Heba Abou-El-Sood and Dalia El-Sayed
The authors investigate whether abnormal tone in corporate narrative disclosures is associated with earnings management and earnings quality, in an emerging market context. Based…
Abstract
Purpose
The authors investigate whether abnormal tone in corporate narrative disclosures is associated with earnings management and earnings quality, in an emerging market context. Based on agency theory and opportunistic/impression management perspective, this study examines whether executives manage disclosure tone to support their opportunistic behavior, when using earnings management.
Design/methodology/approach
This study uses a sample of earnings press releases of publicly traded firms in the MENA region during 2014–2019. It employs textual analysis to measure disclosure tone. The authors estimate abnormal disclosure tone after controlling for firm characteristics. Discretionary accruals proxy for earnings management and are estimated using Modified Jones model. Earnings quality is measured using accounting-based and market-based proxies: earnings smoothness, persistence, predictability and value relevance/informativeness.
Findings
Results show a positive association between abnormal disclosure tone and earnings management. Additionally, results show that earnings persistence is higher for firms with lower levels of abnormal disclosure tone. Results are sustained for earnings smoothness, but not for predictability and value relevance/informativeness.
Research limitations/implications
Results provide initial evidence of management's use of tone management jointly with earnings management. This adds to prior studies adopting the opportunistic perspective of disclosure tone, through showing that discretionary tone in narrative disclosures can be strategically used by management to influence investors' perceptions.
Practical implications
The results provide valuable insight to board of directors, auditors and market participants on the possible biases emerging from tone of narrative disclosures in corporate reports. For regulators and standard-setters, results shed light on the need for regulations and rules beyond financial statements, to guide disclosure of narrative information in different corporate reports.
Originality/value
This study contributes to the rare evidence that investigates textual disclosure characteristics to uncover management's opportunistic practices and assess earnings quality. Where majority of studies concentrate on developed markets, this study provides novel evidence of emerging markets by examining the association between abnormal disclosure tone and earnings management/earnings quality. Also, it validates the tone management model proposed by Huang et al. (2014) for capturing tone manipulation.
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Beibei Yan, Özgür Arslan-Ayaydin, James Thewissen and Wouter Torsin
Prior research shows that managers with lower ability release less accurate management earnings forecasts and have more earnings restatements, lower earnings persistence and lower…
Abstract
Purpose
Prior research shows that managers with lower ability release less accurate management earnings forecasts and have more earnings restatements, lower earnings persistence and lower quality accruals estimations. Yet, whether the impact of managerial ability (MA) on financial reporting can be extended to the narrative section of firms' financial disclosures needs to be theoretically and empirically examined. The authors theorize in this paper that managers with low ability opportunistically inflate the tone to increase outsiders' perceptions of their ability. The authors also examine the relation between MA and the informativeness of tone to predict future firm performance and explain investors' reaction at earnings announcement.
Design/methodology/approach
The authors collect 24,000 earnings press releases of 1,149 distinct firms between 2004 and 2013. Content analysis is used to proxy the tone of the disclosures. The authors use the score developed by Demerjian et al. (2012) to measure MA. The authors then employ panel data regressions to examine the impact of MA on disclosure tone.
Findings
The authors find that low-ability managers inflate the disclosure tone to positively influence labor market's perceptions about their ability. This effect is magnified for younger and shorter-tenured managers, for firms with more intense monitoring and during bear markets. The authors also find that the tone of earnings press releases of low-ability managers results in a lower stock price reaction. Supplementary analyses show that the results do not only hold for the tone, but also can be extended to other linguistic features such as the numerical intensity and the readability of earnings press releases. The results are robust to alternative library specifications and other corporate disclosures such as CEO letters to shareholders or 10-K filings.
Research limitations/implications
The paper shows that managers worry about how firm performance influences the labor market assessment of their ability. In particular, the authors find that managers of low ability are willing to opportunistically manipulate the content of corporate disclosures to improve this perception and build their reputation.
Originality/value
The authors contribute by providing theoretical and empirical evidence on how managers attempt to steer assessments of their ability by manipulating corporate disclosures. Consistent with prior business research suggesting that one's ability is a key feature that affects managers' propensity to engage in ethical practices, such as tax avoidance or manipulation of financial information, this study shows that less able managers tend to inflate the tone of the earnings announcements and that this ability-driven bias is likely to be magnified by career concerns.
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Henry Huang, Li Sun and Joseph Zhang
This paper examines the relationship between environmental uncertainty and tax avoidance at the firm level. We posit that managers faced with more uncertain environments are…
Abstract
This paper examines the relationship between environmental uncertainty and tax avoidance at the firm level. We posit that managers faced with more uncertain environments are likely to engage in more tax avoidance activities. We find a significant and negative relationship between environmental uncertainty and effective tax rates, and our results persist through a battery of robust checks. We further find that managerial ability mitigates the above relationship. Moreover, we find that small, highly leveraged, and innovative firms operating in uncertain environments engage in more tax avoidance.
