08 Financial Accounting 3: Determinants and consequences of financial reporting attributes (FAR3)
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ItemNet Income Measurement, Investor Inattention, and Firm Decisions( 2022)This paper studies the interaction between investor inattention and firms' capital allocation decisions by exploiting an accounting rule change that requires publicly traded firms to incorporate changes in unrealized gains and losses (UGL) from equity securities into net income. We build a model with risk-averse investors who can be attentive or inattentive and managers who choose how much to invest in financial assets. The model makes two main predictions. First, with inattentive investors, the rule change will cause firms' stock prices to react more strongly to changes in UGL. Second, we identify conditions under which the rule can lead to a higher stock price discount because of higher perceived residual uncertainty, and managers respond by cutting investment in financial assets. We use US insurance company data to test these predictions. We find that insurers' stock returns react more strongly to changes in UGL on equity securities after the rule change, and more so for firms with low analyst coverage. Using a difference-in-differences approach, we find that by 2020, public insurance companies cut investments in publicly traded stocks by almost 20%. Our results highlight the impact that investor inattention has on firms' stock prices and resource allocation decisions.
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ItemProsocial CEOs and Accounting Information Quality( 2022)This paper examines the association between Chief Executive Officers’ (CEOs’) prosocial tendency and their companies’ accounting information quality. We measure CEOs’ prosocial tendency using their involvement with charitable organizations. Our results suggest that prosocial CEOs are less likely to manipulate financial statements, proxied by accounting irregularities identified by material non-reliance restatements and SEC or DOJ enforcement actions. Moreover, a company is less likely to have accounting irregularities and regulatory enforcement actions after a prosocial CEO replaces a non-prosocial CEO than after other types of CEO replacements. The effect of prosocial CEOs on accounting manipulations is concentrated in situations where firms are under financial distress, when Chief Financial Officers are also prosocial, and when the direct aim of the charitable organization(s) that CEOs are involved with is to improve the welfare of people in need. Further, we find that prosocial CEOs are less likely to withhold bad news and issue more earnings forecasts. Taken together, our results suggest that prosocial CEOs, who are less subject to the agency problem, provide higher quality accounting information to investors than non-prosocial CEOs.
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ItemDid the Securities Exchange Act of 1934 Increase Accounting Comparability?( 2022)We examine whether the Securities and Exchange Act of 1934 increased earnings informativeness by increasing accounting comparability, consistent with regulators’ intent. Specifically, we document that the Act made the accounting of similar firms (i.e., firms in the same industry) and differing firms (i.e., firms in different industries) look more similar. However, inconsistent with the Act simply imposing uniformity, we find that the increase in similarity is stronger when firms are similar than when firms differ. Further, consistent with increased comparability leading to increased information transfers among firms, we document that the Act increased information spillovers from earnings news released during bellwether firms’ earnings announcements to other firms within the same industry. Lastly, we find that the Act increased earnings informativeness only for firms that experienced larger increases in comparability.
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ItemImpact of ASC 606 on the Cost of Debt: Lessons for Principles-Based Accounting Standards( 2022)This paper examines the consequences of adopting principles-based accounting standards on the cost of debt using a quasi-natural experiment surrounding the adoption of ASC 606. We find that affected firms experience increases in uncertainty regarding future earnings captured by both higher analyst absolute forecast error and analyst forecast dispersion. Consequently, the cost of debt rises for materially affected firms as covenants are used less in debt contracts due to decreased effectiveness of earnings-based covenants. The effect is concentrated in firms with high pre-ASC 606 revenue/operating income volatility and is mitigated by relationship lending. We also show that the increased cost of debt dissipates over time, consistent with learning and adapting to new standards by the debt market. Our analyses imply a costly transition from rules-based to principles-based accounting standards in the short run, but the costs are not long-lasting.