Based on a unique arrangement of trading and disclosure times around earnings announcements in the Chinese stock market, we provide evidence of a striking overnight-intraday disparity in terms of the reaction to earnings news. Specifically, we find that the overnight period exhibits a strong and consistent reaction to earnings announcements, whereas the intraday period trades against both the earnings news and the prior market reaction during the overnight period. In addition, we show that abnormal overnight returns on earnings announcement days exhibit strong predictability for future stock returns, consistent with the overnight returns containing value-relevant signals. In contrast, we observe no return predictability for abnormal intraday returns on earnings announcement days, which as a result, also undermines the return predictability of abnormal daily returns. We propose possible explanations for the overnight-intraday disparity. We conclude that the differences in trading mechanisms between the two periods as well as in investor composition likely drive the phenomenon.
Corporate spinoffs are important events that are accompanied by valuation and credit-risk implications for the parent firm. Among other benefits, spinoffs can improve corporate focus and enhance valuation transparency. In the debt-contracting context, however, spinoffs can also be associated with negative outcomes for the divesting firms. We examine whether banks, due to their timely access to material private information, are able to ascertain the likelihood and the implications of impending spinoffs for the parent firm before a formal public announcement of the spinoff. Our empirical analyses indicate that, in the 365-day pre-spinoff announcement period, banks charge incrementally higher (lower) spreads to borrowers with increased (decreased) post-spinoff riskiness relative to nondivesting firms. This suggests that, while lenders recognize the value- and transparency-enhancing effects of spinoffs, they are also able to foresee potentially negative implications of these divestitures. Cross-sectional analyses indicate that banks charge incrementally lower loan spreads if spinoffs result in high-risk borrowers having either higher reporting quality or lower reporting or operational complexity. These results suggest that the post-spinoff increase in riskiness is compensated by the divestiture benefits typically associated with spinoffs. Similarly, high-risk borrowers incur larger spreads if they do not undergo “focus-increasing” spinoffs. Overall, our findings suggest that banks are able to ex ante determine the implications of important corporate events such as spinoffs.
Public Communication of Audit Risks and Related-Party Transactions: Evidence from China
Auditing: A journal of Practice and Theory (AJPT), 42(4), s. 23- 44. Doi: 10.2308/AJPT-2021-184
This paper examines whether and how firms’ engagement in related-party transactions (RPTs) is shaped by public communication of audit risks as required by the expanded audit report. Using the phased regulatory changes in China and a difference-in-differences design with firm fixed effects and matching, we find that firms significantly reduce their RPTs after the adoption of expanded audit reports (EARs). To investigate potential mechanisms, we find that (1) investor scrutiny increases after the adoption of EARs, (2) the reduction of RPTs is more pronounced when EARs are more likely to attract investor attention, and (3) the reduction of RPTs is weaker when firms are less concerned about investor scrutiny. The results suggest that EARs can attract investor scrutiny and increase the possible penalty associated with self-dealing, thus motivating firms to reduce RPTs.
Chen, Jeff Zeyun; Elemes, Anastasios, Hope, Ole-Kristian & Yoon, Aaron S. (2023)
Audit-Firm Profitability: Determinants and Implications for Audit Outcomes
We use a novel dataset that links audit-firm and client-firm financial statement information from the U.K.’s largest audit firms to examine drivers of audit-firm profitability and its implications for audit outcomes. We first explore the determinants of audit-firm profitability and conclude that Big-4 and non-Big-4 audit firms have fundamentally different profitability structures. Big-4 firms have higher profit margins than non-Big-4 firms. Furthermore, Big-4 profitability increases with client size and complexity, while non-Big-4 profitability is higher for smaller, private-firm clients. Next, we examine the relation between audit-firm profitability and audit outcomes. Using a battery of alternative outcome measures, we find that more profitable audit firms deliver higher audit quality. In supplemental analyses we show that the positive relation between audit-firm profitability and audit outcomes is generally stronger for more influential and illiquid clients (i.e. when auditors are exposed to more litigation risk). Our inferences are robust to several endogeneity controls, such as using an instrumental variables approach, controlling for client-firm and audit-firm fixed effects, employing lead-lag and changes specifications, and assessing bias from correlated omitted variables. Our study contributes to the literature by being the first to provide insights into audit-firm profitability and examine in detail its implications for audit quality.
