratings reduced transaction costs primarily for retail investors. We also find that the dissemination effects are concentrated in bond purchases and are amplified when the information environment of the issuer is poor. Collectively, we interpret these results as indicating that the broad dissemination of credit rating information lowers transaction costs when information acquisition costs are high.
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    Material information in Managers’ Private Disclosures: Evidence from Professional Investors’ Perceptions
    ( 2022) Park, Jihwon ; Durney, Michael ; Kyung, Hoyoun ; Soltes, Eugene
    Using both survey and experimental methods, we provide evidence on the materiality and the nature of information communicated in private meetings from the perspective of 308 professional investors. While benefits of private meetings for investors are well documented, the source of such benefits remains unclear due to unobservability of such events, challenging the enforcement of Regulation Fair Disclosure. We find that a significant portion of information in managers’ private disclosures can only be obtained through private interactions with senior management, and that the information is likely material, influencing investor judgments. In contrast to assumptions made by prior academics and regulators, we document that nonverbal and qualitative information are important sources of private meeting usefulness. Further, nonverbal information in private meetings is salient enough to affect the informativeness of meeting in different formats (i.e. in-person vs. virtual). Overall, our study documents whether and how material information is communicated through managers’ private disclosures.
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    Capital Market Incentives and Regulatory Challenges in Investor-State Dispute Settlement
    ( 2022) Liu, Lisa ; Le, Anthony
    We study a previously under-explored channel through which firms can exert influence over foreign governments’ policy-making—investor-state dispute settlement—and provide descriptive evidence of firms’ economic incentives. Guided by the theory on firms’ regulatory challenges, we find that a firm being public is positively associated with the likelihood that the challenged measure in investor-state dispute settlement is an industry-wide regulation. We also find that it takes significantly longer to resolve these cases when they are challenged by public companies as opposed to private companies. We further demonstrate that challenging foreign regulations is consistent with firms prioritizing domestic shareholder interests over foreign stakeholder interests, and that the financial stake of public firms in the industry reduces their free-riding incentives.
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    Interest in the Short Interest: The Rise of Private Sector Data
    ( 2022) Kim, Minjae ; McInnis, John ; Zhao, Wuyang
    The extent to which a stock is sold short (the “short interest”) is currently required to be disclosed twice per month, but regulators have consistently expressed a desire to increase this frequency. Meanwhile, short interest and lending data from private, third-party vendors has arisen to meet investor demand for short selling information on a daily basis. We find that this daily private-sector data is a strong predictor of the bimonthly regulatory short interest disclosure and investors appear to react to this daily data. Moreover, we find evidence that the daily private-sector data partially preempts investor reaction to the regulatory short interest data, but the magnitude of the effect is small. In fact, investors appear to under-react to the information content of the daily private-sector data. Although access to this data is relatively expensive, we find no evidence that retail investors are harmed in their trades around daily changes in the private-sector short interest. Overall, our findings suggest that increasing investor awareness of, or access to, private-sector short interest data may be a less-costly alternative to mandating increased frequency of regulatory short interest. We contribute to short selling literature by studying the interplay of private-sector and regulatory solutions in enhancing short selling transparency.
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    Window Dressing in a Regulated Transaction-Level Disclosure Regime
    ( 2022) Hagenberg, Thomas ; Hodder, Leslie ; Miller, Brian
    This study examines whether managers window dress their year-end reports in a disclosure regime requiring the disclosure of transaction level investment data. Proponents of mandatory transaction-level disclosure argue that the opportunity to window dress is negated when all transactions can be observed, thus revealing a more accurate depiction of a firm’s during-period financial condition. We examine this conjecture by exploiting the U.S. based insurance industry, where all investment transactions are reported at the 9-digit CUSIP level. Although insurance companies may have incentives to increase investment risk to increase investment returns, they also have incentives to manage their year-end portfolio to circumvent regulatory scrutiny. Consistent with these incentives, our results suggest insurance companies increase risk during the year only to decrease risk significantly at year-end. This relation is magnified for firms with greater regulatory risk. This evidence suggests that the disclosure of transaction level data does not fully eliminate window dressing, even in highly regulated industries, likely due to processing costs and budgetary constraints of the regulator.
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    Why Value the Enterprise en route to Equity? Valuation Practice in M&A
    ( 2022) Shaffer, Matthew ; Lee, Jason
    In recent decades, M&A advisors have increasingly used enterprise-value (EV) multiples in the valuations they provide to directors and shareholders as benchmarks for valuing their shares. This contrasts with equity analysts, who predominantly use price (equity value) multiples, typically price-to-adjusted earnings, directly. We ask why. We find that M&A advisors’ use of EV multiples is not systematically related to capital structure. Instead, this choice is driven by income statement properties: Advisors respond to non-recurring special items by moving up the income statement, especially to EBITDA, as the value driver, which entails EV valuation for consistency. M&A advisors rarely use explicitly “adjusted” bottom-line earnings measures. They use EV/EBITDA multiples, which established conventional usage in M&A for other reasons, to achieve the same end, while appearing less “discretionary,” in this setting. But using EBITDA multiples entails other, questionable, assumptions. We explain variation in valuation practice and identify a novel manifestation of the “non-GAAP” phenomenon. And we contribute evidence relevant to standards and practice, by showing how financial statement users address non-recurring items in this institutional setting.
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    Does Access to Patent Information Help Technological Acquisitions?
    ( 2022) Mao, Connie ; Qin, Yueru ; Tian, Xuan ; Zhang, Chi
    Technology acquirers face significant information asymmetry when identifying appropriate acquisition targets. Employing plausibly exogenous variation in technological information gathering costs caused by staggered openings of patent libraries, we find that firms become more active in technological acquisitions following local patent library openings. In addition, acquirers prefer targets that are geographically close or are similar in technological space to a lesser extent, technology M&A completion rates increase, acquirers’ abnormal announcement returns are higher, and long-term stock returns of combined firms are better. Acquirers’ access to patent libraries also leads to greater post-merger innovation output through fostering more collaboration between acquirers’ and targets’ inventors. Overall, our study sheds new light on the importance of information gathering costs in corporate takeovers and the search for human capital synergies.