Agency theory predicts that tighter monitoring can motivate managers to exert higher effort. However, psychology theory suggests that managers may perceive increased monitoring as an indication of distrust, thereby reducing their effort level -- known as a crowding-out effect. Prior research on the role of the crowding-out effect in incentive contracting is limited. To fill this void, we first develop a theoretical model with moral hazard and predict that incentive pay is decreasing in the effectiveness of monitoring. Using social capital as a proxy for the trust between firms and CEOs, we hypothesize and find that social capital is negatively associated with the proportion of incentive pay, suggesting that social capital mitigates the crowding-out effect created by increased monitoring. We further show that this negative association is more pronounced for firms with stronger boards, higher accounting quality, and Big 4 auditors, indicating that the effect of social capital on managerial compensation is greater when stronger monitoring intensifies the crowding-out effect. Our results are robust to controlling for headquarters relocations, alternative measures of social capital and incentive pay, additional corporate governance and firm characteristics, and regional fixed effects. Taken together, our evidence suggests that: 1) while not directly observable, the crowding-out effect does play an important role in incentive contracting; and 2) social capital alleviates the crowding-out effect through enhancing the mutual trust between the firm and the CEO.
{"title":"Monitoring Versus Crowding-Out Effect: The Role of Social Capital in Managerial Compensation","authors":"Jing Dai, Mingcherng Deng, Ronghong Huang","doi":"10.2139/ssrn.3057157","DOIUrl":"https://doi.org/10.2139/ssrn.3057157","url":null,"abstract":"Agency theory predicts that tighter monitoring can motivate managers to exert higher effort. However, psychology theory suggests that managers may perceive increased monitoring as an indication of distrust, thereby reducing their effort level -- known as a crowding-out effect. Prior research on the role of the crowding-out effect in incentive contracting is limited. To fill this void, we first develop a theoretical model with moral hazard and predict that incentive pay is decreasing in the effectiveness of monitoring. Using social capital as a proxy for the trust between firms and CEOs, we hypothesize and find that social capital is negatively associated with the proportion of incentive pay, suggesting that social capital mitigates the crowding-out effect created by increased monitoring. We further show that this negative association is more pronounced for firms with stronger boards, higher accounting quality, and Big 4 auditors, indicating that the effect of social capital on managerial compensation is greater when stronger monitoring intensifies the crowding-out effect. Our results are robust to controlling for headquarters relocations, alternative measures of social capital and incentive pay, additional corporate governance and firm characteristics, and regional fixed effects. Taken together, our evidence suggests that: 1) while not directly observable, the crowding-out effect does play an important role in incentive contracting; and 2) social capital alleviates the crowding-out effect through enhancing the mutual trust between the firm and the CEO.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"26 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2017-10-22","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"131813904","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
We assess whether financial statement audits reduce the risk of losses to capital providers. Prior research documents a negative association between financial statement audits and perceived credit risk or interest costs, but surprisingly few studies assess whether lower perceived risk or interest costs are associated with fewer adverse risk-related operational outcomes, such as defaults. Using a sample of small, privately held commercial and savings banks subject to failure during the crisis years, and operationalizing default as failures resulting in losses to the FDIC insurance fund, we find firms having mandatory or voluntary financial statement audits are 33% to 50% less likely to experience defaults, compared to samples of unaudited firms, including samples matched on propensity to obtain an audit. These results are consistent with audited firms posing less default risk to creditors. That both mandatory and voluntary audits are negatively associated with failure after matching on other firm characteristics suggests the benefits of audits are not limited to voluntary audit regimes. Finding the presence of an audit is associated with a reduction in failure outcomes is important for regulators and other stakeholders as they weigh costs and benefits of mandatory audits.
