Firms with Inconsistently Signed Earnings Surprises: Do Potential Investors Use a Counting Heuristic?
Koonce, Lisa; Lipe, Marlys Gascho. Contemporary Accounting Research. Mar2017, Vol. 34 Issue 1, p292-313.
Although prior research reports that firms that consistently beat their earnings expectations are rewarded with a market-valuation premium, most firms are inconsistent in the sign of their benchmark performance, sometimes missing and sometimes beating. In this paper, we report the results of multiple experiments to test the idea that potential investors, evaluating firms that have inconsistent benchmark performance, use a counting heuristic to discriminate among them. Our results provide strong support for the hypothesis that these investors distinguish among firms by counting the number of beats and misses they experience over an observed time interval. The judgmental effect of this beat-frequency is incremental to the effect of the magnitude of the beats and misses of the benchmark. Our study has implications for firm managers who have inconsistent benchmark performance, suggesting that market participants do make systematic discriminations among such inconsistent firms. It also has implications for researchers by introducing a new theoretical construct to the literature-namely, the counting heuristic.
Example-Based Reasoning and Fact-Weighting Guidance in Account Standards
Capps, Greg; Koonce, Lisa; White, Brian J. Contemporary Accounting Research. Mar2017, Vol. 34 Issue 1, p582-600.
The provision of examples as implementation guidance is pervasive in accounting standards. Prior research has established that preparers engage in 'example-based reasoning,' a tendency to favor the accounting treatment in an example, even when the example does not exactly match the transaction at hand. In this paper, we investigate whether fact-weighting guidance counteracts this tendency. Such guidance, now found in some accounting standards, indicates whether particular transaction facts are more important than others in determining the appropriate accounting treatment. Using an experiment, we find that fact-weighting guidance does reduce preparers' tendency to favor the accounting treatment in an example. However, results also suggest that some degree of example-based reasoning persists even with fact-weighting guidance, and that preparers are not fully aware of how fact-weighting guidance affects their judgments. Our findings have practical implications. They suggest to standard setters a potential remedy-namely, fact-weighting guidance-for the misuse of accounting examples. They also provide insights to accounting preparers regarding how fact-weighting guidance influences their judgments in ways they may not anticipate.
Corporate Governance, Accounting Conservatism, and Manipulation
Caskey, Judson; Laux, Volker. Management Science. Feb2017, Vol. 63 Issue 2, p424-437.
We develop a model to analyze how board governance affects firms' financial reporting choices and managers' incentives to manipulate accounting reports. In our setting, ceteris paribus, conservative accounting is desirable because it allows the board of directors to better oversee the firm's investment decisions. This feature of conservatism, however, causes the manager to manipulate the accounting system to mislead the board and distort its decisions. Effective reporting oversight curtails managers' ability to manipulate, which increases the benefits of conservative accounting and simultaneously reduces its costs. Our model predicts that stronger reporting oversight leads to greater accounting conservatism, manipulation, and investment efficiency. This paper was accepted by Mary Barth, accounting.
Military Experience and Corporate Tax Avoidance
Law, Kelvin; Mills, Lillian. Review of Accounting Studies. Mar2017, Vol. 22 Issue 1, p141-184.
We find that managers with military experience pursue less tax avoidance than other managers and pay an estimated $1-$2 million more in corporate taxes per firm-year. These managers also undertake less aggressive tax planning strategies with smaller tax reserves and fewer tax havens. Although they leave tax money on the table, boards hiring these managers benefit from reductions in other gray areas in corporate reporting. The broad implications are as follows: for employee selection, boards can consider employees' personal characteristics as a control mechanism when outputs are difficult to contract ex ante or measure ex post.
Using IRS Data to Identify Income Shifting Firms
De Simone, Lisa; Mills, Lillian F.; Stomberg, Bridget. [NOTE] Working Papers (Faculty) -- Stanford Graduate School of Business. Dec2016, preceding p1-47. 49p.
We use confidential Internal Revenue Service (IRS) data on the reported magnitude of U.S.-foreign intercompany transactions to develop a measure of the likelihood that U.S. multinational entities (MNEs) shift income out of the U.S. Results show that the likelihood of net outbound income shifting is positively related to tax haven subsidiaries, high tech operations, income tax incentives, R&D, and foreign profitability, and negatively related to foreign sales, gross profits, size, and capital expenditures. Supplemental analyses explore cross-sectional differences in IRS audit scrutiny of outbound income shifters and aggressive income shifters. Results suggest outbound and aggressive income shifters are no more likely to be audited than other MNEs and that the rate of audit of both outbound shifters and aggressive shifters has decreased since the financial crisis. Our study provides researchers, investors and tax authorities with a measure of the likelihood that a firm engages in net outbound or potentially aggressive income shifting.
