Charles McClure

Competition Enforcement and Accounting for Intangible Capital
Date Posted:Wed, 12 Jun 2024 12:56:08 -0500
Antitrust laws mandate regulatory review of mergers and acquisitions (M&A) when the book value of the acquired assets exceeds a specified threshold. However, these policies overlook the fact that accounting standards do not allow firms to recognize most internally generated intangible capital as assets. We show this omission leads to hundreds of acquisitions of intangible capital-intensive firms-mostly in the pharmaceutical and technology sectors-to go unreported to antitrust authorities each year. Consistent with the potentially anticompetitive nature of these acquisitions, we document that acquirers in unreported deals in developed markets achieve higher equity values, markups, and technological rents. We also show unreported deals in undeveloped pharmaceutical markets exhibit anticompetitive behavior. These deals are nearly three times more likely to consolidate overlapping drug projects, and acquirers are more than three times as likely to terminate these overlapping projects as compared with reported deals. Furthermore, this behavior encourages "copycat" drugs at the expense of novel projects. Our results suggest the growth of intangible assets may exacerbate market consolidation through unreported mergers in the sectors most concerning to consumers.

Information Supporting Investor Valuations: Evidence from a Comparative Content Analysis of Analyst Reports and Form 10-K
Date Posted:Tue, 19 Mar 2024 15:11:37 -0500
We address whether financial reports include information supporting investor valuations. We view analyst reports (AR) as reflecting this information and employ topic modeling to compare the contents of AR and Form 10-K. Our main findings follow. (i) Form 10-K focuses heavily on financial reporting, whereas AR focuses most on performance, followed by analysis, and business. However, AR discusses financial reporting almost as much as business, which suggests financial reporting is a crucial component of AR. The proportion of AR and Form 10-K dedicated to each category of topics has been converging since 2005. (ii) For topics within the performance category, AR and Form 10-K both focus most on revenues and margins. As expected, Form 10-K focuses more than AR on earnings and expenses, whereas AR focuses more on ratios, target prices, recommendations, and adjusted earnings. How AR and Form 10-K discuss performance topics diverged early in our sample. (iii) Form 10-K?s MD&A section focuses more than AR on performance, analysis, and business, which suggests MD&A discussion resembles AR discussion. (iv) AR and Form 10-K are more similar for loss firms. Additionally, technology firms exhibit similar differences in AR and Form 10-K as nontechnology firms. Together, our findings reveal financial reports include information supporting investors? valuations, which is inconsistent with financial reports lacking relevance.

Accounting for Goodwill
Date Posted:Fri, 03 Nov 2023 19:05:05 -0500
A significant portion of a merger?s purchase price is allocated to goodwill. Currently, goodwill is not amortized but tested annually for impairment. When managers care about earnings, goodwill?s accounting treatment can have large effects on future earnings and may influence how much a manager will bid for a target company. We quantify the effects of goodwill accounting by estimating a structural model of corporate takeovers. Our estimates suggest that accrual accounting increases buyout premia by an average of nearly 10 percentage points. If firms needed to amortize goodwill over 10 years, we estimate premia would reduce by 6 percentage points and M&A volume would shrink by 4.29% or $68.6 billion per year. Furthermore, the fraction of private equity acquirers increases by 7.74 percentage points, shifting control over productive assets to the private and financial sector. Our results suggest the accounting treatment for goodwill has a meaningful effect on the market for corporate control.

Accounting for Goodwill
Date Posted:Tue, 17 Oct 2023 13:19:18 -0500
A significant portion of a merger?s purchase price is allocated to goodwill. Currently, goodwill is not amortized but rather tested annually for impairment. When managers of acquiring firms care about earnings, goodwill?s accounting treatment can have large effects on future earnings and may influence how much a manager will bid for a target company. We quantify the effects of goodwill accounting by estimating a structural model of corporate takeovers. Our estimates suggest accrual accounting increases buyout premia by an average of approximately 12 percentage points. If firms needed to amortize goodwill over 10 years, we estimate premia would reduce by 6 percentage points and M&A volume would shrink by 4.4% or $71 billion per year. Furthermore, the fraction of private equity acquirers would increase by 7.3 percentage points, shifting control over productive assets to the private and financial sector. Our results suggest the accounting treatment for goodwill has a meaningful effect on the market for corporate control.

Examining the Effects of the Tax Cuts and Jobs Act on Executive Compensation
Date Posted:Wed, 08 Mar 2023 15:48:42 -0600
As part of the Tax Cuts and Jobs Act (TCJA), the US Congress repealed a long-standing exception that allowed companies to deduct executives? qualified performance-based compensation in excess of $1 million. The purpose of this study is to examine whether Congress achieved its stated objective of reversing a shift in executive compensation away from cash compensation and towards performance pay, which Congress believed led executives to focus on short-term results rather than the long-term success of the company. Across a battery of tests, including a difference-in-differences design that exploits the staggered time-series implementation of the deduction limit, we find evidence compatible with the new deduction limit having no effect on executives? salary, performance pay or total compensation, inconsistent with Congressional intent. Our results suggest that taxes are not a first-order effect of executive pay and that tax regulation could be relatively ineffective at curbing executive compensation.

