Internal Control Weaknesses and Financial Reporting Fraud.
Donelson, Dain C.; Ege, Matthew S.; McInnis, John M. Auditing: A Journal of Practice & Theory. Aug2017, Vol. 36 Issue 3, p45-69.
This study examines whether and how weak internal controls increase the risk of financial reporting fraud by top managers. There is a longstanding debate on whether control strength significantly affects fraud risk, yet little evidence on this issue. Further, there is no evidence on the mechanism linking control strength to fraud risk. We find a strong association between material weaknesses and future fraud revelation. We theorize that this link could be attributable to weak controls (1) giving managers greater opportunity to commit fraud, or (2) signaling a management characteristic that does not emphasize reporting quality and integrity. We find support for the opportunity explanation, but not through specific accounts linked to control weaknesses. Instead, consistent with the PCAOB's assertion, weaknesses in entity-wide controls, not process-level controls, are associated with a higher risk of reporting fraud.
Trump's Infrastructure Plan Isn't Much of a Plan.
. 7/12/2017, p1-1.
Prompting the Benefit of the Doubt: The Joint Effect of Auditor-Client Social Bonds and Measurement Uncertainty on Audit Adjustments.
KACHELMEIER, STEVEN J.; VAN LANDUYT, BEN W. Journal of Accounting Research. Sep2017, Vol. 55 Issue 4, p963-994.
We design an incentivized experiment to test whether measurement uncertainty elevates the risk that social bonds between auditors and reporters compromise audit adjustments. Results indicate that, when audit evidence is characterized by some residual uncertainty, the adjustments our auditor-participants require are sensitive to whether auditors have an opportunity to form a modest but friendly social bond with reporters. In contrast, although auditors do not adjust fully even when misstatements are known with certainty, social bonding has no effect in this scenario. Accordingly, our experiment contributes beyond the main effects of social bonding and measurement uncertainty demonstrated in prior research by showing that these forces interact. A practical implication is that regulators and practitioners should consider both the technical and the social challenges facing audits of complex estimates.
Supporting and Assessing Agents.
LAUX, VOLKER. Journal of Accounting Research. Sep2017, Vol. 55 Issue 4, p995-1016.
This manuscript proposes a theory of why and when organizations 'support' their employees with resources, time, and freedom beyond what seems economically optimal. The idea is that support plays an information-generating role in that it renders output more informative about employees' abilities. This effect reduces the need to gather additional information about ability via costly monitoring and commits the firm to make replacement/promotion decisions that are more sensitive to performance. Consequently, support indirectly strengthens employees' career concern incentives and reduces the pressure on costly bonus payments. I apply the model to tech companies, academia, and capital budgeting.
Blockholder exit threats in the presence of private benefits of control.
Hope, Ole-Kristian; Wu, Han; Zhao, Wuyang. Review of Accounting Studies. Jun2017, Vol. 22 Issue 2, p873-902.
Exit theory predicts a governance role for outside blockholders' exit threats, but this role could be ineffective if managers' potential private benefits exceed their loss in stock-price declines caused by the blockholders' exits. We test this prediction using the Split-Share Structure Reform (SSSR) in China, which provided a large exogenous and permanent shock to the cost for outside blockholders to exit. We find that firms whose outside blockholders experience an increase in exit threats improve performance more than those whose outside blockholders experience no increase. The governance effect of exit threats also is ineffective in the group of firms with the highest concern for private benefits of control. Finally, a battery of theory-motivated tests shows that the documented effects are unlikely explained by outside blockholder intervention or some well-known intended effects of SSSR.
(When) Do Antipoverty Programs Reduce Violence? India's Rural Employment Guarantee and Maoist Conflict.
Dasgupta, Aditya; Gawande, Kishore; Kapur, Devesh. International Organization. Summer2017, Vol. 71 Issue 3, p605-632.
Theory and extensive evidence connect poverty and underdevelopment to civil conflict, yet evidence on the impact of development programs on violence is surprisingly mixed. To break this impasse, we exploit a within-country policy experiment to examine the conditions under which anti-poverty programs reduce violence. The roll-out of India's National Rural Employment Guarantee Scheme caused a large long-run reduction in Maoist conflict violence, as measured with an original data set based on local language press sources. These pacifying effects were not uniform, however, but overwhelmingly concentrated in districts with sufficient pre-existing local state capacity to implement the program effectively. The results demonstrate the potential for anti-poverty programs to mitigate violent civil conflict by improving livelihoods, but also highlight the crucial role of state capacity in shaping these effects.
Campaign Contributions from Corporate Executives in Lieu of Political Action Committees.
