REVISION: Examining the Immediate Effects of Recent Tax Law Changes on the Structure of Executive Compensation
We exploit a recent law change to examine the relation between corporate taxes and executive compensation. The “Tax Cuts and Jobs Act” (TCJA) repealed a long-standing exception that allowed publicly traded companies to deduct executives’ qualified performance-based compensation (e.g., stock options) in excess of $1 million. The new regime is effective for tax years beginning after December 31, 2017, and limits total deductible compensation to $1 million for each covered executive. Using a difference-in-differences design to examine executive compensation paid in fiscal years 2017 and 2018, we find no evidence that the average firm affected by the TCJA in their 2018 fiscal years changed total compensation or compensation mix relative to control firms not subject to the new regime until their 2019 fiscal years. We find limited evidence of a reduction in total compensation among less than 10 percent of treated firms. We execute a battery of tests to validate these results. Overall, our ...
New: Non-GAAP Reporting and Investment
GAAP earnings often contain transitory items that can distort firms’ investment decisions when a manager cares about his firm’s stock price. Non-GAAP earnings can alleviate investment distortions because they allow the manager to remove transitory items. In addition to removing transitory items, the manager can also opportunistically bias non-GAAP earnings. We quantify this trade-off by estimating a dynamic model in which the manager makes an investment and a non-GAAP disclosure decision, and where the stock market rationally anticipates the manager’s incentives. The estimated parameters suggest managers care about stock prices significantly more than fundamentals. In the estimated model, investment and non-GAAP disclosure serve as complements. Because of that, relative to a scenario where managers can only provide GAAP earnings, managers who can provide non-GAAP earnings increase investment, but do so opportunistically. We find that permitting bias in non-GAAP earnings creates ...
REVISION: Peer Group Choice and Chief Executive Officer Compensation
We examine the selection of peer groups that boards of directors use when setting the level of CEO compensation. This choice is controversial because it is difficult to ascertain whether peer groups are selected to (i) attract and retain top executive talent or (ii) enable rent extraction by inappropriately increasing CEO compensation. In contrast to prior research, our analysis utilizes the degree to which the observed compensation level for the portfolio of peers is unusual relative to all potential portfolios of peers the board of directors could have reasonably selected. Using a sample of 9,247 firm-year observations from 2008 to 2014, we estimate that roughly 39% of board of directors’ choices appear to be associated with rent extraction, whereas the remaining 61% appear to be associated with attracting and retaining high-quality CEO talent. Relative to firms that appear to select peers for aspirational labor market reasons, we find rent extraction firms have more structural ...
REVISION: Evolution in Value Relevance of Accounting Information
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance from 1962 to 2014. We assess evolution in each amount’s value relevance and find increases, most notably for amounts related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant amounts also increases. We also consider separately new economy, non-new economy profit, and non-new economy loss firms. The relevance trends are more pronounced for, but extend beyond, new economy firms. We base inferences on a non-parametric approach that automatically incorporates nonlinearities and interactions, thereby unconstraining the valuation relation. Taken together, our findings reveal a more nuanced, but not declining, relation between share ...
REVISION: Long-Term Economic Consequences of Hedge Fund Activist Interventions
We examine the long-term effects of interventions by activist hedge funds. Research documents positive equal-weighted long-term returns and operating performance improvements following activist interventions, and typically conclude that activism is beneficial. We extend the literature in two ways. First, we find that equal-weighted long-term returns are driven by the smallest 20% of firms, with an average market value of $22 million. The larger 80% of firms experience insignificant negative long-term returns. On a value-weighted basis, which likely best gauges the effects on shareholder wealth and the economy, we find that pre- to post-activism long-term returns insignificantly differ from zero. For operating performance, we find that prior results are a manifestation of abnormal trends in pre-activism performance. Using an appropriately matched sample, we find no evidence of abnormal post-activism performance improvements. Overall, our results do not strongly support the hypothesis ...
REVISION: Tax Avoidance and the Real Effect of Tax-Risk Disclosures
I study the financial reporting effect of tax-risk disclosures (“FIN 48”) on tax avoidance. To isolate this effect from other factors that influence tax avoidance, I build a dynamic structural model in which a firm chooses a set of tax-saving projects in each period to maximize shareholder value. In this model, the firm trades off the tax savings with the financial-reporting costs, tax authority scrutiny, and operational frictions imposed by tax avoidance that reduce pre-tax income. I find that the FIN 48 disclosure increases effective tax rates by 2.8 percentage points relative to when firms can immediately recognize all of the tax savings on the income statement. I also find that average operational frictions from tax avoidance decrease pre-tax earnings by 7.4%. The magnitude of these frictions suggest they have a large impact on firms' tax planning and can explain the “undersheltering ...