Diversity Washing
Date Posted:Mon, 12 Dec 2022 16:49:44 -0600
We provide large-sample evidence on whether U.S. publicly traded corporations use voluntary disclosures about their commitments to employee diversity opportunistically. We document significant discrepancies between companies' external stances on diversity, equity, and inclusion (DEI) and their hiring practices. Firms that discuss DEI excessively relative to their actual employee gender and racial diversity (?diversity washers") obtain superior scores from environmental, social, and governance (ESG) rating organizations and attract more investment from institutional investors with an ESG focus. These outcomes occur even though diversity-washing firms are more likely to incur discrimination violations and have negative human-capital-related news events. Our study provides evidence consistent with growing allegations of misleading statements from firms about their DEI initiatives and highlights the potential consequences of selective ESG disclosures.

REVISION: Non-GAAP Reporting and Investment
Date Posted:Mon, 23 May 2022 14:03:55 -0500
When investors use GAAP earnings to value firms’ shares, managers’ investments into intangible assets become sensitive to transitory earnings. Non-GAAP earnings can remove these transitory earnings, and thus improve investment efficiency, but also introduce opportunistic bias, and thus hide inefficient investment. We quantify this trade-off by estimating a dynamic model in which a manager makes investment and non-GAAP disclosure decisions. We find the manager’s ability to bias non-GAAP earnings creates inefficient investment choices and destroys firm value. We estimate the magnitude of overinvestment at 6% and the corresponding loss in the average firm value at just under 1%.

REVISION: Examining the Effects of the TCJA on Executive Compensation
Date Posted:Fri, 29 Apr 2022 14:39:29 -0500
As part of the “Tax Cuts and Jobs Act” (TCJA), Congress repealed a long-standing
exception that allowed companies to deduct executives’ qualified performance-based
compensation in excess of $1 million. The purpose of this study is to examine whether Congress
achieved its stated objective of reversing a shift in executive compensation away from cash
compensation and towards performance pay, which Congress believed led executives to focus on
short-term results rather than the long-term success of the company. Across a battery of tests,
including a difference-in-differences design that exploits the staggered time-series
implementation of the deduction limit, we find evidence compatible with the new deduction limit
having no effect on executives’ salary, performance pay or total compensation, inconsistent with
Congressional intent.

REVISION: Disclosure Processing Costs and Market Feedback around the World
Date Posted:Tue, 26 Apr 2022 11:26:35 -0500
We study how changes in disclosure processing costs affect managers’ ability to learn from their own firms’ stock prices. To provide evidence on this issue, we examine country-level adoptions of centralized electronic disclosure systems (CEDS). These systems, which digitize and centralize firm disclosures, reduce disclosure processing costs for investors. We find a significant decrease in managers’ investment sensitivity to price following the adoption of CEDS, consistent with managers relying less on the information contained in their firms’ stock prices for their investment decisions. We observe this decrease is most pronounced in countries with the largest reductions in information processing costs. We provide evidence that the decrease is directly attributable to CEDS crowding out investors’ private-information production and indirectly to improvements in the relative informativeness of peer disclosures and prices. Overall, our results show that disclosure technologies that ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Fri, 22 Apr 2022 09:27:52 -0500
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting items and find no decline in combined value relevance from 1962 to 2018. We assess evolution in each item’s value relevance and find increases, most notably for items related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant items also increases. We also consider separately new economy, old economy profit, and old economy loss firms. The trends are more pronounced for, but extend beyond, new economy firms. We base inferences on a non-parametric approach that does not require specifying the valuation relation. Taken together, our findings reveal an evolution to a more nuanced, but not declining, relation between accounting information and share price.

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Tue, 22 Feb 2022 04:03:41 -0600
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance from 1962 to 2018. We assess evolution in each amount’s value relevance and find increases, most notably for amounts related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant amounts also ncreases. We also consider separately new economy, old economy profit, and old economy loss firms. The trends are more pronounced for, but extend beyond, new economy firms. We base inferences on a non-parametric approach that does not require specifying the valuation relation. Taken together, our findings reveal a more nuanced, but not declining, relation between share price and accounting information that reflects the new economy.

Demand for Stocks and Accounting Information
Date Posted:Wed, 02 Feb 2022 17:41:54 -0600
We use equity portfolio allocation decisions to study the relevance of accounting information for investors? demand for stocks. Investors? revealed preferences indicate that operating profit dominates gross profit and net income in explaining the aggregate demand for stocks. Further, accrual-based profitability measures dominate and largely subsume cash-based measures. However, these conclusions do not hold for investor-specific demands. We document significant heterogeneity across investors in the demand relevance of profitability measures. We predict and find that the relevance of accounting information varies as a function of investors? objectives. Furthermore, our findings reveal that individual investors? demands have an important effect on the equilibrium relation between stock prices and accounting profits.

