Inside Governance

Kevin Lewis

December 01, 2020

Undisclosed SEC Investigations
Terrence Blackburne et al.
Management Science, forthcoming


One of the hallmarks of the Security and Exchange Commission's (SEC's) investigative process is that it is shrouded in secrecy - only the SEC staff, high-level managers of the company being investigated, and outside counsel are typically aware of active investigations. We obtain novel data on all investigations closed by the SEC between 2000 and 2017 - data that were heretofore nonpublic - and find that such investigations predict economically material declines in future firm performance. Despite evidence that the vast majority of these investigations are economically material, firms are not required to disclose them, and only 19% of investigations are initially disclosed. We examine whether corporate insiders exploit the undisclosed nature of these investigations for personal gain. Despite the undisclosed and economically material nature of these investigations, we find that insiders are not abstaining from trading. In particular, we find a pronounced spike in insider selling among undisclosed investigations with the most severe negative outcomes; and that abnormal selling activity appears highly opportunistic and earns significant abnormal returns. Our results suggest that SEC investigations are often undisclosed, economically material nonpublic events, and that insiders are trading in conjunction with these events.

Political corruption and mergers and acquisitions
Nam Nguyen, Hieu Phan & Thuy Simpson
Journal of Corporate Finance, forthcoming


This research examines the relation between political corruption and mergers and acquisitions (M&As). We find that local corruption increases firm acquisitiveness but decreases firm targetiveness. The levels of corruption in acquirer areas relate positively to the bid premiums and negatively to the likelihood of deal completion. Corruption motivates acquiring firms to use excess cash for payment, which mitigates the negative effect of corruption on acquirer shareholder value. The evidence indicates that acquisitions help acquiring firms convert cash into hard-to-extract assets and relocate assets from the high to low corruption areas, thereby shielding their liquid assets from expropriation by local officials.

Is Wall Street Turning Blue?
Yosef Bonaparte
University of Colorado Working Paper, November 2020


We demonstrate that since the early 1990's, it is becoming increasingly common for firms to be run by CEOs who are aligned with the Democratic Party, which we refer to as the blue trend. We find evidence that at least one factor driving this trend appears to be the rise of the role of women, who tend to have values that align with the Democratic Party. Further, we find that the blue trend is stronger in industries that are more considerable to women as a source of employees or customers (e.g., hospitality, computers, etc.). Nevertheless, the trend appears to be quite pervasive, as nearly 75% of industries turned bluer. The blue trend also has several implications on corporate governing and on the overall stock market performance and volatility, as the presence of more CEOs who are aligned with the Democratic Party is associated with the lower overall stock market returns. Collectively, our evidence suggests that there is a change in the leadership on Wall Street and that has implications for corporate culture, and the stock market landscape.

Cash is Queen: Female CEOs' propensity to hoard cash
Nilesh Sah
Journal of Behavioral and Experimental Finance, forthcoming


Recent research makes contradictory claims regarding why female CEOs eschew riskier policies. Benchmarking risk aversion by how much cash is accumulated and managed, we find strong evidence of greater female risk aversion above the glass ceiling. Using propensity-score matching and difference-in-differences around CEO transitions to account for possible endogeneity, we find that female CEOs hold more cash, reverse cash deficits faster, and are more likely to use excess cash to increase dividends, but not investment. We also find that, in the presence of high cash holdings, female CEOs are able to generate significantly higher Return on Assets (ROA) suggesting that risk aversion on the part of female CEOs doesn't hurt financial performance but rather enhances it.

Do Emotions Affect Audit Practice? Terrorist Attacks and Accounting Misstatements
Pengkai Lin
Tulane Working Paper, August 2020


Psychology and neuroscience research shows that individuals with negative emotions (e.g., fear) are more sensitive to negative signals and exhibit a higher degree of risk aversion. Using local terrorist attacks as exogenous shocks that cause auditors to experience more negative emotions in the audit period, I empirically study the impact of negative emotions on audit practice. I find that accounting misstatements are less likely to occur for firms when there is a local terrorist attack in the audit period. The reduction in misstatements is stronger for auditors who are located closer to the terrorist attacks. Further evidence suggests that affected auditors are more likely to issue going concern opinions, spend more time on the audit, and charge higher audit fees. I obtain a similar set of results using airplane crashes as an alternative source of emotional shocks. Overall, the evidence is consistent with the idea that auditors with more negative emotions exert greater effort to lower misstatement risks. My findings provide large-scale archival causal evidence that emotions can affect audit outcomes.

