John R. M. Hand

Going, Going, Gone? The Apparent Demise of the Accruals Anomaly

Consistent with public statements made by sophisticated practitioners, we document that the hedge returns to Sloans (Sloan, R. G. 1996. Do stock prices fully reflect information in accruals and cash flows about future earnings? Accounting Rev.71(3) 289--315) accruals anomaly appear to have decayed in U.S. stock markets to the point that they are, on average, no longer reliably positive. We explore some potential reasons why this has happened. Our empirical analyses suggest that the anomalys demise stems in part from an increase in the amount of capital invested by hedge funds into exploiting it, as measured by hedge fund assets under management and trading volume in extreme accrual firms. A decline in the size of the accrual mispricing signal, as measured by the magnitude of extreme decile accruals and the relative persistence of cash flows and accruals, may also play a (weaker) role. This paper was accepted by Stefan Reichelstein, accounting.

The indirect economic penalties in SEC investigations of underwriters

Abstract We document that an SEC investigation of an underwriter imposes indirect penalties on the underwriter and its past clients, particularly IPO clients. Targeted underwriters experience large declines in IPO market share and increased regulatory scrutiny and client risk after an SEC investigation is announced. Stock prices of clients decline significantly. We attribute these effects to a sudden deterioration in the value of the underwriters reputation capital, suggesting that the general assumption in prior IPO research that underwriter reputation is stationary may be inappropriate. Our results also suggest that the SECs power to institute investigations should be considered when designing optimal securities regulation.

The Characteristics that Provide Independent Information about Average U.S. Monthly Stock Returns

We take up Cochrane’s (2011) challenge to identify the firm characteristics that provide independent information about average U.S. monthly stock returns by simultaneously including 94 characteristics in Fama-MacBeth regressions that avoid overweighting microcaps and adjust for data snooping bias. We find that while 12 characteristics are reliably independent determinants in non-microcap stocks during 1980-2014 as a whole, return predictability fell sharply in 2003 such that just two characteristics have been independent determinants since then. Outside of microcaps, the hedge returns to exploiting characteristics-based predictability have also been insignificantly different from zero since 2003.20+ years after Fama & French (1992), we re-measure the dimensionality of the cross-section of expected U.S. monthly stock returns in light of the large number of return predictive signals (RPS) that have been identified by business academics over the past 40 years. Using 100 readily programmed RPS, we find that a remarkable 24 are multidimensionally priced as defined by their mean coefficients having an absolute t-statistic  3.0 in Fama-MacBeth regressions where all RPS are simultaneously projected onto 1-month ahead returns during 1980-2012. We confirm the high degree of dimensionality in returns using factor analysis of RPS, factor analysis of long/short RPS hedge returns, LASSO regression, regressions of portfolio returns on RPS factor returns, and out-ofsample RPS hedge portfolio returns. We put forward a new empirically determined 10-RPS model of expected returns for consideration by researchers and practitioners. We also discuss other implications of our findings, chief of which is the need for research that explains why stock returns are so multidimensional and why the most empirically important RPS are priced the way they are. This version: April 2, 2014 * Corresponding author. Our paper has greatly benefitted from the comments of Jeff Abarbanell, Sanjeev Bhojraj, Matt Bloomfield, John Cochrane, Oleg Grudin, Bruce Jacobs, Bryan Kelly, Juhani Linnainmaa, Ed Maydew, Scott Richardson, Jacob Sagi, Eric Yeung, and workshop participants at the University of Chicago, Cornell University, UNC Chapel Hill, the Fall 2013 Conference of the Society of Quantitative Analysts, and the Fall 2013 Chicago Quantitative Alliance Conference. The SAS programs we use to create our RPS data and execute most of our statistical analyses will be made publicly available on 7/1/14.

Insubstance defeasances : Security Price Reactions and Motivations

Abstract This paper examines the bond and stock price reactions to the announcement of insubstance defeasances, and the motivations for the transaction. We find a reliably positive bond price reaction and a reliably negative stock price reaction. However, the bond price reaction is much less than would be predicted had the defeased bonds been made riskless. We find evidence suggesting that some firms defease to window-dress their earnings, some defease to avoid restrictions in bond covenants, and some defease as a use for excess cash on hand.

Employee Compensation in Entrepreneurial Companies

Despite the central role played by human capital in entrepreneurship, little is known about how employees in entrepreneurial firms are compensated and incentivized. We address this gap in the literature by studying 18,935 non-CEO compensation contracts across 1,809 privately-held venture-backed companies. Our key finding is that employee compensation varies with the degree to which VCs versus founders control the business. We show that relative to founder-controlled firms, VC-controlled firms pay their hired-on (i.e., non-founder) employees higher cash salaries, provide stronger cash and equity incentives, and have more formal pay policies in place. We also observe that founder employees earn less cash pay and face weaker cash incentives than do hired-on employees, but have stronger equity incentives. We propose that the compensation differences we identify arise because the preferences and capabilities of controlling shareholders significantly influence the quality of the human capital attracted and retained by the firm.

