Posts Tagged ‘Restatements’

The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday December 2, 2014 at 8:58 am
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Editor’s Note: The following post comes to us from Ronen Gal-Or and Udi Hoitash, both of the Department of Accounting at Northeastern University, and Rani Hoitash of the Department of Accountancy at Bentley University. Recent work from the Program on Corporate Governance about staggered boards includes: How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment (discussed on the Forum here).

In our paper, The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards: The Case of Audit Committee Elections, which was recently made available on SSRN, we study the efficacy of audit committee member elections in staggered and non-staggered boards.

Voting in director elections and auditor ratifications is a primary mechanism shareholders can use to voice their opinion. Past research shows that shareholders cast votes against directors that exhibit poor performance, and these votes, in turn, are associated with subsequent board reaction. However, because a significant number of U.S. public companies have staggered boards, not all directors are up for election every year. Therefore, the efficacy of shareholder votes may not be uniform. Under the staggered board voting regime, shareholders and proxy advising firms can typically voice their opinion on any given director only once every three years. This election structure may increase the likelihood that directors who are not up for election following poor performance will be insulated from the scrutiny of shareholders and proxy advisors. In turn, this may influence the accountability of staggered directors and the overall efficacy of shareholder votes.

…continue reading: The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards

What Happens in Nevada? Self-Selecting into Lax Law

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday October 28, 2014 at 9:02 am
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Editor’s Note: The following post comes to us from Michal Barzuza, Professor of Law at the University of Virginia School of Law, and David Smith, Professor of Finance at the University of Virginia.

In our paper, What Happens in Nevada? Self-Selecting into Lax Law, forthcoming in the Review of Financial Studies, we study the financial reporting behavior of firms that incorporate in Nevada, the second most popular state for out-of-state incorporations, after Delaware. Compared to Delaware, Nevada law has weak fiduciary requirements for corporate managers and board members. We find evidence consistent with the idea that lax shareholder protection under Nevada law induces firms prone to financial reporting errors to incorporate in Nevada, and that lax Nevada law may also cause firms to engage in risky reporting behavior. [1] In particular, we find that Nevada-incorporated firms are 30 – 40% more likely to report financial results that later require restatement than firms incorporated in other states, including Delaware. These results hold when we narrow our set of restatements to more serious infractions, including restatements that reduce reported earnings, and to restatements that raise suspicions of fraud or lead to regulatory investigations.

…continue reading: What Happens in Nevada? Self-Selecting into Lax Law

A New Tool to Detect Financial Reporting Irregularities

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday July 9, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Dan Amiram and Ethan Rouen, both of the Accounting Division at Columbia University, and Zahn Bozanic of the Department of Accounting and MIS at Ohio State University.

Irregularities in financial statements lead to inefficiencies in capital allocation and can become costly to investors, regulators, and potentially taxpayers if left unchecked. Finding an effective way to detect accounting irregularities has been challenging for academics and regulators. Responding to this challenge, we rely on a peculiar mathematical property known as Benford’s Law to create a summary red-flag measure to capture the likelihood that a company may be manipulating its financial statement numbers.

…continue reading: A New Tool to Detect Financial Reporting Irregularities

Regulating the Timing of Disclosure

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday December 10, 2013 at 9:15 am
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Editor’s Note: The following post comes to us from Lisa Bryant-Kutcher of the Department of Accounting at Colorado State University, Emma Peng of the Accounting Area at Fordham, and David Weber of the Department of Accounting at the University of Connecticut.

In our paper, Regulating the Timing of Disclosure: Insights from the Acceleration of 10-K Filing Deadlines, forthcoming in the Journal of Accounting and Public Policy, we examine how regulatory reforms that accelerate 10-K filing deadlines in 2003 affect the reliability of accounting information. The intended purpose of the new deadlines is to improve the efficiency of capital markets by making accounting information available to market participants more quickly. However, accelerating filing deadlines compresses the time available for firms and their auditors to prepare, review, and audit accounting reports, suggesting potential costs in the form of increased misstatements and lower reliability. We provide empirical evidence on the effects of accelerating deadlines by comparing the likelihood of restatement of 10-K filings before and after the rule change.