Adapting to Radical Change: The Benefits of Short-Horizon Investors
Mariassunta Giannetti & Xiaoyun Yu
Management Science, forthcoming


We show that, following shocks that change an industry's competitive environment, firms with more short-term institutional investors experience smaller drops in sales and investment and have better long-term performance than similar firms affected by the shocks. To do so, these firms introduce new products, file more trademarks, intensify their innovation efforts, conduct more diversifying acquisitions, and have higher executive turnover in the aftermath of the shocks. Our findings suggest that firms with more short-term investors adapt better to the new competitive environment. Endogeneity of institutional ownership and other selection problems do not appear to drive our findings.

More is Less: Publicizing Information and Market Feedback
Andrew Bird et al.
Review of Finance, forthcoming


We study whether and how publicizing internal information affects the value of financial markets to the real economy. By publicizing corporate filings, the SEC's EDGAR web platform reduces the cost of acquiring internal information for outsiders and so makes it relatively less attractive to gather external information. We find that the staggered introduction of EDGAR reduced the sensitivity of firm investment to prices, consistent with prices being less informative to managers due to the crowding out of external information gathering. This crowding out effect is stronger when outsiders' incentives for gathering information are stronger and for firms that rely more on external information. Our findings suggest that policies designed to "level the playing field" by publicizing internal information can have significant unintended consequences by reducing the informativeness of prices for real decisions.

Common Ownership in America: 1980-2017
Matthew Backus, Christopher Conlon & Michael Sinkinson
American Economic Journal: Microeconomics, forthcoming


We empirically assess the implications of the common ownership hypothesis from a historical perspective using the set of S&P 500 firms from 1980-2017. We show that the dramatic rise in common ownership in the time series is driven primarily by the rise of indexing and diversification and, in the cross-section, by investor concentration, which the theory presumes to drive a wedge between cash ow rights and control. We also show that the theory predicts incentives for expropriation of undiversified shareholders via tunneling, even in the Berle and Means (1932) world of the widely held firm.

The Dark Side of Investor Conferences: Evidence of Managerial Opportunism
Brian Bushee, Daniel Taylor & Christina Zhu
University of Pennsylvania Working Paper, September 2020


While the shareholder benefits of investor conferences are well-documented, evidence on whether these conferences facilitate managerial opportunism is scarce. In this paper, we examine whether managers opportunistically exploit heightened attention around the conference to "hype" the stock. Consistent with hype, we find that managers increase the quantity of voluntary disclosure over the ten days prior to the conference, and that these disclosures increase prices to a greater extent than post-conference disclosures. Investigating managers' incentives for pre-conference disclosure, we find that the increase in pre-conference disclosure is more pronounced when insiders sell their shares immediately prior to the conference. In those circumstances where pre-conference disclosures coincide with pre-conference insider selling, we find evidence of a significant return reversal: large positive returns before the conference, and large negative returns after the conference. Collectively, our findings are consistent with some managers hyping the stock prior to the conference and selling their shares at inflated prices.

How to Talk When a Machine is Listening: Corporate Disclosure in the Age of AI
Sean Caoet al.
NBER Working Paper, October 2020


This paper analyzes how corporate disclosure has been reshaped by machine processors, employed by algorithmic traders, robot investment advisors, and quantitative analysts. Our findings indicate that increasing machine and AI readership, proxied by machine downloads, motivates firms to prepare filings that are more friendly to machine parsing and processing. Moreover, firms with high expected machine downloads manage textual sentiment and audio emotion in ways catered to machine and AI readers, such as by differentially avoiding words that are perceived as negative by computational algorithms as compared to those by human readers, and by exhibiting speech emotion favored by machine learning software processors. The publication of Loughran and McDonald (2011) is instrumental in attributing the change in the measured sentiment to machine and AI readership. While existing research has explored how investors and researchers apply machine learning and computational tools to quantify qualitative information from disclosure and news, this study is the first to identify and analyze the feedback effect on corporate disclosure decisions, i.e., how companies adjust the way they talk knowing that machines are listening.

