Research

Published and Accepted Peer-Reviewed Research

(reverse chronological order)


1.  Getting Back to the Source: A New Approach to Measuring Ex Ante Litigation Risk using Plaintiff-Lawyer Views of SEC Filings with Antonis Kartapanis. 

Journal of Financial and Quantitative Analysis, forthcoming.  Online Appendix available here. Plaintiff-lawyer views dataset is available here.

Abstract: This study introduces a new measure of ex ante litigation risk using scrutiny of SEC filings by the source of securities litigation—plaintiffs' lawyers—to reduce measurement error, relative to existing measures. We show that plaintiff-lawyer views proxy for the largely unobservable factors that make firms more likely to face litigation risk. Lagged views precede the public bad news revelation that triggers litigation and predict future realized litigation risk (i.e., securities class actions filings and plaintiff-lawyer investigations) and stock market outcomes. Finally, we provide new insights into the plaintiff-lawyer case selection process that otherwise cannot be observed.

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2.  Spillover Effects in Disclosure-Related Securities Litigation with Dain C. Donelson and Rachel Flam.

The Accounting Review, Vol. 97 (5), pp. 275–299, September 2022. 

Abstract: Securities litigation is relatively rare but can significantly affect sued firms. We extend this research by examining the spillover effect of securities litigation on industry peers using a sample of disclosure-related litigation—distinct from events such as restatements and SEC enforcement. We find investors respond immediately as peers exhibit negative abnormal returns before and after case filings. Additionally, peers provide more voluntary earnings and sales forecasts. Notably, investors and peers respond primarily to cases that eventually settle, where litigation costs are concentrated. Further, disclosure results are concentrated in growth firms, where voluntary disclosure is most important, and in low litigation industries, where litigation is more noteworthy. Peers also adjust attributes of mandatory disclosures: disclosures become shorter, more readable, and contain fewer litigation-related terms. These changes appear successful as peers have lower future litigation incidence. Collectively, our findings indicate securities litigation has significant effects beyond the firms that directly face litigation.

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3.  The Effects of Independent Director Litigation Risk with Dain C. Donelson and Elizabeth Tori.

Contemporary Accounting Research, Vol. 39 (2), pp. 982–1022, Summer 2022. Online Appendix available here.

Abstract: Does personal litigation risk for independent directors materially affect firm valuation, compensation-related issues for independent directors, and board composition decisions? We use the unexpected In re Investors Bancorp decision in 2017 by the Delaware Supreme Court, which lowered the liability threshold only for directors in derivative litigation over their own equity grants and increased their future litigation risk, to examine these issues. Understanding changes in independent director litigation risk is important because such changes may affect directors’ willingness or ability to serve on boards and advise executives. Consistent with our predictions, investors and firms reacted to the decision. First, Delaware firms experienced significant negative short-window returns, concentrated in high litigation risk firms where equity compensation is most important. Second, Delaware firms responded by increasing the use of director compensation caps, highlighting that they did not pay excessive amounts. Third, Delaware firms with higher abnormal director compensation decreased director compensation, while those with lower abnormal director compensation did not. Finally, Delaware firms added higher-quality directors to the compensation committee, consistent with concerns about heightened litigation risk for those positions. Notably, these new, higher-quality directors did not accept lower pay, unlike holdover directors who previously served on the committee. Overall, results are consistent with director litigation concerns having a significant effect on shareholder value and firm and director behavior.

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4.  Is Tax Aggressiveness Associated with Tax Litigation Risk? Evidence from D&O Insurance with Dain C. Donelson and Jennifer L. Glenn. 

Review of Accounting Studies, Vol. 27, pp. 519–569, June 2022. 

