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This study models a firm's investors as connected via a social network and examines how an appropriate investor relations (IR) strategy can maximize information flow through this network. When IR can initially reach only a few investors, information flows faster when IR targets highly connected investors through, for example, direct contact. When IR can initially reach many investors, information flows faster from un-targeted broadcast-type communications that reach random investors. Turning to empirically measurable outcomes of information flow, we show that the time series of bid-ask spreads have a hump-shaped pattern, first increasing and then decreasing. Faster information flows cause a sharper, but briefer, bid-ask spread spike. Such results provide a rigorous framework for thinking about how IR activities drive stock liquidity, and unite several observed empirical regularities into an investor social network based framework for investor relations activities, a research area where descriptive empirical findings have outpaced theory.

We use required 8-K filings around major borrowings to shed light on firms’ choices of whether to comply with SEC disclosure rules. Exploiting within-firm variation, we find that firms are more likely to hide loans with high spreads and tight financial covenants. We further find that firms appear to exploit the ambiguity of the definition of materiality as they are more likely to selectively disclose (hide) “immaterial” loans when interest rates are low (high). Firms are less likely to hide loans when investors anticipate borrowing during asset acquisition, when firms are followed by more equity analysts or receive more investor attention, and when the firms’ stock prices are more volatile. Lastly, we provide evidence that the SEC does not rigorously enforce compliance with 8-K loan disclosures. 

This study sheds light on the extent to which the use of operating leases depends on reporting incentives, such as understating liabilities, and non-reporting incentives that partly arise from the overlap between accounting, bankruptcy, and tax laws, such as increasing financing capacity and flexibility. We provide evidence that expanding financing capacity, accommodating volatile operations, and maximizing the present value of tax deductions are all important drivers of leasing decisions. Our findings suggest that capital markets and contracting based reporting incentives have little influence on operating lease use. In particular, we find weak evidence that firms increase operating leases in advance of issuing equity and no evidence that firms use operating leases to window-dress in advance of issuing debt, to avoid debt covenant violations, for compensation purposes, or to paint a better picture on an ongoing basis. These findings are consistent with reporting incentives playing a second-order role in leasing decisions. 

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. 

We examine the relation between workplace safety and managers’ attempts to meet earnings expectations. Using establishment-level data on workplace safety from the Occupational Safety and Health Administration, we document significantly higher injury/illness rates in firms that meet or just beat analyst forecasts compared to firms that miss or comfortably beat analyst forecasts. The higher injury/illness rates in firms that meet or just beat analyst forecasts are associated with both increases in employee workloads and in abnormal reductions of discretionary expenses. The relation between benchmark beating and workplace safety is stronger when there is less union presence, when workers’ compensation premiums are less sensitive to injury claims, and among firms with less government business. Our findings highlight a specific consequence of managers’ attempts to meet earnings expectations through real activities management. 

We examine how strategic trade affects expected returns in a large economy. In our model, both a monopolist (strategic) informed trader and uninformed traders consider the impact of their demands on prices. In contrast to settings with price-taking traders, private information never eliminates a priced risk, and can lead to higher risk premiums. Also unlike settings with price-taking informed traders, risk premiums decrease in response to an increase in liquidity-motivated trades in diversified portfolios. These differing effects arise because a privately informed strategic trader conceals her trades by taking small positions relative to the magnitude of noise trades. Although prices partially reveal her information and reduce uncertainty, a concomitant decrease in her risk absorption dominates and leads to higher risk premiums. Similar to settings with price-taking traders, private information affects expected returns only via factor loadings and risk premiums on existing payoff risks – it introduces no new priced risks and factor loadings (betas) explain all cross-sectional differences in expected returns. 

The price reactions to corrective disclosures often serve as a benchmark for settlements in securities class action lawsuits. When the firm bears litigation costs, this benchmark creates a feedback effect that exacerbates the price reaction to news that contradicts managers' earlier reports. Litigation insurance provides value in this setting by reducing the need for investors to price the effects of anticipated litigation. Insurance also affects how changes in the litigation environment impact the firm, with some changes having opposite effects on the frequency of lawsuits against uninsured and insured firms. The pricing behavior of rational investors eliminates the valuation impact of the portion of settlements paid to investors, similar to dividends. The valuation impact of litigation arises from transaction costs, such as attorney fees, that the firm can mitigate by constraining misreporting and by purchasing insurance. 