Richter, Brian Kelleher; Werner, Timothy. Journal of Law, Economics & Organization. Aug2017, Vol. 33 Issue 3, p443-474.
Limiting corporate participation in electoral politics is a central focus of campaign finance reform. In this spirit, individual candidates for office have prohibited corporate-linked political action committees (PACs) from contributing to their campaigns. On the surface, such no-PAC policies might seem like an effective way to keep corporate-linked monies out of electoral politics; however, they ignore the reality that corporate monies have a variety of ways to find their way into candidates' campaign accounts. We leverage these candidate-specific refusals to accept PAC monies to uncover concomitant spikes in the pattern of corporate executives' personal campaign contributions that are most pronounced for executives at firms with active PACs which contributed to the candidates in question. These results come from a newly constructed dataset that includes all CEO-firm-candidate contribution pairs for active S&P500 firms over an 18-year period and suggests that CEOs strategically act in lieu of their firms' linked PACs.
Corporate Finance Policies and Social Networks.
Fracassi, Cesare. Management Science. Aug2017, Vol. 63 Issue 8, p2420-2438.
This paper shows that managers are influenced by their social peers when making corporate policy decisions. Using biographical information about executives and directors of U.S. public companies, we define social ties from current and past employment, education, and other activities. We find that more connections two companies share with each other, more similar their capital investments are. To address endogeneity concerns, we find that companies invest less similarly when an individual connecting them dies. The results extend to other corporate finance policies. Furthermore, central companies in the social network invest in a less idiosyncratic way and exhibit better economic performance. This paper was accepted by Amit Seru, finance.
Information Spillovers in Asset Markets with Correlated Values.
Asriyan, Vladimir; Fuchs, William; Green, Brett. American Economic Review. Jul2017, Vol. 107 Issue 7, p2007-2040.
We study information spillovers in a dynamic setting with correlated assets owned by privately informed sellers. In the model, a trade of one asset can provide information about the value of other assets. Importantly, the information content of trading behavior is endogenously determined. We show that this endogeneity leads to multiple equilibria when assets are sufficiently correlated. The equilibria are ranked in terms of both trade volume and efficiency. The model has implications for policies targeting post-trade transparency. We show that introducing post-trade transparency can increase or decrease welfare and trading volume depending on the asset correlation, equilibrium being played, and the composition of market participants.
Debt correlations in the wake of the financial crisis: What are appropriate default correlations for structured products?
Nickerson, Jordan; Griffin, John M. Journal of Financial Economics. Sep2017, Vol. 125 Issue 3, p454-474.
This paper proposes several frameworks to estimate the appropriate default correlations for structured products, each of which jointly considers the role of co-movements in modeled risk characteristics and unmodeled systematic risk, or ‘frailty.’ We contrast our estimates with credit rating agencies’ default correlation assumptions, which were only 0.01 for Collateralized Loan Obligations (CLOs) pre-crisis and have increased to 0.03 post-crisis. In contrast, the joint consideration of observable risk factors and frailty leads to substantially higher estimates of 0.12. We show that this translates into CLOs with credit risk understated by 26%, suggesting caution for the post-crisis structured finance market.
Selling Failed Banks.
GRANJA, JOÃO; MATVOS, GREGOR; SERU, AMIT. Journal of Finance. Aug2017, Vol. 72 Issue 4, p1723-1784.
The average FDIC loss from selling a failed bank is 28% of assets. We document that failed banks are predominantly sold to bidders within the same county, with similar assets business lines, when these bidders are well capitalized. Otherwise, they are acquired by less similar banks located further away. We interpret these facts within a model of auctions with budget constraints, in which poor capitalization of some potential acquirers drives a wedge between their willingness and ability to pay for failed banks. We document that this wedge drives misallocation, and partially explains the FDIC losses from failed bank sales.
Network Analysis of Search Dynamics: The Case of Stock Habitats.
Leung, Alvin Chung Man; Agarwal, Ashish; Konana, Prabhudev; Kumar, Alok. Management Science. Aug2017, Vol. 63 Issue 8, p2667-2687.
