Future Firm Performance Research Articles

How high-speed railway expands beyond local knowledge search in interdisciplinary innovation: Evidence from China

Breaking through local knowledge search limitations is essential for fostering interdisciplinary innovation. This paper investigates how High-speed Railway (HSR) facilitates these firms in integrating information technology (IT) knowledge from other cities into their innovation processes. By connecting cities through faster transportation, HSR diminishes the constraints of geographical proximity, enabling firms to bypass the traditional reliance on local knowledge clusters and access a broader pool of IT expertise. Utilizing a difference-in-differences (DID) approach, our results reveal that HSR enhances knowledge search scope by improving access to IT resources, increasing human capital mobility, and raising competitive awareness. Additionally, we identify heterogeneity in this effect based on factors such as the marketization level of a firm's location, the degree of digital infrastructure development, whether a firm is located in a provincial capital, and the specific industry sector. Our findings further demonstrate that the expansion of knowledge search scope due to HSR significantly boosts future firm performance. These findings highlight the critical role of transportation infrastructure, exemplified by HSR, in breaking down geographic barriers to interdisciplinary knowledge flows and fostering more dynamic innovation ecosystems.

Risk disclosure, earnings smoothing and firm perceived risk

Purpose This paper aims to examine the association between perceived firm risk and two reporting mechanisms: risk disclosure and earnings smoothing in the UK context. Design/methodology/approach This study juxtaposes three competing views, the “null”, the “divergence” and the “convergence” hypotheses, and empirically investigates whether risk disclosure and earnings smoothing affect firm perceived risk for a sample of large UK firms with rich and poor information environments. This study also uses the global financial crisis as an external shock on overall risk in the economy to investigate when and how managers use these two reporting mechanisms to shape the firm perceived risk. Findings This paper documents that risk disclosures have no significant effect on investors’ risk perceptions, consistent with risk disclosures containing boilerplate and generic statements about firm risk. This paper also finds that earnings smoothing reduces investors’ risk perceptions, reflecting investors’ interpretations about future firm performance. Additional tests reveal that earnings smoothing is not associated with perceived firm risk for firms with rich information environments and expanded risk disclosures. Furthermore, reporting smooth earnings decreases perceived firm risk following the global financial crisis. These findings are robust to alternative specifications and measures of earnings smoothing as well as post-filing perceived firm risk. Research limitations/implications This study does not distinguish between the garbling role and the informational role of earnings smoothing. The risk disclosure measurement used in this study, developed based on UK annual reports, may limit the generalizability of findings to other countries. Practical implications The findings suggest that managers should revise their risk disclosure strategies to provide in-depth details on firm risk. Investors might require information and thorough assessment to evaluate investment risks when firms provide generic risk disclosures and smoothed earnings by consulting sources like financial intermediaries. Regulators should keep an eye on firms reporting boilerplate risk disclosures and on how smoothing earnings impacts the firm perceived risk following economic turmoil, to guide interventions that promote market stability. Originality/value The findings provide new insights into when and how managers use their financial reporting discretion to make firms appear less risky and, therefore, influence investors’ risk perceptions.

Peer Effects of Corporate Disclosures: Evidence From the Registration-Based IPO System in China

China launched the registration-based IPO system in 2019 whereby all firms listed on the newly established STAR board (“peer firms”) are required to disclose specific innovation and industry-related information in their prospectus. Using this event as a quasi-experiment, our study investigates the causal effects of peer firms’ disclosures on individual firms’ disclosure strategy. We find that the precision of individual firms’ management earnings forecast (MEF), both its form and width, significantly decreases when peer firms disclose more information during the IPO period. In cross-sectional analyses, we find this effect to be more pronounced for individual firms that are likely to experience greater competitive pressure from industry peer firms and firms with higher risks and performance uncertainty that make them more cautious to external competitive pressure. This result suggests that peer firms’ disclosures induce greater competitive pressure and uncertainty about future firm performance, triggering managers of individual firms to adopt a more cautious disclosure strategy. Overall, our study extends the literature on the peer effects in corporate disclosure decisions and documents potential unintended consequences of mandatory disclosure policies.

Forward-looking disclosure effects on stock liquidity in China: Evidence from MD&A text analysis

We investigate the impact of forward-looking disclosures in annual reports on stock liquidity in China. Analysis of the MD&A sections within annual reports demonstrate a strong positive correlation between forward-looking disclosures and a company's stock liquidity. This promotional effect appears more pronounced within high-tech companies and those with lower levels of information transparency. Mechanistic tests indicate that the increase in equity liquidity attributable to forward-looking disclosures can be traced to heightened interest from analysts and media coverage. Further examination of the impact of MD&A textual characteristics reveals that improvements in the readability and tone of the text strengthen the effect of forward-looking information on enhancing stock liquidity. Economic consequence tests show that forward-looking disclosures not only enhance stock liquidity but also contribute to expanding investment scale, reducing financing costs, and improving both future firm performance and market valuation. These findings suggest that augmenting the efficiency of capital market information dissemination could significantly bolster financial support for the real economy.