…continue reading: Regulating the Timing of Disclosure

The Effect of Audit Committee Expertise on Monitoring Financial Reporting

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday December 5, 2013 at 9:10 am
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Editor’s Note: The following post comes to us from Udi Hoitash, Ganesh Krishnamoorthy, and Arnold Wright, all of the Accounting Group at Northeastern University, and Jeffrey Cohen, Professor of Accounting at Boston College.

In our paper, The Effect of Audit Committee Industry Expertise on Monitoring the Financial Reporting Process, forthcoming in The Accounting Review, we examine the impact of audit committee (AC) industry expertise on the AC’s effectiveness in monitoring the financial reporting process. Despite the increased responsibilities, authority, independence, and financial expertise requirements placed on ACs by the Sarbanes-Oxley Act (SOX), ACs may, nonetheless, lack sufficient industry expertise to understand and thus properly monitor complex industry specific accounting issues. For instance, expertise in the retail industry may assist ACs to ensure that companies take an adequate write-down of inventory when their products face potential obsolescence. Similarly, revenue recognition, a prominent area of accounting manipulation (Beasley et al. 2000, 2010), entails an evaluation and understanding of the earnings process, which is tied to a company’s business processes that are often industry specific.

…continue reading: The Effect of Audit Committee Expertise on Monitoring Financial Reporting

Measuring Intentional Manipulation: A Structural Approach

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday June 7, 2013 at 9:18 am
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Editor’s Note: The following post comes to us from Anastasia Zakolyukina of the University of Chicago Booth School of Business.

In the paper, Measuring Intentional Manipulation: A Structural Approach, which was recently made publicly available on SSRN, I suggest a structural model of a manager’s manipulation decision that allows me to estimate his costs of manipulation and to infer the amount of undetected intentional manipulation for each executive in my sample. The model follows the economic approach to crime (Becker, 1968) and incorporates the costs and benefits of manipulation decisions. The model is a dynamic finite-horizon problem in which the risk-averse manager maximizes his terminal wealth. The manager’s total wealth depends on his equity holdings in the firm and his cash wealth. The model yields three predictions. First, according to the wealth effect, managers having greater wealth manipulate less. Second, according to the valuation effect, the current-period bias in net assets increases in the existing bias. Third, the manager’s risk aversion, the linearity of his terminal wealth in reported earnings, and the stochastic evolution of the firm’s intrinsic value produce income smoothing. Furthermore, the structural approach allows partial observability of manipulation decisions in the data; hence, I am able to estimate the probability of detection as well as the loss in the manager’s wealth using the data on detected misstatements (i.e., financial restatements).

…continue reading: Measuring Intentional Manipulation: A Structural Approach

Accounting and Litigation Risk

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday November 26, 2012 at 8:59 am
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Editor’s Note: The following post comes to us from Zhiyan Cao, Assistant Professor of Accountancy at the University of Washington Tacoma, and Ganapathi S. Narayanamoorthy, Assistant Professor of Accountancy at the University of Illinois at Urbana-Champaign.

In our paper, Accounting and Litigation Risk: Evidence from Directors’ & Officers’ Insurance Pricing, forthcoming in the Review of Accounting Studies, we study whether and how financial reporting concerns and traditional measures of corporate governance are priced by insurers that sell Directors’ and Officers’ (D&O) insurance to public firms. As D&O insurers typically assume the liabilities arising from shareholder litigation, the insurance premiums they charge for D&O coverage reflect their assessment of a company’s litigation risk.

Estimation of ex-ante litigation risk has always been a challenge for empirical research. Past studies employ ex-post lawsuits to derive an ex-ante measure of litigation risk. In such studies, a litigation risk prediction model is first estimated with the dependent variable being whether the firm got sued ex-post. The predicted values of the probability of getting sued are then used as ex-ante measures of litigation risk in an empirical model. Such measures ignore lawsuits filed in other jurisdictions and also cannot distinguish between frivolous and serious lawsuits. We employ a market-based measure of ex-ante litigation risk; that is, the D&O liability insurance premium, which incorporates the ex-ante expectation of both the likelihood of lawsuits and the magnitude of damages. In the U.S., public firms routinely purchase D&O insurance coverage for their directors and officers for reimbursement of defense costs and settlements arising from shareholder litigation. Most shareholder litigation is settled within policy limits, with the D&O insurers primarily footing the bill. Therefore, we expect the D&O insurers to price financial reporting risk and corporate governance risk efficiently in order to compensate for their expected payout obligations in the case of lawsuits.