Abstract: This study uses directors’ and officers’ (D&O) insurance data to examine the relation between tax aggressiveness and tax litigation risk. D&O insurance covers litigation costs for tax-related cases. Thus, D&O insurance premiums provide an independent and direct assessment of the risk in a firm’s tax aggressiveness strategies, which mitigates some of the challenges in studying tax risk. Based on pricing decisions, D&O insurers appear to view tax aggressiveness, as measured by industry- and size-adjusted cash effective tax rates (a measure where higher rates are associated with more tax aggressiveness), as increasing tax-related litigation risk. Regarding tax uncertainty, premiums increase (decrease) as unrecognized tax benefits (UTB-related settlements with tax authorities) increase. Finally, D&O insurers focus on firms with outbound tax haven activity when pricing tax aggressiveness. Overall, this suggests D&O insurers include aspects of both low taxes and tax uncertainty when pricing tax litigation risk. 

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5.  Are All Activists Created Equal? The Effect of Interventions by Hedge Funds and Other Private Activists on Long-term Shareholder Value with Edward P. Swanson and Glen M. Young.

Journal of Corporate Finance, Vol. 72, February 2022. Online Appendix available here. Activist classification dataset here; Read Me instructions and data description here.

Abstract: The allegation that activist investors demand changes that increase short-term stock prices at the expense of long-term shareholder value (“short-termism”) has led to extensive research on interventions by hedge funds. Few studies include other private (non-hedge fund) activists, even though we find they constitute almost half of interventions. Using a 20-year sample that includes over 2,000 interventions by each type of activist, we find that short- and long-window abnormal returns are positive and economically significant around ownership announcements for each activist, and they do not reverse. Importantly, positive returns are observed for both sale and most other (non-sale) demands. Demands to sell all, or part, of the targeted firms earn especially sizable returns, and interestingly, sale demands are made more frequently by other private activists than by hedge funds. Despite the sizable returns, informed users do not regard the equity as overvalued. Analysts’ recommendations become more favorable—a reversal of the pre-announcement trend—and long-term, “dedicated” institutional investors increase their ownership. We also find post-intervention improvements in operating performance (ROA) and firm valuation (Tobin’s Q), further justifying the positive response by market participants. Our study provides new evidence that activism increases long-term shareholder value and opens an avenue for a line of research on other private activists. 

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6.  U.S. Evidence from D&O Insurance on Agency Costs: Implications for Country-Specific Studies with Dain C. Donelson and Brian Monsen. 

Journal of Financial Reporting, Vol. 6 (2), pp. 63–87, Fall 2021.

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

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7.  Measuring Accounting Fraud and Irregularities Using Public and Private Enforcement with Dain C. Donelson, Antonis Kartapanis, and John M. McInnis. 

The Accounting Review, Vol. 96 (6), pp. 183–213, November 2021. Online Appendix available here. Python code to download the Stanford securities class action data available here. 

Abstract: Most accounting studies use only public enforcement actions (SEC cases) to measure accounting fraud. However, private cases (securities class actions) also play an important enforcement role. We discuss the legal standards and processes for both public and private enforcement regimes, emphasize the importance of screening cases for credible fraud allegations, and show both yield credible fraud measures. Further, we demonstrate these research design choices affect inferences from prior research and a hypothetical research setting. Finally, we show common measures of accounting irregularities using Audit Analytics to proxy for fraud result in significant false positives and negatives and develop a fraud prediction model for use in future research. We recommend using both public and private enforcement with appropriate screening when examining accounting fraud to reduce Type I and II errors, or reporting the sensitivity of findings across regimes. This is particularly important given the reduction in accounting-related enforcement after 2005. 

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8.  Does Media Coverage Cause Meritorious Shareholder Litigation? Evidence from the Stock Option Backdating Scandal with Dain C. Donelson and Antonis Kartapanis.

Journal of Law and Economics, Vol. 64 (3), pp. 567–601, August 2021. Online Appendix available here.

Abstract: This study examines the role of media coverage on meritorious shareholder litigation. Asserting a causal effect of the media on litigation is normally difficult due to the endogenous nature of media coverage. However, we use the Wall Street Journal’s backdating coverage to overcome these issues. Using a matched sample of firms with similar probabilities of backdating and related government investigations, we find consistent evidence of a causal relation between media coverage and meritorious litigation. We also find a negative abnormal market reaction to the articles and conduct a variety of analyses to show that it was the content of the articles, rather than the coverage itself, that resulted in litigation. Our results demonstrate that the media serves an important role in corporate accountability that both disincentivizes misconduct and holds firms accountable.