A Study on the Impact of Investor Sentiment on the Relationship between R&D Investment and Future Firm Performance

A Study on the Impact of Investor Sentiment on the Relationship between R&D Investment and Future Firm Performance

Improving the prediction of firm performance using nonfinancial disclosures: a machine learning approach

PurposeThe purpose of this study is to test whether the prediction of firm performance can be enhanced by incorporating nonfinancial disclosures, such as narrative disclosure tone and corporate governance indicators, into financial predictive models.Design/methodology/approachThree predictive models are developed, each with a different set of predictors. This study utilises two machine learning techniques, random forest and stochastic gradient boosting, for prediction via the three models. The data are collected from a sample of 1,250 annual reports of 125 nonfinancial firms in Pakistan for the period 2011–2020.FindingsOur results indicate that both narrative disclosure tone and corporate governance indicators significantly add to the accuracy of financial predictive models of firm performance.Practical implicationsOur results offer implications for the restoration of investor confidence in the highly uncertain Pakistani market by establishing nonfinancial disclosures as reliable predictors of future firm performance. Accordingly, they encourage investors to pay more attention to these disclosures while making investment decisions. In addition, they urge regulators to promote and strengthen the reporting of such nonfinancial information.Originality/valueThis study addresses the neglect of nonfinancial disclosures in the prediction of firm performance and the scarcity of corporate governance literature relevant to the use of machine learning techniques.

The predictive ability of share-based compensation expense

This paper examines the ability of share-based compensation expense (SBCE) to predict future firm performance relative to other employee compensation expenses. It also examines whether cash settled-based compensation expense has greater predictive ability for future performance than equity settled expense. Using a sample of 443 firms listed in the UK between 2005 and 2018, we find that the predictive ability of SBCE is statistically significantly higher than that of other employee compensation expenses. Furthermore, the results show that the predictive ability of SBCE classified as cash settled is statistically significantly higher than that of equity settled SBCE. Overall, our findings suggest that recognised SBCE, particularly cash settled SBCE (i.e. fair value-adjusted expense), is useful for predicting future firm performance.

Complexity of CEO compensation packages

This paper examines complexity in CEO compensation contracts. We develop a measure of compensation complexity and provide empirical evidence that complexity has increased substantially over time. We document that complexity results not only from factors reflecting efficient contracting, but also from external pressures from compensation consultants, institutional investors, proxy advisors, and attempts to benchmark to peers, with these external factors having greater impact in more recent years. Examining consequences of contract complexity, we find an association with lower future firm performance that is related to the influence of external factors on compensation design. We further find this relation is partially mitigated when a contract's performance metrics are more highly correlated, consistent with information processing costs hampering decision-making. Collectively, these findings confirm concerns raised by investors and the media regarding compensation complexity and can inform boards in their design of CEO pay packages.

Impact of initial business model on the growth trajectory of new technology-based firms: a path dependency perspective

AbstractOur study explores links between the initial business model design and the post-founding development of new technology-based firms (NTBFs) through a selection of recently established NTBFs across Sweden, Finland, and France (481 firms). The trajectory of these firms’ performance has been observed and analyzed over the span of five years. The study examines the long-term effects of NTBFs’ initial business model design on their development and the path dependency of these designs on future firm performance. Our results indicate that high-growth and stable NTBFs have distinct initial designs, implying that new firms’ founders and their business design decisions have important consequences for subsequent NTBF development. Specifically, our study examines how business model characteristics impact the growth trajectory of NTBFs by empirically differentiating between the foundational characteristics of high-growth and stable NTBFs. We find that maintaining stable activity is linked to a low level of uniqueness, less demanding business objectives, and a lack of risk while high-growth is related to a larger early access to resources. We propose an explanation using path dependency literature, arguing how early business model choices predetermine long-term growth paths. Our research also provides valuable insights for stakeholders in designing targeted strategies for sustainable development.

New product announcements, innovation disclosure, and future firm performance

AbstractThis study examines the properties of innovation disclosures contained in new product announcements, a form of voluntary, nonfinancial disclosure. We analyze these properties using a novel, text-based measure of the extent of product innovation disclosed in new product announcements. We find that stock prices react more positively to announcements with more extensive innovation disclosure. In our main analyses, we first find that a higher level of innovation disclosure predicts a greater increase in future sales. We further find that this predictive ability falls when managers have stronger incentives to maximize their wealth and when the corporate governance structure and customers’ bargaining power weaken. Our research enhances the understanding of the properties of managerial voluntary, nonfinancial disclosures and contributes a text-based measure of innovation that captures managerial assessment of the extent of product innovation. This new measure is more generalizable and incrementally informative for firm value and future performance than conventional innovation measures that depend on the existence of patents or research and development expenses.