REVISION: How Costly Is Tax Avoidance? Evidence from Structural Estimation
Date Posted:Thu, 02 Dec 2021 20:13:39 -0600
I develop a structural model to quantify the costs of tax avoidance. In the model, the firm trades off tax savings with tax-audit risk, financial-reporting considerations, and operational frictions imposed by tax avoidance, the last of which I label as non-tax costs. The estimated parameters suggest non-tax costs, which are difficult to observe, decrease pretax income by 6.4%, or $58 million per firm-year. The large magnitude of this estimate can explain why firms appear to under-utilize tax-avoidance strategies. Through counterfactual analysis, I estimate the effect of tax-audit risk and financial-reporting considerations to find that financial-reporting considerations have an effect on tax avoidance similar to the penalties imposed by tax authorities. Overall, the estimated parameters help explain the “undersheltering ...

REVISION: How Costly Is Tax Avoidance? Evidence from Structural Estimation
Date Posted:Tue, 23 Nov 2021 22:11:30 -0600
trades off tax savings with tax-audit risk, financial-reporting considerations, and operational
frictions imposed by tax avoidance, the last of which I label as non-tax costs. The estimated parameters suggest non-tax costs, which are difficult to observe, decrease pretax income by 6.4%, or $58 million per firm-year. The large magnitude of this estimate can explain why firms appear to under-utilize tax-avoidance strategies. Through counterfactual analysis, I estimate the effect of tax-audit risk and financial-reporting considerations to find that financial-reporting considerations have an effect on tax avoidance similar to the penalties imposed by tax authorities. Overall, the estimated parameters help explain
the “undersheltering ...

REVISION: Disclosure Processing Costs and Market Feedback Around the World
Date Posted:Tue, 26 Oct 2021 08:30:50 -0500
We study how disclosure processing costs affect managers’ ability to learn from their own firms’ stock price and incorporate this information into their investment decisions. To provide evidence on this issue, we examine country-level adoptions of centralized electronic disclosure systems. These systems, which digitize and centralize firm disclosures, are among regulators’ most critical technological interventions to reduce disclosure processing costs for investors. Consistent with CEDS crowding out investors’ private-information acquisition, which induces managers to learn less from their stock price, we find a significant decrease in managers’ investment sensitivity to price following these adoptions. Leveraging country-level variation, we also show these effects are heterogeneous across several country-specific dimensions. We find that decreased managerial learning is greatest in places that benefit most from CEDS: smaller and more opaque countries and those with better-developed ...

REVISION: Non-GAAP Reporting and Investment
Date Posted:Fri, 18 Jun 2021 08:47:30 -0500
Managers’ incentives depend on their firms’ stock prices, which are often determined by investors using earnings. When investors use GAAP earnings, managers’ investment decisions into internally generated intangible assets become sensitive to the transitory items in these earnings. Non-GAAP earnings can remove these transitory items, and thus improve investment efficiency, but also introduce opportunistic bias, and thus hide inefficient investment. We quantify this trade-off by estimating a dynamic model in which a manager makes investment and non-GAAP disclosure decisions and where investors rationally anticipate his incentives. We find the manager’s ability to distort non-GAAP earnings creates inefficient investment choices and destroys firm value. We estimate the magnitude of the loss in the average firm value at just under 1%.

REVISION: Examining the Effects of the TCJA on Executive Compensation
Date Posted:Tue, 16 Mar 2021 11:19:52 -0500
As part of the “Tax Cuts and Jobs Act” (TCJA), Congress repealed a long-standing exception that allowed companies to deduct executives’ qualified performance-based compensation in excess of $1 million. The reason for the change was to reverse a shift in executive compensation away from cash compensation and towards performance pay, which Congress believed led executives to focus on short-term results rather than the long-term success of the company. The purpose of this study is to test the efficacy of this provision as part of the TCJA. Across a battery of tests, including a difference-in-differences design that exploits the staggered time-series implementation of the deduction limit, we find little evidence that the average firm changed the level or structure of CEO compensation after the TCJA as Congress intended. Overall, our findings suggest this change was ineffectual as enacted. Our results have implications for future policymakers who endeavor to adjust pay inequality or ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Tue, 02 Mar 2021 11:21:51 -0600
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance from 1962 to 2018. We assess evolution in each amount’s value relevance and find increases, most notably for amounts related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant amounts also increases. We also consider separately new economy, old economy profit, and old economy loss firms. The trends are more pronounced for, but extend beyond, new economy firms. We base inferences on a non-parametric approach that does not require specifying the valuation relation. Taken together, our findings reveal a more nuanced, but not declining, relation between share price and accounting information that reflects the new economy.

REVISION: Peer-Group Choice, Chief Executive Officer Compensation, and Firm Performance
Date Posted:Fri, 19 Feb 2021 03:40:03 -0600
We examine the selection of peer groups that boards of directors use when setting CEO compensation. The challenge is to ascertain whether peer groups are selected to (i) attract and retain executive talent and/or (ii) enable rent extraction by inappropriately increasing compensation. We find that the inferences in prior research are based on questionable methodological choices and do not generalize with an expanded sample. After addressing these concerns, we find that, on average, excess peer compensation has a negative association with future firm operating performance. However, significant variation in CEO talent and corporate governance exists within the cross-section of firms. The negative association between excess peer compensation and future performance is mitigated when the firm has a high level of CEO talent, and exacerbated when the firm has low-quality corporate governance. Thus, the economic consequences of peer-group choice are highly contextual. In general, we find that ...

