Future Firm Performance Research Articles

Skin in the Game: Operating Growth, Firm Performance, and Future Stock Returns

Prior research documents that asset growth is negatively associated with future firm performance. In contrast, we show that growth financed by product market stakeholders (i.e., “operating growth”) is positively associated with future firm performance. Investors and security analysts under-estimate the positive effects of operating growth on future performance, resulting in return predictability and overly pessimistic earnings forecasts for firms with high operating growth. Future stock returns largely concentrate around subsequent earnings announcements with declining magnitudes, consistent with the error-in-expectation explanation. Results from cross-sectional tests further support the hypothesis that operating growth signals high future performance but investors underreact to it.

Strategic Use of Volume of Financial Items in 10-K Reports

We investigate whether firms limit the volume of financial items in annual reports (including the financial statements and footnotes) to obfuscate poor future firm performance, and how investors react to this reduced volume. We estimate abnormal volume to capture managers’ discretion over reporting in the 10-K and find that abnormally low volume predicts poor future earnings. This relation is more pronounced in firms where the market has difficulty in detecting managerial intervention in the disclosure process. We also find that abnormally low volume predicts negative future returns, suggesting that managers benefit from disclosing fewer financial items by delaying the incorporation of bad news into stock prices. Further corroborating our results, we find that the volume is abnormally low when there exist strong managerial incentives to withhold bad news and manipulate investor perceptions upward. Overall, our evidence is consistent with the notion that managers attempt to obfuscate poor future performance and inflate current stock prices by disclosing fewer financial items in the 10-K.

The effect of independent directors' financial expertise on the use of private information in setting bank CEO bonuses

PurposeThe purpose of this study is to examine whether independent directors' financial expertise affects the use of private information in setting bank chief executive officer (CEO) bonuses.Design/methodology/approachThe association between future firm performance and bank CEO bonuses is used to measure the incorporation of private information into bonuses. Both level and change specifications are employed to test the effect of independent directors' financial expertise on the use of private information in setting CEO bonuses.FindingsIt is found that future firm performance is more positively associated with bank CEO bonuses for banks with a higher proportion of financial experts among independent directors than for other banks. The findings suggest that independent directors with financial expertise can more effectively use private information in setting bank CEO bonuses.Originality/valueResearch on independent directors' role in the use of private information in setting compensation is valuable for understanding how corporate governance can enhance the efficiency of CEO compensation contracts. This study indicates that financial experts on the bank board play an important role in this regard.

Real earnings management in bankrupt firms

AbstractWe investigate: (1) whether managers in bankrupt firms manipulate earnings through real earnings management (REM); (2) the incentives and tradeoff strategies to engage in REM; (3) how REM influences the subsequent firm performance and bankruptcy probability. We find that bankrupt firms are more likely to manipulate earnings via REM than continuous firms. There is an increasing trend of REM activities in the 5‐year window before bankruptcy. The major incentive for bankrupt firms to engage in REM is the issuance of new debt. Bankrupt firms treat REM and accrual‐based earnings management (AEM) as complementary tools for earnings management. We further find that REM is associated with low future firm performance. The REM score defined in this study can more accurately predict bankruptcy than the Altman Z score by 15%. Overall, the findings in this paper will help investors, regulators, and academics identify REM activities and understand the incentives and consequences of REM.

Does firm payout policy affect shareholders’ dissatisfaction with directors?

In this study we investigate the information content of firm payout policy to shareholders. We focus on the association between a firm’s payout policy and shareholders’ satisfaction with board directors, as expressed by the percentage of negative or withheld votes for directors during annual elections (shareholders’ dissent voting). We fill a gap in the literature by using shareholders’ voting results in the election of board members at annual meeting as a setting to examine shareholder perception of firms’ payout policies. We find that higher share repurchase and/or higher dividend payout are associated with lower shareholders’ dissenting votes. We also find that such relationship is conditional on the level of free cash flow, firm future performance, the degree of management entrenchment, and the type of institutional investors. Our study contributes to the payout literature by providing empirical evidence that shows the outcome of shareholders’ votes in director elections may be influenced by the board of directors’ payout decisions.

Do Managers Voluntarily Disclose to Guide Themselves Through Policy Uncertainty? A Managerial Learning Perspective

We examine whether economic policy uncertainty (EPU) encourages managers to issue voluntary disclosures to facilitate learning from stock prices regarding investment decisions. We find that EPU is positively associated with subsequent capital expenditure (capex) forecast issuance. Consistent with a learning channel, we find that this relation is pronounced when potential investments are irreversible, when managers are less informed regarding potential policy changes, and in the presence of politically-connected institutional ownership in the firm’s equity. We also find our results are robust to addressing omitted variable bias when using the 2016 presidential election and the 2018-19 U.S.–China trade dispute as shocks to specific sources of policy uncertainty. Further consistent with managers learning from price reactions, we find that realized capital expenditures are significantly adjusted in the direction of market reactions to capex forecasts, particularly during periods of elevated EPU, and that these market-related capital expenditure adjustments are positively associated with future firm performance. Finally, we provide evidence that the effect of EPU on capex forecasts appears distinct from an information asymmetry channel through which prior studies link voluntary disclosures to policy uncertainty. Overall, we document managerial learning as a novel voluntary disclosure incentive in response to policy uncertainty.

