Opaque Information Environment Research Articles

Corporate Governance, Tax Avoidance, and Financial Constraints

AbstractWe examine how corporate governance affects the relationship between corporate tax avoidance and financial constraints. Conditional on having poor governance, tax avoidance is associated with greater financial constraints and a greater likelihood of financial distress. In firms with strong governance, however, we find that tax avoidance does not have a negative impact on financial constraints. Our results suggest that tax avoidance is a less useful source of financing for constrained firms when they are plagued with potential agency problems and opaque information environments. Stronger governance mechanisms can help firms mitigate the negative consequences of tax avoidance.

Institutional Ownership and Stock Liquidity: International Evidence

AbstractThis paper investigates the relation between institutional ownership and stock liquidity, and explores whether this relation differs across institutional settings. Using a comprehensive data set across 41 countries from 2000 to 2010, we find that institutional ownership is positively correlated with stock liquidity. Importantly, the positive association between institutional ownership and stock liquidity is stronger (weaker) for firms in countries with opaque (transparent) information environments or poor (good) institutional characteristics. Our additional analysis reveals that the positive association between institutional ownership and liquidity is attributable to non‐block institutional investors.

Innovation, financial reporting quality, and audit quality

We examine the relation between innovation and financial reporting quality (FRQ) and the implications of audit quality for this relation. We first document a negative relation between innovation and FRQ. This result is consistent with greater earnings management at higher innovation firms, likely because of the more opaque information environment that gives managers the opportunity to act opportunistically. We then examine whether audit quality moderates the observed negative relation between innovation and FRQ because audit quality constrains managers’ opportunities to manage earnings. We find results consistent with the predicted moderating effect. Lastly, we verify that these findings hold in a difference-in-differences test designed around an exogenous event, state R&D tax credits.

Do Government Subsidies Affect Income Smoothing?

This study examines the relationship between government subsidies and income smoothing using a sample of US listed firms. We find that subsidized firms smooth their earnings more aggressively than their unsubsidized peers, consistent with firms that receive subsidies bearing higher political costs and having more incentives to smooth earnings to avoid public attention. Smoothing by subsidized firms is more pronounced when the subsidies are granted through non-tax-related channels than tax-based channels, and for firms with more opaque information environments. In addition, smoothing by subsidized firms reduces the ability of current earnings to predict future cash flows. Using textual content analysis, we find that the MD&As of subsidized firms provide less explanatory content to explain accruals, consistent with smoothing being used to obfuscate earnings. Overall, our results shed light on how government subsidies shape the accounting and disclosure choices of firms.

Takeover Threats, Job Security Concerns, and Earnings Management

Exploiting the staggered adoption of country-level takeover laws that increased takeover threats, this paper examines whether the resulting increase in CEOs’ job security concerns leads to greater earnings management. Using a difference-in-difference design, I find that the enactment of laws designed to promote takeover activity is associated with greater earnings management activities (abnormally high accruals, target beating, and poor accruals quality). Furthermore, these activities contribute to increased opacity, as liquidity declines significantly (increased bid-ask spread, percentage of zero-return days, and price impact of trades) following takeover regulation. Impact on earnings management is most pronounced for managers facing the greatest risk of termination at the time of takeover law implementation – those who had been leading firms with poor performance, displaying higher inherent turnover risk, working in a merger intense industry, or working in a country-industry with heavy product market competition. However, strong institutions that can limit CEOs’ ability to manipulate accounting information mitigate the earnings management effects of takeover laws. Overall, my results suggest that reforms aimed at enhancing the monitoring role of governance have unintended consequences because these reforms increase CEOs’ job security concerns and thereby lead to greater earnings management and a more opaque information environment.