The Importance of Accounting Information in Portfolio Optimization

We study the economic importance of accounting information as defined by the value that a sophisticated investor can extract from publicly available financial statements when optimizing a portfolio of U.S. equities. Our approach applies the elegant new parametric portfolio policy method of Brandt, Santa-Clara, and Valkanov (2009) to three simple and firm-specific annual accounting characteristics-accruals, change in earnings, and asset growth. We find that the set of optimal portfolio weights generated by accounting characteristics yield an out-of-sample, pre-transact ions-costs annual information ratio of 1.9 as compared to 1.5 for the standard price-based characteristics of firm size, book-to-market, and momentum. We also find that the delevered hedge portion of the accounting-based optimal portfolio was especially valuable during the severe bear market of 2008 because unlike many hedge finds it delivered a hedged return in 2008 of 12 percent versus only 3 percent for price-based strategies and −38 percent for the value-weighted market.

Market-to-Revenue Multiples in Public and Private Capital Markets

The behavior and determinants of market-to-revenue ratios in public and private capital markets is examined. Three samples are analysed: (1) all publicly traded stocks listed at some time on the New York Stock Exchange/American Stock Exchange/National Association of Securities Dealers Automated Quotation System in the 1980—2004 period; (2) sample of over 300 so-called ‘internet companies’ in the 1996—2004 period; and (3) over 5500 privately held venture capital-backed companies in the 1992—2004 period. Both company size and the most recent revenue growth rate are found to explain significant variation across companies in their market-to-revenue multiples — smaller companies and companies with higher recent revenue growth rates have higher multiples. We also document how the capital market appears to use a broad-based information set when setting market-to-revenue multiples for companies with negative revenue growth rates — transitory revenue growth components appear to be identified (in a probabilistic sense) by the capital market. Contrary to much anecdotal comment, we present evidence that the capital market behaved directionally along the lines predicted by capital market theory in the pricing of internet stocks in the 1996—2004 period.

The Causes and Effects of Mandated Accounting Standards: SFAS No. 94 as a Test of the Level Playing Field Theory

In this paper we explore two different explanations for why accounting standards are mandated and examine their direct and indirect effects on shareholder wealth. First, the prevailing positive view of the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) is that the motivation for their actions is solely economic selfinterest. This view predicts that the wealth effects of mandating standards will not be to increase firm value, but rather to impose deadweight costs in proportion to the degree to which firms’ behavior is suboptimally constrained by the standards. Second, and in contrast, we propose that as a loose team, the SEC and the FASB are motivated by social welfare considerations to mandate disclosures and set standards so as to bring about a “level playing field” across users of accounting information. This view predicts that mandating standards will bring about a wealth transfer from user groups enjoying the benefits of an unlevel playing field to those bearing the costs. We test these models using the issuance of Statement of Financial Accounting Standard No. 94 (SFAS No. 94): Consolidation for All MajorityOwned Subsidiaries. We find no evidence that the FASB issued SFAS No. 94 for self-interested, personal wealth-maximizing reasons. However, consistent with the level playing field view, we do find evidence that the FASB issued SFAS No. 94 as an experimental first step in countering the grow-

CEO Compensation in Venture Capital Markets

We study the compensation earned by CEOs in private venture-backed firms. We extend the traditional view of pay-for-performance by proposing that the economic characteristics of startups and venture capital markets interact in such a way that CEOs will be rewarded for successfully raising new equity. In a novel dataset of 1,585 U.S. companies, we demonstrate that CEO total cash pay is strongly increasing in the quantity and quality of money raised in the firms most recent equity round, and in the cumulative amount of venture funding secured. The link between cash compensation and fundraising success is stronger when fundraising is more difficult and more important. Our results hold for both founder and non-founder CEOs. We also show CEO total cash pay is positively associated with operating performance metrics such as revenues and employees. Overall, our findings suggest that the complex set of equity incentives and non-compensation governance mechanisms that venture capitalists put in place to solve agency problems are complemented by performance-based CEO cash pay.

Employee Compensation in Venture-Backed Firms

We show that the degree of control exerted by investors over entrepreneurial firms helps explain the design of employee compensation contracts, and in ways that are asymmetric for founders versus hired-on employees. Across 1,809 U.S. venture-backed companies, we find that firms with more VC/less founder dominance on average pay their employees higher cash salaries, provide stronger cash and equity incentives, and have more formal pay policies in place. However, the differences in cash pay and incentives only apply to hired-on employees and not to founders. Founders are special in that they receive similar compensation contracts regardless of the degree of founder/VC dominance. Our results are consistent with the argument that investor control diminishes hired-on employees’ non-pecuniary benefits and access to the firm’s unique technologies, both of which are important motivators of employment in innovative, high-potential young businesses.