In the paper, Executive Turnover Following Option Backdating Allegations, forthcoming in The Accounting Review, we investigate how the Board of Directors and the managerial labor market (two private-sector monitoring mechanisms) respond to an allegation of option backdating. Allegations have been directed at numerous well-known public companies, including Microsoft, Apple, Home Depot, Costco, and United Health. Backdating occurs when executives designate as the grant date a day earlier than the one on which the board actually made the decision to grant options. Managers typically select an earlier date when the market price was lower, so they receive options that are already “in-the-money” on the actual grant date.
Posts Tagged ‘Rebecca Files’
In the paper, SEC Enforcement: Does Forthright Disclosure and Cooperation Really Matter? forthcoming in the Journal of Accounting and Economics as published by Elsevier, I investigate SEC enforcement leniency by exploring whether the SEC rewards firm cooperation and forthright disclosures following a restatement. I develop models that explain SEC sanctions and SEC monetary penalties, and then assess the incremental impact of cooperation and forthright disclosures. I consider a firm to have cooperated with the SEC if it voluntarily initiates an independent investigation into its misconduct. Forensic accountants, legal counsel, or independent committees of directors usually perform the investigations and the firm subsequently passes the information on to the SEC.
I follow the SEC’s 2001 Seaboard Report in defining forthright disclosures as those that are timely, complete, and effective. Timeliness captures the speed with which managers release information to market participants, and it is defined as the number of days between the end of the violation period and the first public announcement of the misconduct. I define complete and effective disclosures in two ways, with both capturing the visibility of misconduct-related disclosures to investors and the SEC. The first identifies where information about the misconduct is placed within a press release. I consider information disclosed in the headline of a press release (rather than the text or footnotes) to be the most effective form of disclosure, as it increases the likelihood that investors and SEC staff will notice and react to the information (Files et al. 2009; Gordon et al. 2009). The second identifies the type of SEC filing used to report the misconduct, with disclosure in a Form 8-K or an amended periodic filing considered the most effective.
In our paper, Stealth Disclosure of Accounting Restatements, which was recently accepted for publication in the Accounting Review, we investigate whether the prominence of the disclosure of a restatement is correlated with the market reaction and the likelihood of litigation. In our sample, we observe and categorize firms into three levels of disclosure. Some companies disclose their restatement prominently in the headline of a press release, usually one that is dedicated to the accounting misstatement (high prominence). Other firms provide less prominent disclosure, typically citing an earnings release in the headline, but still discussing the misstatement in the body of the press release (medium prominence). Most of the remaining firms simply restate prior-period comparative balances in an earnings release, with a footnote briefly explaining that the financial figures for the prior year have been changed (low prominence).
We investigate whether companies providing medium or low prominence disclosure of their restatement benefit from a less negative market reaction and/or a reduced likelihood of litigation. Our first finding is that the magnitude of the market response to a restatement announcement is related to press release format. Three-day returns differ substantially across the three categories of disclosure prominence, averaging -8.3 percent, -4.0 percent, and -1.5 percent for high, medium, and low prominence, respectively. Returns for the high prominence group are statistically different from those for the medium and low prominence groups. Next, we extend the return window to 20 days after the announcement to investigate post- announcement responses to restatements. We find returns of -7.9 percent, -6.4 percent, and -3.2 percent for the high, medium, and low prominence firms, respectively. These returns are considerably less dispersed than the short-window returns, and the 1.5 percent return difference between high and medium prominence is not statistically significant. Apparently, market participants initially underestimate the seriousness of some misstatements disclosed without a headline but subsequently correct their underreaction.
Next, we find that the average return for firms that have post-restatement news items is not significantly different from zero. In contrast, we find a statistically significant drift of -3.7 percent for firms with no news items in the 20-day period, which suggests that investors further evaluate the original press release information. Analysts appear to play an important role in this evaluation because most of the drift is in companies covered by three or more analysts. In addition, once we control for the seriousness of the accounting misstatement, we find that the press release remains highly significant in explaining announcement period returns (-1, +1), but not significantly associated with returns over the longer window (-1, +20).
Lastly, we find that the frequency of lawsuits declines monotonically across the three categories of disclosure prominence (27 percent, 16 percent, and 0 percent for the high, medium, and low prominence firms, respectively). The 16 percent litigation rate for medium disclosure suggests that some managers use medium prominence disclosure for an accounting misstatement that plaintiff attorneys view as serious. We estimate a logistic regression model of the likelihood of litigation in our sample, and find that the prominence index coefficient is positive and significant in the model (even after controlling for endogeneity), suggesting that the likelihood of litigation rises with disclosure prominence. Reducing disclosure prominence by one level (e.g., medium instead of high) reduces the odds of a lawsuit by about half.
The full paper is available for download here.