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

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    Net Income Measurement, Investor Inattention, and Firm Decisions
    ( 2022) Huang, Zeqiong ; Lin, Jinjie ; Kwon, David ; Amornsiripanitch, Natee
    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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    Compliance with Financial Reporting Standards and Efficiency Gains: Evidence from ASC 842
    ( 2022) Kim, Doyeon
    This study examines the impact of compliance with changes in mandated financial reporting on corporate investment decisions. I employ the recent implementation of ASC 842, which required the capitalization of all operating leases, as a plausible exogenous shock to managers' information set and conduct a differences-in-differences analysis. Using a novel dataset on machine equipment transactions, I provide four unique insights. First, relative to private firms unaffected by ASC 842, public firms exhibit a significant decline in leased equipment. In contrast there is no corresponding decline in equipment purchased through secured loans. Second, although there is no change in the aggregate amount of purchases, I show that the change equipment characteristics such as machine age and ``deployability" suggest public firms substitute their financing method from leasing to purchasing following ASC 842. Third, consistent with the notion that leases allow divisional managers more flexibility to invest without having to seek approval from the corporate office, the post-ASC 842 decrease in leasing activity is more pronounced among public firms with multiple branches and subsidiaries. Finally, I show that public firms improve investment efficiency as a result of compliance with ASC 842.
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    Economic Consequences of Bias in Fair Value Accounting: Evidence from the Korean Bond Markets
    ( 2022) Kim, Doyeon
    I study the impact of competition among bond pricing agencies (BPAs) on bias in fair value prices, and whether there is an effect on liquidity in the corporate bond markets. Unique to Korea, BPAs are agencies which provide fair value estimates of all OTC traded products to financial institutions. I conduct a difference-in-differences analysis using the entry of a fourth BPA as a shock to competition to study the BPAs' reporting behavior. I find that an increased competition led to an increased bias. The impact of competition is higher for securities that are not traded, less liquid, and have higher credit ratings. Moreover, my results provide new insights on the real effects of accounting by showing that bias in fair value estimates decreases liquidity in the corporate bond markets.
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    Determinants and Consequences of Management’s Reporting Materiality Discretion
    ( 2022) Black, Jonathan ; Choudhary, Preeti ; Goodman, Ted
    We identify a unique setting where managers discontinue reporting values below one million in their financial statements, and use it as a reflection of managers’ discretion over what information they consider to be material. We examine both the determinants and consequences of increasing reporting materiality. Consistent with managerial opportunism, we observe that managers tend to increase materiality before decreases in operating performance, when risk-taking incentives are high, and when external monitoring is low. Furthermore, we find an increase in reporting materiality is associated decreased financial statement disclosure and increased earnings management. Consistent with opportunism generally motivating materiality increases, we find that investors on average respond negatively to the increase in reporting materiality. Our evidence suggests that managers generally use their discretion over changes in reporting materiality opportunistically, to reduce disclosure obligations.
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    How Much Does Imprecision in Accounting Measurement Enhance Value?
    ( 2022) Liang, Ying
    Theory on real effects suggests that more precise accounting does not necessarily improve investment efficiency. However, with investment efficiency mostly unobservable, empirical assessment of the theory is rare. This paper develops an empirical framework based on Kanodia, Singh, and Spero (2005) to structurally estimate the effect of imprecision in accounting measurement on investment efficiency. My estimates suggest that imprecision in accounting measurement has mitigated over-investment in capital expenditures and R&D by 28.6% and 4.9%, respectively. On average, firms still over-invest relative to the first-best full-information benchmark. In counterfactual analyses, my estimates suggest that the optimal investment efficiency could be achieved by reducing the current accounting precision by four percentage points (19.5 percentage points) in capital expenditures (R&D), which would increase investor welfare by 4.2% (22%). My study is among the first to provide a quantitative assessment of real effects and presents early evidence of excessive precision in accounting measurement.
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    Prosocial CEOs and Accounting Information Quality
    ( 2022) Feng, Mei ; Ge, Weili ; Ling, Zhejia ; Loh, Wei Ting
    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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    Did the Securities Exchange Act of 1934 Increase Accounting Comparability?
    ( 2022) Binz, Oliver ; Roulstone, Darren
    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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    Institutional mobility in global capital markets
    ( 2022) Hayes, Rachel ; Silvers, Roger
    When financial conduct in one country intrudes on another country, jurisdictional limitations effectively sever country-level institutional features (e.g., securities laws and their enforcement). This fragmentation of regulatory authority can expose global capital market participants to expropriation and information risks. We describe how cooperation between securities regulators via specific instruments restores institutional features by allowing country-level regulation to reach foreign jurisdictions. Using a powerful research design that controls for other country-level factors (even time-variant ones), we find that cooperation increases the number and dollar volume of deals in the cross-border merger and acquisition (M&A) market. Additional tests indicate larger effects of cooperation in country pairs where pre-cooperation M&A is scant (consistent with an extensive margin of investment). Moreover, we find that subtle and previously unexplored legal issues affect firm value in ways that refine the bonding hypothesis. Ultimately, we conclude that institutional features determined at the country-pair level are key determinants of economic outcomes in global markets.
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    How do markets capitalize earnings information?
    ( 2022) Silvers, Roger
    I develop a simple measure—the daily earnings response coefficient (ERC)—that captures when the market capitalizes payoffs summarized by earnings. I find wide variation in the capitalization of earnings information across different days of the same annual return horizon. To explore why, I predict daily ERCs as a function of daily market-wide characteristics—information signals, valuation-related factors, and secular patterns. Several findings resemble themes in prior studies and thus help validate the measure. Yet, in contrast to prior work, I find that turbulent (risky) market-wide conditions strengthen the return–earnings relation. I also use daily ERCs to identify novel information spillovers. I find that markets parse bellwether firms’ disclosures into heterogeneous performance implications for industry peers. Finally, I find that daily ERCs covary with fluctuations in the market’s response to a unit of news, which advances risk-based explanations for findings previously attributed to investor (in)attention.
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    Impact of ASC 606 on the Cost of Debt: Lessons for Principles-Based Accounting Standards
    ( 2022) Lee, Kyungran ; Lee, Shinwoo ; Sadka, Gil
    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.