{"title":"Audits and Bank Failure: Do Financial Statement Audits Reduce Losses to Capital Providers?","authors":"Jan Barton, Leslie D. Hodder, Marcy L. Shepardson","doi":"10.2139/ssrn.2719198","DOIUrl":"https://doi.org/10.2139/ssrn.2719198","url":null,"abstract":"We assess whether financial statement audits reduce the risk of losses to capital providers. Prior research documents a negative association between financial statement audits and perceived credit risk or interest costs, but surprisingly few studies assess whether lower perceived risk or interest costs are associated with fewer adverse risk-related operational outcomes, such as defaults. Using a sample of small, privately held commercial and savings banks subject to failure during the crisis years, and operationalizing default as failures resulting in losses to the FDIC insurance fund, we find firms having mandatory or voluntary financial statement audits are 33% to 50% less likely to experience defaults, compared to samples of unaudited firms, including samples matched on propensity to obtain an audit. These results are consistent with audited firms posing less default risk to creditors. That both mandatory and voluntary audits are negatively associated with failure after matching on other firm characteristics suggests the benefits of audits are not limited to voluntary audit regimes. Finding the presence of an audit is associated with a reduction in failure outcomes is important for regulators and other stakeholders as they weigh costs and benefits of mandatory audits.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"192 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-12-28","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"124261272","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Working capital is an important indicator of firm operational efficiency. All else being equal, lower levels signal greater efficiency. Managers are thus likely to be motivated to report lower levels of working capital at times of greater external attention. We find that working capital levels decrease in the fourth fiscal quarter significantly more than expected, conditional on seasonal changes in economic activity. The decrease subsequently reverses in the following first fiscal quarter. Evidence indicates that firms manage down year-end working capital through transactions that increase year-end operating cash flow and that firms spread this activity over all working capital accounts. Finally, the temporary decrease in year-end working capital is correlated with compensation benchmarks and analysts’ annual cash flow forecasts. The temporary drop is also more pronounced for firms with industry dominance. This paper was accepted by Mary Barth, accounting.
{"title":"Factors Associated with the Year-End Decline in Working Capital","authors":"Richard Frankel, Hagit Levy, Ron Shalev","doi":"10.2139/ssrn.1697922","DOIUrl":"https://doi.org/10.2139/ssrn.1697922","url":null,"abstract":"Working capital is an important indicator of firm operational efficiency. All else being equal, lower levels signal greater efficiency. Managers are thus likely to be motivated to report lower levels of working capital at times of greater external attention. We find that working capital levels decrease in the fourth fiscal quarter significantly more than expected, conditional on seasonal changes in economic activity. The decrease subsequently reverses in the following first fiscal quarter. Evidence indicates that firms manage down year-end working capital through transactions that increase year-end operating cash flow and that firms spread this activity over all working capital accounts. Finally, the temporary decrease in year-end working capital is correlated with compensation benchmarks and analysts’ annual cash flow forecasts. The temporary drop is also more pronounced for firms with industry dominance. This paper was accepted by Mary Barth, accounting.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-09-02","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129295512","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
A. Lawrence, Subprasiri Siriviriyakul, Richard G. Sloan
ABSTRACT: Prior research examining the ASC 820 fair value hierarchy concludes that Level 3 fair value measurements are significantly less value-relevant than Level 1 and Level 2 fair value measurements. We reevaluate this conclusion using the closed-end fund setting, in which fair value measurements are available for substantially all assets. Contrary to prior research, we find that Level 3 fair values are of similar value relevance to Level 1 and Level 2 fair values. Our findings suggest that the results in previous research are attributable to correlated omitted variable bias arising from the absence of fair value data for most assets. JEL Classifications: M41; G12; G29. Data Availability: Data are publicly available from sources identified in the article.
{"title":"Who's the Fairest of Them All? Evidence from Closed-End Funds","authors":"A. Lawrence, Subprasiri Siriviriyakul, Richard G. Sloan","doi":"10.2139/ssrn.2330490","DOIUrl":"https://doi.org/10.2139/ssrn.2330490","url":null,"abstract":"ABSTRACT: Prior research examining the ASC 820 fair value hierarchy concludes that Level 3 fair value measurements are significantly less value-relevant than Level 1 and Level 2 fair value measurements. We reevaluate this conclusion using the closed-end fund setting, in which fair value measurements are available for substantially all assets. Contrary to prior research, we find that Level 3 fair values are of similar value relevance to Level 1 and Level 2 fair values. Our findings suggest that the results in previous research are attributable to correlated omitted variable bias arising from the absence of fair value data for most assets. JEL Classifications: M41; G12; G29. Data Availability: Data are publicly available from sources identified in the article.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"4 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2015-04-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"121724140","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper examines the spillover effect of the news about fraud allegedly committed by Chinese reverse merger companies (CRMs). These CRMs recently became public through reverse mergers with U.S. shell companies rather than through traditional IPOs. A number of these CRMs had allegations brought against them for fraudulent reporting or activities. Once the regulators and the public became alarmed by the frequency of alleged-fraud revelations, the stock prices of the offending as well as other companies were hammered. In particular, other CRMs and U.S.-listed Chinese IPOs experienced strong negative spillover effects. The intensity of the effect differed according to short selling activities, suggesting that short sellers played an important role in the spillover effect. Since non-Chinese (U.S. and other foreign) RMs have escaped the wrath of investors, the stock market reaction appears to be based on the country of origin rather than the method of going public.