Strategic earnings management in family firms

AbstractWe examine how family firms strategically manage earnings by using discretionary accruals (AEM) and real activities (REM). Using a sample of privately controlled but publicly listed firms in China between 2007 and 2018, we find that, under normal circumstances, family firms are less (more) likely than nonfamily firms to use REM (AEM) for earnings management, and they use REM and AEM as substitutes. However, when firms are under pressure to meet important earnings benchmarks that are critical to the survival of their businesses, family firms increase their use of REM more than do nonfamily firms. Finally, family firms strategically use REM to improve their future firm performance. This study challenges the unidirectional relationship between family firms and earnings management that is typically documented in existing studies.

Disclosure specificity: Evidence from book‐to‐bill ratios

AbstractWe investigate whether managers vary disclosure specificity strategically, by examining how the voluntary disclosure of a key performance indicator, the book‐to‐bill (BTB) ratio (the ratio of orders received to orders billed), varies with future firm performance. Consistent with theoretical predictions from prior research, we find that managers are more likely to provide precise BTB disclosures when the news is positive, while offering less precise disclosures when the news is negative. We find that managers strategically vary specificity more when valuation incentives are higher and monitoring is lower. We find that the tone of qualitative descriptions is informative, with or without precise disclosure, inconsistent with the predictions of strategic withholding models. Our results are consistent with persuasion models in which managers vary the specificity of news strategically, to affect the weight stakeholders place on the signal.

Nonprofessional Investor Judgments: Linking Dependent Measures to Constructs

ABSTRACTThere is limited evidence on the construct validity of the dependent measures commonly used in the literature on nonprofessional investor judgments. In this paper, we first survey the literature to understand the types of dependent measures typically used by researchers. We then conduct factor analyses to uncover linkages between dependent measures and the constructs underlying these nonprofessional investor judgments. Our results suggest that, while the wide variety of dependent measures can appear on their face to represent many nuanced economic constructs, these measures capture three distinct factors. These factors relate to nonprofessional investors’ (1) expectations regarding future firm performance and value, (2) holistic perceptions of the firm, and (3) evaluations of the risk associated with investing in the firm. Next, we provide recommendations for selecting, analyzing, and reporting dependent measures in future research. Finally, we provide directions for future research to further our understanding of the judgments made by investors.

Does high cash compensation compromise the independence of outside directors? Evidence from directors' dissenting votes in China

Using data on directors' voting behaviour in board meetings in China, we examine whether high cash compensation compromises outside directors' independence in markets with weak investor protection. The results show that highly paid outside directors are more likely to vote against proposals sponsored by executives, particularly in firms with weaker monitoring of executives. Highly paid outside directors are also positively associated with cash dividends and future firm performance. Overall, the evidence suggests that high cash compensation reflects the market value of reputable outside directors and reputation concerns motivate outside directors to maintain their independence and challenge executives in board meetings.

Common ownership and executive pay-for-performance sensitivity: Evidence from China

This study focuses on the impact of common ownership on executive pay-for-performance sensitivity using a sample of A-share listed firms in China from 2008 to 2020. We find common ownership significantly improves executive pay-for-performance sensitivity and plays a monitoring and governance role. Meanwhile, the impact of common ownership on executive pay-for-performance sensitivity is more significant in non-state-owned firms (non-SOEs) and when a firm faces a highly competitive product market. The mechanism tests indicate that common ownership affects executive pay-for-performance sensitivity through the information and governance mechanisms. Further analyses show that the portion of compensation explained by common ownership significantly enhances future firm performance. Overall, our findings validate the positive role of common ownership in corporate governance.

Managerial sentiment and predicted and opportunistic special items

AbstractPrior studies suggest that firm managers misclassify core expenses as special items to influence investors’ perception of firm performance. In this investigation, we find that managerial decisions regarding misclassification of expenses are affected by managerial sentiment. Managerial sentiment has a negative relation with special‐item reporting because optimistic (pessimistic) managers pursue a misclassification that is lower (higher) than what is justified by the information available to the manager. By decomposing special items into predicted (PREDSI) and opportunistic (OPSI) components, we find that the effect of managerial sentiment is pronounced among opportunistic special items. Our results show that PREDSI (OPSI) has a non‐negative (negative) relation with future firm performance, and special items associated with managerial sentiment adversely affect future firm performance. We also find results that suggest that financial constraints serve as a channel that reinforces the negative association between managerial sentiment and special items. Specifically, financial constraints impose a limit on how frequently sentiment‐driven managers can misclassify core expenses because misclassifications obscure firm transparency and harm the credit supply. Our results remain consistent after a battery of robustness tests.

