REVISION: Peer-Group Choice, Chief Executive Officer Compensation, and Firm Performance
We examine the selection of peer groups that boards of directors use when setting CEO compensation. The challenge is to ascertain whether peer groups are selected to (i) attract and retain executive talent and/or (ii) enable rent extraction by inappropriately increasing compensation. We find that the inferences in prior research are based on questionable methodological choices and do not generalize with an expanded sample. After addressing these concerns, we find that, on average, excess peer compensation has a negative association with future firm operating performance. However, significant variation in CEO talent and corporate governance exists within the cross-section of firms. The negative association between excess peer compensation and future performance is mitigated when the firm has a high level of CEO talent, and exacerbated when the firm has low-quality corporate governance. Thus, the economic consequences of peer-group choice are highly contextual. In general, we find that ...
REVISION: Non-GAAP Reporting and Investment
When managers care about their firms’ stock prices, their investment decisions become sensitive to transitory items in GAAP earnings. Non-GAAP earnings can remove these transitory items, and thus improve investment efficiency, but also introduce opportunistic bias, and thus hide inefficient investment. We quantify this trade-off by estimating a dynamic model in which a manager makes investment and non-GAAP disclosure decisions, and where investors rationally anticipate his incentives. We find the manager’s ability to distort non-GAAP earnings creates inefficient investment choices and destroys firm value.We estimate the magnitude of the loss in the average firm value at just under 1%.
New: Disclosure Processing Costs and Market Feedback Around the World
Investors' incentive to acquire private information—and the extent it is reflected in price—is a function of disclosure processing costs. Theory predicts that if these costs change, the amount the manager can learn from price will also vary. To provide evidence on this issue, we exploit the worldwide introduction of centralized electronic disclosure systems, which, like the SEC's EDGAR, substantially reduces disclosure processing costs. Leveraging country- and firm-level variation resulting from these platforms' adoptions, we find an economically significant decrease in investment sensitivity to price. Moreover, we find that higher levels of country-wide technology use, more developed capital markets, and better regulatory environments mute this decline in investment sensitivity to price. Collectively, our findings show that technology adoptions that reduce disclosure processing costs have real effects on the economy.
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) lowered the corporate tax rate from 35 to 21 percent and repealed a long-standing exception that allowed companies to deduct executives’ qualified performance-based compensation in excess of $1 million. These changes are effective for tax years beginning after December 31, 2017. Using a difference-in-differences design, we find no evidence that the average firm affected by the TCJA in their 2018 fiscal years changed compensation 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 findings suggest the tax benefits of executive compensation do not outweigh non-tax considerations when firms structure pay.
REVISION: How Costly Is Tax Avoidance? Evidence from Structural Estimation
I develop a structural model to quantify the costs of tax avoidance. In the model, the firm trades off tax savings with tax-audit risk, financial-reporting benefits, and non-tax costs (which affect pre-tax income). The comparative statics suggest tax avoidance is path-dependent, which can help resolve the unexplained persistent differences across firms. The estimated parameters suggest non-tax costs, which are difficult to observe, decrease pre-tax earnings by 7.8%. The large magnitude of this estimate can explain why firms appear to under-utilize tax-avoidance strategies. When I estimate the model on different subsamples, I find larger firms engage in more tax avoidance primarily because they can better identify lower-risk opportunities. I find multinationals have lower-risk opportunities to avoid taxes but incur more non-tax costs relative to domestic firms, which helps to explain similar levels of tax avoidance. Overall, the estimated parameters help to explain the ...
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 ...