April Klein

Audit committee, board of director characteristics, and earnings management

This study examines whether audit committee and board characteristics are related to earnings management by the firm. A negative relation is found between audit committee independence and abnormal accruals. A negative relation is also found between board independence and abnormal accruals. Reductions in board or audit committee independence are accompanied by large increases in abnormal accruals. The most pronounced effects occur when either the board or the audit committee is comprised of a minority of outside directors. These results suggest that boards structured to be more independent of the CEO are more effective in monitoring the corporate financial accounting process.

Board Composition, Committees and Organizational Efficiency: The Case of Nonprofits

This article investigates the relationship between nonprofit board composition and organizational efficiency. Overall,we find a significant statistical association between the presence of major donors on the board and indicators of organizational efficiency. Although causality cannot be demonstrated,our findings are consistent with the Fama and Jensen (1983) conjecture that major donors monitor nonprofit organizations at least in part through their board membership. The multivariate analysis shows that the ratio of total expenses to program expenses is significantly and negatively associated with higher donor representation. Decomposing the total expense ratio into its two components,we find that different factors affect the administrative and fundraising expense ratios. The percentage of major donors on the finance committee,a key committee overseeing budgets and administrative expenses,is negatively related to the organization’s administrative expenses ratio. The presence of major donors on other board committees is not significantly statistically associated with nonprofit efficiency.

A direct test of the cognitive bias theory of share price reversals

Abstract The cognitive bias theory of share price reversals predicts that the market forms overly optimistic (pessimistic) earnings expectations for firms that experienced high (low) stock returns. This paper finds evidence inconsistent with this theory. Analysts do not underpredict earnings following large stock price declines; instead, they remain overly optimistic about future earnings. Similarly, analysts do not overpredict earnings for firms after periods of extreme price rises. It appears, then, that other factors are responsible for the observed mean reversions in share prices.

Audit Committee Financial Expertise, Competing Corporate Governance Mechanisms, and Earnings Management

A prime objective of the Sarbanes-Oxley Act and recent changes to stock exchange listing standards is to improve the quality of financial reporting. We examine the associations between audit committee financial expertise and alternate corporate governance mechanisms and earnings management. We find that both accounting and certain types of non-accounting financial expertise reduce earnings management for firms with weak alternate corporate governance mechanisms, but that independent audit committee members with financial expertise are most effective in mitigating earnings management. Importantly we find that alternate corporate governance mechanisms are an effective substitute for audit committee financial expertise in constraining earnings management. Finally, we find either no association or a positive association between financial expertise and real earnings management. Our results suggest that alternate governance approaches are equally effective in improving the quality of financial reporting, and that firms should have the flexibility to design the particular set of governance mechanisms that best fit their unique situations.

Fundamentals of Accounting Losses

This paper examines accounting and non-accounting factors behind accounting losses over a fifty-year period. Using multivariate time-series analysis, we report evidence that the annual percentage of losses for U.S. firms is significantly related to accounting conservatism, Compustat coverage of small firms, real firm performance as measured by cash flows from operations, and business cycle factors. We further find that non-accounting factors tend to play the dominant role in explaining accounting losses over our sample period. Our results are robust to alternative definitions of macroeconomic productivity, as well as to varying model specifications. Our findings contribute to the literature on accounting losses and accounting conservatism and have implications for the use of accounting loss information in numerous settings.

Targeted share repurchases and top management changes

Abstract Firms paying greenmail, i.e., repurchasing a block of stock on favorable terms from a particular shareholder or shareholders, experience above-average management turnover within one year of the payment. This high turnover is not necessarily connected only with the greenmail payment, since it follows other evidence of conflict between the target company and its shareholders. Since companies paying greenmail experience positive stock returns before the management change, the high management turnover is not related to poor share-price performance. Given that greenmail harms shareholders, our findings support the view that internal mechanisms monitor top management activity.

The Influence of Market Conditions on Event-Study Residuals

This paper presents evidence that the mean-adjusted returns and raw-market returns models are misspecified when the event under investigation occurs during either bull or bear markets. To demonstrate this phenomenon, simulation techniques as well as an actual event are employed to examine the reliability of four different return-generating models. When the event occurs during a bull (bear) market, both the mean-adjusted and raw-market returns models produce upwardly (downwardly) biased positive (negative) abnormal returns. This results in statistically significant cumulative abnormal returns over selected preevent and postevent intervals. In contrast, both the market-adjusted and single-index models show far less evidence of any unusual price activity over these same intervals.

Affiliated Directors: Puppets of Management or Effective Directors?

This paper examines four non-mutually-exclusive hypotheses behind the inclusion of different types of directors and the impact they have on firm performance. Strong associations are found between the specific economic needs of companies and the incidence of directors most likely to fulfill these needs. In particular, theoretical and empirical evidence is presented that most affiliated directors are not puppets of management, but are placed on boards to serve specific, strategic needs of firms. In addition, no systematic relation is found between various measures of performance and director type. In total, it appears that, on average, boards of directors are constructed in a rational manner.

Do Analysts Use the Freedom of Information Act to Improve Stock Recommendations and Forecast Accuracy

A number of sell-side healthcare analysts gain access to information outside the purview of management through Freedom of Information Act requests to the Food and Drug Administration for records on factory inspections, complaints, and drug and medical device applications. Using a difference-in-differences methodology, we find that buy (sell) recommendations and upgrades (downgrades) earn higher (lower) stock returns over the year following the receipt of FDA records. We also examine the type of information revealed in FDA factory inspection reports, and find that analysts are less likely to downgrade and are less pessimistic in their recommendations than the consensus recommendation when the information contained in the FDA report is not particularly severe. Our findings are consistent with a subset of analysts utilizing non-public information channels independent of management to gain value-relevant information about their covered firms.