Financial Reporting Frequency and Corporate Innovation
Renhui Fu et al.
Journal of Law and Economics, August 2020, Pages 501-530


We examine how the regulation of financial reporting frequency affects corporate innovation. We use a difference-in-differences approach based on a sample of treatment firms that experience a change in their reporting frequency and matched industry peers and control firms whose reporting frequency remains unchanged. We find that higher reporting frequency significantly reduces treatment firms' innovation output but find no evidence that the net externality effect on industry peers is statistically significant. Together, our results are consistent with the hypothesis that frequent reporting induces managerial myopia and impedes corporate innovation.

The Dark Side of Executive Compensation Duration: Evidence from Mergers and Acquisitions
Zhi Li & Qiyuan Peng
Journal of Financial and Quantitative Analysis, forthcoming


We find that contrary to popular belief, CEOs with long compensation duration do not make better long-term investment decisions. Using a comprehensive pay duration measure, we find that acquisitions conducted by CEOs with long compensation duration receive more negative announcement returns, and experience significantly worse post-acquisition abnormal operating and stock performance, compared with deals conducted by CEOs with short compensation duration. The negative correlation between compensation duration and M&A performance is driven by long-term time-vesting plans, not by performance-vesting plans. The results suggest that extending CEO pay horizon without implementing performance requirements is insufficient to improve managerial long-term investment decisions.

Price Ceiling, Market Structure, and Payout Policies
Mao Ye, Miles Zheng & Xiongshi Li
NBER Working Paper, November 2020


To prevent firms from manipulating prices, U.S. regulators set price ceilings for open-market share repurchases. We find that market structure reforms in the 1990s and 2000s dramatically increased share repurchases because they relaxed constraints that prevent firms from competing with other traders under price ceilings. The 2016 Tick Size Pilot, a controlled experiment that partially reversed previous reforms, significantly reduced share repurchases. Market structure frictions provide a unified explanation for two puzzles: the dividend puzzle exists because previous research has overlooked market structure frictions; share repurchases increase relative to dividends over time because market structure reforms gradually reduce these frictions.

How Vertical Integration Affects Firm Innovation: Quasi-Experimental Evidence
Yuchen Zhang & Tony Tong
Organization Science, forthcoming


Although it is well established that vertical integration decisions have important consequences for firms, direct evidence on how vertical integration matters to firm innovation has been scarce. This study draws from seminal research on organizing for innovation and recent synthesis of transaction cost and capabilities theories to examine how vertical integration affects the rate and types of firm innovation pursued. To strengthen identification of causal effects, we exploit a quasi-experimental design to compare firms that announced and completed a vertical merger and acquisition (M&A) with those announcing but not completing the transaction. We show that firms completing vertical M&As experience a growth in their rate of innovation; in addition, such firms witness an increase in systemic innovation but a drop in autonomous innovation. Our study contributes important empirical evidence to bear on the literature on the organization of innovation, highlighting that organizational mode choices are a critical determinant of the rate and direction of inventive activity.

Do IPO Firms Misclassify Expenses? Implications for IPO Price Formation and Post-IPO Stock Performance
Xiaotao (Kelvin) Liu & Biyu Wu
Management Science, forthcoming


This study investigates whether initial public offering (IPO) firms inflate "core" earnings through classification shifting (i.e., misclassifying core expenses as income-decreasing special items) immediately prior to IPOs. We provide initial evidence that IPO firms engage in classification shifting in the pre-IPO period. Using hand-collected price and share information from IPO prospectuses, we find that pre-IPO classification shifting is positively associated with a price revision from the midpoint of the initial price range to the final offer price, suggesting that pre-IPO classification shifting influences IPO price formation. Furthermore, we find that pre-IPO classification shifting is negatively associated with post-IPO stock returns. Overall, our findings caution investors, auditors, and regulators that classification shifting, a seemingly innocuous accounting maneuver, can mislead investors in their IPO valuation and is associated with post-IPO underperformance.


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