There is an increasing attention in information systems to be able to predict outcomes using search frequency on popular portals. This growing literature focuses on revealing demand patterns of individual assets (e.g., products, stocks, services). However, users typically search many different assets together (e.g., correlated searches) and leave a digital footprint, which can help provide insights on the behaviors of a group of assets. Furthermore, such group behavior can be used to predict outcomes (e.g., demand, stock returns) in the future. We analyze the underlying behavior of distinct subnetworks formed by correlated user searches for multiple items in the stock market and use such information for return prediction. Using cosearch data for stocks from Yahoo! Finance, we find 50-79 search clusters representing 230-349 stocks among Russell 3000 stocks at different time periods. These clusters reveal interesting habitats where the returns of stocks within a cluster tend to comove after controlling for known determinants of comovement. When a stock enters (departs) a cluster, the focal stock return comoves (detaches) with the cluster returns. Thus, search cluster-based habitats reveal aggregate investment preferences and are more granular than fundamental-based habitats. We find that search-based habitats can also improve return predictability of related stocks. This paper was accepted by Chris Forman, information systems.
Joint Label Inference in Networks.
Chakrabarti, Deepayan; Funiak, Stanislav; Chang, Jonathan; Macskassy, Sofus A. Journal of Machine Learning Research. 2017, Vol. 18 Issue 54-63, p1-39.
We consider the problem of inferring node labels in a partially labeled graph where each node in the graph has multiple label types and each label type has a large number of possible labels. Our primary example, and the focus of this paper, is the joint inference of label types such as hometown, current city, and employers for people connected by a social network; by predicting these user profile fields, the network can provide a better experience to its users. Existing approaches such as Label Propagation (Zhu et al., 2003) fail to consider interactions between the label types. Our proposed method, called EDGEEXPLAIN, explicitly models these interactions, while still allowing scalable inference under a distributed message-passing architecture. On a large subset of the Facebook social network, collected in a previous study (Chakrabarti et al., 2014), EDGEEXPLAIN outperforms label propagation for several label types, with lifts of up to 120% for recall@1 and 60% for recall@3
The time-varying nature of social media sentiments in modeling stock returns.
Ho, Chi-San; Damien, Paul; Gu, Bin; Konana, Prabhudev. Decision Support Systems. Sep2017, Vol. 101, p69-81.
The broad aim of this paper is to answer the following query: is the relationship between social media sentiments and stock returns time-varying? To provide a satisfactory response, a novel methodology—a symbiosis of Bayesian Dynamic Linear Models and Seemingly Unrelated Regressions —is introduced. Two sets of Dow Jones Industrial Average stock data and corresponding social media data from Yahoo! Finance stock message boards are used in a comprehensive empirical study. Some key findings are: (a) Affirmative response to the above question; (b) Models with only social media sentiments and market returns perform at least as well as models that include Fama-French and Momentum factors; (c) There are significant correlations between stocks, ranging from −0.8 to 0.6 in both data sets.
Channel Integration, Sales Dispersion, and Inventory Management.
Gallino, Santiago; Moreno, Antonio; Stamatopoulos, Ioannis. Management Science. Sep2017, Vol. 63 Issue 9, p2813-2831.
We study the effects of the introduction of cross-channel functionalities on the overall sales dispersion of retailers and the implications of these effects for inventory management. To do that, we analyze data from a leading U.S. retailer who introduced a 'ship-to-store' (STS) functionality that allows customers to ship products to their local store free of charge when those products are not available in their local store. Based on the fact that stores prioritize carrying products for which local demand is high, we test the hypothesis that introducing the STS functionality increased the retailer's overall sales dispersion. We find that, on average, the contribution of the 90% lowest-selling products to total sales increased by 0.75 percentage points, increasing sales dispersion. Calibrating conventional inventory-ordering models, we show that to respond optimally to the observed increase in dispersion, the retailer would need to increase its cycle and safety inventories by approximately 2.7%. Our paper points out the effect of an increasingly important retail phenomenon (channel integration) on a key factor for inventory management (sales dispersion). This paper was accepted by Vishal Gaur, Operations Management.
Unifying the Role of IT In Hyperturbulence and Competitive Advantage Via a Multilevel Perspective of IS Strategy
Ning, Nan; Tanriverdi, Hüseyin. MIS Quarterly. Sep2017, Vol. 41 Issue 3, p937-A8.
While information technology (IT) serves as a new source of sustainable competitive advantage for firms, it also induces hyperturbulent environments (or hyperturbulence) that erode that sustainable competitive advantage. In this paper, we posit that these contradictions might be due to cross-level nonlinear causality between firm-level IT-based strategic actions and collective-level IT-induced hyperturbulence. We develop a multilevel perspective of IS strategy for theorizing this causality, and unifying novel with established research. Complex adaptive systems theory is employed as the overarching framework for its strength in formalizing cross-level nonlinear causal paths. Using literature-based theorization and agent-based modeling, we establish two bottom-up nonlinear causal paths by which IT drives hyperturbulence: IT can act as an external force (i.e., component IT innovation) to locally instigate firm strategic actions that aggregate to temporary hyperturbulence or as an internal force (i.e., architectural IT innovation) to drive pervasive firm strategic interactions that aggregate to persistent hyperturbulence. Each causal path produces varied amounts of reducible and irreducible uncertainties and thereby renders a top-down nonlinear effect that reshapes the opportunity for IT to contribute to competitive advantage. This multilevel theorization paves the way for new, IS-specific theory regarding IT’s unique role in inducing nonlinear dynamics and in affording new business strategies in today’s competitive environments.