REVISION: Non-GAAP Reporting and Investment
Date Posted:Mon, 08 Feb 2021 07:44:02 -0600
When managers care about their firms’ stock prices, their investment decisions become sensitive to transitory items in GAAP earnings. Non-GAAP earnings can remove these transitory items, and thus improve investment efficiency, but also introduce opportunistic bias, and thus hide inefficient investment. We quantify this trade-off by estimating a dynamic model in which a manager makes investment and non-GAAP disclosure decisions, and where investors rationally anticipate his incentives. We find the manager’s ability to distort non-GAAP earnings creates inefficient investment choices and destroys firm value.We estimate the magnitude of the loss in the average firm value at just under 1%.

Information Acquisition Costs and Price Informativeness: Global Evidence
Date Posted:Mon, 25 Jan 2021 20:53:38 -0600
We study how global changes in information acquisition costs through disclosure technologies affect price informativeness with respect to earnings news. To provide evidence on this issue, we examine worldwide adoptions of centralized electronic disclosure systems, which significantly reduce the cost and broaden access to financial disclosures. Consistent with extant theory, we show a significant reduction in private information acquisition before earnings announcements and an increase in price reaction at the time of the announcement after the introduction of these platforms. These effects are most pronounced in countries with the most substantial reductions in information acquisition costs and where we find more significant decreases in informed trade. Overall, we highlight an important, unintended cost of broadening financial disclosures through technology adoptions.

REVISION: Disclosure Processing Costs and Market Feedback Around the World
Date Posted:Mon, 25 Jan 2021 10:56:31 -0600
Investors' incentive to acquire private information—and the extent it is reflected in price—is a function of disclosure processing costs. Theory predicts that if these costs change, the amount the manager can learn from price will also vary. To provide evidence on this issue, we exploit the worldwide introduction of centralized electronic disclosure systems, which, like the SEC's EDGAR, substantially reduces disclosure processing costs. Leveraging country- and firm-level variation resulting from these platforms' adoptions, we find an economically significant decrease in investment sensitivity to price. Moreover, we find that higher levels of country-wide technology use, more developed capital markets, and better regulatory environments mute this decline in investment sensitivity to price. Collectively, our findings show that technology adoptions that reduce disclosure processing costs have real effects on the economy.

REVISION: Peer-Group Choice, Chief Executive Officer Compensation, and Firm Performance
Date Posted:Fri, 18 Dec 2020 11:18:25 -0600
We examine the selection of peer groups that boards of directors use when setting CEO compensation. The challenge is to ascertain whether peer groups are selected to (i) attract and retain executive talent and/or (ii) enable rent extraction by inappropriately increasing compensation. We find that the inferences in prior research are based on questionable methodological choices and do not generalize with an expanded sample. After addressing these concerns, we find that, on average, excess peer compensation has a negative association with future firm operating performance. However, significant variation in CEO talent and corporate governance exists within the cross-section of firms. The negative association between excess peer compensation and future performance is mitigated when the firm has a high level of CEO talent, and exacerbated when the firm has low-quality corporate governance. Thus, the economic consequences of peer-group choice are highly contextual. In general, we find that ...

REVISION: Examining the Immediate Effects of Recent Tax Law Changes on the Structure of Executive Compensation
Date Posted:Thu, 30 Jul 2020 03:11:25 -0500
We exploit a recent law change to examine the relation between corporate taxes and executive compensation. The “Tax Cuts and Jobs Act” (TCJA) lowered the corporate tax rate from 35 to 21 percent and repealed a long-standing exception that allowed companies to deduct executives’ qualified performance-based compensation in excess of $1 million. These changes are effective for tax years beginning after December 31, 2017. Using a difference-in-differences design, we find no evidence that the average firm affected by the TCJA in their 2018 fiscal years changed compensation relative to control firms not subject to the new regime until their 2019 fiscal years. We find limited evidence of a reduction in total compensation among less than 10 percent of treated firms. We execute a battery of tests to validate these results. Overall, our findings suggest the tax benefits of executive compensation do not outweigh non-tax considerations when firms structure pay.

REVISION: How Costly Is Tax Avoidance? Evidence from Structural Estimation
Date Posted:Thu, 23 Jul 2020 03:22:20 -0500
I develop a structural model to quantify the costs of tax avoidance. In the model, the firm trades off tax savings with tax-audit risk, financial-reporting benefits, and non-tax costs (which affect pre-tax income). The comparative statics suggest tax avoidance is path-dependent, which can help resolve the unexplained persistent differences across firms. The estimated parameters suggest non-tax costs, which are difficult to observe, decrease pre-tax earnings by 7.8%. The large magnitude of this estimate can explain why firms appear to under-utilize tax-avoidance strategies. When I estimate the model on different subsamples, I find larger firms engage in more tax avoidance primarily because they can better identify lower-risk opportunities. I find multinationals have lower-risk opportunities to avoid taxes but incur more non-tax costs relative to domestic firms, which helps to explain similar levels of tax avoidance. Overall, the estimated parameters help to explain the ...