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Xiaonong Zhang, Sakthi Mahenthiran and Henry He Huang
The purpose of this paper is to examine governance and earnings management implications of the delisting regulation in China, which designates firms with two consecutive losses as…
Abstract
Purpose
The purpose of this paper is to examine governance and earnings management implications of the delisting regulation in China, which designates firms with two consecutive losses as Special Treatment (ST) firms and delists such firms, should two more years of consecutive losses occur.
Design/methodology/approach
Samples were selected using the matching‐sampling method, and interrupted time‐series Logit regression analyses was used to test the determinants of ST firms using corporate governance factors and earnings quality.
Findings
It was found that firms which subsequently become ST firms have greater agency problems, as indicated by divergence of ownership and less independent boards, as measured by the number of independent directors. The ST firms subsequently reduce their agency costs by increasing ownership concentration and increasing the number of independent directors. Additionally, the results suggest that ST firms engage in earnings management after the first year of loss.
Practical implications
The paper suggests that agency problems play an important role in financial performance, and the Chinese delisting regulation does lead to improvements in governance; nevertheless, it might force firms to engage in earnings manipulation.
Originality/value
Distinct from previous empirical research that has examined earnings management, the authors study it in the context of the delisting regulation in China. Additionally, it is a longitudinal study examining how delisting regulations affect the governance of the firm under financial distress.
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Richard Fisher, Chris J. van Staden and Glenn Richards
The purpose of this paper is to investigate: how dimensions of tone vary across different forms of corporate accountability narrative; the impact of tone on readability; and the…
Abstract
Purpose
The purpose of this paper is to investigate: how dimensions of tone vary across different forms of corporate accountability narrative; the impact of tone on readability; and the determinants of tone, including consideration of its use in impression management.
Design/methodology/approach
Using a multi-year sample of listed companies, the authors measure dimensions of tone across multiple narrative types within the annual report and standalone corporate social responsibility report. Statistical analysis is used to investigate variations of tone across narrative type, each dimension’s influence on readability and the role of antecedent factors.
Findings
Analysis reveals that dimensions of tone vary significantly across narrative types (genres) suggesting that tonal patterns form part of the specific stylistic conventions of each genre. Tone is found to be a significant determinant of readability. Little evidence of obfuscation using tone was found, while disclosure type is the most salient determinant of tone.
Practical implications
The study illuminates latent or underlying disclosure norms that can facilitate the identification of “exceptional” cases that do not conform with expected tonal patterns of a particular narrative type and may warrant closer inspection by preparers, auditors or regulators. The issues raised regarding the clarity and balance of textual disclosures highlight the challenges in regulating corporate narratives.
Originality/value
This study highlights that tone is a more nuanced and layered concept than suggested by much of the prior literature. Further, tone ought to be considered in studies examining textual complexity.
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The purpose of this paper is to investigate the effects of individual provisions of firm‐level shareholder rights on the cost of equity capital in the USA setting.
Abstract
Purpose
The purpose of this paper is to investigate the effects of individual provisions of firm‐level shareholder rights on the cost of equity capital in the USA setting.
Design/methodology/approach
Prior literature has shown that strong shareholder rights, as measured by aggregated shareholder rights indices, could mitigate the agency costs and reduce the cost of equity capital. Stepwise regression method with control variables for financial risks and corporate governance risks is used to empirically test whether individual shareholder rights provisions have varying degrees of impacts on a firm's cost of equity capital.
Findings
Of the 24 shareholder rights provisions in the shareholder rights index, four provisions are found to be the most significant determinants of cost of equity capital with the absence of three provisions (poison pill, golden parachute, and control share cash out) and the presence of fair value provision reducing the firm's cost of equity capital.
Research limitations/implications
First, the results suggest that a few individual provisions are major determinants of firm value. Hence, investors and regulators should pay the most attention to these provisions. Second, the result that some provisions that limit shareholders' rights actually reduce cost of equity capital suggests that investors and regulators should not view all aspects of weak shareholder rights negatively.
Originality/value
This paper tests the impact of shareholder rights on cost of equity capital from an individual provision basis.
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Most of the major Islamic countries’ stock exchanges have not been able to perform at the same pace with the major emerging countries’ stock exchanges since the mid of 1990s. The…
Abstract
Purpose
Most of the major Islamic countries’ stock exchanges have not been able to perform at the same pace with the major emerging countries’ stock exchanges since the mid of 1990s. The purpose of this paper is to examine the implications of stock market liberalization on cost of capital as one of the crucial driver to stock market development and physical investment growth in emerging Islamic countries.
Design/methodology/approach
This study employs static panel data techniques on the sample of seven emerging Islamic countries over the years 1989-2008.