…continue reading: Accounting and Litigation Risk

New PCAOB Auditing Standards

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday May 1, 2012 at 9:48 am
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Editor’s Note: The following post comes to us from Robert Buckholz, partner and co-coordinator of the Corporate and Finance Group at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication.

The Public Company Accounting Oversight Board is proposing a new auditing standard that relates to the auditor’s evaluation of a company’s relationships and transactions with related parties, and amendments to existing auditing standards that relate to significant unusual transactions and financial relationships and transactions by a company with its executive officers (including incentive compensation arrangements). The new and amended standards are intended to focus auditors’ efforts on areas that may pose an increased risk of material misstatement to a company’s financial statements.

The PCAOB’s proposals largely build upon and enhance existing requirements in these areas, primarily by providing greater specificity around the procedures that must be employed and inquiries that must be made. While the proposals would not directly impact the non-financial-statement disclosure (such as proxy disclosure) relating to related party transactions and executive compensation under SEC rules, companies should anticipate greater auditor focus and additional audit procedures on the financial statement impact of these areas if these proposals are adopted.

Subject to SEC approval, the new and amended standards would be effective for audits of financial statements for fiscal years beginning on or after December 15, 2012. The deadline for public comment is May 15, 2012.

…continue reading: New PCAOB Auditing Standards

Detecting Deceptive Discussions in Conference Calls

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday March 21, 2012 at 9:21 am
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Editor’s Note: The following post comes to us from David Larcker, Professor of Accounting at Stanford University, and Anastasia Zakolyukina of the Department of Accounting at Stanford University.

Considerable accounting and finance research has attempted to identify whether reported financial statements have been manipulated by executives. Most of these classification models are developed using accounting and financial market explanatory variables. Despite extensive prior work, the ability of these models to identify accounting manipulations is modest. In the paper, Detecting Deceptive Discussions in Conference Calls, forthcoming in the Journal of Accounting Research, we take a different approach to detecting financial statement manipulations by analyzing linguistic features present in CEO and CFO narratives during quarterly earnings conference calls. Based on prior theoretical and empirical research from psychology and linguistics on deception detection, we select the word categories that theoretically should be able to detect deceptive behavior by executives. We use these linguistic features to develop classification models for a very large sample of quarterly conference call transcripts.

A novel feature of our methodology is that we know whether the financial statements related to each conference call were restated in subsequent time periods. Because the CEO and CFO are likely to know that financial statements have been manipulated, we are able to reasonably identify which executive discussions are actually “deceptive”. Thus, we can estimate a linguistic-based model for detecting deception and test the out-of-sample performance of this classification method.

…continue reading: Detecting Deceptive Discussions in Conference Calls

Internal Corporate Governance, CEO Turnover, and Earnings Management

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday March 7, 2012 at 9:25 am
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Editor’s Note: The following post comes to us from Jonathan Karpoff, Professor of Finance at the University of Washington, and Sonali Hazarika and  Rajarishi Nahata, both of the Department of Finance at Baruch College, City University of New York.

In our paper, Internal Corporate Governance, CEO Turnover, and Earnings Management, forthcoming in the Journal of Financial Economics, we examine whether executives who manage earnings increase the risk of losing their jobs. We find that earnings management is strongly associated with the subsequent likelihood of forced CEO turnover, but is not significantly related to voluntary turnover. This basic result holds through several test specifications, including multinomial logistic regressions and competing risks hazard models. In the short run, aggressive earnings management in any given year is associated with an increased likelihood of forced ouster the next year. And in the long run, a CEO’s job tenure is negatively related to earnings management over the time he or she is in the CEO position. Similar results hold when we examine the forced turnover of CFOs. A large battery of sensitivity tests reported in the Internet Appendix indicate that these results are robust to alternate measures of earnings management and different model specifications.

…continue reading: Internal Corporate Governance, CEO Turnover, and Earnings Management

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