{"title":"Spillover Effect of Fraud Allegations and Investor Sentiment","authors":"M. Darrough, Ronghong Huang, Shan Zhao","doi":"10.2139/ssrn.2144483","DOIUrl":"https://doi.org/10.2139/ssrn.2144483","url":null,"abstract":"This paper examines the spillover effect of the news about fraud allegedly committed by Chinese reverse merger companies (CRMs). These CRMs recently became public through reverse mergers with U.S. shell companies rather than through traditional IPOs. A number of these CRMs had allegations brought against them for fraudulent reporting or activities. Once the regulators and the public became alarmed by the frequency of alleged-fraud revelations, the stock prices of the offending as well as other companies were hammered. In particular, other CRMs and U.S.-listed Chinese IPOs experienced strong negative spillover effects. The intensity of the effect differed according to short selling activities, suggesting that short sellers played an important role in the spillover effect. Since non-Chinese (U.S. and other foreign) RMs have escaped the wrath of investors, the stock market reaction appears to be based on the country of origin rather than the method of going public.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"75 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-12-30","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"126772203","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper analyzes the relationship between a firm’s demand for different quality auditors and opportunities for earnings management.In our model, the firm simultaneously chooses the bias it introduces into its pre-audited earnings and the quality of its auditor. We show that firms that choose a highlevel of bias also choose a low-quality auditor, even though the market-maker makes a correction for the level of residual bias in audited reports. Firms that choose a low level of bias choose a high-quality auditor.We also study the effect of changes in the regulatory environment on the market equilibrium.Our analysis shows that stricter regulation leads to more firms choosing low-quality auditors, thus it is not in the interest of high quality auditors to support such measures.
{"title":"Earnings Management and Auditor Quality","authors":"Savita A. Sahay, H. Z. Davis, M. Peikes","doi":"10.5430/AFR.V1N1P38","DOIUrl":"https://doi.org/10.5430/AFR.V1N1P38","url":null,"abstract":"This paper analyzes the relationship between a firm’s demand for different quality auditors and opportunities for earnings management.In our model, the firm simultaneously chooses the bias it introduces into its pre-audited earnings and the quality of its auditor. We show that firms that choose a highlevel of bias also choose a low-quality auditor, even though the market-maker makes a correction for the level of residual bias in audited reports. Firms that choose a low level of bias choose a high-quality auditor.We also study the effect of changes in the regulatory environment on the market equilibrium.Our analysis shows that stricter regulation leads to more firms choosing low-quality auditors, thus it is not in the interest of high quality auditors to support such measures.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"19 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2012-03-05","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"129819447","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
TThere has been debate over the economic consequences of accounting conservatism in debt contracting. We contribute to this debate by arguing that the prospect of signaling project return may give rise to the demand for conservative accounting, even though it may not improve contracting efficiency ex post. The empirical evidence of the negative correlation between interest rates and conservative accounting may be explained by the heterogeneity among firms, such as riskiness, leverage and the strength of balance sheet. While debt covenants may also serve as a signaling device, they lead to a lower Type-I error, but a higher Type-II error, than signaling via accounting conservatism. Our results further indicate that conditional conservatism may either alleviate or amplify the distortion required for the signaling purpose.
