Laurence van Lent

The endogeneity bias in the relation between cost-of-debt capital and corporate disclosure policy

Abstract The purpose of this paper is twofold. First, we provide a discussion of the problems associated with endogeneity in empirical accounting research. We emphasize problems arising when endogeneity is caused by (1) unobservable firm-specific factors and (2) omitted variables, and discuss the merits and drawbacks of using panel data techniques to address these causes. Second, we investigate the magnitude of endogeneity bias in Ordinary Least Squares (OLS) regressions of cost-of-debt capital on firm disclosure policy. We document how including a set of variables which theory suggests to be related with both cost-of-debt capital and disclosure and using fixed effects estimation in a panel data-set reduces the endogeneity bias and produces consistent results. This analysis reveals that the effect of disclosure policy on cost-of-debt capital is 200% higher than what is found in OLS estimation. Finally, we provide direct evidence that disclosure is impacted by unobservable firm-specific factors that are also correlated with cost of capital.

Assessing the Performance of Business Unit Managers

Using a sample of 140 managers, we investigate the use of various performance metrics in determining the periodic assessment, bonus decisions, and career paths of business unit managers. We show that the weight on accounting return measures is associated with the authority of these managers, and we document that both disaggregated measures (expenses and revenues), and nonfinancial measures play a greater role as interdependencies between business units increase. The results suggest separate and distinct roles for different types of performance measures. Accounting return measures are used to create the proper incentives for managers with greater authority, while disaggregated and nonfinancial measures are employed in response to interdependencies.

Endogeneity in Management Accounting Research: A Comment

Abstract Chenhall and Moers (European Accounting Review, this issue, pp. 173–195) provide an excellent overview of the econometrics of endogeneity. In response to their discussion I argue that researchers should be courageous enough to set aside endogeneity concerns when their research question is important. Theory does not admit a definite answer to the question whether endogeneity is present in a particular model and econometrics has few technical solutions to offer. Since we cannot be sure endogeneity exists, and if we were to be sure of its existence, there is little we can do about it, researchers are well advised to move on to more serious problems.Abstract Chenhall and Moers (European Accounting Review, this issue, pp. 173–195) provide an excellent overview of the econometrics of endogeneity. In response to their discussion I argue that researchers should be courageous enough to set aside endogeneity concerns when their research question is important. Theory does not admit a definite answer to the question whether endogeneity is present in a particular model and econometrics has few technical solutions to offer. Since we cannot be sure endogeneity exists, and if we were to be sure of its existence, there is little we can do about it, researchers are well advised to move on to more serious problems.

Discussion of the Influence of Elections on the Accounting Choices of Governmental Entities

Kido, Petacchi and Weber [2012] investigate whether the occurrence of a state gubernatorial election is important to understanding the accrual choices of preparers of the state’s comprehensive annual financial report. Central to the authors’ argument is the idea that voters do not like budget deficits. Politicians, in response, have incentives to use accounting choices to mask deficits in the period before elections. Focusing on a specific accrual, the changes in compensated absences liability, the authors find evidence that the discretionary part of this accrual is smaller in the period before an election, which is consistent with politicians attempting to improve the picture of the state’s financial health. In addition, the authors show that accrual manipulation is positively associated with the vote share of incumbent governors in elections. In my discussion, I ask two questions: (1) how strong are governors’ political incentives to manipulate accruals in the run-up to elections? (2) Can the association between discretionary compensated absence accruals and elections be explained by forces other than politically motivated accounting manipulation? I argue that the incentives to manipulate accruals might well be weak given strong disciplinary mechanisms that induce politicians to transparency. What’s more, I document that elections might produce patterns in state employment. As the compensated absences liability is linked to the payroll, election-induced changes in state employment might be reflected in this accrual. Evidence of an association between the compensated absences accrual and elections, then, does not necessarily imply that politicians manage accounting numbers. To further illustrate this point, I show empirically that gubernatorial elections have little explanatory power for state financial reporting choices that are unaffected by state employment.

