Sunday, October 8, 2017

The Financial Crisis and Corporate Credit Ratings

ABSTRACT

Credit ratings on many financial instruments failed to accurately portray default risk before the global financial crisis. I find no decline in the performance of corporate credit ratings during or after the crisis, indicating that the failures of ratings on financial instruments were due to conditions unique to the rating agencies' financial instruments divisions. Rather, the preponderance of tests indicate that corporate credit rating performance improves after the crisis, consistent with the rating agencies positively responding to public criticism and regulatory pressures. At the same time, I find evidence of sophisticated market participants decreasing their reliance on corporate credit ratings after the crisis. Consistent with theoretical models of reputation cyclicality, a likely explanation is that the rating agencies suffer spillover reputation damage from their failed ratings on financial instruments. My study informs regulators, practitioners, and academics about the performance of corporate credit ratings during and after the crisis, and provides novel empirical evidence consistent with reputation concerns affecting credit rating usage decisions.

Keywords: credit ratings, financial crisis, rating reputation, rating performance, debt contracting

Article Citation:
Ed deHaan (2017) The Financial Crisis and Corporate Credit Ratings. The Accounting Review: July 2017, Vol. 92, No. 4, pp. 161-189. 

Auditing Challenging Fair Value Measurements: Evidence from the Field

ABSTRACT

Concern about effective auditing of fair value measurements (FVMs) has risen in recent decades. Building on prior interview-based and experimental research, we provide an engagement-level analysis of challenging FVMs, using quantitative and qualitative data on audit phases from risk assessment to booking adjustments. Challenging FVMs have high estimation uncertainty, high subjectivity, significant/complex assumptions, and multiple valuation techniques. Estimation uncertainty is associated with higher inherent risk assessments, which are, in turn, predictive of client problems identified during the engagement. The use of a valuation specialist by auditors, associated with higher inherent risk and client specialist use, is a key decision: procedures performed by specialists have the highest yield in identifying problems. Auditor-client discussion of an adjustment increases with problem identification and auditors' expressions of residual concern about uncertainty post-testing. However, booked audit adjustments are infrequent; the only factors explaining income-decreasing adjustments are better evidential support and breadth of problems identified.

Keywords: auditing, fair value measurement, estimation uncertainty, materiality, valuation specialists

Article Citation:
Nathan H. Cannon and Jean C. Bedard (2017) Auditing Challenging Fair Value Measurements: Evidence from the Field. The Accounting Review: July 2017, Vol. 92, No. 4, pp. 81-114. 

Do CEO Succession and Succession Planning Affect Stakeholders' Perceptions of Financial Reporting Risk? Evidence from Audit Fees

ABSTRACT

In this paper, we examine how CEO succession and succession planning affect perceptions of financial reporting risk among stakeholders who are responsible for and oversee firms' financial reporting (e.g., auditors, management, and audit committees). Management succession introduces uncertainty about firms' future operations, financial policies, and potential motivation for earnings management, which we predict elevates the perceived risk of financial reporting improprieties. Consistent with this prediction, we find that audit fees are higher for firms with new CEOs. Importantly, however, we note that careful CEO succession planning (i.e., promoting an “heir apparent”) attenuates perceptions of higher risk, as evidenced by a lack of an audit pricing adjustment. These results are robust to several alternative specifications and analyses designed to mitigate the concern that the association between audit fees and CEO succession and succession planning is driven by factors leading to the CEO change. We also show that audit fee increases dissipate over time as the new, non-heir CEO stays longer at the firm, reinforcing the inference that audit fees increase in response to the uncertainty surrounding a new CEO. Additionally, we do not find evidence of a deterioration in audit quality with new CEOs, independent of the succession plan.