Future firm performance and textual characteristics of 10-K disclosures

Future firm performance and textual characteristics of 10-K disclosures

Future firm performance and textual characteristics of 10-K disclosures

The paper examines the influence of contextual information within 10-K reports on the future performance of a firm. Based on an earnings expectation model, we uncover the incremental informational ...

International Earnings Announcements: Tone, Forward-looking Statements, and Informativeness

This paper examines two attributes of earnings press releases issued by firms cross-listed on U.S. stock exchanges: the tone and frequency of forward-looking statements. A more conservative tone and a greater proportion of forward-looking statements are often viewed as contributing to more credible disclosures. Our analysis indicates that culturally and institutionally more distant firms are generally less positive in their disclosures and include more forward-looking statements than U.S. firms. Further, we find that the tone and frequency of forward-looking statements of cross-listed firms’ earnings announcements are more informative than those of U.S. firms in predicting future firm performance, and this informativeness generally increases with the cultural and institutional distance of the home country from the U.S. In explaining market reaction to earnings announcements, tone informativeness in particular increases with the cultural distance of the home country from the U.S. Overall, in the context of home bias theory, we interpret our findings as suggesting that a cautious disclosure tone and more forward-looking information serve to mitigate potential home bias-related credibility and asymmetric information concerns arising from cultural and institutional distance.

Margin trading shareholder activists

ABSTRACT We examine margin trading activists that we define as shareholders that are identified by Schedule 13D filings and state therein that they may use margin borrowings to finance their holdings. We find that arrivals of margin trading activists are associated with positive target announcement returns compared to those of non-margin trading activists. This indicates that margin trading activists’ arrivals are perceived as signals of positive future target firm performance. Moreover, we find that their investment horizon is likely contingent on how long they have invested in the targets prior to their filings or whether markets react positively to their arrivals.

Do Firms Consider Economic Outlook When Determining Payout Policy?

Payout policy is one of the most important policies set by firms and represents a major use of capital by publicly traded corporations. Firms should consider future economic activity and future firm performance when determining payout policy choices, given they are cash outflow commitments from the firm. We empirically examine whether firms use economic outlook when determining payout policy using publicly available data from the Chicago Federal Reserve Bank and Compustat. We find that economic outlook is positively related to firm payout policy. Specifically, we find that firms are more likely to pay out cash dividends and repurchase shares when economic outlook is positive. Furthermore, when examining only firms already paying dividends and/or repurchasing shares, firms pay greater amounts of cash dividends and repurchase more shares when economic outlook is positive. We are the first, to our knowledge, to examine whether firms use economic outlook to determine their payout policy. Our paper motivates future research in corporate finance to examine how firms use economic outlook when making capital planning decisions.

What a firm produces matters: Processes of diversification, coherence and performances of Indian manufacturing firms

Economic growth and development of a country involves the accumulation of knowledge and dynamic capabilities. Past research has begun to investigate capability accumulation and macro-economic development of countries and sectors, and the role of new products in these processes. In this work, we focus on the firm-level process of capability accumulation and diversification in a developing country, namely, India. First, we explore the drivers of firm diversification strategies, and the effects of diversification upon firm performance in terms of profitability and sales growth. Second, we look at the idiosyncratic characteristics of different products, trying to identify the synergies of a product line with respect to the overall product basket of the firm – i.e. the “coherence” of its diversification patterns. We observe that the future performance of firms crucially depends on the interactions between the products they produce.

Undisclosed SEC Investigations

One of the hallmarks of the Security and Exchange Commision's (SEC's) investigative process is that it is shrouded in secrecy—only the SEC staff, high-level managers of the company being investigated, and outside counsel are typically aware of active investigations. We obtain novel data on all investigations closed by the SEC between 2000 and 2017—data that were heretofore nonpublic—and find that such investigations predict economically material declines in future firm performance. Despite evidence that the vast majority of these investigations are economically material, firms are not required to disclose them, and only 19% of investigations are initially disclosed. We examine whether corporate insiders exploit the undisclosed nature of these investigations for personal gain. Despite the undisclosed and economically material nature of these investigations, we find that insiders are not abstaining from trading. In particular, we find a pronounced spike in insider selling among undisclosed investigations with the most severe negative outcomes; and that abnormal selling activity appears highly opportunistic and earns significant abnormal returns. Our results suggest that SEC investigations are often undisclosed, economically material nonpublic events, and that insiders are trading in conjunction with these events. This paper was accepted by Suraj Srinivasan, accounting.

