Christine I. Wiedman

Earnings Management through Transaction Structuring: Contingent Convertible Debt and Diluted Earnings per Share

In this article we examine whether firms structure their convertible bond transactions to manage diluted earnings per share (EPS). We find that the likelihood of firms issuing contingent convertible bonds (COCOs), which are often excluded from diluted EPS calculations under Statement of Financial Accounting Standard (SFAS) 128, is significantly associated with the reduction that would occur in diluted EPS if the bonds were traditionally structured. We also document that firms` use of EPS-based compensation contracts significantly affects the likelihood of COCO issuance and find weak evidence that reputation costs, measured using earnings restatement data, play a role in the structuring decision. These results are robust to controlling for alternative motivations for issuing COCOs, including tax and dilution arguments. In addition, an examination of announcement returns reveals that investors view the net benefits and costs of COCOs as offsetting one another. Our results contribute to the literature on earnings management, diluted EPS, financial reporting costs, and financial innovation.

The impact of capacity expansion on the market value of the firm

Abstract This paper empirically investigates the impact of capacity expansion decisions on the market value of the firm. Event study methodology is used to estimate the abnormal change in stock prices around capacity expansion decision announcements. On the day of the announcement, the magnitude of the price change is abnormally high, evidenced by a significantly positive mean standardized square of the abnormal change (Beavers U-statistic). We also analyze factors that we could affect the direction and magnitude of the abnormal change in the stock prices. We find that the change in price on the day of the announcement is positively and significantly related to the real growth rate of the industry, and negatively and significantly related to the variability of demand. A negative relationship between the price change and industry capacity utilization is also found which can have important implications for companies which follow the wait-and-see approach to capacity expansion decisions. We also find management ownership to be a significant predictor in explaining stock price changes around these announcements.

Management of Note Disclosures: The Case of Unconsolidated Subsidiaries Prior to FAS No. 94:

Statement of Financial Accounting Standards Number 94 (FAS 94) requires that firms consolidate all majority-owned subsidiaries, including those that were previously exempt from consolidation requirements due to the dissimilarity of parent/subsidiary operations. Prior to FAS 94, firms disclosed summary information on unconsolidated subsidiaries in their notes. This research demonstrates that, although the overall sample is unbiased, pre–FAS 94 note disclosures were insufficient to enable users to obtain an accurate picture of consolidated leverage for a number of firms. The research also illustrates that firms that underreported subsidiary debt had significantly higher consolidated leverage (as measured using pre–FAS 94 note disclosures) than other firms and that the market appeared to have relied on these inaccurate disclosures in assessing firm value.

Transaction Structuring and Canadian Convertible Debt

We examine whether Canadian firms issuing convertible debt over the period 1996–2003 structured issuances to minimize reported leverage. Over this sample period, some firms using payment-in-kind (PIK) provisions providing them with the option to make interest and/or principal payments in company shares were able to record significant amounts of the issuance as equity. In a sample of 195 convertible debt offerings, we find significant variation in accounting treatment, ranging from firms recording the entire issuance as debt to some recording the entire issuance as equity. We find evidence consistent with the contention that reporting benefits are an important reason why high-leverage corporations with material convertible debt transactions used PIK provisions. In contrast, our evidence suggests that the future financial flexibility ensuing from the use of PIK provisions was an important determinant of income trusts’ use of this feature. We acknowledge, however, that during our sample period PIK provisions simultaneously provide both financial flexibility and reporting benefits to any issuer, whether corporation or trust. Finally, we document a negative share price reaction on the part of convertible debt issuers employing PIK provisions at the time when the likelihood of the introduction of more restrictive accounting rules increased. This negative reaction is driven by the corporations in our sample, with the income trusts largely unaffected. Our findings are relevant to standard setters as they debate alternative models for distinguishing between equity and liabilities.

Shareholder Activism and Voluntary Disclosure Initiation: The Case of Political Spending

Using corporate political spending disclosures as our empirical setting, we conduct a detailed inquiry of shareholder proposals to highlight the role of shareholder activism in the diffusion of disclosure practices. We examine a sample of 541 political spending-related shareholder proposals from 2004 to 2012. In a departure from prior research, we examine both proposals voted on and proposals withdrawn by the activist, allowing us to more comprehensively assess the success of shareholder activism. We find that 20% of disclosure proposals are subsequently implemented by targeted firms, with implementation rates varying significantly by proposal type – 8% for proposals voted on versus 56% for withdrawn proposals. We also find that unions and public pension funds are less likely to target firms with agency problems, are less successful in having proposals withdrawn, and the implementations they do obtain are viewed as value-destroying by the broader investor base. Our findings highlight shareholder proposals as one mechanism by which investors can express their preferences for and successfully influence corporate disclosure policies. Given activists’ long-standing interest in compensation and social disclosure policies, we believe our findings can generalize to these other disclosure settings.

Measuring CEO Personality Using Machine-Learning Algorithms: A Study of CEO Risk Tolerance and Audit Fees

We rely on recent developments in machine learning and artificial intelligence and use the IBM Watson Personality Insights service to measure personality based on transcripts of Q&A sessions of conference calls made by CEOs. We obtain Big-five personality traits and compute a measure for risk tolerance. We conduct a number of validation tests to show that all personality traits are CEO-specific and not related to firm characteristics and firm performance. We then examine the relation between CEO risk tolerance and audit fees. We find that higher CEO risk tolerance is associated with significantly higher audit fees and that this association is consistent across several Big Five index components. Moreover, we find some evidence that the influence of the CEO’s risk tolerance on audit fees is greater when CEO power is greater. Consistent with upper echelons theory, our results suggest that CEO personalities have an incremental impact on auditors’ assessment of engagement risk.