REVISION: How Costly Is Tax Avoidance? Evidence from Structural Estimation
Date Posted:Mon, 20 Jul 2020 03:45:14 -0500
I develop a structural model to quantify the costs of tax avoidance. In the model, the firm trades off tax savings with tax-audit risk, financial-reporting benefits, and non-tax costs (which affect pre-tax income). The comparative statics suggest tax avoidance is path-dependent, which can help resolve the unexplained persistent differences across firms. The estimated parameters suggest non-tax costs, which are difficult to observe, decrease pre-tax earnings by 7.8%. The large magnitude of this estimate can explain why firms appear to under-utilize tax-avoidance strategies. When I estimate the model on different subsamples, I find larger firms engage in more tax avoidance primarily because they can better identify lower-risk opportunities. I find multinationals have lower-risk opportunities to avoid taxes but incur more non-tax costs relative to domestic firms, which helps to explain similar levels of tax avoidance. Overall, the estimated parameters help to explain the ...

REVISION: Examining the Immediate Effects of Recent Tax Law Changes on the Structure of Executive Compensation
Date Posted:Wed, 18 Mar 2020 03:35:50 -0500
We exploit a recent law change to examine the relation between corporate taxes and executive compensation. The “Tax Cuts and Jobs Act” (TCJA) repealed a long-standing exception that allowed publicly traded companies to deduct executives’ qualified performance-based compensation (e.g., stock options) in excess of $1 million. The new regime is effective for tax years beginning after December 31, 2017, and limits total deductible compensation to $1 million for each covered executive. Using a difference-in-differences design to examine executive compensation paid in fiscal years 2017 and 2018, we find no evidence that the average firm affected by the TCJA in their 2018 fiscal years changed total compensation or compensation mix relative to control firms not subject to the new regime until their 2019 fiscal years. We find limited evidence of a reduction in total compensation among less than 10 percent of treated firms. We execute a battery of tests to validate these results. Overall, our ...

Non-GAAP Reporting and Investment
Date Posted:Fri, 20 Dec 2019 21:36:05 -0600
The wide-spread reporting of non-GAAP earnings suggests efficiency gains from doing so. By estimating a dynamic investment model, we examine the real implications of investors using both GAAP and non-GAAP earnings to value firms. When investors use the firm?s GAAP earnings only, the firm?s manager?who cares about current stock prices?underinvests, and his investment is sensitive to transitory earnings. Non-GAAP earnings can improve investment efficiency by adjusting for these transitory earnings, but can also hide inefficient investment by introducing opportunistic bias. Although non-GAAP earnings induce overinvestment, they dominate GAAP-only reporting. Counterfactual analysis reveals supplementing GAAP earnings with biased non-GAAP earnings increases firm value by 3.4% relative to GAAP-only reporting. Precluding bias reduces overinvestment and further increases firm value by 1%.

REVISION: Non-GAAP Reporting and Investment
Date Posted:Fri, 20 Dec 2019 11:36:41 -0600
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: Examining the Immediate Effects of Recent Tax Law Changes on the Structure of Executive Compensation
Date Posted:Fri, 27 Sep 2019 19:59:20 -0500
We exploit a December 22, 2017 law change to examine the relation between corporate taxes and executive compensation. The so-called “Tax Cuts and Jobs Act” (TCJA) repealed a long-standing exception that allowed publicly-traded companies to deduct executives’ qualified performance-based compensation (e.g., stock options) in excess of $1 million. The new regime is effective for tax years beginning after December 31, 2017 and limits total deductible compensation to $1 million for each covered executive. Using a difference-in-differences design to examine executive compensation paid in fiscal years 2017 and 2018, we find no evidence that firms impacted by the TCJA in their 2018 fiscal years changed total compensation, compensation mix, or pay-performance sensitivity relative to control firms that are not subject to the new regime until their 2019 fiscal years. These findings suggest the tax benefits of deductible executive compensation decisions do not outweigh non-tax considerations ...

REVISION: Peer Group Choice and Chief Executive Officer Compensation
Date Posted:Sun, 01 Sep 2019 04:08:41 -0500
We examine the selection of peer groups that boards of directors use when setting the level of CEO compensation. This choice is controversial because it is difficult to ascertain whether peer groups are selected to (i) attract and retain top executive talent or (ii) enable rent extraction by inappropriately increasing CEO compensation. In contrast to prior research, our analysis utilizes the degree to which the observed compensation level for the portfolio of peers is unusual relative to all potential portfolios of peers the board of directors could have reasonably selected. Using a sample of 9,247 firm-year observations from 2008 to 2014, we estimate that roughly 39% of board of directors’ choices appear to be associated with rent extraction, whereas the remaining 61% appear to be associated with attracting and retaining high-quality CEO talent. Relative to firms that appear to select peers for aspirational labor market reasons, we find rent extraction firms have more structural ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Thu, 29 Aug 2019 11:08:59 -0500
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance from 1962 to 2014. We assess evolution in each amount’s value relevance and find increases, most notably for amounts related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant amounts also increases. We also consider separately new economy, non-new economy profit, and non-new economy loss firms. The relevance trends are more pronounced for, but extend beyond, new economy firms. We base inferences on a non-parametric approach that automatically incorporates nonlinearities and interactions, thereby unconstraining the valuation relation. Taken together, our findings reveal a more nuanced, but not declining, relation between share ...