The Influence of Management’s Internal Audit Experience on Earnings Management

We examine whether firms with managers that have prior internal audit experience are less likely to manage earnings. We find that firms with managers that have internal audit experience are associated with less overall earnings management, driven by lower real earnings management. Importantly, these firms do not trade-off reduced real earnings management with increased accruals-based earnings management. Further tests reveal that this effect is generally strongest when managers with internal audit experience currently hold financial roles or roles with higher power within the company. We also confirm that real earnings management is negatively correlated with future firm performance, as measured by Tobin’s Q and abnormal returns. Overall, these results point to a potentially important benefit of manager internal audit experience, as research suggests that real earnings management is common, difficult to detect, not always within the scope of financial reporting regulators, and detrimental to future performance.

An Empirical Investigation of Non-GAAP Exclusion Quality Indicators

We examine commonly used indicators of low non-GAAP earnings quality and find that, contrary to researchers’ intentions, most indicators identify firm-quarters with excluded earnings components that (1) have relatively low persistence for future firm performance, and (2) improve the value relevance of earnings when excluded. We conclude that existing indicators of non-GAAP earnings quality perform poorly at identifying low-quality non-GAAP earnings. We propose a new indicator that relies on identifying firm-quarters where GAAP earnings quality is high but managers disclose non-GAAP earnings anyway. We find this indicator performs far better at identifying firm-quarters with low-quality non-GAAP earnings. Our results are robust to a variety of specification checks.

The roles of auditors’ report in investors’ decision making in Nigeria

Audit reports are an indispensable element in the decision process of lenders and investors. This work examined the roles of auditors’ report in investors’ decision making in Nigeria. Secondary data was used and descriptive method to analyze the mean, median, maximum, minimum and standard deviation, while Tobin’s Q is applied to measure the influence of independent variables on the dependent variables for future firm performance through unit root test, ADF test and regression equation between both variables. Findings revealed that the auditors’ report has positive effect on the investors’ decision making in Nigeria, which is an indication that lack of proper auditors’ report will lead to poor investors’ decisions. The study recommended that auditors’ report should be detailed and comprehensive because users rely on audit report in making decisions, be it investing and, or financing.

Change and Stability in Industry Architectures: Firm Actions and Performance Effects

This study analyzes performance effects of firm efforts to shape the structure of an industry. We view industry structure through the conceptual lens of industry architectures and posit that firms shape these architectures by carrying out a single or multiple of change- and stability-oriented actions over time. We hypothesize that both types of actions differently affect firm performance and that this relationship is moderated by the predictability, segment conformity, and simplicity of firms’ competitive behavior. To test our hypotheses, we created a unique dataset of airline actions that fostered either stability or change in the flight-ticket distribution architecture and assessed, as a proxy for firm performance, the change these actions cause in investors’ expectations of future firm performance once an action is announced. Our findings reveal that change-oriented actions negatively affect firm performance and that this effect is further exacerbated by simplicity in firms’ competitive behavior, but that stability-oriented actions have an inconclusive effect. Our findings challenge the literature’s overwhelming focus on firm-driven change and its associated benefits and makes an initial effort at identifying the factors that both facilitate firm efforts to shape architecture and influence firm performance.

The impact of economic policy uncertainty on insider trades: A cross-country analysis

This study examines whether economic policy uncertainty affects insider trades. Using data from 22 countries, I find a positive association between economic policy uncertainty and the frequency and volume of insider trades. Moreover, there is a negative relationship between insider trades and future firm performance during periods of high economic policy uncertainty. The effect is larger in firms with a poor information environment, firms with less strict monitoring, and for firms that are more sensitive to economic policy uncertainty. The findings are robust to alternative sample periods, alternative dependent and independent variables, different model specifications, and after including additional country-level factors. Additional analysis suggests that investor sentiment and firm risks increase during periods of high uncertainty. Overall, I provide evidence that increased economic policy uncertainty enlarges the information advantage of insiders, and increases insider trading.

Lead independent directors and investment efficiency

I show that the presence of a lead independent director on the corporate board is positively associated with investment efficiency. The result is more pronounced for firms with weaker corporate governance standards, less transparent financial disclosure, and greater financial constraints. The lead director presence is negatively associated with overinvestment (underinvestment) for firms with large cash balances and low leverage (high cash flow volatility). Moreover, the lead director investment-related committee membership as well as CEO power matter in this setting. The lead director board role is also positively associated with future firm performance.

The Effect of Mandatory Disclosure on Market Inefficiencies: Evidence from FASB Statement No. 161

ABSTRACTPrior research finds that unrealized gains/losses on cash flow hedges are negatively associated with future earnings, and that investors and analysts fail to anticipate this association. These studies speculate that this mispricing is due to either poor derivatives disclosures or the accounting model for cash flow hedges. We examine whether enhanced mandatory derivatives disclosures set forth in FAS 161 improve users' understanding of firms' hedging activities and offer three main findings. First, we find that this mispricing does not persist after FAS 161. Second, we find that the correction of mispricing is greatest when disclosure might help investors most. Finally, we find that analyst forecast accuracy improves after FAS 161. Overall, our results suggest that the enhanced mandatory derivative disclosures required by FAS 161 improved users' understanding of the effects of derivative and hedging activities on future firm performance and firm value—and consequently mitigated investor mispricing.