{"title":"The Signaling Role of Accounting Conservatism in Debt Contracting","authors":"Ying‐ju Chen, Mingcherng Deng","doi":"10.2139/ssrn.1590577","DOIUrl":"https://doi.org/10.2139/ssrn.1590577","url":null,"abstract":"TThere has been debate over the economic consequences of accounting conservatism in debt contracting. We contribute to this debate by arguing that the prospect of signaling project return may give rise to the demand for conservative accounting, even though it may not improve contracting efficiency ex post. The empirical evidence of the negative correlation between interest rates and conservative accounting may be explained by the heterogeneity among firms, such as riskiness, leverage and the strength of balance sheet. While debt covenants may also serve as a signaling device, they lead to a lower Type-I error, but a higher Type-II error, than signaling via accounting conservatism. Our results further indicate that conditional conservatism may either alleviate or amplify the distortion required for the signaling purpose.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"129 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2010-08-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"130601588","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Viewing equity as a call option on the firm's assets with a strike price equal to contractual debt obligations yields an asymmetric prediction on how debt and equity markets view sustained growth. Debt holders are expected to benefit from sustained growth when the default risk is high, while equity holders value such growth when risk is low. Using Altman's Z-score and debt ratings as alternative proxies for the default risk, we document a negative association between bond yield spreads and sustained growth in earnings for firms with high risk only. In sharp contrast, using earnings multiples from returns-earnings regressions as a proxy for equity market rewards, we find earnings multiples are larger when earnings growth is sustained for the low risk sample only. Decomposing earnings growth into revenue and non-revenue growth, we find that the debt market rewards for firms with revenue growth are confined to the high risk sample only, while non-revenue growth firms are not rewarded for either sample. Equity investors value revenue-led earnings growth for low and high risk samples while non-revenue growth is rewarded for the low risk sample only. Our study adds to our understanding of how changes in firm value from sustained earnings and revenue growth are divided between key providers of capital and how default risk plays an instrumental role in this valuation process.
{"title":"Asymmetric Valuation of Sustained Growth by Debt- and Equity-Holders","authors":"John A. Elliott, Doo-cheol Moon, A. Ghosh","doi":"10.2139/ssrn.1091279","DOIUrl":"https://doi.org/10.2139/ssrn.1091279","url":null,"abstract":"Viewing equity as a call option on the firm's assets with a strike price equal to contractual debt obligations yields an asymmetric prediction on how debt and equity markets view sustained growth. Debt holders are expected to benefit from sustained growth when the default risk is high, while equity holders value such growth when risk is low. Using Altman's Z-score and debt ratings as alternative proxies for the default risk, we document a negative association between bond yield spreads and sustained growth in earnings for firms with high risk only. In sharp contrast, using earnings multiples from returns-earnings regressions as a proxy for equity market rewards, we find earnings multiples are larger when earnings growth is sustained for the low risk sample only. Decomposing earnings growth into revenue and non-revenue growth, we find that the debt market rewards for firms with revenue growth are confined to the high risk sample only, while non-revenue growth firms are not rewarded for either sample. Equity investors value revenue-led earnings growth for low and high risk samples while non-revenue growth is rewarded for the low risk sample only. Our study adds to our understanding of how changes in firm value from sustained earnings and revenue growth are divided between key providers of capital and how default risk plays an instrumental role in this valuation process.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"1 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2008-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"125527603","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This study provides evidence on whether auditor independence-in-appearance, proxied by earnings response coefficients, is related to the non-audit fee ratio (non-audit to total fees from a client) or client importance (total fees from a client as a percentage of the total revenues of the audit firm). The results from large samples over the period 2001-2006 show, contrary to popular belief and the findings of some prior studies, that there is no evidence of a relation between perceived auditor independence and the non-audit fee ratio. However, perceived auditor independence is negatively associated with client importance, consistent with the economic theory of auditing. Our paper adds to the literature by examining the relative importance of non-audit fee ratios and client importance as determinants of independence-in-appearance.
{"title":"Audit and Non-Audit Fees and Capital Market Perceptions of Auditor Independence","authors":"A. Ghosh, Sanjay Kallapur, Doo-cheol Moon","doi":"10.2139/ssrn.612481","DOIUrl":"https://doi.org/10.2139/ssrn.612481","url":null,"abstract":"This study provides evidence on whether auditor independence-in-appearance, proxied by earnings response coefficients, is related to the non-audit fee ratio (non-audit to total fees from a client) or client importance (total fees from a client as a percentage of the total revenues of the audit firm). The results from large samples over the period 2001-2006 show, contrary to popular belief and the findings of some prior studies, that there is no evidence of a relation between perceived auditor independence and the non-audit fee ratio. However, perceived auditor independence is negatively associated with client importance, consistent with the economic theory of auditing. Our paper adds to the literature by examining the relative importance of non-audit fee ratios and client importance as determinants of independence-in-appearance.","PeriodicalId":138173,"journal":{"name":"Baruch: Accounting (Topic)","volume":"108 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2004-08-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"117289877","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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