BOZANIC, ZAHN; HOOPES, JEFFREY L.; THORNOCK, JACOB R.; WILLIAMS, BRADEN M. Journal of Accounting Research. Mar2017, Vol. 55 Issue 1, p79-114.
We study how public and private disclosure requirements interact to influence both tax regulator enforcement and firm disclosure. To capture IRS enforcement activities, we introduce a novel data set of IRS acquisition of firms' public financial disclosures, which we label IRS attention. We examine the implementation of two new disclosure requirements that potentially alter IRS attention: FIN 48, which increased public tax disclosure requirements, and Schedule UTP, which increased private tax disclosure. We find that IRS attention increased following FIN 48 but subsequently decreased following Schedule UTP, consistent with public and private disclosure interacting to influence tax enforcement. We next examine how private tax disclosure requirements under Schedule UTP affected firms' public disclosure responses. We find that, following Schedule UTP, firms significantly increased the quantity and altered the content of their tax-related disclosures, consistent with lower tax-related proprietary costs of disclosure. Our results suggest that changes in SEC disclosure requirements altered the IRS's behavior with regard to public information acquisition, and, relatedly, changes in IRS private disclosure requirements appear to change firms' public disclosure behavior.
Earnings Announcement Disclosures and Changes in Analysts' Information
Barron, Orie E.; Byard, Donal; Yu, Yong. Contemporary Accounting Research. Mar2017, Vol. 34 Issue 1, p343-373.
This study examines how financial disclosures with earnings announcements affect sell-side analysts' information about future earnings, focusing on disclosures of financial statements and management earnings forecasts. We find that disclosures of balance sheets and segment data are associated with an increase in the degree to which analysts' forecasts of upcoming quarterly earnings are based on private information. Further analyses show that balance sheet disclosures are associated with an increase in the precision of both analysts' common and private information, segment disclosures are associated with an increase in analysts' private information, and management earnings forecast disclosures are associated with an increase in analysts' common information. These results are consistent with analysts processing balance sheet and segment disclosures into new private information regarding near-term earnings. Additional analysis of conference calls shows that balance sheet, segment, and management earnings forecast disclosures are all associated with more discussion related to these items in the questions-and-answers section of conference calls, consistent with analysts playing an information interpretation role with respect to these disclosures.
The Design of Debt Clearing Markets: Clearinghouse Mechanisms in Pre-Industrial Europe
John Hatfield and Lars Borner. Journal of Political Economy. (Not published: forthcoming)
We examine the evolution of the decentralized clearinghouse mechanisms that were in use throughout Europe from the 13th century to the 18th century; in particular, we explore the clearing of non- or limited-tradable debts like bills of exchange. We construct a theoretical model of these clearinghouse mechanisms and show that the specific decentralized multilateral clearing algorithms known as rescontre, skontrieren or virement des parties, used by merchants in this period, were efficient in specific historical contexts. Our analysis contributes to the understanding of both the emergence and evolution of these mechanisms during late medieval and early modern fairs and their robustness during the 17th and 18th centuries.
Did Dubious Mortgage Origination Practices Distort House Prices?
Griffin, John M.; Maturana, Gonzalo. Review of Financial Studies. Jul2016, Vol. 29 Issue 7, p1671-1708.
ZIP codes with high concentrations of originators who misreported mortgage information experienced a 75% larger relative increase in house prices from 2003 to 2006 and a 90% larger relative decrease from 2007 to 2012 compared with other ZIP codes. Several causality tests show that high fractions of dubious originators in a ZIP code lead to large price distortions. Originators with high misreporting gave credit to borrowers with high ex ante risk, yet further understated the borrowers' true risk. Overall, excess credit facilitated through dubious origination practices explain much of the regional variation in house prices over a decade.
Spillover Effects in Mutual Fund Companies
Sialm, Clemens, and T. Mandy Tham. Management Science. May 2016. 62(5): 1472-1486.
Our paper investigates spillover effects across different business segments of publicly traded financial conglomerates. We find that the investment decisions of mutual fund shareholders do not depend only on the prior performance of the mutual funds; they also depend on the prior performance of the funds’ management companies. Flows into equity and bond mutual funds increase with the prior stock price performance of the funds’ management companies after controlling for fund performance and other fund characteristics. The sensitivity of flows to the management company’s performance is not justified by the subsequent performance of the affiliated funds. The results indicate that the reputation of a company’s brand has a significant impact on the behavior of its customers.