This paper examines whether there is information sharing between mutual funds and their auditors about the auditors’ other listed firm clients. Using data from the Chinese market, we find that mutual funds earn higher profits from trading in firms that share the same auditors. The effects are more pronounced when firms have a more opaque information environment and when the audit partners for the fund and the partners for the listed firm share school ties. The evidence is consistent with information flowing from auditors to mutual funds, providing mutual funds with an information advantage in firms that share the same auditors. Our findings are robust to the use of audit-firm mergers and acquisitions (M&As) as exogenous shocks and several other robustness checks. We further find that auditors benefit by charging higher audit fees for mutual fund clients and by improving their audit quality for listed firm clients. Our study provides evidence of bi-directional information sharing between two important market intermediaries.
This paper examines the effect of internal information quality on workplace safety. Using establishmentlevel data on workplace injuries from the Occupational Safety and Health Administration (OSHA) and employing a strict fixed-effects structure, we show that higher information quality is associated with significantly lower work-related injury rates. Further investigation reveals that the effect is stronger when more decision rights reside in headquarters, weaker when employees have greater bargaining power, and weaker when firms are subject to financial constraints. Our findings are robust to the use of two plausibly exogenous shocks and other robustness checks. Our study suggests an important economic consequence of information quality not examined by prior literature.
Hope, Ole-Kristian; Li, Congcong, Ma, Mark Shuai & Su, Xijiang (2022)
Is silence golden sometimes? Management guidance withdrawals during the COVID-19 pandemic
The many management guidance withdrawals during the COVID-19 pandemic have attracted considerable attention from the media, investors, and regulators. This study analyzes the determinants and consequences of these withdrawals. We find that guidance withdrawals are due to economic uncertainty, resulting from firms’ exposure to the COVID-19 pandemic rather than poor financial performance. Also, the effect of COVID-19 exposure on guidance withdrawals is stronger when firms face higher litigation risk. Further, guidance withdrawals result in abnormally large trading volumes and high analyst forecast dispersion but do not harm stock prices or the level of analyst earnings forecasts. Overall we believe the findings have implications for understanding corporate disclosure practices during periods with heightened economic uncertainty.
Hope, Ole-Kristian & Liu, Junhao (2022)
Does stock liquidity shape voluntary disclosure? Evidence from the SEC tick size pilot program
Employing the SEC Tick Size Pilot Program, which increases the minimum trading unit of a set of randomly selected small-capitalization stocks, we examine whether and how an exogenous change in stock liquidity affects corporate voluntary disclosure. Using difference-in-differences analyses with firm fixed effects, we find that treatment firms respond to the liquidity decline by issuing fewer management earnings forecasts, while, in contrast, control firms do not exhibit a significant change. Next we show that the effect is more pronounced when firms experience more severe liquidity decreases during the TSPP and rule out a set of alternative explanations. Further strengthening the identification, we find a consistent reversal effect after the end of the pilot program. To generalize our findings, we use voluntary 8-K filings and conference calls as alternative voluntary disclosure proxies and find similar effects. Overall, these findings show how an exogenous change in stock liquidity shapes the corporate information environment.