We examine how the patterns of inter-industry trade flows impact the transfer of information and economic shocks. We provide evidence that the intensity of transfers depends on industries’ positions within the economy. In particular, some industries occupy central positions in the flow of trade, serving as hubs. Consistent with a diversification effect, we find that these industries’ returns depend relatively more on aggregate risks than do returns of noncentral industries. Analogously, we find that the accounting performance of central industries associates more strongly with macroeconomic measures than does the accounting performance of noncentral industries. Comparing central industries to noncentral ones, we find that the stock returns and accounting performance of central industries better predict the performance of industries linked to them. This suggests that shocks to central industries propagate more strongly than shocks to other industries. Our results highlight how industries’ positions within the economy affect the transfer of information and economic shocks. 

Recent studies show that regression-based estimates of accounting conservatism reflect both differences in the asymmetric recognition of bad news and differences in asset composition. In particular, a firm’s market value and returns reflect both assets-in-place and expected future rents, while book values tend to reflect only assets-in-place. We propose two tests that remove the effect of asset composition on cross-sectional comparisons of accounting conservatism. First, a test based on a ratio of regression coefficients allows for valid cross-sectional comparisons of conservatism relative to overall news recognition. Second, in some cases, researchers can separately identify and make cross-sectional comparisons of the fraction of good news recognized and the fraction of bad news recognized. The estimates in this second scenario use a regression of earnings on returns interacted with a book-to-market ratio. We validate our model by deriving and testing several predictions based on it. 

Recent studies and some policy experts have posited that dividends indicate higher quality earnings. In this study, we test this conjecture by comparing the dividend policies of firms accused of accounting fraud to those of firms not accused of accounting fraud. Specifically, we examine whether alleged fraud firms are as likely to be dividend payers as non-fraud firms and whether managers of dividend-paying fraud firms increase dividends at the same rate as managers of non-fraud firms. Our data reveal that dividend paying status is negatively associated with the probability of committing accounting fraud. In addition, we also find that, during the alleged fraud period, the earnings-dividends relation is weaker for the alleged fraud firms relative to firms not accused of fraud. Finally, using propensity score match tests, the data provide evidence that managers of alleged fraud-firms increase dividends less often than managers of firms not accused of fraud, consistent with the alleged fraud firms not being able to match the dividend policies of firms not accused of fraud. Overall, our results suggest that dividends, especially dividend increases, are associated with higher earnings quality. 

We examine the cross-sectional relation between leverage and future returns while considering the dynamic nature of capital structure and potentially delayed market reactions. Prior studies find a negative relation between leverage and future returns that contradicts standard finance theory. We decompose leverage into optimal and excess components and find that excess leverage tends to drive this negative relation. We also find that excess leverage predicts firm fundamentals, and that the negative relation between excess leverage and future returns may be explained by investors’ failure to react promptly to information contained in excess leverage about future financial distress and asset growth. 

We examine how alternative accounting measures of fair value impact the ability of debt covenants to mitigate inefficient investment decisions. In our setting, shareholders make a non-contractible project choice after signing a debt contract. At a later date, the project can be abandoned and new information determines whether shareholders or creditors make that decision. The value of debt covenants depends on their ability to deter costly asset substitution while also mitigating inefficient continuation decisions. A covenant based on a conservative fair value measure tends to perform best in this respect. Departing from purely fair value-based covenants, an even more conservative covenant based on fair values and historical cost outperforms those based solely on fair values. Notably, the “highest and best use” measure advocated by the FASB performs poorly in deterring the choice of inferior projects. Our results provide a setting in which the contracting efficiencies associated with different accounting measures cannot be replicated across measures by altering covenant “triggers”. 

This study models a manager who privately reports earnings to an independent audit committee that, after its own due diligence, modifies the report for public release to investors. The audit committee alters the reporting and valuation dynamics by attempting to remove the manager's reporting bias, but then presents the information it has collected with its own bias. The audit committee's presence changes the impact of penalties and incentives on reporting, valuation, and due-diligence activities. For example, increasing penalties can sometimes degrade the reporting process. Our simultaneous consideration of the manager, audit committee, and investors provides a new framework for reporting and valuation, and sheds light on empirical earnings quality research that has largely studied the management and audit effects separately. 

This paper shows that persistent mispricing is consistent with a market that includes ambiguity-averse investors. In particular, ambiguity-averse investors may prefer to trade based on aggregate signals that reduce ambiguity at the cost of a loss in information. Equilibrium prices may therefore fail to impound publicly available information. While this creates profit opportunities for ambiguity-neutral investors, ambiguity-averse investors perceive that the benefit of ambiguity reduction outweighs the cost of trading against investors who have superior information. The model can explain both underreaction, such as that evident in postearnings announcement drifts and momentum, and overreaction to accounting accruals. 