The Relationship between Product Market Competition and Corporate Earnings Quality

This paper empirically analyzes the relationship between product market competition and earnings quality of firms listed on the Korea Exchange from 1999 to 2015. The proxy variable for product market competition is the industrial concentration measured by the Herfindahl -Hirschman index, while industry homogeneity on the other hand is measured using the partial correlation coefficients among firms’ common stock returns within the industry. Earnings quality is estimated using the Dechow, Sloan and Sweeney (1995) model, the Dechow, Kothari and Watts (1998) CFO model, the Kothari, Leone and Wasley (2005) ROA-performance -matched-discretionary-accrual model, and their aggregate measure. The empirical results are as follows. First, product market competition has positive and significant effects on earnings quality, implying that firms from more competitive industries are associated with a higher level of earnings quality. Second, the earnings of firms operating in concentrated and homogeneous industries are associated with a lower level of earnings quality than are those of firms operating in concentrated and heterogeneous industries. This result suggest that firms facing less competition tend to create a more opaque information environment to protect their competitive advantage. These findings imply that product market competition may be recognized as a new mechanism which has a significant effect on earnings quality in the Korean capital market.

The Good in Being Notoriously Bad: Repeated Acts of Corporate Illegality and Investor Reactions

When news about a firm’s illegal behavior become public, investors face considerable difficulties in assessing the magnitude of its impact on the offender’s financial performance. Facing this opaque information environment, investors are likely to look for alternative informational cues. Research on organizational reputation and cognition suggests that a firm’s “criminal history” (i.e., the number of its prior illegal acts) may convey important information to investors about whether the focal allegation is warranted and whether the alleged illegal act is likely to remain a one-off event. Based on an in-depth analysis of illegal acts in the U.S. utilities industry over a 28-year time horizon, we find support for the proposition that a firm’s criminal history influences investor reactions to newly detected illegal acts. Investors penalize firms with no or a minor criminal history less severely. Interestingly, however, we also find that investors react less negatively to new illegal acts involving firms with extensive criminal histories than to new acts involving firms with moderate criminal histories. We further find that the pervasiveness of corporate illegality in the industry and prior firm acquittals alter the effect of recidivism on investor reactions. Collectively, our study thus answers recent calls to explore the role of recidivism in the context of corporate illegality and provides some evidence for positive side effects of a bad corporate reputation.

Consequences of Low-Quality Audits for Engagement Partners

We investigate the consequences of low-quality audits for engagement partners in the US and the role audit firm quality control systems play in this process. We employ a sample period during which the identity of the engagement partner on specific audits is not publicly known to isolate the effect of quality control systems on partner management. We find that restatements result in partner changes for both restating and non-restating clients. Because the identity of the partner on an audit is not publicly known, non-restating clients may not be fully aware of the restatements associated with their engagement partners. We find that audit firms with ineffective partner quality control systems take advantage of this opaque information environment and do not replace low quality partners, especially if the partners can bring in large audit fees. Even if these audit firms replace the partner, they do not supply a new partner with higher quality. Our results highlight the importance of an effective quality control system in disciplining partners. When audit firm quality control systems fail, enhanced transparency through disclosing the identity of the engagement partner may be necessary in disciplining the auditing labor market.

The determinants and pricing of liquidity commonality around the world

In this paper, we examine the determinants and pricing of liquidity commonality using intraday data from 39 markets over 15 years. We show that liquidity commonality is driven by both market-level and firm-level factors. Liquidity commonality is higher in weaker and more-volatile economic and financial environments, in areas with poor investor protection, and in opaque information environments. Liquidity commonality is also affected by cultural and behavioral factors, including individualism and uncertainty avoidance. Moreover, we find that liquidity commonality is priced in the world's stock markets and that the pricing effect is stronger in developed markets.

Analyst coverage and corporate tax aggressiveness

Abstract We examine the impact of analyst coverage on corporate tax aggressiveness. To address endogeneity concerns, we perform a difference-in-differences analysis using a setting which causes exogenous decreases in analyst coverage. Our tests identify a negative causal effect of analyst coverage on tax aggressiveness, suggesting that higher analyst coverage constrains corporate tax aggressiveness. Further cross-sectional variation tests find that this constraining effect on tax aggressiveness is more pronounced in firms with lower investor recognition and firms with more opaque information environments. Our results are consistent with the notion that higher analyst coverage increases the visibility of aggressive tax planning behavior as well as heightens analysts’ demand for more transparent information, which in turn reduces tax aggressiveness.