CFA Digest: It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans
Pool, Veronika K.; Sialm, Clemens; Stefanescu, Irina. CFA Digest. Feb2017, Vol. 47 Issue 2, p1-2.
Mutual fund management companies that provide services to sponsors of 401(k) savings plans exhibit favoritism toward their own affiliated funds. Underperforming affiliated funds are less likely to be removed from the menu of available investment options compared with similarly underperforming non-affiliated funds. The investment choices of plan participants tend to suggest that they are unaware of the potential conflicts of interest involved and continue to invest in underperforming investment options.
CFA Digest: Indexing and Active Fund Management: International Evidence
Cremers, Martijn; Ferreira, Miguel A.; Matos, Pedro; Starks, Laura. CFA Digest. Feb2017, Vol. 47 Issue 2, p1-2.
A key pillar in the active versus passive management debate is the positive impact that index-tracking alternatives can have on the performance and behavior of active fund managers. The authors demonstrate improved competition in markets where explicit indexing is more common. They also relate explicit and closet indexing to the regulatory environment. Competitive improvements found include not only lower fees but also better product differentiation through greater active share and even higher average alpha.
On the Failure (Success) of the Markets for Longevity Risk Transfer
MacMinn, Richard; Brockett, Patrick. Journal of Risk & Insurance. Apr2017 Supplement, Vol. 84, p299-317.
Longevity risk is the chance that people will live longer than expected. That potential increase in life expectancy exposes insurers and pension funds to the risk of not having sufficient funds to pay a longer stream of annuity benefits than promised. Longevity bonds and forwards provide insurers and pension funds with financial market instruments designed to hedge the longevity risk that these organization face. The European Investment Bank and World Bank have both discussed longevity bond issues, but those issues have failed due to insufficient demand. Forward contracts have also been created, but that market remains dormant. The extant literature suggests that these failures may be due to design or pricing problems. In this article the analysis shows that the market failure is instead due to a moral hazard problem.
Health State Transitions and Longevity Effects on Retirees' Optimal Annuitization
Ai, Jing; Brockett, Patrick L.; Golden, Linda L.; Zhu, Wei. Journal of Risk & Insurance. Apr2017 Supplement, Vol. 84, p319-343.
The interplay between longevity risk and health state transitions for retirees' optimal annuitization decisions is investigated. Using a life-cycle framework incorporating wealth levels, bequest motives, and consumption floors created by government subsidies, we examine how increased longevity in conjunction with an individual's health state transition process impacts annuity purchase decisions. Health state transition matrices are estimated from the Health and Retirement Survey (HRS) data. The effects of increased longevity on annuitization decisions are considered when longevity is both accompanied by increased time spent in healthier states (morbidity compression) or experienced by more time in unhealthy states (morbidity expansion). We find that retirees' annuity demand is affected by wealth, initial health status, and expansion or compression of morbidity. Wealthier retirees have higher annuity demand when health shocks are considered, and increased longevity increases demand even more when retirees expect an expansion or slight morbidity compression. With health shocks and expectations of severe morbidity compression considered, the opposite effect might occur. Thus, an annuity can help retirees hedge health shock costs when slight compression or expansion of morbidity occurs. For retirees with lower wealth, the consumption floor provided by governmental subsidies will create a decreased propensity to annuitize.
Bayesian Mode Regression Using Mixtures of Triangular Densities
Ho, Chi-san; Damien, Paul; Walker, Stephen. Journal of Econometrics. Apr2017, Vol. 197 Issue 2, p273-283.
Bayesian semiparametric models for mean and median regressions abound, but a void for mode regressions exists. We fill this gap by nonparametrically modeling the error distribution in such regressions that entails constructing prior distributions on densities which exhibit flexibility, while fixing the mode at 0. Such priors exist when constraining the mean and median but, to our knowledge, there is none for the mode. Our solution with mixtures of triangular distributions results in a conditionally conjugate prior on the space of unimodal, untruncated, convex densities. Consistency properties of the resulting modal estimators are studied, followed by simulated and real data illustrations.
A Geographically Resolved Method to Estimate Levelized Power Plant Costs with Environmental Externalities
Rhodes, Joshua D.; King, Carey; Gulen, Gürcan; Olmstead, Sheila M.; Dyer, James S.; Hebner, Robert E.; Beach, Fred C.; Edgar, Thomas F.; Webber, Michael E. Energy Policy. Mar2017, Vol. 102, p491-499.
