Corporate Compliance, Regulation, and Litigation
Too Many Managers: Strategic Use of Titles to Avoid Overtime Payments (Coauthors: Lauren Cohen and Umit Gurun), NBER Working Paper
We find widespread evidence of firms appearing to avoid paying overtime wages by exploiting a federal law that allows them to do so for employees termed as “managers” and paid a salary above a pre-defined dollar threshold. We show that listings for salaried positions with managerial titles exhibit an almost five-fold increase around the federal regulatory threshold, including the listing of managerial positions such as “Directors of First Impression,” whose jobs are otherwise equivalent to non-managerial employees (in this case, a front desk assistant). Overtime avoidance is more pronounced when firms have stronger bargaining power and employees have weaker rights. Moreover, it is more pronounced for firms with financial constraints and when there are weaker labor outside options in the region. We find stronger results for occupations in low-wage industries that are penalized more often for overtime violations. Our results suggest broad usage of overtime avoidance using job titles across locations and over time, persisting through the present day. Moreover, the wages avoided are substantial - we estimate that firms avoid roughly 13.5% in overtime expenses for each strategic “manager” hired during our sample period.
A graph from the study: Under FLSA, firms can avoid paying overtime to salaried employees who are classified as managers and paid above a threshold ($455 /week). Managerial positions exhibit a big jump at this threshold:
Executive Compensation, Individual-Level Tax Rates, and Insider Trading Profits (Coauthor: Nathan Goldman), 2023, Journal of Accounting and Economics
We examine whether individual-level taxes affect executives’ propensity to use nonpublic information in insider trades. We predict and find a positive relation between abnormal insider trading profitability and income tax rates. Using plausibly exogenous variation in state income tax rates, we estimate that the average executive uses insider trading profits to offset between 12.2% and 19.6% of the effect that income taxes have on their net compensation. We show that the sensitivity of these profits to tax rates varies predictably with the executives’ compensation and shareholdings, firm monitoring effectiveness, and information asymmetry between insiders and outside investors. We also demonstrate a positive association between SEC enforcement actions and tax rates, suggesting that tax-rate-driven changes in abnormal trading profits expose insiders to legal risk. We find that insider trading volume exhibits little sensitivity to tax rates. Our findings show that income taxes affect executives’ tendency to use private information in their trades.
Disclosure and Lawsuits ahead of IPOs (Coauthors: Burcu Esmer & Suhas Sridharan), 2022, The Accounting Review, 98(2), 123-147.
We examine whether IPO registration disclosures expose firms to greater nonshareholder litigation risk. Using hand-collected data on lawsuits initiated at federal and state courts against IPO firms, we show that firms that submit their IPO registration statement with the SEC publicly experience a 16% increase in litigation risk between the registration filing and issuance date. Consistent with the public filing of the registration driving this heightened litigation risk, firms that file their registration confidentially under the JOBS Act do not experience such an increase in litigation risk. The effects of confidential filing are concentrated among business-initiated lawsuits, intellectual property/ contract lawsuits, and potentially meritless lawsuits. We find no disproportionate increase in post-IPO lawsuits for confidential filers, suggesting that withholding information during the IPO registration period mitigates litigation risk.
A graph from the study: There is a significant increase in the number of lawsuits against IPO firms show between the filing of S-1 form and the issue date, except when S-1 is filed confidentially:
Earnings Expectations and Employee Safety (Coauthor: Judson Caskey), 2017, Journal of Accounting and Economics, 63 (1), 121-141.
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.
A graph from the study: Firms that meet or just beat forecasts tend to have lower rates of injuries compared to firms that meet/miss the forecasts by a large margin and firms that miss their forecasts by a small margin
Corporate Disclosure
Economic Uncertainty and Investor Attention (Coauthors: Daniel Andrei and Henry Friedman), 2023, Journal of Financial Economics, 149(2): 179-217.
We develop a multi-firm equilibrium model of information acquisition based on differences in firms’ characteristics. The model shows that heightened economic uncertainty amplifies stock price reactions to earnings announcements via increased investor attention, which varies by firm characteristics. Firms with higher systematic risk or more informative announcements attract more attention and exhibit stronger reactions to earnings announcements. Moreover, heightened investor attention caused by high economic uncertainty leads to a steeper CAPM relation and higher betas for announcing firms. Empirical analyses using firm-level attention measures and CAPM tests on high- versus low-attention days support the model’s predictions.
Reporting and Nonreporting Incentives in Leasing (Coauthor: Judson Caskey), 2019, The Accounting Review, 94(6): 137-164.
We examine the role that reporting and non-reporting incentives play in operating lease financing. Using three separate datasets (publicly traded firms from Compustat, and comprehensive datasets of publicly-traded and privately-held U.S. airlines and electric utilities), we provide evidence that expanding financing capacity, accommodating volatile operations, and maximizing present value of tax deductions are important drivers of leasing decisions. Contrary to the common assertion, we find no evidence that reporting lower indebtedness, or “hiding” liabilities from investors, motivates lease usage, suggesting that reporting incentives play, at most, a secondary role. We discuss implications of these findings for standard setters and future research, and their relevance for proposed changes in financial reporting rules for leases.