Hope, Ole-Kristian; Li, Yi, Liu, Qiliang & Wu, Han (2021)
Newspaper Censorship in China: Evidence from Tunneling Scandals
Media dissemination plays an important role in facilitating price discovery. Political pressure that restricts media dissemination can hinder this function and affect investors’ perceptions. This paper studies the magnitude of newspaper censorship in China and its economic consequences using a setting of tunneling scandals. We find significant evidence of censorship of tunneling-related negative news at the national and local levels. We further show that news that survives censorship reduces information asymmetry and improves pricing efficiency. Censorship blocks informative tunneling news and delays incorporation of tunneling reporting into prices.
This study examines the effect of peer-level analyst transitions (i.e., switching between brokerage houses) on associated regular incumbent analysts' forecasting performance. We employ a difference-in-differences research design with analyst fixed effects and compare incumbent analysts of different groups within the same broker and same time periods. We find that incumbents who cover at least one common industry as the transiting analyst (i.e., affected incumbents) issue more accurate and timely forecasts after a transiting analyst arrives than incumbents who cover different industries (i.e., unaffected incumbents). Further, affected incumbents issue less accurate forecasts after a transiting analyst leaves than do unaffected incumbents. We also examine potential mechanisms of knowledge spillover and find some evidence that the effect is more salient when the transiting analyst switches from a larger brokerage house, has greater industry scope, or covers geographically linked firms.
Deng, Yingwen; Hope, Ole-Kristian, Wang, Cyndia & Zhang, Min (2021)
Capital market liberalization and auditors’accounting adjustments: Evidence from aquasi-experiment
Using a shock to the Chinese capital market and unique and detailed audit-adjustment data, this paper investigates the effect of a capital market liberalization program on auditors’ adjustments to their clients’ financial reports. Employing difference-in-differences tests with propensity score matching and firm fixed effects (FE), we find that the capital market liberalization induced by the implementation of the Shanghai-Hong Kong Stock Connect affects auditors’ professional judgment and leads to audit-adjustment changes stimulated by greater reputational and litigation risks for auditors. Specifically, while the liberalization significantly decreases the frequency and magnitude of upward audit adjustments, the probability of downward adjustments remains the same in most cases. Further evidence shows that the effect is more pronounced for companies with high trading volume from Hong Kong investors, audited by the largest audit firms and with low financial transparency.
Studies show that incumbents reduce prices in response to higher entry threats in consumer industries. We provide new insights on the importance of an incumbent firm's reputation to the limit-pricing decision by examining a professional service industry where the supplier's reputation serves as an existing barrier. The recent staggered passage of mergers of three Canadian accounting certification bodies exogenously increases the probability of future entry to incumbent audit firms. Employing difference-in-differences analyses and a strict fixed-effects structure (client-firm, audit-firm, province and year-month fixed effects), we find that incumbent audit firms reduce audit fees in response to a higher entry threat induced by the merger. The microstructure of the audit industry provides further insights—non-Big-4 audit firms reduce fees after the merger, while Big-4 audit firms can withstand higher entry threats and do not adjust fees.
We examine the informational role of governments in the private sector in emerging economies. Using a large sample of private firms, we show that governments’ ability and willingness to collect and disseminate economic information (government transparency) is positively associated with firm-level operational efficiency and access to external financing. Several cross-sectional analyses corroborate our main findings. We find that the effect of government transparency is stronger for firms operating in weaker alternative information environments. We also find a reduced effect of government transparency in countries with better-developed capital markets that facilitate capital allocation and production efficiency. Additional analyses using the World Bank-supported Open Government Data initiative as a staggered shock to government transparency provide further support to our primary results. Overall, our paper sheds light on the important role played by governments in emerging markets in aggregating and disseminating economic information.
We examine the effect of auditor conservatism on corporate innovation. We hypothesize that, because conservative auditors constrain income-increasing accounting discretion, managers may sacrifice long-term investments in innovation to boost current earnings and meet short-term performance targets. Exploiting state-level auditor legal liability shocks as a means of identification, we find evidence consistent with this hypothesis. Cross-sectional analyses reveal that the negative effect of increased auditor conservatism on corporate innovation is more pronounced when the client firms are under greater equity- and debt-market pressures, when the client firms are exposed to greater litigation risk, and when the client firms are audited by large auditors. Our study highlights how auditors, as external monitors, can affect not only the financial reporting quality of their clients but may also induce alterations in their real operations.
