REVISION: Regulatory Spillovers in Common Audit Markets
We find that Sarbanes-Oxley (SOX) had large, persistent effects on how nonpublic entities access the audit market. Private companies reduced their use of attested financial reports in bank financing by 12%. For nonprofit organizations (NPOs), audit fee increases and the rate of switching to smaller audit firms more than doubled. We trace these effects to a shortage of audit labor by studying exogenous variation in audit labor availability across otherwise similar clients. Moreover, as a result of the substantial auditor switches in the nonprofit market, we find the audit supply structure changed. Both the audit supply concentration and Big 4 market share dropped in half. These changes in supply structure are persistent through 2011. Our results demonstrate how public company regulation causes spillovers for nonpublic entities, and identifies significant consequences of regulations that expand beyond audit and disclosure requirements for public firms.
New: Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans
Using a data set that records banks’ ongoing requests of information from small commercial borrowers, we examine when banks use financial statements to monitor borrowers after loan origination. We find that banks request financial statements for half the loans and this variation is related to borrower credit risk, relationship length, collateral, and the provision of business tax returns, but in complex ways. The relation between borrower risk and financial statement requests has an inverted U-shape; and tax returns can be both substitutes and complements to financial statements, conditional on borrower characteristics and the degree of bank–borrower information asymmetry. Frequent financial reporting is used to monitor collateral, but only for non–real estate loans and only when the collateral is easily accessible to lenders. Collectively, our results provide novel evidence of a fundamental information demand for financial reporting in monitoring small commercial borrowers and a ...
REVISION: Why Regulate Private Firm Disclosure and Auditing?
Private firms face differing financial disclosure and auditing regulations around the world. In the United States and Canada, for example, private firms are generally neither required to disclose their financial results nor have their financial statements audited. By contrast, many firms with limited liability in most other countries are required to file at least some financial information publicly and are also required to have their financial statements audited. This paper discusses and analyzes the reasons for differential financial reporting regulation of private firms. We first discuss various definitions of a private firm. Next, we examine theoretical arguments for regulating the financial reporting of these firms, particularly related to public disclosure and auditing. We then provide new survey based evidence of firms’ and standard setters’ views of regulation. We conclude by identifying future research opportunities.
REVISION: Commercial Lending Concentration and Bank Expertise: Evidence from Borrower Financial Statements
Lending concentration features prominently in models of information acquisition by banks, but empirical evidence on its role is limited because banks rarely disclose details about their exposures or information collection. Using a dataset of bank-level commercial loan exposures, we find banks are less likely to collect audited financial statements from firms in industries and regions in which they have more exposure. These findings are stronger in settings in which adverse selection is acute and muted when the bank lacks experience with an exposure. Our results offer novel evidence on how bank characteristics are related to the type of financial information they use and support theoretical predictions suggesting portfolio concentration reveals a bank’s relative expertise.
REVISION: Accounting Choices and Capital Allocation: Evidence from Large Private U.S. Firms
We provide new evidence on the relation between capital allocation and firms’ accounting choices. Using confidential data on the production of audited GAAP financial statements by large privately held U.S. firms, we focus on an economically important setting that controls approximately $10 trillion of capital, but is not subject to financial reporting mandates. Our main findings are threefold. First, we find the majority of firms (over 60%) do not produce audited GAAP financial statements, which publicly held firms are mandated to produce. Second, in contrast to prior literature focusing on debt contracting in the setting of private firms, the evidence reveals that capital allocated via equity and trade credit is more strongly related to the decision to produce audited GAAP financial statements compared to debt. Third, exploiting variation across firm, industry, and time, we find characteristics such as growth opportunities, firm youth, and the presence of intangibles are positively ...
REVISION: Economic Growth and Financial Statement Verification
We use a proprietary dataset of financial statements collected by banks to examine whether economic growth is related to the use of financial statement verification in debt financing. Exploiting the distinct economic growth and contraction patterns of the construction industry over the years 2002 to 2011, our estimates reveal that banks reduced their collection of unqualified audited financial statements from construction firms at nearly twice the rate of firms in other industries during the housing boom period before 2008. This reduction was most severe in the regions that experienced the most significant construction growth. These trends reversed during the sub-sequent housing crisis in 2008 to 2011 when construction activity contracted. Moreover, using bank- and firm-level data we find a strong negative (positive) relation between audited financial statements during the growth period and subsequent loan losses (construction firm survival) during the contraction period. ...
REVISION: Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans
Using a dataset which records banks’ ongoing requests of information from small commercial borrowers, we examine when banks use financial statements to monitor borrowers after loan origination. We find banks request financial statements for half the loans and this variation is related to borrower credit risk, relationship length, collateral, and the provision of business tax returns, but in complex ways. The relation between borrower risk and financial statement requests has an inverted U-shape; and tax returns can be both substitutes and complements to financial statements, conditional on borrower characteristics and the degree of bank-borrower information asymmetry. Frequent financial reporting is used to monitor collateral, but only for non-real estate loans and only when the collateral is easily accessible to lenders. Collectively, our results provide novel evidence of a fundamental information demand for financial reporting in monitoring small commercial borrowers and a specific ...
REVISION: Knowledge, Compensation, and Firm Value: An Empirical Analysis of Firm Communication
Knowledge is central to managing an organization, but its presence in employees is difficult to measure directly. We hypothesize that external communication patterns reveal the location of knowledge within the management team. Using a large database of firm conference call transcripts, we find that CEOs speak less in settings where they are likely to be relatively less knowledgeable. CEOs who speak more are also paid more, and firms whose CEO pay is not commensurate with CEO speaking have a lower industry-adjusted Tobin’s Q. Communication thus appears to reveal knowledge.
REVISION: Investor Relations and the Flow of Information through Investor Networks
This study develops a model to examine how companies' investor relations can impact the dissemination of information and how the dissemination of information affects the time-series behavior of bid-ask spreads. In our model, investors become aware of the information release either directly from investor relations or via person-to person communication. The person-to-person communication then spreads in a network of heterogeneous individuals, where some serve as 'hubs' with high connectivity to others. We show that the optimal investor relations strategy relies on targeting highly connected investors, especially for time-sensitive and complex information. We also show that targeted disclosure can reduce bid-ask spreads over long horizons, indicating a benefit in terms of lower trading costs. We also show that investor relations activities to expand the investor base facilitate the optimal information release by increasing the number of hub-type investors who follow the company and ...
REVISION: A Measure of Competition Based on 10-K Filings
In this paper we develop a measure of competition based on management’s disclosures in their 10-K filing and find that firms’ rates of diminishing marginal returns on new and existing investment vary significantly with our measure. We show that these firm-level disclosures are related to existing industry-level measures of disclosure (e.g. Herfindahl index), but capture something distinctly new. In particular, we show that the measure is associated with the rates of diminishing marginal ...
New: The Value of Verification in Debt Financing: Evidence from Private U.S. Firms
I examine how verification of financial statements influences debt pricing. I use a large proprietary database of privately-held U.S. firms, an important business sector in which the information environment is opaque and financial statement audits are not mandated. I find that audited firms have a significantly lower cost of debt and that lenders place more weight on audited financial information in setting the interest rate. Further, I provide evidence of a mechanism for this increased ...