A graph from the study: Estimated use of operating leases in capital structure by industry
Real Activity Forecasts Using Loan Portfolio Information (Coauthor: Urooj Khan), 2016, Journal of Accounting Research, 54(3), 895-937.
To extend and monitor loans, banks collect detailed and proprietary information about the financial prospects of their customers, many of whom are local businesses and households. Therefore, banks’ loan portfolios contain potentially useful information about local economic conditions. We investigate the association between information in loan portfolios and local economic conditions. Using a sample of U.S. commercial banks from 1990:Q1 to 2013:Q4, we document that information in loan portfolios aggregated to the state level is associated with current and future changes in statewide economic conditions. Furthermore, the provision for loan and lease losses contains information incremental to leading indicators of state-level economic activity and recessions. Loan portfolio information also helps to improve predictions of economic conditions at more granular levels, such as at the commuting zone level. We discuss relevance of these findings for economic analysis and forecasting, and the relation of our study to prior work on the informativeness of accounting information about the macroeconomy.
A graph from the study: Economic conditions, like weather patterns, vary significantly across states. Bank disclosures help us predict state economic conditions.
Inter-Industry Network Structure and the Cross-Predictability of Earnings and Stock Returns (Coauthors: Daniel Aobdia and Judson Caskey), 2014, Review of Accounting Studies, 19(3), 1191-1224.
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 non-central industries. Analogously, we find that the accounting performance of central industries associate more strongly with macroeconomic measures than does the accounting performance of non-central industries. Comparing central industries to non-central industries, 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.
A graph from the study: Here is a map of industry network in the U.S. economy, where white squares represent more "central" industries. Shocks to such industries could diffuse more strongly in the economy than shocks to other industries.
Debt Markets
What Moves Stock Prices Ahead of Credit Rating Changes? (Coauthor: Omri Even-Tov), 2021, Review of Accounting Studies , 26, 1390–1427
A stream of research dating back to the 1970’s shows that credit rating change announcements often reveal new information to investors and lead to significant stock price reactions. We revisit these findings to investigate stock return patterns around credit rating changes using intraday data. We show that stock prices start moving in the direction of rating changes prior to the announcement and that the reaction to the announcement itself is small but significant. We test three explanations for these patterns. First, we show that over 85% of rating changes take place after other corporate news events and that these events can explain a large portion of the pre-announcement period return patterns. Nevertheless, even rating changes that are not preceded by corporate news events evidence a strong pre-announcement return pattern concentrated over the 780 trading minutes prior to the announcement. Second, we document that investor anticipation of rating changes, along with the impact of corporate news events, can fully explain the pre-announcement returns for rating upgrades, but not for downgrades. Finally, we consider leakage of private information regarding rating changes. We find that pre-announcement price patterns for downgrades are concentrated in observations where the credit analyst has stronger career-related incentives for leaking information and that the beneficiaries of the pre-announcement return patterns are institutional investors.
A graph from the study: Stock prices move ahead of S&P's corporate credit rating changes even in the absence of other news events
Information Asymmetry and Bond Coupon Choice (Coauthors: Dan Amiram, Alon Kalay, and Avner Kalay), 2018, The Accounting Review
We examine the role of the coupon choice in bond contracts in addressing information asymmetry between borrowers and lenders about the credit quality of the borrower. Prior literature that examines the effect of information asymmetry on bond contract design focuses on the choice of maturity, which determines when the face value is paid. We conjecture that prior studies struggle to find a relation between maturity and information asymmetry in bond contracts, because the coupon choice, which determines the distribution of future interim cash flows, is a more effective mechanism with which to adjust the bond’s duration and address information asymmetry. This is because adjustments of maturity entail significant issuance costs. We use Regulation Fair Disclosure (RegFD) as an exogenous shock to the level of information asymmetry of unrated firms, relative to rated firms, in a difference-in-differences research design. We find that following the enactment of RegFD, the coupon rates for unrated firms increased relatively more than those of rated firms, consistent with the coupon choice addressing information asymmetry. As predicted, we fail to find similar increases in maturity, consistent with the findings in prior literature. We also find that the coupon is used more extensively when issuance costs are higher, which is when maturity is predicted to be a less efficient contract term with which to address information asymmetry.
Earnings Announcements, Information Asymmetry, and Timing of Debt Offerings (Coauthor: Jon Kerr) 2015, The Accounting Review, 90(6), 2375-2410.
We empirically examine the joint predictions of the pecking order theory and the theory of time-varying asymmetric information regarding the timing of security offerings around information disclosures. We analyze loan originations and bond offerings around earnings announcements and compare them against equity offerings. In support of the theories’ predictions, we find a positive association between the information sensitivity of securities and the likelihood of their issuance after earnings announcements. In particular, we find that clustering after earnings announcements is weakest in loan originations, stronger in bond offerings, and strongest in equity offerings. Also consistent with the theories, we find that the size of news in earnings announcements matters in the timing decision. We find weak evidence regarding the theories’ implication that the direction of news in the announcement plays a role in the timing decision. We test and find that this latter result is attributable partly to potential costs associated with the omission of material negative information, such as litigation risk.
A graph from the study: Accounting information is an important consideration not only in capital structure but also timing of financing transactions depending on the type of security being issued.