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9.  Internal Control Quality and Bank Risk-Taking and Performance with Matthew Baugh and Matthew Ege. 

AUDITING: A Journal of Practice & Theory, Vol. 40 (2), pp. 49–84, May 2021. 

Abstract: Using a sample of bank-years from 2005 to 2017, we examine the effect of internal control quality on future risk-taking and performance. We find that banks that disclose a material weakness in internal controls have higher risk-taking and worse performance in the future, including having a higher (lower) likelihood of experiencing large losses (gains). These findings suggest that weak controls increase (reduce) downside (upside) risk-taking or conversely that strong controls increase (reduce) upside (downside) risk-taking. Path analyses suggest that 22.3 to 43.7 percent of the effect of internal control quality on future performance is through risk-taking. Additionally, material weaknesses are negatively associated with total asset, loan, interest income, and non-interest income growth, suggesting that internal control quality affects both core and non-core activities of banks. Overall, results suggest that strong internal controls improve bank risk-taking, in part through asymmetrically reducing downside risk-taking while facilitating upside risk-taking, ultimately improving bank performance.

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10.  Insurers and Lenders as Monitors During Securities Litigation: Evidence from D&O Insurance Premiums, Interest Rates and Litigation Costs with Dain C. Donelson.

Journal of Risk and Insurance, Vol. 86 (3), pp. 663–696, September 2019. Online Appendix available here.

Abstract: This study examines whether directors’ and officers’ insurers and lenders effectively monitor securities litigation and respond through pricing before case outcomes are known. By “monitoring,” we refer to tracking case progress and obtaining information from the insured (defendant) firm and its counsel prior to case resolution. We find that insurers and lenders increase rates, and that this effect is almost completely isolated to firms with cases that eventually settle. We confirm that this response is reasonable as settled cases are associated with lower future earnings, while there is generally no relation between future earnings and dismissed cases. As direct costs appear low, our results suggest that most costs are indirect in the form of reputational damage. Overall, our results suggest that researchers and policymakers interested in litigation should focus on settled cases, which are the only cases with material long-term costs.

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11.  Tainted Portfolios: How Impairment Accounting Rules Restrict Security Sales with Brett W. Cantrell. 

Journal of Business Finance and Accounting, Vol. 46 (5-6), pp. 608–635, May/June 2019. 

Abstract: Contrary to claims that fair value accounting exacerbated banks’ securities sales during the recent financial crisis, we present evidence that suggests – if anything – that the current impairment accounting rules served as a deterrent to selling. Specifically, because banks must provide evidence of their “intent and ability” to hold securities with unrealized losses, there are strong incentives to reduce, rather than increase, security sales when market values decline to avoid “tainting” their remaining securities portfolio. Validating this concern, we find that banks incur greater other-than-temporary impairment (OTTI) charges when they sell more securities. We then find that banks sell fewer securities when their security portfolios have larger unrealized losses (and thus larger potential impairment charges), and these results are concentrated in banks with homogenous securities portfolios, expert auditors, more experienced managers, and greater regulatory capital slack. Overall, our results suggest that – contrary to critics’ claims – the accounting rules appear to have reduced banks’ propensity to sell their securities during the financial crisis.

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12.  Déjà vu: The Effect of Executives and Directors with Prior Banking Crisis Experience on Bank Outcomes around the Global Financial Crisis with Anwer S. Ahmed, Brant E. Christensen, and Adam J. Olson. 

Contemporary Accounting Research, Vol. 36 (2), pp. 958–998, Summer 2019. 