Findings
The findings of this study suggest that stock market liberalization significantly reduces cost of capital in the stock markets of sample Islamic countries, which carries policy-oriented implications. Reduction in the cost of capital increases the number of exchange-traded companies, profitability of projects and aggregate investment level; therefore, the study findings are highly concerned by the economic policymakers, corporations and investors alike.
Research limitations/implications
In the literature, different proxies are employed to measure stock market liberalization and cost of capital as well. Due to data limitations, this study could not employ different proxies for both, especially for stock market liberalization, for robustness purpose. That limitation further restricted the coverage of Islamic stock markets and time period. Therefore, generalization of the study results for overall Islamic stock markets can be slightly drawn.
Originality/value
The paper provides further understanding regarding the effects of SML on cost of capital, thereby indirectly on the stock market development, in the context of EIC.
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This paper aims to analyze Public Companies Accounting Oversight Board (PCAOB) inspection reports on audit reports of those inspected accounting firms in Brazil, Russia, India and…
Abstract
Purpose
This paper aims to analyze Public Companies Accounting Oversight Board (PCAOB) inspection reports on audit reports of those inspected accounting firms in Brazil, Russia, India and China (BRIC). In meeting the requirements of the Sarbanes-Oxley Act, the PCAOB conducts inspections on audit reports of firms listed on the New York Stock Exchange.
Design/methodology/approach
The reports include those submitted by both the US audit parent firms and their secondary firms located outside the USA. In each PCAOB report, it unravels the nature of audit deficiencies. The focus is on Big Four because they play a dominant role in the marketplace and issuers’ market capitalization. All the seven-year deficiencies are documented since publications of the reports from 2004 to 2012.
Findings
Of the 37 reports, 19 (51 per cent) were issued relating to audits conducted by the Big Four. Out of these 19 reports, 10 (53 per cent) contain inspection criticism. These include audit quality and common recurring audit deficiencies.
Research limitations/implications
This paper is based solely on those inspection reports published by the PCAOB.
Practical implications
The findings have significant implications to audit firms and the audit profession on improving audit quality, firms’ internal control and reports.
Originality/value
No known prior research paper is available on the ramifications of the PCAOB’s inspection reports relating to BRIC.
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Henry Huang, Quanxi Wang and Xiaonong Zhang
The purpose of this paper is to investigate whether managerial ownership affects the association between shareholder rights and the cost of equity capital.
Abstract
Purpose
The purpose of this paper is to investigate whether managerial ownership affects the association between shareholder rights and the cost of equity capital.
Design/methodology/approach
Prior literature has shown that strong shareholder rights are associated with a lower level of cost of equity capital. This paper empirically tests the interaction between managerial ownership and shareholder rights on affecting the cost of equity capital, using Gompers et al.'s governance score and Ohlson and Juettner‐Nauroth's estimate of cost of equity capital. To mitigate the endogeneity arising from other governance variables affecting both shareholder rights and the cost of equity capital, the paper adopts both OLS and two‐stage regression.
Findings
The results indicate that managerial ownership aligns managers' interests with those of shareholders, leading to a lesser degree of agency problems and lower cost of equity capital. Furthermore, the evidence suggests that managerial ownership could substitute for shareholder rights in affecting the cost of equity capital, making strong shareholder rights less important in a high managerial ownership setting.
Research limitations/applications
Findings in this paper suggest that firms need to consider the interaction between managerial ownership and shareholder rights in designing their governance structure to minimize their cost of equity capital.
Originality/value
This paper reveals the interaction between two major governance variables in affecting firm valuation.
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Sudheer Chava, C.S. Agnes Cheng, Henry Huang and Gerald J. Lobo
The purpose of this paper is to investigate the effects of class action litigation on firms' cost of equity capital.
Abstract
Purpose
The purpose of this paper is to investigate the effects of class action litigation on firms' cost of equity capital.
Design/methodology/approach
The paper uses three different models to estimate the cost of equity capital. To separate the impact of lawsuit filings on the cost of equity capital from that of the revelation event, a sample of lawsuits with a long lag between the disclosure events and filing dates was analyzed. Also, a comparison group study was conducted to illustrate the distinct impact of a lawsuit filing on the defendant firm's cost of equity capital. Finally, a multivariate analysis was used to examine the factors that affect the magnitude of such impact.
Findings
The paper finds that filing of a class action lawsuit results in a significant increase in the defendant firm's cost of equity capital incremental to the effect of the disclosure event. Additionally, increases in the cost of equity capital after the lawsuit filings are higher when the lawsuits involve generally accepted accounting principle (GAAP) violation and have high merit, and when the defendant firms are small and have high leverage.
Practical implications
Findings in this paper suggest that the filing of a lawsuit brings new information to the market and is likely to increase the defendant firm's cost of equity capital by increasing the perceived risk in corporate governance, information asymmetry and operation.
Originality/value
This paper reveals securities class actions increase the defendant firms' cost of equity capital.