This paper examines the practice of hiring financial analysts as investor relations officers (IRO). We posit that analysts-turned-IROs (AIROs) have a competitive advantage in communicating with investors, thereby lowering the effort expended by the investment community to process corporate disclosures. Using a unique manually-collected dataset on the employment history of IROs (compiled from LinkedIn, Capital IQ, RelationshipScience.com, and appointment press releases), we show that disclosure readability in 8-K and 10-K filings improves and that companies are more likely to host analyst/investor days after hiring former analysts as IROs. Most importantly, we find increases in analyst following, institutional investors, and stock liquidity after hiring a former analyst as IRO. We conclude that both a disclosure and a network channel are at play in the relation between AIROs and increased interest from the investment community. Overall, our findings suggest that firms benefit from hiring Wall Street analysts as IROs.
This paper is thefirst to investigate the role of work-life balance infinancial analysts’performance andcareer advancement. Using a large sample of Glassdoor reviews byfinancial analysts, wefind a significantnon-linear relation between perceived work-life balance and analyst performance and analyst careeradvancement. Specifically, when perceived work-life balance is relatively low, an increase in work-lifebalance is associated with better analyst performance and career advancement; however, whenperceived work-life balance is already high, a further increase in work-life balance is associated withworse analyst performance and career advancement.
In this paper, we examine the monitoring role of government customers in emerging markets, a setting where public procurement is significant but the procurement institutions are weak. In these countries, financial statement certifications could be an important mechanism for a private firm to facilitate contracting with governments. Employing a sample of private firms across 98 emerging economies, we first document in-depth private-firm audit regulations for each country. We find that firms are more likely to have financial statements certified by an external auditor when they have government contracts. We further find that the association is less pronounced when governments have weaker monitoring incentives – when suppliers are subject to monitoring from tax authorities or creditors, when government contracting officials receive bribes, and when government spending is less transparent. We corroborate our inferences using the staggered adoption of an E-Procurement system to infer changes in governments’ monitoring incentives and several other robustness checks.
This paper provides early but broad empirical evidence on MiFID II, which requires investment firms to unbundle investment research from other costs they charge to clients. Employing difference-in-differences matched-sample research designs with firm fixed effects, we find a decrease in the number of sell-side analysts covering European firms after MiFID II implementation, particularly for firms that are less important to the sell-side. However, research quality improves; specifically, individual analyst forecasts are more accurate and stock recommendations garner greater market reactions. In addition, sell-side analysts seem to cater more to the buy-side after MiFID II by providing industry recommendations along with stock recommendations. Importantly, we predict and find evidence that buy-side investment firms turn to more in-house research after MiFID II implementation. Equally interesting, buy-side analysts increase their participation and engagement in earnings conference calls, compared to the control group. We find some evidence that stock-market liquidity decreases post MiFID II.
This paper examines the impact of teamwork on sell-side analysts’ performance. Using a hand-collected sample of over 50,000 analyst research reports, we find that analyst teams issue more than 70% of annual earnings forecasts. In contrast, most research implicitly assumes that forecasts are issued by individual analysts. We document that analyst teams generate more accurate earnings forecasts than individual analysts and that the stock market reacts more strongly to forecast revisions issued by teams. Analyst teams also cover more firms, issue earnings forecasts more frequently, and issue less stale forecasts. Analysts working in teams are more likely to be voted as All-Star analysts in the future. Among analyst teams, we show that team size and team member ability are significantly associated with forecast accuracy. Moreover, using detailed analyst background information from LinkedIn, we find that forecast accuracy is positively associated with team diversity based on sell-side experience, educational background, and gender. Additional analyses suggest that analyst teams, especially more diverse ones, are more likely to issue cash-flow forecasts and use discounted cash-flow valuation models in their reports. These findings suggest that teamwork and team diversity play a crucial role in understanding sell-side analysts’ performance.