Examining the Effects of the TCJA on Executive Compensation
Date Posted:Mon, 17 Jun 2019 17:49:51 -0500
As part of the ?Tax Cuts and Jobs Act? (TCJA), Congress repealed a long-standing
exception that allowed companies to deduct executives? qualified performance-based
compensation in excess of $1 million. The purpose of this study is to examine whether Congress
achieved its stated objective of reversing a shift in executive compensation away from cash
compensation and towards performance pay, which Congress believed led executives to focus on
short-term results rather than the long-term success of the company. Across a battery of tests,
including a difference-in-differences design that exploits the staggered time-series
implementation of the deduction limit, we find evidence compatible with the new deduction limit
having no effect on executives? salary, performance pay or total compensation, inconsistent with
Congressional intent.

REVISION: Examining the Immediate Effects of Recent Tax Law Changes on the Structure of Executive Compensation
Date Posted:Mon, 17 Jun 2019 08:49:55 -0500
We exploit a December 22, 2017 law change to examine the relation between corporate taxes and executive compensation. The so-called “Tax Cuts and Jobs Act” (TCJA) repealed a long-standing exception that previously allowed publicly-traded companies to deduct executives’ qualified performance-based compensation in excess of $1 million. The new regime is effective for tax years beginning after December 31, 2017. Using a difference-in-differences design to examine executive compensation paid in fiscal years 2017 and 2018, we find no evidence that firms impacted by the TCJA in their 2018 fiscal years changed total compensation, compensation mix, or pay-performance sensitivity relative to control firms that are not subject to the new regime until their 2019 fiscal years. These findings suggest Congress may have structured the law inefficiently or that Treasury delayed guidance for too long, potentially causing delays in firms’ responses.

REVISION: Long-Term Economic Consequences of Hedge Fund Activist Interventions
Date Posted:Thu, 06 Jun 2019 23:27:19 -0500
We examine the long-term effects of interventions by activist hedge funds. Research documents positive equal-weighted long-term returns and operating performance improvements following activist interventions, and typically conclude that activism is beneficial. We extend the literature in two ways. First, we find that equal-weighted long-term returns are driven by the smallest 20% of firms, with an average market value of $22 million. The larger 80% of firms experience insignificant negative long-term returns. On a value-weighted basis, which likely best gauges the effects on shareholder wealth and the economy, we find that pre- to post-activism long-term returns insignificantly differ from zero. For operating performance, we find that prior results are a manifestation of abnormal trends in pre-activism performance. Using an appropriately matched sample, we find no evidence of abnormal post-activism performance improvements. Overall, our results do not strongly support the hypothesis ...

REVISION: Tax Avoidance and the Real Effect of Tax-Risk Disclosures
Date Posted:Sun, 19 May 2019 07:22:19 -0500
I study the financial reporting effect of tax-risk disclosures (“FIN 48”) on tax avoidance. To isolate this effect from other factors that influence tax avoidance, I build a dynamic structural model in which a firm chooses a set of tax-saving projects in each period to maximize shareholder value. In this model, the firm trades off the tax savings with the financial-reporting costs, tax authority scrutiny, and operational frictions imposed by tax avoidance that reduce pre-tax income. I find that the FIN 48 disclosure increases effective tax rates by 2.8 percentage points relative to when firms can immediately recognize all of the tax savings on the income statement. I also find that average operational frictions from tax avoidance decrease pre-tax earnings by 7.4%. The magnitude of these frictions suggest they have a large impact on firms' tax planning and can explain the “undersheltering ...

How Costly Is Tax Avoidance? Evidence from Structural Estimation
Date Posted:Thu, 16 May 2019 15:25:07 -0500
I develop a structural model to quantify the costs of tax avoidance. In the model, the firm trades off tax savings with tax-audit risk, financial-reporting considerations, and operational frictions imposed by tax avoidance, the last of which I label as non-tax costs. The estimated parameters suggest non-tax costs, which are difficult to observe, decrease pretax income by 6.4% or $58 million per firm-year. The large magnitude of this estimate can explain why firms appear to under-utilize tax-avoidance strategies. Through counterfactual analysis, I estimate the effect of tax-audit risk and financial-reporting considerations to find that financial-reporting considerations have an effect on tax avoidance similar to the penalties imposed by tax authorities. Overall, the estimated parameters help explain the ?undersheltering puzzle.?

REVISION: Tax Avoidance and the Real Effect of Tax-Risk Disclosures
Date Posted:Thu, 16 May 2019 06:25:15 -0500
Abstract I study the financial reporting effect of tax-risk disclosures (“FIN 48”) on tax avoidance. To isolate this effect from other factors that influence tax avoidance, I build a dynamic structural model in which a firm chooses a set of tax-saving projects in each period to maximize shareholder value. In this model, the firm trades off the tax savings with the financial-reporting costs, tax authority scrutiny, and operational frictions imposed by tax avoidance that reduce pre-tax income. I find that the FIN 48 disclosure increases effective tax rates by 2.8 percentage points relative to when firms can immediately recognize all of the tax savings on the income statement. I also find that average operational frictions from tax avoidance decrease pre-tax earnings by 7.4%. The magnitude of these frictions suggest they have a large impact on firms' tax planning and can explain the “undersheltering ...

