Ivy Xiying Zhang

CEO Compensation and Fair Value Accounting: Evidence from Purchase Price Allocation

This study investigates the impact of CEO compensation structure on post-acquisition purchase price allocation, an accounting procedure that involves fair value estimation of various assets and liabilities. We find that CEOs whose compensation packages rely more on earnings-based bonuses are more likely to overallocate the purchase price to goodwill, the largest asset recorded post-acquisition. Because goodwill is not amortized, the overallocation likely increases post-acquisition earnings and bonuses. We also find that, when the acquirers CEO bonus plan includes performance measures that are not affected, or are less affected, by the overstatement of goodwill, such as cash flows, sales, or earnings growth, the overallocation to goodwill motivated by bonus plans diminishes.

The Adoption of Internationally Recognized Accounting Standards Implications for the Credit Markets

We examine whether the adoption of internationally recognized accounting standards is associated with a greater sensitivity of credit ratings to accounting information. We find that credit ratings are significantly more sensitive to the accounting default factor post voluntary International Financial Reporting Standards (IFRS)/U.S. Generally Accepted Accounting Principle (GAAP) adoption. Similar evidence is also found post mandatory IFRS adoption in countries with strong rules of law. Collectively, the above evidence suggests that firms’ incentives to comply are important in determining the consequences of accounting standard changes.

Accounting Discretion and Purchase Price Allocation After Acquisitions

The recent movement in standards setting toward fair-value-based accounting beyond financial assets and liabilities calls for more empirical evidence on fair-value measurement, especially that of intangible assets. This article studies the initial valuation of goodwill and identifiable intangible assets after acquisitions. We find that the allocation of purchase price to goodwill and identifiable intangible assets is related to the economic determinants of the valuation. However, it is also significantly affected by managerial incentives arising from the differential treatments of goodwill and identifiable intangible assets under Statement of Financial Accounting Standards (SFAS) 142. The same managerial discretions are not exhibited in the purchase price allocation prior to SFAS 142, when goodwill and other intangibles are both amortized. These findings suggest that unverifiable fair value measures are associated with the underlying economics but also deviate from the true values in the presence of management reporting incentives. Further analysis suggests that external appraisers constrain managerial discretion in intangible asset valuation to an extent but do not completely eliminate it.

CEO Power, Internal Control Quality, and Audit Committee Effectiveness in Substance Versus in Form†

During the past decade, new regulations have been adopted to improve audit committee effectiveness. Prior research has generally provided evidence in support of these regulations and suggests that a more independent and expert audit committee is more effective. We posit that CEO power reduces or even eliminates the improvements in audit committee effectiveness resulting from independent and financially expert committee members. Thus, CEO power may result in an audit committee that appears effective in form but is not in substance. We construct a composite index for CEO power by combining ten CEO characteristics and employ the incidence of internal control weaknesses as a proxy for audit committee monitoring quality. Since all the firms in our sample have completely independent audit committees, we use financial expertise to examine the impact of CEO power on audit committee effectiveness. We find that, when CEO power is low, audit committee financial expertise is negatively associated with the incidence of internal control weaknesses. However, as CEO power increases, this association monotonically weakens. When CEO power reaches a sufficiently high level, this association is no longer negative. The moderating effect of CEO power on audit committee effectiveness is more prominent when the CEO extracts more rents from the firm through insider trading. Our results are not driven by the CEOs involvement in director selection. Our paper suggests that more expert audit committees in form do not automatically translate into more effective monitoring. Rather, the substantive monitoring effectiveness of audit committees is contingent on CEO power.

Insider Trading Restrictions and Insiders’ Supply of Information: Evidence from Reporting Quality

We exploit the natural experiment of first-time enforcement of insider trading laws to investigate the relationship between insider trading opportunities and insiders’ supply of information. We propose that insider trading opportunities curtail the informational efficiency of financial markets by motivating insiders to reduce financial reporting quality for the purpose of increasing their informational advantage over outsiders and extracting trading profits. Using data from 39 countries over the 1988-2004 period, we find that the quality of financial reporting increases significantly after the initial enforcement of insider trading laws in countries with a strong legal infrastructure. Further analyses show that the increase is concentrated in firms that are not closely held. In addition to uncovering a channel through which insider trading restrictions affect the information environment, our evidence also highlights the importance of country- and firm-level governance structures in determining the consequences of insider trading restrictions.

Voluntary IAS and U.S. GAAP Adoption by Continental European Firms: The Role of Labor Relations

We investigate the decision by a sample of Continental European firms to voluntarily adopt the International Accounting Standards (IAS) or U.S. GAAP. The strong employment protection laws in Continental Europe lead to labor practices that lack responsiveness to firm underlying economic performance. We argue that by switching to IAS/U.S. GAAP, a Continental European company can more credibly communicate with its labor force, and/or a potential third party (e.g. a government labor office, an arbitrator, or a labor court judge in the case of labor disputes), the true economic conditions of the firm and potentially reduce the costs associated with labor force adjustments. We expect the costs of rigid labor practices, thus the potential benefits of switching to IAS/U.S. GAAP, to be particularly high for firms with low labor productivity. Therefore, we predict that 1) firms with low labor productivity are more likely to adopt IAS/U.S. GAAP after controlling for other factors potentially affecting the adoption decision; 2) firms adopting IAS/U.S. GAAP and with low labor productivity report lower earnings than before the adoption and the earnings change is more negative than for similar non-adopting firms; 3) firms adopting IAS/U.S. GAAP and with low labor productivity are more likely to reduce labor forces than before the adoption and the reduction in labor forces is more pronounced than for similar non-adopting firms. Our results are consistent with these predictions.