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: Accounting Fundamentals and Systematic Risk: Corporate Failure over the Business Cycle
In this paper, we use accounting fundamentals to measure systematic risk of distress. Our main testable prediction—that this risk increases with the probability of recessionary failure, P(R|F)—is based on a stylized model that guides our empirical analyses. We first apply the lasso method to select accounting fundamentals that can be combined into P(R|F) estimates. We then use the obtained estimates in asset-pricing tests. This approach successfully extracts systematic risk information from accounting data—we document a significant positive premium associated with P(R|F) estimates. The premium covaries with the news about the business cycle and aggregate failure rates. Additional tests underscore the importance of the “structure” imposed through recessionary-failure-probability estimation. The “agnostic” return predictor that relies only on past correlations between the same fundamental variables and returns exhibits markedly different properties.
REVISION: Non-answers during Conference Calls
We construct a novel measure of disclosure choice by firms. Our measure uses linguistic analysis of conference calls to flag a manager’s response as providing an explicit “non-answer” to an analyst’s question. Using our measure, about 11% of questions elicit non-answers, a rate that is stable over time and similar across industries. Consistent with extant theory, we find firms are less willing to disclose when competition is more intense, but more willing to disclose prior to raising capital. An important feature of our measure is that it yields several observations for each firm-quarter, which allows us to examine disclosure choice within a call as a function of properties of the question. We find product-related questions are associated with non-answers, and this association is stronger when competition is more intense, suggesting product-related information has higher proprietary cost. While firms are more forthcoming prior to raising capital, the within-call analyses for ...
REVISION: Information versus Investment
Firms' efficient long-term investment and accurate reporting of information about performance both serve crucial roles in the economy and capital markets. We argue quantitatively that the two goals are in direct conflict in the presence of realistic manager compensation contracts, which provide managers with incentives both to misreport financial statements and to distort their real investment choices. We build a dynamic structural model rich enough to capture a natural tradeoff between investment and information. The model matches a range of observable moments constructed from data on firm investment and periods of detected misreporting by firms. Counterfactuals show that regulations preventing misreporting do in fact incentivize managers to distort real investment, whose volatility rises. This excess volatility lowers firm value, suggesting a quantitatively meaningfully tradeoff.
New: How Common Are Intentional GAAP Violations? Estimates From a Dynamic Model
This paper uses data on detected misstatements — earnings restatements — and a dynamic model to estimate the extent of undetected misstatements that violate GAAP. The model features a CEO who can manipulate his firm's stock price by misstating earnings. I find the CEO's expected cost of misleading investors is low. The probability of detection over a five-year horizon is 13.91%, and the average misstatement, if detected, results in an 8.53% loss in the CEO's retirement wealth. The low expected cost implies a high fraction of CEOs who misstate earnings at least once at 60%, with 2%–22% of CEOs starting to misstate earnings in each year 2003–2010, inflation in stock prices across CEOs who misstate earnings at 2.02%, and inflation in stock prices across all CEOs at 0.77%. Wealthier CEOs manipulate less, and the average misstatement is larger in smaller firms.
REVISION: How Common Are Intentional GAAP Violations? Estimates from a Dynamic Model
This paper uses data on detected misstatements — earnings restatements — and a dynamic model to estimate the extent of undetected misstatements that violate GAAP. The model features a CEO who can manipulate his firm’s stock price by misstating earnings. I find the CEO’s expected cost of misleading investors is low. The probability of detection over a five-year horizon is 13.91%, and the average misstatement, if detected, results in an 8.53% loss in the CEO’s retirement wealth. The low expected cost implies a high fraction of CEOs who misstate earnings at least once at 60% with 2%–22% of CEOs starting to misstate earnings in each year 2003–2010, inflation in stock prices across CEOs who misstate earnings at 2.02%, and inflation in stock prices across all CEOs at 0.77%. Wealthier CEOs manipulate less, and the average misstatement is larger in smaller firms.
REVISION: CEO Personality and Firm Policies
Based on two samples of high quality personality data for chief executive officers (CEOs), we use linguistic features extracted from conferences calls and statistical learning techniques to develop a measure of CEO personality in terms of the Big Five traits: agreeableness, conscientiousness, extraversion, neuroticism, and openness to experience. These personality measures have strong out-of-sample predictive performance and are stable over time. Our measures of the Big Five personality traits are associated with financing choices, investment choices and firm operating performance.
REVISION: Detecting Deceptive Discussions in Conference Calls
We estimate classification models of deceptive discussions during quarterly earnings conference calls. Using data on subsequent financial restatements (and a set of criteria to identify especially serious accounting problems), we label each call as “truthful” or “deceptive”. Our models are developed with the word categories that have been shown by previous psychological and linguistic research to be related to deception. Using conservative statistical tests, we find that the out-of-sample ...