In this analysis we developed and applied a geographically-resolved method to calculate the Levelized Cost of Electricity (LCOE) of new power plants on a county-by-county basis while including estimates of some environmental externalities. We calculated the LCOE for each county of the contiguous United States for 12 power plant technologies. The minimum LCOE option for each county varies based on local conditions, capital and fuel costs, environmental externalities, and resource availability. We considered ten scenarios that vary input assumptions. We present the results in a map format to facilitate comparisons by fuel, technology, and location. For our reference analysis, which includes a cost of $62/tCO 2 for CO 2 emissions natural gas combined cycle, wind, and nuclear are most often the lowest-LCOE option. While the average cost increases when internalizing the environmental externalities (carbon and air pollutants) is small for some technologies, the local cost differences are as high as $0.62/kWh for coal (under our reference analysis). These results display format, and online tools could serve as an educational tool for stakeholders when considering which technologies might or might not be a good fit for a given locality subject to system integration considerations.
Leader-Based Collective Bargaining: Cooperation Mechanism and Incentive Analysis
Hsu, Vernon N.; Lai, Guoming; Niu, Baozhuang; Xiao, Wenqiang. Manufacturing & Service Operations Management. Winter2017, Vol. 19 Issue 1, p72-83.
We study leader-based collective bargaining (LCB), under which a leading buyer (leader) and a following buyer (follower) form an alliance to jointly purchase a common component from a supplier. Although the leader and the follower cooperate in their component purchase, they compete in selling their end products. We first analyze the most common and simple form of LCB, equal price LCB, under which the follower pays to the leader the same wholesale price that the leader obtains from his negotiation with the supplier. We compare each buyer's profit under the equal price LCB with the benchmark where each buyer purchases separately from the supplier. We find that although the alliance might obtain a lower wholesale price and although the leader is always better off under equal price LCB, the follower can be worse off if the competition intensity of the leader's and follower's products is within an intermediate region. We identify a competition effect resulting from equal price LCB that can place the follower at a disadvantage in the competition. This finding implies that the equal price LCB might not be sustainable in practice. In view of this limitation, we investigate an alternative form of LCB, fixed price LCB, under which the follower pays a fixed price to the leader regardless of the wholesale price the leader obtains from the supplier. We show that fixed price LCB benefits not only the leader but also the follower, compared with separate purchases, which implies that fixed price LCB always achieves a win-win outcome for the buyers. Our analysis further shows that even the supplier might benefit from this form of LCB.
Selling to Customers with Both Veblen and Network Effects
Wang, Xiaofang; Wang, Tong; Lai, Guoming. Operations Research Letters. Jan2017, Vol. 45 Issue 1, p25-29.
For the products that provide not only intrinsic value from their functions but also stylish consumption experience, there often exist both Veblen and network effects. Some customers are more likely to purchase the product if fewer customers can afford it, while others might appreciate the existence of more peers. Focusing on these products, we study the market equilibrium under rational expectations. The optimal pricing and quantity decisions reveal interesting insights about the effects of such mixed consumption externalities.
Loyal to Whom? The Effects of Relation Embeddedness and Managers' Mobility on Market Tie Dissolution
Bermiss, Y. Sekou; Greenbaum, Bruce E. Administrative Science Quarterly. Jun2017, Vol. 62 Issue 2, p254-290. [*This article has been corrected since it was published in vol. 61(2) of same journal in Jun 2016]
In this study we use a social embeddedness perspective to investigate the paradoxical role that individual-level embedded relationships have on the dissolution of interorganizational ties. Prior studies have found that managers who form close interpersonal relationships with clients can stabilize market ties, but these relationships can also be a source of increased market tie dissolution in the event of an exchange manager’s departure from the firm. Using data on all state-level lobbyists and clients in the Texas lobbying industry from 2001 to 2009, we confirm that a client is more likely to remain with a firm than to follow a departing manager to a new firm, but the depth, focus, and shared ownership of a manager’s client relationship moderate the impact of his or her mobility on market tie dissolution. We find that the tenure of the relationship with a manager, the number of clients on a manager’s roster, the level of attention received from a manager, and the presence of an additional manager relationship at the same firm all influence where a client places its business when a manager departs. Our results suggest that embeddedness explanations strongly predict interpersonal market tie dissolution when managers are stationary but lose their predictive power when managers move to new firms. We propose that an alternative logic of interorganizational market ties, based on power and resource dependence, may be at play in such situations.
Bermiss, Y. Sekou; Hallen, Benjamin L.; McDonald, Rory; Pahnke, Emily C. Strategic Management Journal. Mar2017, Vol. 38 Issue 3, p545-565.