Keywords: CEO succession, succession planning, financial reporting risk, audit fees, heir apparent, insider CEO

Article Citation:
Kenneth L. Bills, Ling Lei Lisic, and Timothy A. Seidel (2017) Do CEO Succession and Succession Planning Affect Stakeholders' Perceptions of Financial Reporting Risk? Evidence from Audit Fees. The Accounting Review: July 2017, Vol. 92, No. 4, pp. 27-52. 

Saturday, June 24, 2017

Comparability and Cost of Equity Capital

SYNOPSIS


We investigate how the comparability of a company's financial statements is related to its cost of equity capital. The Financial Accounting Standards Board's (FASB 2010) Statement of Financial Accounting Concept No. 8 proposes that comparability is a key tenet of accounting because it allows users of financial statements to benchmark a firm against similar firms when distinguishing between alternative investment opportunities. We provide evidence that greater financial statement comparability is associated with lower cost of equity capital, and show that comparability's effect on cost of equity remains after controlling for within-firm accounting quality. Additionally, we find that investors derive greater benefits from financial statement comparability in firms whose information environments are less transparent (high information asymmetry) and whose equity shares trade in markets that are less competitive (imperfect markets). Our findings contribute to accounting research by providing evidence justifying comparability as a separate element of the FASB's conceptual framework.

A Theory of Crowdfunding: A Mechanism Design Approach with Demand Uncertainty and Moral Hazard

ABSTRACT

Crowdfunding provides innovation in enabling entrepreneurs to contract with consumers before investment. Under aggregate demand uncertainty, this improves screening for valuable projects. Entrepreneurial moral hazard and private cost information threatens this benefit. Crowdfunding's after-markets enable consumers to actively implement deferred payments and thereby manage moral hazard. Popular crowdfunding platforms offer schemes that allow consumers to do so through conditional pledging behavior. Efficiency is sustainable only if expected returns exceed an agency cost associated with the entrepreneurial incentive problems. By reducing demand uncertainty, crowdfunding promotes welfare and complements traditional entrepreneurial financing, which focuses on controlling moral hazard. 

Article Citation:
Strausz, Roland. 2017. "A Theory of Crowdfunding: A Mechanism Design Approach with Demand Uncertainty and Moral Hazard." American Economic Review, 107(6):1430-76.  
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Sunday, May 21, 2017

Busy Auditors, Partner-Client Tenure, and Audit Quality: Evidence from an Emerging Market

ABSTRACT

Using a sample of public firms listed in the Chinese market for the years 2000–2009, we find that audit partners with more public clients are associated with lower audit quality, consistent with the “busyness” effect that auditing multiple clients dissipates audit partner effort and, thus, reduces audit quality. However, the negative association is more pronounced for auditors with short audit partner-client tenure, supporting the idea that the lack of client-specific knowledge exacerbates the busyness effect. Collectively, these findings contribute to a better understanding of audit partner behavior in an emerging market.

Keywords: multiple audit clients, audit partner signature, client specific knowledge, and audit quality

Article Citation:
Ferdinand A. Gul, Shuai (Mark) Ma, and Karen Lai (2017) Busy Auditors, Partner-Client Tenure, and Audit Quality: Evidence from an Emerging Market. Journal of International Accounting Research: Spring, Vol. 16, No. 1, pp. 83-105. 

Is Modern Technology Responsible for Jobless Recoveries?

ABSTRACT

Since the early 1990s, recoveries from recessions in the US have been plagued by weak employment growth. We investigate whether a similar problem afflicts other developed economies, and whether technology is a culprit. We study recoveries from 71 recessions in 28 industries and 17 countries from 1970-2011. We find that though GDP recovered more slowly after recent recessions, employment did not. Industries that used more routine tasks, and those more exposed to robotization, did not recently experience slower employment recoveries. Finally, middle-skill employment did not recover more slowly after recent recessions, and this pattern was no different in routine-intensive industries.

Article citation:
Graetz, Georg and Guy Michaels. 2017. "Is Modern Technology Responsible for Jobless Recoveries?." American Economic Review, 107(5):168-73.