Baohua Xin

Accounting Conservatism and Performance Covenants: A Signaling Approach

This study examines the relation between performance covenants in private debt contracting and conservative accounting under adverse selection. We find that under severe adverse selection (i.e., high information asymmetry), accounting conservatism and performance covenants act as complements to signal that the borrower is unlikely to appropriate wealth from the lender. No such relation obtains in a low information asymmetry regime. We further show that in the high information asymmetry regime, borrowers with high levels of conservatism and tight performance covenants generally enjoy lower interest rate spreads than borrowers with low levels of conservatism and loose performance covenants. Consistent with our signaling theory, in the high information asymmetry regime, borrowers with high levels of conservatism and tight performance covenants are less likely to make abnormal payouts to shareholders. Our empirical results are robust to alternative measures of conservatism and covenant restrictiveness.

Leaders and Followers Among Security Analysts: Analysis of Impact and Accuracy

We examine how analysts whose forecasts lag those of timely analysts aid the price discovery process. We classify analysts as lead and follower analysts for a given firm based on the relative timeliness of their earnings forecasts over a two-year period. We find that news in forecasts of lead analysts has a higher price impact relative to that of follower analysts and this difference in impact cannot be explained by analyst reputation or experience. The price impact of follower analysts’ forecasts is significant, although it dissipates as follower analysts become less timely. Moreover, we find that the forecast issued by even the least timely analyst conveys incremental information to the market. The significant market impact of follower analysts arises mostly due to the private information conveyed by their forecast and partly because their forecasts incorporate public information including their predecessor’s forecast. While in general the price impact of the forecast component that mimics prior information is consistent with the post-revision drift documented by prior studies, we find that this impact is significant only when the follower analyst’s forecast confirms the information conveyed by the predecessor analyst. We also find that follower analysts issue more accurate forecasts than lead analysts who appear to trade off accuracy for timeliness. Overall, we conclude that the complementary roles of timely and late forecasters combine the merits of timely and accurate information and facilitate price discovery.

A Peek Behind the Curtain that Conceals Self-Dealing

Because successful self-dealing cannot be observed in naturally occurring data, we conduct an experiment where self-dealing emerges endogenously along with concealment strategies. We show that subjects can profitably self-deal while fashioning complex strategies that include opacity-preserving resource divisions and misleading direct communication that can build false trust in partners that can be later exploited. These strategies also entail profit skimming that has the paradoxical effect of reducing private gains from self-dealing. Ultimately, self-dealing occurs frequently in economies that generate larger social gains from exchange than economies where hard information provision leads to fully transparent resource allocation.

Evidence on the Real Effects of Accounting: The Case of Employee Stock Option Expensing

This study uses the real effects theory to investigate the effects of accounting for employee stock options (ESOs) on corporate investment. We document that in the period before the required expensing of the fair value of ESO costs, firms overinvested in risky projects. We attribute the suboptimal investment policy to the favorable accounting treatment of ESOs. We further find that the incremental rate of return on abnormal investment is negative, suggesting that the removal of the accounting distortion would improve investment efficiency and firm value. Consistent with this prediction, we document a positive association between abnormal investment and the stock price reaction to an event that took place during the deliberation of SFAS No. 123R, a new accounting rule that eliminated the preferential accounting treatment of ESOs. Taken together, our evidence lends support to the theory that accounting has real effects on corporate investment. JEL classification: G14; G24; G28; J24; J33; J63; K22; K23; M41