Firm-Level Political Risk: Measurement and Effects

We propose a new measure of political risk faced by individual US-firms based on textual analysis of earnings conference call transcripts: the share of the conversation between management and analysts that is devoted to political topics. Our measure correlates significantly with firm-level stock return volatility, even after controlling for firm and time fixed effects. We find that increases in idiosyncratic political risk are associated with decreases in investment and hiring, and that the dispersion of idiosyncratic political risk tends to increase significantly in times of high aggregate political risk. About two thirds of the variation in political risk is idiosyncratic in the sense that it is neither captured by firm or time fixed effects, nor by heterogeneous exposure of individual firms to aggregate political risk. Further decomposing our measure by political topic, we find that discussion of risk associated with corporate regulation and health care is associated with the largest decreases in investment. We also find that firms actively manage political risk through lobbying: firms that devote more time to discussing the risk associated with a given political topic tend to increase lobbying expenses on that topic that quarter. These effects are most pronounced for large firms and firms headquartered in states that are associated with higher levels of political corruption. JEL classification: D80, E22, G18, G38, H32, L50We adapt simple tools from computational linguistics to construct a new measure of political risk faced by individual US firms: the share of their quarterly earnings conference calls that they devote to political risks. We validate our measure by showing it correctly identifies calls containing extensive conversations on risks that are political in nature, that it varies intuitively over time and across sectors, and that it correlates with the firms actions and stock market volatility in a manner that is highly indicative of political risk. Firms exposed to political risk retrench hiring and investment and actively lobby and donate to politicians. Interestingly, the vast majority of the variation in our measure is at the firm level rather than at the aggregate or sector level, in the sense that it is neither captured by time fixed effects and the interaction of sector and time fixed effects, nor by heterogeneous exposure of individual firms to aggregate political risk. The dispersion of this firm-level political risk increases significantly at times with high aggregate political risk. Decomposing our measure of political risk by topic, we find that firms that devote more time to discussing risks associated with a given political topic tend to increase lobbying on that topic, but not on other topics, in the following quarter.

Performance Measures and Intra-Firm Spillovers: Theory and Evidence

We revisit the question of how performance measures are used to evaluate business unit managers in response to intra-firm spillovers because prior studies have documented conflicting empirical evidence. Specifically, we are interested in variation in the relative incentive weightings of aggregated “above-level�? measures (e.g., firm-wide net income), “own-level�? business unit measures (e.g., business unit profit), and specific “below-level�? measures (e.g., R&D expenses) in response to spillover arising from either the focal manager’s effect on other business units’ performance or the other units’ effect on the focal manager’s performance. Our theory highlights existence of an interaction between the two directions of spillovers. In our empirical work, we account for the interaction effect. Based on a purpose-developed survey of 122 business unit managers, we report that the incentive weighting on above-level measures increases by approximately 50 percentage points when managers face both types of spillovers (as opposed to one type of spillover).

Introduction to the Special Section on Conservatism in Accounting

The idea that financial reporting embeds the doctrine of conservatism has been recognized since its inception. It is therefore unsurprising that textbooks and research have dealt with this accounting issue. The traditional approach has focused on the balance sheet (like the lower of cost and market principle) and on the fact that a firm’s book value of equity is typically less than its market value. However, a paper due to Basu, published in 1997, changed the perspective radically by studying conservatism empirically from the point of view of the income statement. In this view, conservatism means accountants are prescribed not to shy away from anticipating losses but leave potential gains untouched until realized. The paper has had a significant impact on research, and accordingly, we decided that there might well be a considerable demand for a European Accounting Review issue that focuses on conservatism. Hence the reason for this Special Section. We also faced the fact that, as tends to be the case whenever a topic catches fire, there is controversy and confusion surrounding the underlying paradigm. This led to a second decision. We invited Stephen Ryan, at the Stern School of Business, New York University, to write a general commentary on issues surrounding the research of conservatism. Fortunately, Steve accepted and thus his contribution appears in this Section. Much of his discussion clarifies some of the outstanding confusion, in particular, the difference between unconditional vs. conditional conservatism (i.e. the balance sheet vs. the income statement). Perhaps more importantly, Steve also elaborates on the many econometric problems a researcher must face up to in any application of the basic Basu European Accounting Review Vol. 15, No. 4, 507–509, 2006

The Personal Wealth Interests of Politicians and the Stabilization of Financial Markets

We examine whether personal wealth interests affect politicians’ decisions about stabilizing financial markets. We use the setting of the government’s support of financial institutions under the 2008 Emergency Economic Stabilization Act. We find that the personal wealth interests of politicians are positively associated with voting in favor of the EESA. We implement several analyses to show that personal wealth interests rather than unobservable beliefs in the financial sector explain our result.