The effects of firms’ information environment on analysts’ herding behavior

We find financial analysts herd to a greater degree in firms with more opaque information environments as measured by the incidence of short-term institutional investors present. The S-statistic, a measure of forecast bias, and forecast timing and quality metrics are used to measure analyst herding behavior. The results are consistent with the notion that opaque information environments are more conducive to analysts engaging in reputational herding behavior where more capable analysts act first and less capable analysts follow. Additionally, analysts are more likely to issue forecast revisions subsequent to management earnings guidance in less opaque environments. Robustness tests indicate our operational measure of opacity is not subsumed by other measures of the information environment, namely information asymmetry.

Do Social Networks Encourage Risk-Taking? Evidence from Bank CEOs

This paper studies how CEO social networks affect bank risk-taking. Using a sample of 481 publicly traded U.S. banks, we find that bank risk increases with CEOs’ social networks. Our results are robust with a bank fixed-effects model and a difference-in-difference approach, as well as with various alternative bank risk measures. Alternative explanations such as corporate governance, managerial ownership, compensation, or CEO ability do not drive the findings. We evaluate potential channels through which social networks affect bank risk and find that CEO social networks increase bank risk more when banks face opaque information environments, when CEO job market conditions worsen, and when there are higher odds of group-think mentality in the networks. We further find that social networks present banks with an inefficient trade-off between risk and return, showing a “dark side” of social networks.

The Effect of CEO Power on the Informativeness of Stock Prices: An Empirical Note

Motivated by agency theory, we explore how powerful CEOs influence the extent of stock price informativeness. Using idiosyncratic volatility to measure stock price informativeness, we find that firms with more powerful CEOs experience a more opaque information environment. This is consistent with the notion that more powerful CEOs tend to be more entrenched and are more likely to take actions that do not maximize shareholders’ wealth. To conceal their opportunistic actions, they are less likely to disclose information, resulting in more information asymmetry and therefore lower stock price informativeness. Our additional results based on propensity score matching also confirm the conclusion.

Cross-listings and liquidity commonality around the world

In this paper, we investigate the effects of international cross-listings on commonality in liquidity. We find that cross-listings have asymmetric effects on cross-listed stocks׳ liquidity commonality that include reducing the stocks׳ liquidity commonality with the local market and increasing the stocks׳ liquidity commonality with the host market. We also find that the negative impact of cross-listings on home liquidity commonality is more pronounced for stocks from countries with high market segmentation, an opaque information environment, and a poor institutional infrastructure. These results suggest that cross-listings reduce the vulnerability of stocks׳ liquidity to aggregate liquidity shocks in the local market.

Industry concentration and corporate disclosure policy

This study examines the association between U.S. Census industry concentration measures and the informativeness of corporate disclosure policy. We find that in more concentrated industries firms׳ management earnings forecasts are less frequent and have shorter horizons, their disclosure ratings by analysts are lower, and they have more opaque information environments, as measured by the properties of analysts׳ earnings forecasts. Also, when these firms raise funds they prefer private placements, which have minimal SEC-mandated disclosure requirements, over seasoned equity offerings. Overall, our findings suggest that firms in more concentrated industries disclose less and avoid certain financing decisions that have non-trivial disclosure implications, presumably due to proprietary costs of disclosure.

Social Concentration on Boards, Corporate Information Environment and Cost of Capital

AbstractPrior evidence on the relationship between demographic diversity in corporate boards and firm performance is mixed. Some studies have found that the relationship between board attributes and firm performance is driven by a firm's information environment. This study examines whether corporate transparency also impacts the relationship between gender and ethnic diversity of directors and firm performance. To test this hypothesis, I use a Herfindahl Index based on directors’ gender and ethnicity to measure board diversity, and an opacity index based on analyst following, analyst forecast error, bid‐ask spread, and share turnover to measure corporate transparency. I find that the cost of capital is positively associated with social concentration on corporate boards and that this premium is larger for highly opaque firms. In further analysis, I find that the interaction of corporate information environment and social concentration on boards is more important for operationally complex firms. Compared with simple firms, operationally complex firms pay a greater premium on their capital if they have a socially concentrated board and an opaque information environment.