Abstract: We investigate the effect of executives and directors with prior banking crisis experience on bank outcomes around the global financial crisis (GFC). Executives and directors with previous experience leading banks through a bank crisis may have been uniquely able to understand the risks, recognize the warnings signs early, and thus more effectively respond to the GFC. Controlling for other executive, director, and bank-level characteristics, we examine whether bank performance, risk taking, and accounting quality in the period immediately before and during the GFC are affected by having executives or directors who previously served as bank executives or directors during the 1980s/1990s banking crisis (80s/90s crisis). Overall, we find that banks led by these crisis-experienced executives and directors exhibit stronger performance, lower risk taking, and higher accounting quality in the period around the GFC. These effects are strongest among bank leaders for whom the 80s/90s crisis was most salient. Results are robust to propensity matched samples and other analyses performed to rule out alternative explanations. Our results suggest these individuals were able to learn from prior crisis experience. 

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13.  Does Fair Value Accounting Provide More Useful Financial Statements Than Current GAAP for Banks? with John M. McInnis and Yong Yu. 

The Accounting Review, Vol. 93 (6), pp. 257–279, November 2018. 

Abstract: Standard setters contend fair value accounting yields the most relevant measurement for financial instruments. We examine this claim by comparing the value relevance of banks’ financial statements under fair value accounting with that under current GAAP, which is largely based on historical costs. We find the combined value relevance of book value of equity and income under fair value is less than that under GAAP. We also find fair value income is less value relevant than GAAP income because of the inclusion of transitory unrealized gains and losses in fair value income. More surprisingly, we find book value of equity under fair value is not more value relevant than under GAAP, due both to divergence between exit value and value-in-use and to measurement error in fair value estimates. Overall, our results suggest that financial statements under fair value accounting provide less relevant information for bank valuation than financial statements under current GAAP.

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14.  The Cost of Disclosure Regulation: Evidence from D&O Insurance and Nonmeritorious Securities Litigation with Dain C. Donelson and Justin J. Hopkins. 

Review of Accounting Studies, Vol. 23 (2), pp. 528–588, June 2018. 

Abstract: This study examines whether the required disclosure of directors’ and officers’ (D&O) insurance premiums leads to nonmeritorious securities litigation. Our research setting uses a proprietary D&O insurance database that includes New York and non-New York firms, combined with the fact that New York firms must disclose D&O insurance premiums. We thus can exploit a natural experiment based on inter-state variation in disclosure regulation. Disclosed premiums may influence case selection in two ways. First, higher premiums signal higher limits, which plaintiffs’ lawyers likely believe enable higher settlements. Second, higher premiums indicate higher risk assessments from insurers and thus a higher likelihood that stock price drops signal misconduct rather than bad luck. We find that D&O insurance premiums for New York firms are associated with a higher dismissal rate. Offsetting this higher dismissal rate, plaintiffs’ lawyers can achieve higher settlements in the relatively few successful cases. 

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15.  The Relation between Religiosity and Private Banks with Brett W. Cantrell. 

Journal of Banking & Finance, Vol. 91 (1), pp. 86–105, June 2018. 

Abstract: We examine the effect of headquarters’ local religiosity on private bank outcomes. Religiosity is associated with lower risk-taking for public banks, but the unique features of private banks may result in a different effect for private banks. We find religiosity is associated with greater asset risk-taking. At the same time, however, religiosity, is negatively associated with solvency risk and return on asset (ROA) volatility and is associated with higher ROAs and fewer failures. We reconcile these results by finding banks in areas with higher religiosity recognize larger fees from providing additional banking services, likely due to relationships formed from more risky lending. As a result, these banks are more (less) likely to realize extreme positive (negative) performance. We also find religiosity is associated with lower earnings management and increased conservatism. Collectively, our results confirm private banks are unique and religiosity can have a significant, and nuanced, effect on bank outcomes. 

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16.  The Role of D&O Insurance in Securities Fraud Class Action Settlements with Dain C. Donelson and Justin J. Hopkins. 

Journal of Law and Economics, Vol. 58 (4), pp. 747–778 (lead article), November 2015. 