Kim, McGuire, Savoy, and Wilson (2019; hereafter KMSW) provide evidence that firms have a target tax rate that they adjust to over time. The observed pattern in tax rates resembles what wesee in partial adjustment models for dividends and capital structure (e.g., Fama and French 2002).The authorsfind faster movement to the estimated target tax rate forfirms whose tax rate exceedsthe estimated target; maturefirms; and multinationals. By providing evidence thatfirms appear tohave a target tax rate, the study represents an important early step in considering how taxes affectfirm behavior. The study leaves several questions that I think future research should answer.

This discussion first draws some parallels to the use of partial adjustment models in the corporate finance literature. A common example is capital structure, where trade-off theory posits that firms weigh the benefits of high leverage (e.g., tax savings or lower agency costs of free cashflow) against the costs of high leverage (e.g., financial distress risk or debt overhang). Partial adjustment models simultaneously estimate the target leverage and how quickly firms adjust to the target. These models tend to perform poorly in matching data, which has led to the development of truly dynamic models of capital structure.

This paper provides our comments on Chen, Gerakos, Glode, and Taylor's (2016) panel session held at the 2015 Junior Accounting Theory Conference on the relation between theoretical and empirical research in accounting. Consistent with a declining fraction of theory papers in accounting journals, we show that the number of accounting theorists has been stable since the 2001–2005 period, while the rest of the field has grown. We offer our perspectives on how the knowledge generated by accounting researchers depends on a healthy interaction between theory and empirical work. We also comment on and add to Chen et al.'s (2016) discussion of how to improve the links between theoretical and empirical work. 

Ye and Simunic (2012; hereafter ‘YS’) analyze the preferences of investors and auditors for auditing standards. YS model two dimensions of auditing standards – toughness and vagueness. The standards come to bear in the event of an audit failure, which, in their model, corresponds to a ‘bad project’ that escaped detection. ‘Toughness’ refers to the typical level of effort that would be judged adequate and therefore protect the auditor from liability in the event of an audit failure. ‘Vagueness’ refers to variation around the ‘toughness’ level due to, for example, uncertainty about how a particular jury might interpret the standards. YS predict that vagueness can mitigate the costs of an inability to optimally set a bright-line standard. Such an inability might arise from, for example, technical constraints or heterogeneity among auditor wealth. They also predict that investors and auditors share preferences for standards, rendering it somewhat irrelevant which party sets standards. 

Most loan contracts in the US contain a provision for lender voting rules. We study the optimal voting rules to modify, waive or renegotiate syndicated loan contracts using an extension of Gârleanu and Zwiebel (2009). In the model, we allow lenders to waive a covenant violation based on a pre-specified voting rule. We show that the optimal voting rule limits lenders’ ability to extract the surplus of profitable projects, thereby improving contracting efficiency. The model predicts that the optimal voting rule is (i) increasing in the agency conflicts within the lending syndicate, and (ii) decreasing in the default risk of the borrower. We test these predictions empirically and find consistent results. Lastly, we extend our model to analyze how the preference for conservative accounting and covenant choices varies with the optimal voting rule. Overall, our results shed light on the economic incentives behind the wide use of voting rules in loan contracts. 

We provide evidence that environmental, social, and governance (ESG) loans improve the credibility of firms' ESG disclosures. We develop our predictions using a theoretical model in which companies may withhold ESG information, or disclose it subject to misreporting costs. Higher misreporting costs increase the proportion of firms who report, reduce the extent of cheap talk, and overall increase the informativeness of disclosed. Firms with ESG-linked loans are subject to additional monitoring and liability for misreporting, as misreporting can impact their loan terms. Consistent with ESG-linked loans leading to higher misreporting costs, we find that the ESG disclosures of firms with ESG-linked loans are more forthcoming with bad news, exaggerate less, and garner more media attention. 

In this paper, I analyze security markets where the only restrictions on investor beliefs are that (i) they agree on zero-probability events and (ii) some subset of investors believes that there is a small number of companies that are large relative to the economy. I show that the latter restriction implies that the covariance matrix of payoffs can be represented by an approximate factor structure in the sense of having a finite number of systematic risks. The former restriction implies that all investors agree on the span of systematic risks, but allows for disagreement regarding correlations between systematic risks. The restrictions also imply that investors agree on what companies are large relative to the economy, and are sufficient to preclude the pricing of idiosyncratic risks. I apply these results to agree-to-disagree models and to ambiguity aversion. In a linear rational expectations framework where these restrictions do not apply to ambiguity-averse investors, I show that if there are at least three rational traders whose combined risk-bearing capacity is non-negligible relative to the economy, then idiosyncratic risks continue not to be priced.