An exploratory study of earnings management detectability, analyst coverage and the impact of IFRS adoption: Evidence from China

Analysts serving as external monitors to managers is a topic of considerable interest in the analyst coverage literature. There are two outcomes of analyst coverage studies: curbing and stimulating earnings management. However, recent studies (such as Yu, 2008) only provide evidence supporting the curbing side. Given the fact that the data of these studies focus on developed markets and the finding of Rodríguez-Pérez and Hemmen (2010) that external governance mechanisms may stimulate earnings management in an opaque information environment, we conjecture whether stimulating side would be dominant in emerging markets. China offers a valuable setting for us to test the question. Using the data of China capital market from 2003 to 2009, we find that analyst coverage stimulates earnings management through above-the-line items (ALIs) where earnings management cannot be easily detected, and curbs earnings management through below-the-line items (BLIs) where earnings management can be easily detected. We also find that the adoption of International Financial Reporting Standards (IFRS) in China does create many new opportunities for managers’ earnings management but does not significantly improve the monitoring effect of analyst coverage. We only find that compared to those without analyst coverage, firms with analyst coverage have a lower level of earnings management through BLIs after IFRS adoption. These findings suggest that information opacity may weaken the monitoring effect of external corporate governance mechanisms and high quality accounting standards in the literal sense may not enhance the monitoring effect of external corporate governance mechanisms if it is not compatible with the market’s institutional environment. In addition, we find that firms with earnings meeting the benchmark have a lower level of earnings management, which indicates that bright-line accounting based rules used in emerging capital markets may constrain the managers’ behavior.

Monitoring or Pressure: The Impact of Analyst Coverage on Corporate Tax Avoidance

We examine the impact of analyst coverage on corporate tax aggressiveness. To address endogeneity concerns, we perform a difference-in-differences analysis using a setting which causes exogenous decreases in analyst coverage. Our tests identify a negative causal effect of analyst coverage on tax aggressiveness, suggesting that higher analyst coverage constrains corporate tax aggressiveness. Further cross-sectional variation tests find that this constraining effect on tax aggressiveness is more pronounced in firms with lower investor recognition and firms with more opaque information environments. Our results are consistent with the notion that higher analyst coverage increases the visibility of aggressive tax planning behavior as well as heightens analysts’ demand for more transparent information, which in turn reduces tax aggressiveness.

Managerss Pay Duration and Voluntary Disclosures

In this paper, we examine the effect of managers’ pay duration on firms’ voluntary disclosures. Pay duration refers to the average period that it takes for managers’ annual compensation to vest. We hypothesize and find that pay duration can incentivize managers to provide more bad news earnings forecasts. This result holds after controlling for the level of stock-based compensation and the endogeneity of pay duration. In addition, we find that the effect of pay duration is more pronounced for firms with weaker governance and for firms with a more opaque information environment, where the marginal benefits of additional disclosures are higher. Our additional analyses indicate that managers with a longer pay duration issue more accurate earnings forecasts. Overall, our paper contributes to the literature by documenting that lengthening the vesting periods of managers’ compensation can induce managers to be more forthcoming with bad news.

The Real Effects of Opacity: Evidence from Tax Avoidance

This study provides evidence on a significant real consequence of an opaque financial reporting information environment: increased corporate tax avoidance. Using an international sample of firms, I find that firms with a more opaque information environment, as measured at both the firm and country level, exhibit higher levels of firm-specific tax avoidance. More importantly, additional tests using the adoption of International Financial Reporting Standards (IFRS) as an exogenous shock to the information environment while simultaneously controlling for tax regime changes around the date of IFRS adoption provide direct evidence on the direction of the association, namely that opacity causes tax avoidance. Similarly, the results from tests using the initial enforcement of insider trading laws provide additional support for a directional hypothesis. In support of the firm-level findings, I also find evidence in the aggregate that opacity is associated with countries collecting less corporate tax revenues as a percentage of gross domestic product. In whole, these findings suggest that tax avoidance is a significant real effect of opacity with implications for practitioners, regulators, researchers, and tax-enforcement agencies.