Abstract: Due to previous data unavailability, it is unclear how important directors’ and officers’ (D&O) insurance is in securities fraud class action settlements. Using a unique dataset of U.S. D&O policies, we find that D&O coverage is a less significant determinant of settlement amounts than estimated damages and proxies for case merits. D&O limits are related to settlements in only the weakest cases (those without accounting allegations or institutional lead plaintiffs) where proxies for case merits play a minimal role. Our findings suggest that most securities fraud class action settlements are meritorious and accounting-related cases are a reasonable proxy for fraud.

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17.  Litigation Risk and Agency Costs: Evidence from Nevada Corporate Law with Dain C. Donelson. 

Journal of Law and Economics, Vol. 57 (3), pp. 747–780, August 2014. 

Abstract: In 2001, Nevada significantly limited the personal legal liability of corporate officers and directors. We use this exogenous shock to implement a difference-in- differences design that examines the impact of officer and director litigation risk on agency costs. We find decreased firm value, especially for firms with lower levels of investor protection and the highest expected agency costs. We also find that managerial incentives are reduced as measured by lower chief executive officers’ pay-for-performance sensitivity. Finally, we find an adverse impact on operating performance and increased error-based restatements for Nevada firms subsequent to the change. Our findings emphasize that officer and director litigation risk is an important governance mechanism.

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18.  Predicting Credit Losses: Loan Fair Values versus Historical Costs with Brett W. Cantrell and John M. McInnis. 

The Accounting Review, Vol. 89 (1), pp. 147–176, January 2014. 

Abstract: Standard setters and many investors argue that loan fair values provide more useful information about credit losses than historical cost information while bankers and others generally disagree. We examine the ability of reported loan fair values to predict credit losses relative to the ability of net historical costs currently recognized under U.S. GAAP. Our analysis is important because credit losses in the banking sector can have severe and widespread economic effects, as the recent financial crisis demonstrates. Overall, we find that net historical loan costs are a better predictor of credit losses than reported loan fair values. Specifically, we find that historical cost information is more useful in predicting future net chargeoffs, non-performing loans, and bank failures over both short and long time horizons. Further tests indicate that the relative predictive ability of reported loan fair values improves in higher scrutiny environments, suggesting that a lack of scrutiny over reported loan fair values may contribute to our findings.

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Select Working Papers

 

The Effect of Shareholder Scrutiny on Corporate Tax Behavior: Evidence from Shareholder Tax Litigation with Dain C. Donelson, Jennifer L. Glenn, and Sean T. McGuire.

Abstract: This study examines the effect of shareholder scrutiny of tax issues on corporate tax behavior. Specifically, we use a difference-in-differences design to examine the effect of shareholder tax litigation on the future tax behavior of both the sued firm and its peers. We find that sued firms decrease tax avoidance activities relative to matched control firms after the litigation. Additionally, we find a spillover effect from shareholder scrutiny over tax issues. That is, treatment firms from the same industry as sued firms reduce both their level of tax avoidance and the likelihood of extreme tax avoidance relative to control firms after the sued firm’s shareholder tax litigation. Spillover results are strongest when sued firms have product market power, the litigation filing receives abnormal media coverage, and the litigation allegations explicitly focus on tax issues, such as aggressive tax planning strategies.

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Earnings Momentum and Bank Loan Quality with Shuping Chen and John M. McInnis.

Abstract: In the aftermath of the financial crisis, bankers, regulators, lawmakers, and others claimed that bank CEOs’ incentives to sustain high past earnings growth (earnings momentum) led banks to originate lower quality loans, which subsequently defaulted at high rates in the financial crisis. We examine this claim. Using a sample of 267 U.S. bank holding companies from 2001 to 2009, we find banks with high earnings momentum have more future non-performing loans (NPLs). In contrast, neither CEO compensation incentives nor benchmark beating metrics are associated with future NPLs. Consistent with career concerns, the effect of earnings momentum on future NPLs is concentrated in banks with younger CEOs. We also find earnings momentum is positively associated with bank failures. Further analyses show results are independent of competition pressures and earnings guidance. Our study contributes to the literature on factors associated with the dramatic collapse of the banking system during the financial crisis.