Hope, Ole-Kristian & Lu, Haihao (2020)
Economic consequences of corporate governance disclosure: Evidence from the 2006 SEC regulation on related-party transactions
This paper examines economic consequences of a 2006 Securities and Exchange Commission regulation that mandated public firms to disclose their governance policies on related-party transactions (RPTs). Employing hand-collected RPT data for S&P 1500 firms, we find that the initiation of RPT governance disclosure significantly reduces the occurrence of RPTs, and that the reduction in RPTs is negatively associated with the implied cost of capital (ICC) and positively related to Tobin's Q. These effects are more pronounced for low-monitored firms and for firms with RPTs that are more likely to be opportunistic. We further find that firms with a formal written policy, a designated committee to review and approve RPTs, or more extensive disclosure on RPT governance benefit in terms of lower ICC.
We examine the impact of China's anti‐corruption campaign on firm‐level financial reporting quality (FRQ). As an important component of the anti‐corruption campaign, in October 2013, “Rule 18” was issued to prohibit party and government officials from serving as directors for publicly listed firms. The regulation led to a large number of official directors resigning from their roles as directors involuntarily. As such, Rule 18 has effectively weakened, if not fully discontinued, the political connections of the firms that previously hired officials as directors. Our empirical analyses employ a difference‐in‐differences research design with firm fixed effects and propensity‐score matching to examine the pre‐ and post‐period FRQ around the enactment of Rule 18. We find that, compared to propensity‐score‐matched control firms, FRQ of firms with resigned official directors increases after Rule 18. Further evidence suggests that the impact is stronger when firms are located in regions with more developed financial markets and in regions with higher judiciary efficiency. We also find that the effect is more pronounced when firms are non‐state‐owned, received preferential credits, and face refinancing pressure.
Che, Limei; Hope, Ole-Kristian & Langli, John Christian (2020)
This paper studies whether and how Big-4 firms provide higher-quality audits than non-Big-4 firms. Specifically, we first examine a Big-4 effect and then explore three sources of the Big-4 effect. To test the Big-4 effect, we use a unique data set of individual audit partners for a large sample of private companies and a novel research design exploiting the fact that auditees may follow the auditor who switches affiliation from a non-Big-4 firm to a Big-4 firm. Thus, we compare audit quality and audit fees of the same partner–auditee pairs before and after the switch. The results show that the Big-4 effect exists in the private-firm segment. More important, we find evidence for three sources of the Big-4 effect. First, Big-4 firms are able to recruit non-Big-4 partners who deliver higher audit quality than other non-Big-4 partners in the preswitch period. Second, enhanced learning has taken place after the switch. Third, the increased audit quality can also be attributed to stronger incentives/monitoring. These are new findings to the literature.
This paper examines whether independent directors’ compensation is associated with related party transactions. We focus both on directors’ total compensation and their equity-based compensation. Employing hand-collected data for S&P 1500 firms, we find that independent directors’ compensation is significantly associated with related party transactions. Specifically, we find that the level of compensation is positively related to these transactions, but we do not find equity-based compensation to be associated with them. Next, we decompose the compensation measures into “market” (i.e., predicted) level and “excessive” components and find that the results are driven by the excessive components. This association between related party transactions and director compensation is moderated by corporate governance mechanisms, suggesting that the association between the two reflects a conflict of interest between insiders and shareholders.
