The Effect of Local Holdings on Audit Policy and Outcomes

This paper examines whether local block holdings are associated with audit policy and outcomes. For local investors are long-term investors and they tend to invest a larger portion of their total investment in local companies, I posit that local block holders will be dedicated investors and have strong incentives to monitor management. Consistently I find that companies with local block holders are less likely to have unclean/going-concern opinions, and more likely to have long-term relationships with auditors. In addition, although I find weak evidence that the existence of local block investors affects audit fees, I do not observe any significant difference of audit fees between firms with local block holdings and firms with nonlocal block holdings. Overall, this paper shows that information advantage of local investors can have real effects on audit process through monitoring activities

Narrative R&D Disclosure and the R&D Anomaly

Prior research documents that investors underreact to R&D expense because they have difficulty valuing innovation (Chan et al 2001; Eberhart et al. 2004; Cohen et al. 2013). This phenomenon is commonly referred to as the R&D anomaly. We extend prior research by examining how narrative R&D disclosure in 10-K filings impacts market participants’ understanding of the value of innovation. We first show that narrative R&D disclosure is positively related with future R&D outcome. Despite such value-relevance, we find that R&D anomaly is magnified in intense narrative R&D disclosure firms, as reflected in larger future returns associated with current R&D expense. We further find that the impact of R&D disclosure on the R&D anomaly is more pronounced when the number of investors’ 10-K views is low and when 10-K reports are less readable. Overall, our findings suggest that narrative R&D disclosure does not necessarily help investors’ ability to impound information about R&D into stock prices on a timely basis. Our study has implications for regulators in that users of financial statements have difficulty processing on a timely basis the information contained not only in R&D, but also in R&D narrative disclosure

Shocks to Product Networks and Post-Earnings Announcement Drift

This paper examines whether shocks to less visible product market peers are an important determinant of industry level post-earnings announcement drift (IPEAD) (Ayers and Freeman 1997; Hui et al. 2016). On the real-side, we find that a focal firm’s earnings are persistently related to the earnings surprises of its peers. On the financial-side, IPEAD arises only when these peers are less visible and when shocks are driven by persistent supply-side shocks to expenses, and not by demand-side shocks to sales. Text-based measures of disclosure opacity show that IPEAD is also stronger when firms provide less informative 10-K disclosures regarding their expenses. Collectively, our results suggest that inattention to less visible peers and a poor informational environment surrounding supply-side shocks are likely channels that generate IPEAD. IPEAD returns are economically large in subsamples motivated by this explanation

Changes in Order Backlog and Future Returns

This paper examines whether investors recognize the implications of changes in order backlog, a non-GAAP leading indicator, for future performance. A hedge portfolio strategy taking a long position in the highest decile of order backlog change and a short position in the lowest decile of order backlog change earns 13.7 percent in the year after the hedge portfolio is formed. Moreover, analysts forecast errors are large and negative (overoptimistic) for firms experiencing declines in order backlog. Overall, our evidence indicates that analysts underreact to the information in changes in order backlog. In addition, the market does not appear to see through the relation between changes in order backlog and future performance and underweights the implications of order backlog, which contrasts with the findings of Rajgopal, Shevlin, and Venkatachalam (2003)

Managerial Ability and the Quality of Firms’ Information Environment

In this study, we examine the relation between managerial ability and the quality of a firm’s information environment. An emerging stream of research has identified managerial ability as an important determinant of accruals quality and management forecast quality. However, our understanding of the impact of managerial ability on a firm’s broader information environment is incomplete because it captures more than these specific financial reporting disclosures. Using a composite index based on various proxies for a firm’s information environment, we find a positive relation between managerial ability and a firm’s information environment. Consistent with our argument that managers’ equity incentives improve disclosure quality, we find that the quality of a firm’s information environment improves when managers have higher levels of equity incentives. We contribute to the literature by providing more complete and conclusive evidence about the impact of managerial ability on a firm’s broader information environment

Managerial Ability and Income Smoothing

n this study, we investigate whether managerial ability is related to income smoothing and, if so, whether smoothing associated with managerial ability improves the informativeness of earnings and stock prices about future performance. Using a large sample of firms, we find that managerial ability is positively related to smoothing. More importantly, we show that high-ability managers incorporate more forward-looking information about cash flows into current earnings through smoothing, thereby enhancing earnings informativeness. We also find that smoothing associated with high-ability managers improves stock price informativeness about future cash flows. Our study should be of interest to researchers, practitioners, and others concerned with understanding the determinants and usefulness of smoothin

Stock Market Rewards for Earnings that Beat Analyst Earnings Forecasts when the Economy is Unforecastable

This study examines whether and why the stock market assigns an incremental premium to the act of beating analyst earnings forecasts when the economy is unforecastable. Our study uses a novel measure of macroeconomic (macro) uncertainty from Jurado et al. (2015) that captures periods during which the real economy is not forecastable and a regression model that controls for the forecast error throughout the quarter. Results show that during high macro uncertainty periods, the market assigns a greater premium to earnings that beat analyst earnings forecasts compared to the premium assigned to these earnings during low macro uncertainty periods. We also report a lower likelihood of managing earnings to beat analyst earnings forecasts during high macro uncertainty periods, suggesting higher accounting information quality. We further show that the incremental premium in high macro uncertainty periods is mainly concentrated within the group of firms that have both low liquidity risk and high accounting information quality. Evidence from our study should be relevant to those interested in understanding the usefulness of earnings during periods of extreme macro uncertainty and forces that determine accounting information quality