Aggregate Accruals and Market Returns: The Role of Aggregate M&A Activity, with Suresh Nallareddy and Mohan Venkatachalam (Journal of Accounting and Economics, 2021)
Presented at the Journal of Accounting and Economics 2020 Conference: https://www.youtube.com/watch?v=46g7_p-VvI0&t=235m55s
ABSTRACT: Extant literature documents that aggregate accruals positively predict future market returns and attributes this relation to either changes in discount rates or systematic earnings management. We offer an alternative explanation: aggregate merger and acquisition (M&A) activity drives this relation. M&A activity affects the magnitude of accruals, which in turn drives the market return predictability of aggregate accruals. We find that the ability of both aggregate accruals and discretionary aggregate accruals (a measure of systematic earnings management) to predict market returns disappears after controlling for aggregate M&A activity. Furthermore, aggregate M&A activity predicts future market returns, consistent with a price response to improvements in macroeconomic outcomes due to aggregate M&A activity.
CFO Co-Option and CEO Compensation, with Shane S. Dikolli, William J. Mayew, and Mani Sethuraman (Management Science, 2021)
ABSTRACT: We study whether relative power in the CEO-CFO relationship influences CEO compensation. To operationalize relative power of a CEO over a CFO, we define CFO co-option as the appointment of a CFO after a CEO assumes office. We find that CFO co-option is associated with a CEO pay premium of about 10%, which is concentrated more in the early years of the co-opted CFO’s tenure and in components of compensation that vary with the achievement of analyst-based earnings targets. Our evidence also indicates that a primary channel through which CEO power over a co-opted CFO yields the achievement of earnings targets is the use of earnings management to inflate earnings. Co-opted CFOs rely primarily on using discretionary accruals to manage earnings prior to the Sarbanes-Oxley regulatory intervention and switch to real activities manipulation afterwards. The evidence thus suggests that the form of earnings management depends on costs imposed on the CFO to inflate earnings.
ABSTRACT: I document that mandated performance disclosure increased managerial risk-taking, resulting in significant unintended consequences and agency conflicts. After the SEC required that all mutual funds disclose a self-selected primary benchmark, I find that most fund managers chose a benchmark that was not the best fit index. Furthermore, I provide evidence that actively managed funds increased risk-taking relative to their disclosed benchmarks in response to the disclosure change. I also find that the mandated disclosure requirement exacerbated the well-documented tendency of managers who underperform during the first half of the year to increase the risks they take in the second half of the year.
Evading the Torpedo: Why Managers Avoid Stock Splits, with Qin Tan, Ye Liu, and Frank Zhang
ABSTRACT: In this paper, we document a previously unknown cost of stock splits: failure to sufficiently beat earnings targets and its associated capital markets punishment. We show that both firms’ earnings announcement returns and likelihood of beating analysts’ expectations by at least two cents decline post-stock split. This patterned decline in both split activity and post-split returns only occurs for publicly-listed firms, whereas abnormal returns for closed-end funds do not consistently vary over time. Overall, the results suggest that declining signaling benefits and increasing costs led to fewer stock splits in recent years.
The Consequences of Fund-level Liquidity Requirements, with Indraneel Chakraborty, Elia Ferracuti, and Matthew Phillips
Presented at the 9th Annual Conference on Financial Market Regulation (CFMR 2022), hosted jointly by the SEC’s Division of Economic and Risk Analysis (DERA), Lehigh University’s Center for Financial Services (CFS), University of Maryland’s Center for Financial Policy (CFP), and CFA Institute: https://www.sec.gov/dera/announcement/dera_event-050622_9th-annual-conference-fin-market-reg
ABSTRACT: We investigate the effects that mutual fund liquidity requirements have on fragility. In 2018, SEC Rule 22e-4 restricted ownership of illiquid securities in funds. As expected, post-rule, funds hold more liquid securities. Firms issuing illiquid securities face higher costs due to a smaller investor pool. However, higher liquidity does not ameliorate adverse shocks. Facing outflows, funds maintain cash levels and sell illiquid securities. This is because liquidity requirements are not sufficiently countercyclical: funds must maintain cash even when they should use it to mitigate flow pressures. Hence, outflows force funds to sell more illiquid securities post-rule change, unintentionally increasing fragility.
Winning Is Not Enough: Changing Landscapes of Earnings Surprises and the Market Reaction, with Qin Tan, Ye Liu, and Frank Zhang
ABSTRACT: In this paper, we examine the changing time-series properties of the earnings-return relation and explore the implications of its changing landscape for the literature. We document strikingly opposite time-series patterns of earnings surprises and associated market reaction. Earnings surprises have been increasing over time, with the mean analyst forecast error rising from negative 8 cents in 1990 to positive 1.4 cents in 2019. However, average earnings announcement returns have declined from 0.30% in 1990 to -0.35% in 2019, turning negative in the past 15 years. As firms strive to meet or beat earnings expectations, strong past performance of a firm and strong performance of other firms raise the market’s earnings expectation above analysts’ consensus forecast, leading to investors’ disappointment upon earnings announcements. Our evidence has broad implications for appropriate earnings benchmarking, for empirical design when examining the earnings-return relation, for a disappearing earnings announcement premium, and for disappearing discontinuity in the earnings surprise distribution around zero.
Does mandatory short selling disclosure lead to investor herding behavior?, with Qin Tan, Ye Liu, and Frank Zhang
ABSTRACT: We investigate two competing hypotheses for why clustering of trades occur around short sale disclosure in the UK: herding- and information-based trading. First, we use a matched sample of firms with similar short interest to compare firms with and without short selling disclosure and find that firm-level short interest exhibits a much smaller reversal for disclosure stocks than for matched non-disclosure stocks. A smaller reversal for disclosure stocks is consistent with short position disclosure inducing investor herding behavior and thus making short interest more persistent. Second, we explore the role of corporate news on the premise that information-based trading is related to news about firm fundamentals. We find that short sale disclosure occurs with similar frequency across the pre-earnings announcement, post-earnings announcement, and no-information windows, suggesting that information shocks related to firm fundamentals are not a major factor of short sale disclosure clustering. More importantly, the clustering of short sale disclosure does not vary significantly between good and bad earnings news. Overall, the evidence is most consistent with investor herding behavior for the clustering of short sale disclosure.