This article investigates the social context of entrepreneurship in organizational sectors. Prior research suggests that firm foundings are driven by collective patterns of activity-such as patterns of prior foundings in a given sector. Building on research on social salience and signals, we consider the influence of singular sector-level triggers, which we call entrepreneurial beacons. We argue that the actions or outcomes of single, salient organizations attract and motivate entrepreneurs, thus increasing the rate of foundings. We test this logic by examining the impact of the Yale University endowment's investment choices and of venture-capital-backed IPO run-ups on venture-capital foundings between 1984 and 2011. We find support for the existence and influence of beacons and outline boundary conditions for their effects. Managerial summary: What leads entrepreneurs to found new companies in nascent sectors? In contrast to prior research, which emphasizes patterns of activity, we argue that entrepreneurial activity can sometimes be driven by the actions of a singular trigger-what we call an entrepreneurial beacon. We examine the influence of two such beacons, Yale University's endowment investments and exceptional venture-capital-backed IPO run-ups, on the founding of new venture-capital firms over a 28-year period. We find that Yale's increased allocations to the venture-capital asset-class has a significant influence on the founding of new venture-capital firms, while exceptional venture-capital-backed IPO run-ups only influence venture-capital foundings under certain conditions. Overall, we offer an explanation for heretofore anecdotal accounts of certain organizations or events that appear to have an outsized influence on entrepreneurial activity.
The Process of Postmerger Integration: A Review and Agenda for Future Research
GRAEBNER, MELISSA E.; HEIMERIKS, KOEN H.; QUY NGUYEN HUY; VAARA, EERO. Academy of Management Annals. Jan2017, Vol. 11 Issue 1, p1-32.
Mergers and acquisitions (M&As) continue to be prevalent despite frequently yielding disappointing outcomes. Postmerger integration plays a critical role in M&A success, yet many questions about M&A implementation remain unanswered. In this article, we review research on postmerger integration, which we organize around strategic integration, sociocultural integration, and experience and learning. We then lay out a research agenda that centers on expanding our understanding of processual dynamics in postmerger integration. We focus on opportunities related to temporality, decision-making, practices and tools, and emotionality.
Accountability Systems and Group Norms: Balancing the Risks of Mindless Conformity and Reckless Deviation
PATIL, SHEFALI V.; TETLOCK, PHILIP E.; MELLERS, BARBARA A. Journal of Behavioral Decision Making. Apr2017, Vol. 30 Issue 2, p282-303.
In dynamic task environments, decision makers are vulnerable to two types of errors: sticking too closely to the rules (excessive conformity) or straying too far from them (excessive deviation). We explore the effects of process and outcome accountability on the susceptibility to these errors. Using a multiple-cue probability-learning task, we show that process accountability encourages conformity errors and outcome accountability promotes deviation errors. Two additional studies explore the moderating effects of self-focused and other-focused group norms. Self-focused norms reduce the effect of process accountability on excessive conformity. Other-focused norms reduce the effect of outcome accountability on excessive deviation. Our results qualify prevailing claims about the benefits of process over outcome accountability and show that those benefits hinge on prevailing group norms, on the effectiveness of prescribed decision rules, and on the amount of irreducible uncertainty in the prediction task.
Values That Shape Marketing Decisions: Influence of Chief Executive Officers' Political Ideologies on Innovation Propensity, Shareholder Value, and Risk
KASHMIRI, SAIM; MAHAJAN, VIJAY. Journal of Marketing Research (JMR). Apr2017, Vol. 54 Issue 2, p260-278.
This research examines the influence of chief executive officers’ (CEOs’) political ideologies—specifically, their degree of political liberalism (i.e., support for the Democratic Party relative to the Republican Party)—on firms’ innovation propensity (i.e., rate of new product introductions [NPIs]). The authors propose that CEOs’ degree of political liberalism positively affects their firms’ rate of NPIs. This impact is weakened, however, when CEOs have low power, when a high proportion of their compensation comes from equity, when the marketing department has high influence in the top management team, and when the economy is growing. Liberal CEOs’ greater rate of NPIs is associated with superior Tobin’s q but also higher stock return volatility. Findings based on observations of 421 publicly listed U.S. firms from 2006 to 2010 provide considerable support for the authors’ hypotheses. The authors also examine changes in firms’ rate of NPIs and performance around CEO turnovers and find corroborating evidence for their thesis. These results highlight the role of executives’ personal values in shaping firms’ innovation strategy as well as the risks and rewards associated with aggressive NPIs.
How Unilever Reaches Rural Consumers in Emerging Markets
Mahajan, Vijay. Harvard Business Review Digital Articles. 12/14/2016, p2-6.
The discusses the strategies used by consumer goods maker Unilever in addressing rural market opportunities, particularly in Asia, which include training local women as rural sales agents, finding grassroots distribution strategies, and offering the services needed by rural consumers.