Shivaram Rajgopal

Institutional Ownership and the Extent to which Stock Prices Reflect Future Earnings

Articles in the financial press suggest that institutional investors are overly focused on current profitability, which suggests that as institutional ownership increases, stock prices reflect less current period information that is predictive of future period earnings. On the other hand, institutional investors are often characterized in academic research as sophisticated investors and sophisticated investors should be better able to use current-period information to predict future earnings compared with other owners. According to this characterization, as institutional ownership increases, stock prices should reflect more current-period information that is predictive of future period earnings. Consistent with this latter view, we find that the extent to which stock prices lead earnings is positively related to the percentage of institutional ownership. This result holds after controlling for various factors that affect the relation between price and earnings. It also holds when we control for endogenous portfolio choices of institutions (e.g., institutional investors may be attracted to firms in richer information environments where stock prices tend to lead earnings). Further, a regression of stock returns on order backlog, conditional on the percentage of institutional ownership, indicates that institutional owners place more weight on order backlog compared with other owners. This result is consistent with institutional owners using non-earnings information to predict future earnings. It also explains, in part, why prices lead earnings to a greater extent when there is a higher concentration of institutional owners.

Accounting Discretion, Corporate Governance, and Firm Performance*

Aromatic compounds in small amounts function as antifoulant additives in pyrolysis furnaces which are subjected to elevated temperatures from about 500 DEG C. to about 1200 DEG C. when thermally convening hydrocarbons to ethylene as well as other useful products. These furnaces produce material that deposits and accumulates upon furnace surfaces including furnace radiant coils and transfer line exchangers. The present antifoulant additives inhibit and suppress the formation and deposition of material on furnace surfaces. The present invention is a method for inhibiting the formation of coke on the surfaces of a radiant heating section of a pyrolysis furnace and the surfaces immediately downstream of such section in contact with a hydrocarbon feedstock which comprises decoking the pyrolysis furnace, and prior to processing the hydrocarbon feedstock, adding an inhibiting compound to the pyrolysis furnace. The inhibiting compound is selected from the group consisting of substituted benzenes, substituted naphthalenes, substituted anthracenes, substituted phenanthrenes, and mixtures thereof wherein the inhibiting compound contains at least one substitutent having at least 2 carbon atoms. A thin catalytically inactive coke layer is formed on the surfaces of the pyrolysis furnace. The hydrocarbon feedstock is then fed into the furnace, whereby the surfaces of the furnace are inhibited against the formation of a catalytically active coke during the processing of the hydrocarbon feedstock.

Value-Glamour and Accruals Mispricing: One Anomaly or Two?

A feed and takeoff assembly particularly adapted for use in connection with a printing press to automatically transfer generally flat stock from a first position to a print position and to a delivery position, having a frame, a transfer carriage mounted for movement along the frame, a single elongated feed gripper mounted near one end of the transfer carriage and disposed transversely to the path of travel of the carriage along the frame, and a low profile delivery gripper mounted near the opposite end of the transfer carriage for movement therewith along the frame. The single elongated feed gripper is capable of repeated precisely registered movement along the frame through a spring-biased cam-operated guide means. The delivery gripper acts to remove an entire sheet of printed stock at a desired time by a cam-operated opening and closing of pivotally mounted upper and lower jaws. The operation of the transfer carriage and associated feed gripper and delivery gripper relative to the operation of the printing press is timed by a plurality of control cams which provide for feeding and delivery of stock and return of the carriage at optimum speeds without errors in registration.

The Interaction between Accrual Management and Hedging: Evidence from Oil and Gas Firms

This research investigates whether oil and gas producing firms use abnormal accruals and hedging with derivatives as substitutes to manage earnings volatility. Firms engaged in oil exploration and drilling are exposed to two kinds of risks that can cause earnings volatility: oil price risk and exploration risk. Firms can use abnormal accrual choices and/or derivatives to reduce earnings volatility caused by oil price risk, but cannot directly hedge the operational risk of unsuccessful drilling. Because hedging and using abnormal accruals are costly activities, and because prior research suggests managers do not eliminate all volatility (Haushalter 2000; Barton 2001), we expect that at the margin managers will use these smoothing mechanisms as substitutes to manage earnings volatility. Our results suggest a sequential process whereby managers of oil and gas producing firms first determine the extent to which they will use derivatives to hedge oil price risk, and then, especially in the fourth quarter, manage residual earnings volatility by trading off abnormal accruals and hedging with derivatives to smooth income.

Reputation Building and Performance: An Empirical Analysis of the Top-50 Pure Internet Firms

This study examines the relationship between three types of reputation building activities - marketing investments, reputation borrowing, and media exposure - and firm performance using a sample of Top-50 pure Internet firms. The study addresses a question of paramount practical importance about how the strategic choices of Internet firms affect their performance in both financial and product markets. The finding suggests that reputation building activities may be one of the key determinants of competitive success for Internet firms. At the same time, it raises questions regarding the longevity of the impact of such activities.

The Value Relevance of Network Advantages: The Case of E-Commerce Firms

We show that network advantages constitute an important intangible asset that goes unrecognized in the financial statements. For a sample of e–commerce firms, we find that network advantages created by Web site traffic have substantial explanatory power for stock prices over and above traditional summary accounting measures such as earnings and book value of equity. Also, network advantages are positively associated with one–year–ahead and two–year–ahead earnings forecasts provided by equity analysts. When we allow network advantages to be endogenously determined by managerial actions, we find that at least part of the value relevance of network effects stems from the presence of affiliate referral programs and higher media visibility.

Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R*

In December 2004, the Financial Accounting Standards Board (FASB) mandated the use of a fair value based measurement attribute to value employee stock options (ESOs) via FAS 123-R. In anticipation of FAS 123-R, between March 2004 and November 2005, several firms accelerated the vesting of ESOs to avoid recognizing existing unvested ESO grants at fair value in future financial statements. We find that the likelihood of accelerated vesting is higher if (i) acceleration has a greater effect on future ESO compensation expense, especially related to underwater options; and (ii) firms suffer greater agency problems, proxied by fewer block-holders, lower pension fund ownership and top five officers holding a greater share of ESOs. We also find a negative stock price reaction around the announcement of the acceleration decision, especially for firms with greater agency problems. Furthermore, stock returns are significantly negative before the new vesting dates and positive afterward, suggesting that vesting dates could have been backdated.

CEO and CFO Career Penalties to Missing Quarterly Analysts Forecasts

This study examines whether the board of directors penalizes CEOs and CFOs in the form of bonus cuts, fewer equity grants, and forced turnover for the act of barely missing the latest consensus analyst forecast and whether such penalties are consistent with efficient contracting or fixation. We find that CEOs are penalized when they just miss the latest consensus analyst forecast via bonus cuts, fewer equity grants, and forced turnover. CFOs are also penalized for just missing the latest consensus analyst forecast via bonus cuts and forced turnover, but do not appear to be penalized with fewer equity grants. Further, we find evidence suggesting that the penalties levied by the board for just missing the latest analyst forecast are more consistent with fixation than efficient contracting.

Financial Reporting Quality and Idiosyncratic Return Volatility Over the Last Four Decades

Campbell, Lettau, Malkiel and Xu (2001) show that stock returns of individual firms have become more volatile in the U.S. since 1960. We hypothesize and find that deteriorating earnings quality is associated with higher idiosyncratic return volatility over the period 1962-2001. These results are robust to controlling for (i) inter-temporal changes in the disclosure of value-relevant earnings information, sophistication of investors and for the possibility that earnings quality can be informative about future cash flows; (ii) stock return performance, cash flow operating performance, cash flow variability, growth, leverage and firm size; and (iii) accounting for new listings, high technology firms and firm-years with losses, mergers and acquisitions and financial distress.

The Revolving Door and the SEC's Enforcement Outcomes: Initial Evidence from Civil Litigation

We provide empirical evidence on the consequences of revolving door phenomenon at the SEC. If future job opportunities make SEC lawyers increase their enforcement effort to showcase their expertise, then the revolving door phenomenon will promote more enthusiastic regulatory effort (the “human capital” hypothesis). In contrast, SEC lawyers can relax enforcement efforts in order to curry favor with prospective employers in the private sector (the “rent seeking” hypothesis”). We collect data on the career paths of 336 SEC lawyers that span 284 SEC enforcement actions against fraudulent financial reporting over the period 1990-2007. We find evidence consistent with the “human capital” hypothesis. Specifically, enforcement efforts, proxied by the fraction of losses collected as damages, the likelihood of criminal proceedings and the likelihood of naming the CEO as a defendant, are higher when the SEC lawyer leaves to join law firms that defend clients charged by the SEC. Our evidence does not support popular concerns that revolving doors undermine the SEC’s enforcement efforts. We would like to thank Jonathan Karpoff, Scott Lee and Gerald Martin for graciously sharing their SEC enforcement data. We thank the seminar participants at Fordham University for their comments. We are grateful for financial support from the Foster School of Business, Nanyang Business School, Goizueta Business School and the Whitcomb Center at Rutgers Business School. Does the Revolving Door Affect the SEC’s Enforcement Outcomes? “At a minimum, the revolving door has undermined the integrity of the SEC’s oversight on numerous occasions, and the SEC isn’t policing as aggressively as it should,” said Nick Schwellenbach, POGO’s director of investigations. 1.0 Introduction In this paper, we examine whether revolving doors are associated with compromised regulatory oversight by the SEC. In particular, we investigate whether regulatory enforcement is influenced by the future job prospects of SEC lawyers. It is commonly recognized that there exist revolving doors connecting government regulatory agencies with the firms that they regulate. These revolving doors lead to both the SEC hiring officials from firms that they regulate, as well as, SEC officials leaving to work for firms that are regulated. For instance, Peter H. Bresnan, a former Deputy Director in the SEC’s Division of Enforcement, resigned in December 2007 and joined the law firm of Simpson Thacher & Bartlett LLP. In November 2009, Mr. Bresnan filed a statement advising the SEC that he had been “retained to represent a client [name redacted (b)(7)(C)] in connection with SEC v. Bank of America Corp. (09-Civ-6892 (JSR)) (S.D.N.Y.).” An example of reverse revolving doors relates to the hiring of Robert S. Khuzami, the SEC’s director of enforcement, who was previously the general counsel of Deutsche Bank. Revolving doors are common as the SEC needs industry specific expertise to monitor and regulate its constituents effectively and regulated firms need experience and knowledge of complex regulations to minimize their cost of compliance. However, revolving doors are a problem if prior experience in industry makes SEC personnel unduly sympathetic to the industry’s interests or if the prospect of future employment makes ex-SEC personnel go easier on violations by regulated firms. The media, members of Congress, academics, former employees of the SEC and investors have all raised questions about the impact of the revolving door on the SEC’s efficacy and independence. Despite the inherent importance of the SEC’s SEC Staff’s ‘revolving door’ prompts concerns about agency’s independence” by David S. Hilzenrath. Published May 13, 2011. Available at http://www.washingtonpost.com/business/economy/sec-staffs-revolving-door-prompts-concernsabout-agencys-independence/2011/05/12/AF9F0f1G_story.html 2 The case charged Bank of America with “misleading investors about billions of dollars in bonuses that were being paid to Merrill Lynch & Co. executives at the time of its