Pricing Strategies under Behavioral Observational Learning in Social Networks.
Qiu, Liangfei; Whinston, Andrew B. Production & Operations Management. Jul2017, Vol. 26 Issue 7, p1249-1267.
The increasing pervasiveness of social networks allows users to share purchase behaviors with their online friends. In this study, we examine optimal pricing strategies of a monopolistic firm using an analytical model that accounts for behavioral observational learning in social networks. We show that a seller could potentially control the information available to future customers and induce behavioral observational learning, using an information-revealing pricing strategy. This result suggests that offering introductory discounts is not always an effective method to boost purchases in social networks. It could prevent the behavioral observational learning that would increase future customers' willingness to pay.
Sustaining Superior Performance in Business Ecosystems: Evidence from Application Software Developers in the iOS and Android Smartphone Ecosystems.
Kapoor, Rahul; Agarwal, Shiva. Organization Science. May/Jun2017, Vol. 28 Issue 3, p531-551.
We study the phenomenon of business ecosystems in which platform firms orchestrate the functioning of ecosystems by providing platforms and setting the rules for participation by complementor firms. We develop a theoretical framework to explain how the structural and evolutionary features of the ecosystem may shape the extent to which participating complementor firms can sustain their superior performance. The structural feature, which we refer to as ecosystem complexity, is a function of the number of unique components or subsystems that interact with the complementor's product. We incorporate the evolutionary features by considering the role of generational transitions initiated by platform firms over time as well as the role of complementors' ecosystem-specific experience. Evidence from Apple's iOS and Google's Android smartphone ecosystems supports our arguments that higher ecosystem complexity helps app developers sustain their superior performance, and that this effect is stronger for more experienced firms. In contrast, platform transitions initiated by Apple and Google make it more difficult for app developers to sustain their performance superiority, and that this effect is exacerbated by the extent of ecosystem complexity. The study offers a novel account of how the performance of complementor firms in platform-based business ecosystems may be shaped by their ecosystem-level interdependencies.
Empowering Questions Affect How People Construe Their Behavior: Why How You Ask Matters in Self-Attributions for Physical Exercise and Healthy Eating.
Daly, John A.; Glowacki, Elizabeth M. Journal of Language & Social Psychology. Oct2017, Vol. 36 Issue 5, p568-584.
Subtle manipulations of wording can significantly affect behavior. We examine differences in how people respond to empowering questions (e.g., “What could you do to exercise more?”) compared with disempowering questions (e.g., “Why aren’t you exercising more?”). Responding to two different topics (exercise and eating behavior), participants in empowering question conditions offered more solutions in their responses, placed more responsibility on themselves rather than on external factors, were more optimistic, and referred more to the future. Participants in disempowering conditions gave more excuses, placed more responsibility on situational factors, were more pessimistic, and focused more on obstacles.
Glass Breaking, Strategy Making, and Value Creating: Meta-Analytic Outcomes of Women as CEOs and TMT Members
SEUNG-HWAN JEONG; HARRISON, DAVID A. Academy of Management Journal. Aug2017, Vol. 60 Issue 4, p1219-1252. 34p. 2 Diagrams, 4 Charts. DOI: 10.5465/amj.2014.0716.
We conduct a comprehensive synthesis of the research on how female representation in the upper echelons (i.e., top management teams and chief executive officer positions) might affect firm performance. To help resolve longstanding theoretical, empirical, and substantive debates, we present an integrative conceptual framework based on the overarching concepts of unique resource portfolios, team decision-processes, and role in-congruence perceptions. We test predictions from this framework using meta-analytic techniques on a sample of 146 primary studies conducted in 33 different countries. We find that female representation in the upper echelons in general is positively and weakly related to forms of long-term financial performance, but negatively and weakly related to short-term stock market returns. We observe that reduced strategic risk-taking is a mediating mechanism that explains why financial performance is improved. We also show that financial performance improvements are accentuated in environmental and organizational contexts that provide greater decision latitude to executives. Finally,we discuss and provide preliminary tests for extending these effects to other stakeholders (corporate social performance) and different time intervals for performance.