Timing is key: When does the market react to unionization efforts?

We estimate short-term capital-market effects of unionization efforts at publicly-listed firms and their subsidiaries in the United States between 2011 and 2019. Our short-horizon event study reports significant negative average cumulative abnormal returns at the public announcement of successful union election certifications. Our results suggest that, on average, the market perceives successful unionization as detrimental to future firm performance, expects unionization efforts, and mainly reacts when all uncertainty is resolved at the publicly-announced certification. Finally, we show that shareholders’ expectations regarding unionization efforts differ for firms with recurrent and rare election cases.

Investment and Firm Performance Variability

Purpose - The study analyzed 90 online firms worldwise and observed them for ten years to investigate their investments and firm performance variabilities. This study attemped to verify the existence of agency problems in online firms. Through this, the paper intends to expand the scope of research in the fields of investment and firm value both empirically and in theory. This study also attempted to supplement the insufficient logic of previous studies by analyzing the relationship between investment and profitability.
 Design/methodology - In this study, the investment is subdivided into over-, under-, and neutral investments, and an empirical analysis of the firm performance was conducted. As investment generally has long-term effects, the impact of a firm's investment on future firm performance and variabilities in firm performance was considered over the short-and medium-term period.
 Findings - It was found that there was a negative relationship between firms with an overinvestment and future firm performance. Underinvestment has no clear statistically significant results on firm performance. This implies that overinvestment causes more reduction in future firm performance than underinvestment. It was also found that underinvestment and overinvestment significantly increased the variability of firm performance. A positive significance was found between under- and over- investment with a variability of 3 years and overinvestment with a variability of 4 years in the future. A negative relationship was found between neutral investment propensity and future performance variabilities. Neutral investment has less effect on the future performance variability of a firm than a firm’s overinvestment and underinvestment. For online firms, underinvestment and overinvestment have a greater effect on the firm's future performance variability than neutral investment.
 Originality/value - The agency theory predicts that information asymmetry and adverse selection problems exacerbate conflicts of interest among stakeholders, thus firm performance. The study contributed to accumulating research on online firms that are currently underexplored by analyzing the investment behavior of major firms in the online industry.

CEO overconfidence and subsequent firm performance an indirect effect via earnings manipulations

Empirical evidence on the indirect effect of chief executive officer (CEO) overconfidence on future firm performance are missing. Corroborating upper echelons theory, this study identifies this effect exploiting the earnings manipulation methods as a mediator. Tobin's Q is used as a proxy for firm performance and financial press-based measure is used to capture CEO overconfidence level through articles counts. Data from 4 European samples listed on Stoxx Europe 600 Index: AEM sample (2305 observations and 461 firms), CFO-REM sample (1770 observations and 354 firms), PR-REM sample (1350 observations and 270 firms) and RD-REM sample (1295 observations and 259 firms), for the period 2010 to 2020 are used to test the mediation model of Baron and Kenny (1986). Evidence reveals that AEM/REM practices partially mediate the relationship between CEO overconfidence and subsequent firm performance. Findings from this paper can be of interest for accounting regulators, since that CEO overconfidence level can impact future performance through AEM and REM. Increasing scrutiny over AEM does not eliminate other modalities. It changes the preference of an overconfident CEO for different strategies even if they are costly for investors.

An analysis of the positive effect of real earnings management on financial performance

PurposeREM models infer abnormal levels of cashflow from operations (AbCFO), selling, general and admin (AbSGA) and production expenses (AbProd) are opportunistic, based on the supposition that engaging in real activities to meet current earnings targets (t) will negatively influence future performance (t+1). However, from a firm productivity perspective, cost reduction (via AbCFO, AbProd and AbSGA) is interpreted as an efficiency enhancing business strategy. This study therefore differentiates between (1) firms with ineffective management that have engaged in AbCFO, AbProd and AbSGA to achieve an optimal resource-cost mix to generate sales (REMF) and (2) firms with effective management that have not (OEF).Design/methodology/approachUsing a sample of Korean listed firms over the 2000–2016 sample period, the study utilizes data envelopment analysis to capture the capability of management to generate sales from resources that are directly under their control. The study then compares the incremental effect that managerial decision making can have on real earnings management (REM) and future firm performance (period t+1 to t+5).FindingsThe study makes two important contributions. First, consistent with the efficiency/productivity literature, but contrary to seminal REM studies, empirical results shows that AbCFO, AbProd and AbSGA improve firm performance in period t and t+1 (to t+5), demonstrating “REM” is not opportunistic by default. Second, OEF have higher financial performance compared to REMF, in periods t and t+1.Originality/valueThe study therefore invokes resource-based theory and data envelopment analysis to integrate managerial effectiveness (human capital) into REM modelling. The study therefore extends the basic REM residual model.