Peer-Group Choice, Chief Executive Officer Compensation, and Firm Performance
Date Posted:Wed, 13 Feb 2019 20:44:13 -0600
We examine the selection of peer groups that boards of directors use when setting CEO compensation. The challenge is to ascertain whether peer groups are selected to (i) attract and retain executive talent and/or (ii) enable rent extraction by inappropriately increasing compensation. We find that the inferences in prior research are based on questionable methodological choices and do not generalize with an expanded sample. After addressing these concerns, we find that, on average, excess peer compensation has a negative association with future firm operating performance. However, significant variation in CEO talent and corporate governance exists within the cross-section of firms. The negative association between excess peer compensation and future performance is mitigated when the firm has a high level of CEO talent, and exacerbated when the firm has low-quality corporate governance. Thus, the economic consequences of peer-group choice are highly contextual. In general, we find that talent motivations explain more of the variation in the future performance implications of peer-group choice than corporate governance.

REVISION: Peer Group Choice and Chief Executive Officer Compensation
Date Posted:Wed, 13 Feb 2019 10:44:13 -0600
We examine the selection of peer groups that boards of directors use when setting the level of CEO compensation. This choice is controversial because it is difficult to ascertain whether peer groups are selected to (i) attract and retain top executive talent or (ii) enable rent extraction by inappropriately increasing CEO compensation. In contrast to prior research, our analysis utilizes the degree to which the observed compensation level of peers in the portfolio is unusual relative to all potential portfolios of peers the board of directors could have reasonably selected. Using a sample of 10,235 firm-year observations from 2008 to 2014, we estimate roughly 33% of board of directors’ choices appear to be associated with rent extraction, whereas the remaining 67% are associated with attracting and retaining high-quality CEO talent. Relative to firms that appear to select peers for aspirational labor market reasons, we find rent extraction firms have ...

REVISION: Long-Term Economic Consequences of Hedge Fund Activist Interventions
Date Posted:Mon, 14 Jan 2019 05:38:15 -0600
We examine the long-term effects of interventions by activist hedge funds. Research documents positive equal-weighted long-term returns and operating performance improvements following activist interventions, and typically conclude that activism is beneficial. We extend the literature in two ways. First, we find that equal-weighted long-term returns are driven by the smallest 20% of firms, with an average market value of $22 million. The larger 80% of firms experience insignificant negative long-term returns. On a value-weighted basis, which likely best gauges the effects on shareholder wealth and the economy, we find that pre- to post-activism long-term returns insignificantly differ from zero. For operating performance, we find that prior results are a manifestation of abnormal trends in pre-activism performance. Using an appropriately matched sample, we find no evidence of abnormal post-activism performance improvements. Overall, our results do not strongly support the hypothesis ...

REVISION: Long-Term Economic Consequences of Hedge Fund Activist Interventions
Date Posted:Wed, 17 Oct 2018 05:10:11 -0500
We examine the long-term effects of interventions by activist hedge funds. Prior papers document positive equal-weighted long-term returns and operating performance improvements following activist interventions, and typically conclude that activism is beneficial. We extend prior literature in two ways. First, we find that equal-weighted long-term returns are driven by the smallest 20% of firms with an average market value of $22 million. The larger 80% of firms experience insignificant negative long-term returns. On a value-weighted basis, which likely best gauges effects on shareholder wealth and the economy, we find that pre- to post-activism long-term returns are insignificantly different from zero. For operating performance, we find that prior results are a manifestation of abnormal trends in pre-activism performance. Using an appropriately matched sample, we find no evidence of abnormal post-activism performance improvements. Overall, our results do not strongly support the ...

Long-Term Economic Consequences of Hedge Fund Activist Interventions
Date Posted:Wed, 03 Oct 2018 19:33:02 -0500
We examine the long-term effects of interventions by activist hedge funds. Research documents positive equal-weighted long-term returns and operating performance improvements following activist interventions, and typically conclude that activism is beneficial. We extend the literature in two ways. First, we find that equal-weighted long-term returns are driven by the smallest 20% of firms, with an average market value of $22 million. The larger 80% of firms experience insignificant negative long-term returns. On a value-weighted basis, which likely best gauges the effects on shareholder wealth and the economy, we find that pre- to post-activism long-term returns insignificantly differ from zero. For operating performance, we find that prior results are a manifestation of abnormal trends in pre-activism performance. Using an appropriately matched sample, we find no evidence of abnormal post-activism performance improvements. Overall, our results do not strongly support the hypothesis that activist interventions drive long-term benefits for the typical shareholder, nor do we find evidence of shareholder harm.