Dou, Yiwei; Hope, Ole-Kristian, Thomas, Wayne B. & Zou, Youli (2018)
Blockholder Exit Threats and Financial Reporting Quality
Recent theoretical and empirical studies suggest that blockholders (shareholders with ownership ≥ 5 percent) exert governance through the threat of exit. Blockholders have strong incentives to gather private information and sell their shares when managers are perceived to underperform. To prevent blockholders from selling their shares and the firm from suffering a stock price decline, managers align their actions with the interests of shareholders. As a result of the greater manager‐shareholder alignment, managers' actions are more likely to be in shareholders' best interest, and consequently there is less need for managers to manipulate earnings. Consistent with these predictions from economic theory, we find evidence that as exit threat increases, firms have higher financial reporting quality. Theory also predicts that the impact of blockholders' exit threat on financial reporting quality (FRQ) should increase as the manager's wealth is tied more closely to the stock price, and this is what we find. Our study contributes to the research on the impact of shareholders on FRQ and to an emerging literature on the impact of blockholders in financial markets. Blockholders play an important role in managers' reporting outcomes through their actions as informed investors.
Hope, Ole-Kristian & Wang, Jingjing (2018)
Management deception, big-bath accounting, and information asymmetry: Evidence from linguistic analysis
Accounting big baths are pervasive in practice. While big baths can improve the information environment and reduce information asymmetry, they can also degrade the information environment and obscure operating performance. In this study, we examine the role of management ethics. Specifically, we investigate whether managers’ truthfulness (or conversely, deceptiveness) affects how investors perceive big baths. Using linguistic analysis on earnings-conference calls to measure managerial deception and employing a difference-in-differences research design with propensity-score matching, we find that information asymmetry is significantly higher following big baths taken by deceptive CEOs, compared with big baths taken by less deceptive CEOs.
Akamah, Herita; Hope, Ole-Kristian & Thomas, Wayne B. (2018)
Prior analyst literature focuses on the impact of financial analysts on the firms they cover, and prior information-transfer literature concentrates on the externalities of information provided by management. This paper fills gaps in both streams of literature by examining the focal firm’s market reactions to the closest peer firm’s (identified by product similarity) analyst revisions. We find that the focal firm’s stock price reacts to the closest peer’s analyst revisions made by analysts who are not covering the focal firm. The focal firm’s cumulative abnormal return for a five-day window centered on the revision date is 0.54% higher if the peer firm’s analyst revision magnitude is in the top decile than if it is in the bottom decile. Cross-sectional tests show that the sensitivity of the focal firm’s market reactions to the peer firm’s revisions increases with the revision informativeness and the similarity between the focal firm and the peer firm. In addition, we find that focal firms do not react to peer firms’ revisions in industries with strong competition where the competitive effects cancel out the spillover effects. Finally, we find that the focal firm’s market reactions can predict its own future analyst revisions, suggesting that the reactions are at least partially rational.
We examine whether international equity mutual fund managers shift their portfolios toward stocks with higher financial reporting quality (FRQ) during periods of high political uncertainty. Our study is motivated by two primary factors. First, prior research shows evidence of fund managers’ “flight to quality” (e.g., to less risky securities) during periods of uncertainty. Second, recent theoretical research concludes that stocks with higher FRQ are assessed as less sensitive to systematic risk (such as political uncertainty). We employ national elections as exogenous increases in systematic risk in the local markets and accordingly use an international sample of mutual funds that focus on local markets. We find that mutual fund managers shift their equity holdings to stocks with higher FRQ during election periods when political uncertainty is higher. Such a flight‐to‐quality effect is less pronounced for elections with larger expected electoral margins in the pre‐election period (i.e., when the incumbent is more likely to win the election) and for countries with higher transactions costs. In contrast, the effect is more pronounced when governments have greater involvement in the local economy. Our inferences are robust to alternative proxies for political uncertainty and FRQ and to numerous other sensitivity analyses.
De Franco, Gus; Hope, Ole-Kristian & Lu, Haihao (2017)
Managerial ability and bank-loan pricing
Journal of Business Finance & Accounting, 44(9-10), s. 1315- 1337. Doi: 10.1111/jbfa.12267