Regulatory Treatment of Changes in Fair Value and the Composition of Banks' Investment Portfolios

In the wake of the financial crisis of 2007-2008, Basel III recommended that bank regulators include changes in the fair value of available-for-sale (AFS) debt securities in Tier 1 capital. However, the U.S. implementation allowed smaller banks to continue excluding these changes through a one-time opt out election. This paper investigates a potential impact of this opt out provision by examining the investment decisions of smaller banks in the 1990's when changes in the fair value of AFS debt securities were temporarily included in regulatory capital. Using a sample of smaller banks and a difference-in-differences research design, we find that low-capitalized banks reduced their investments in more volatile asset classes (e.g., corporate bonds, non-agency MBS) and increased their investments in less volatile asset classes (e.g., treasuries and municipal bonds) after changes in fair value were included in regulatory capital. These findings suggest that providing smaller banks with an opt out election potentially allows low-capitalized, riskier banks to continue to hold more volatile securities in their AFS portfolios.

Randomization Inference for Accounting Researchers

In this short paper we summarize and promote randomization inference for accounting researchers. We discuss applications of randomization inference in both small sample and large sample settings, and we include several examples from our own work. We also provide guidance and sample code to researchers looking to implement randomization inference, as well as caveats to consider.

Investors' Responses to Management Getting Out Ahead of Negative Media Stories: The Moderating Effects of Management's Action Plan and the Media's Focus

Crisis communications experts commonly advise managers to get out ahead of the media to increase management's credibility. We use an experiment to examine how investors' responses to management getting out ahead of a negative media story are moderated by management's action plan and the media's focus on the company. When the company is the focus of the media's lede, investors respond more negatively when the company gets out ahead of the media with plans to change, instead of stay, the course to handle the negative issue. Yet, investors respond more positively when the company responds after the media with plans to change, instead of stay, the course. In contrast, when the media does not focus on the company in its lede, but instead only mentions the company in the story, we find that investors' responses are not sensitive to management's strategic disclosure choices that we examine.

U.S. Evidence from D&O Insurance on Accounting-Related Agency Costs: Implications for Country-Specific Studies

Many studies use country-specific evidence to investigate research questions of broad interest due to research advantages of a given country, such as data availability or to exploit an exogenous event that allows identification. One such research stream largely examines Canadian directors' and officers' (D&O) insurance and finds that more coverage (i.e., higher limits) is negatively associated with financial reporting quality and positively related to litigation (accounting-related agency costs). However, the U.S. and Canada differ on key issues relevant to securities litigation and D&O insurance. Thus, we predict and find that premiums, rather than limits, provide information about U.S. accounting-related agency costs. Nonetheless, the incremental information provided by premiums about accounting-related agency costs is limited, and audit fees provide more consistent and better information about these agency costs. Thus, although researchers argue for disclosure of U.S. D&O insurance information, the usefulness of such disclosures may be limited because audit fees are already disclosed. Our findings also suggest caution in broadly generalizing country-specific studies.

An empirical assessment of real activities manipulation measures

I empirically assess the extent to which real earnings management metrics capture opportunistic behavior versus firms' fundamental factors such as performance. For the traditional proxies proposed by Roychowdhury (2006), I find (1) the economic magnitude of the proxies to be high relative to two relevant benchmarks; (2) they exhibit persistence; and (3) they vary predictably with performance. These findings suggest that the traditional proxies likely capture opportunistic behavior but also likely reflect fundamental factors. I also examine several adjusted proxies based on refinements proposed by subsequent studies. I find that those proposed by Vorst (2016) and those based on Kothari, Mizik, and Roychowdhury (2016) seem to be the most effective at attenuating correlation with underlying fundamentals. Additional simulation tests on bias and power reveal that, between the two adjusted proxies, those based on Kothari et al.'s (2016) are generally more preferable

On Market Concentration and Disclosure

Verrecchia (1983,1990) introduced the proprietary cost hypothesis in which exogenous disclosure costs are a reduced-form interpretation of lost competitive advantage in product markets. We develop a micro-foundation for this disclosure cost in a Cournot game and explicitly derive the cost as a function of market structure. When the market is sufficiently competitive, this model has a reduced-form representation similar to a standard voluntary disclosure game with a partial disclosure equilibrium. Proprietary costs are increasing in the number of competitors, the degree of product substitution, overall uncertainty and production costs. The analysis also offers new empirical predictions on the interaction between disclosure choice, managerial horizon and entry.

The Role of Convex Equity Incentives in Managers’ Forecasting Decisions

Prior literature suggests that voluntary disclosures of forward-looking information tend to lead to capital market benefits, but these disclosures may also result in negative capital market consequences if subsequent performance falls below expectations. We, therefore, hypothesize that convex equity incentives, which reward managers for stock price gains while limiting their exposure to losses, should promote greater voluntary forward-looking disclosure. Consistent with our hypothesis, we find a significantly positive association between equity incentive convexity and forecast issuance and frequency. We also find that the positive association is more pronounced for firms with higher sales volatility and managers with shorter tenure, in which cases managers are more concerned with missing their own forecasts. Our study suggests that the risks arising from providing voluntary disclosures are important considerations in managers’ disclosure decisions.

Prior Forecasting Accuracy and Investor Reaction to Management Earnings Forecasts

We examine the properties of firms’ forecasting records and whether the accuracy of their prior earnings forecasts affects investor response to their subsequent forecasts. Within the context of a Bayesian model of investor learning, we find that the stock price response to management forecast news is increasing in prior forecast accuracy and also in the length of a firm’s forecasting record. Further, we document that investors are more responsive to extreme good and bad news forecasts when a firm has an established forecasting record. Overall, these results suggest that a firm’s prior forecasting behavior allows it to establish a forecasting reputation, and that market forces encourage accurate forecasting as firms benefit from having a reputation for forecasting accurately.