REVISION: Long-Term Economic Consequences of Hedge Fund Activist Interventions
Date Posted:Wed, 03 Oct 2018 10:33:02 -0500
We examine the long-term effects of interventions by activist hedge funds. Prior papers document positive equal-weighted long-term returns and operating performance improvements following activist interventions, and typically conclude that activism is beneficial. We extend prior literature in two ways. First, we find that equal-weighted long-term returns are driven by the smallest 20% of firms with an average market value of $22 million. The larger 80% of firms experience insignificant negative long-term returns. On a value-weighted basis, which likely best gauges effects on shareholder wealth and the economy, we find that pre- to post-activism long-term returns are insignificantly different from zero. For operating performance, we find that prior results are a manifestation of abnormal trends in pre-activism performance. Using an appropriately matched sample, we find no evidence of abnormal post-activism performance improvements. Overall, our results do not strongly support the ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Fri, 21 Sep 2018 05:38:26 -0500
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance from 1962 to 2014. We assess evolution in each amount’s value relevance and find increases, most notably for amounts related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant amounts also increases. We also consider separately new economy, non-new economy profit, and non-new economy loss firms. Although the relevance trends are most pronounced for new economy firms, they are economy-wide. We base inferences on a non-parametric approach that automatically incorporates nonlinearities and interactions, thereby unconstraining the valuation relation. Taken together, our findings reveal a more nuanced, but not declining, ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Fri, 21 Sep 2018 05:24:16 -0500
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance from 1962 to 2014. We assess evolution in each amount’s value relevance and find increases, most notably for amounts related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant amounts also increases. We also consider separately new economy, non-new economy profit, and non-new economy loss firms. Although the relevance trends are most pronounced for new economy firms, they are economy-wide. We base inferences on a non-parametric approach that automatically incorporates nonlinearities and interactions, thereby unconstraining the valuation relation. Taken together, our findings reveal a more nuanced, but not declining, ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Tue, 08 May 2018 00:57:51 -0500
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance from 1962 to 2014. We assess evolution in each amount’s value relevance and find increases, most notably for amounts related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant amounts also increases. We also consider separately new economy, non-new economy profit, and non-new economy loss firms. Although the relevance trends are most pronounced for new economy firms, they are economy-wide. We base inferences on a non-parametric approach that automatically incorporates nonlinearities and interactions, thereby unconstraining the valuation relation. Taken together, our findings reveal a more nuanced, but not declining, ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Mon, 02 Apr 2018 08:27:10 -0500
We address how value relevance of accounting information has evolved as the new economy developed. Prior research concludes accounting information—primarily earnings—has lost relevance. We consider more accounting amounts and find no decline in combined value relevance between 1962 and 2014. We assess the evolution in value relevance of each amount and find several increase, most notably those related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of value relevant accounting amounts also increases. We also consider separately New Economy, Non-New Economy Profit, and Non-New Economy Loss firms. Although the value relevance trends are most pronounced for New Economy firms, they are economy-wide. We base inferences on a non-parametric approach that automatically incorporates nonlinearities and interactions, thereby unconstraining the valuation relation. Taken together, our findings reveal a ...

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Sun, 16 Jul 2017 14:26:18 -0500
We find that between 1962 and 2014 although value relevance of earnings decreases, value relevance of a more comprehensive set of accounting amounts increases. Earnings is the most important accounting amount, but its decreased importance is offset by increased importance of equity book value, operating cash flow, cash, special items, recognized intangible assets, and research and development expense. Dividends decrease in importance. Over time, the number of important accounting amounts increases. The findings reveal an increasing richness and complexity in how share price reflects accounting information relating to future cash flows, growth opportunities, growth in earnings from intangible asset investments, and firm performance. Findings from a constant sample, and top 1,000, young, profit, loss, financial, and technology firms reveal that trends in value relevance reflect changes in firms comprising the economy and changes that affect all firms. We base inferences on a ...

Evolution in Value Relevance of Accounting Information
Date Posted:Tue, 14 Mar 2017 20:12:17 -0500
We address how value relevance of accounting information evolved as the new economy developed. Prior research concludes accounting information?primarily earnings?has lost relevance. We consider more accounting items and find no decline in combined value relevance from 1962 to 2018. We assess evolution in each item?s value relevance and find increases, most notably for items related to intangible assets, growth opportunities, and alternative performance measures, which are important in the new economy. The number of relevant items also increases. We also consider separately new economy, old economy profit, and old economy loss firms. The trends are more pronounced for, but extend beyond, new economy firms. We base inferences on a non-parametric approach that does not require specifying the valuation relation. Taken together, our findings reveal an evolution to a more nuanced, but not declining, relation between accounting information and share price.

REVISION: Evolution in Value Relevance of Accounting Information
Date Posted:Tue, 14 Mar 2017 11:12:18 -0500
We find the value relevance of accounting information has increased between 1962 and 2014. The information we consider comprises twelve accounting amounts plus ten industry indicators. Regarding individual accounting amounts, we find that operating cash flow, cash holdings, and two New Economy-related amounts — recognized intangible assets and research and development expense — increase in value relevance, whereas dividends and, most prominently, earnings decrease. We also find that more accounting amounts become value relevant, which is consistent with a more complex relation between equity price and accounting information. There are marked differences in value relevance of individual accounting amounts for financial, technology, loss, and profit firms. Our findings are based on a non-parametric approach that automatically incorporates nonlinearities and interactions, thereby avoiding under-fitting that can constrain OLS estimation. Because OLS estimation with commonly ...