Vivian W. Fang

The Effect of Liquidity on Governance

This paper demonstrates a positive effect of stock liquidity on blockholder governance. Liquidity increases the likelihood of block formation. Conditional upon acquiring a stake, liquidity reduces the likelihood that the blockholder governs through voice (intervention)--as shown by the lower propensity for active investment (filing Schedule 13D) than passive investment (filing Schedule 13G). The lower frequency of activism does not reflect the abandonment of governance, but governance through the alternative channel of exit (selling ones shares): A 13G filing leads to positive announcement returns and improvements in operating performance, especially in liquid firms. Moreover, taking into account the increase in block formation, liquidity has an unconditional positive effect on voice as well as exit. We use decimalization as an exogenous shock to liquidity to identify causal effects. The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Short Selling and Earnings Management: A Controlled Experiment

During 2005 to 2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short-sale price tests. Pilot firms’ discretionary accruals and likelihood of marginally beating earnings targets decrease during this period, and revert to pre-experiment levels when the program ends. After the program starts, pilot firms are more likely to be caught for fraud initiated before the program, and their stock returns better incorporate earnings information. These results indicate that short selling, or its prospect, curbs earnings management, helps detect fraud, and improves price efficiency.

Equity Vesting and Managerial Myopia

This paper links the CEO’s concerns for the current stock price to reductions in real investment. We identify short-term concerns using the amount of stock and options scheduled to vest in a given quarter. Vesting equity is associated with a decline in the growth of research and development and capital expenditure, positive analyst forecast revisions, and positive earnings guidance, within the same quarter. More broadly, by introducing a measure of incentives that is determined by equity grants made several years prior, and thus unlikely driven by current investment opportunities, we provide evidence that CEO contracts affect real decisions.Received May 12, 2015; editorial decision December 15, 2016 by Editor Andrew Karolyi.

Equity Vesting and Investment

Oxford University Press (OUP) https://academic.oup.com/rfs/article/doi/10.1093/r... This is a pre-copyedited, author-produced version of an article accepted for publication in Review of Financial Studies following peer review. The version of record: Alex Edmans, Vivian W. Fang, Katharina A. Lewellen; ’Equity vesting and investment’, Review of Financial Studies 2017; 30(7); pp.2229-2271 is available online at: https://academic.oup.com/rfs/article/doi/10.1093/rfs/hhx018/3058111/Equity-Vesting-andInvestment and at: https://doi.org/10.1093/rfs/hhx018

Foreign Institutional Ownership and the Global Convergence of Financial Reporting Practices

This paper investigates whether foreign institutional investors affect the global convergence of financial reporting practices. Using several measures of reporting convergence, we show that U.S. institutional ownership is positively associated with subsequent changes in emerging market firms’ accounting comparability to their U.S. industry peers. We identify this association using an instrumental variable approach that exploits exogenous variation in U.S. institutional investment generated by the JGTRRA Act of 2003. Further, we provide evidence of a specific mechanism—the switch to a Big Four audit firm—through which U.S. institutional investors affect reporting convergence. Finally, we show that, for emerging market firms, an increase in comparability to U.S. firms is associated with an improvement in the properties of foreign analysts’ forecasts.This paper investigates whether institutional investors have a significant influence on the comparability of their investee firms’ financial reporting. Using the comparability measure developed in De Franco et al. (2011), we show that emerging market firms with a higher level of U.S. mutual fund ownership experience an increase in their financial statement comparability with their U.S. industry peers. To address the possibility of reverse causality and omitted variables, we adopt a changes-in-changes specification and an instrumental variables approach, both of which suggest changes in institutional ownership drive comparability changes. Consistent with our interpretations, we find no evidence that non-U.S. foreign institutional ownership affects firms’ comparability with their U.S. industry peers. Further, the documented comparability increase is particularly strong when U.S. mutual funds’ positions are concentrated in large blocks and have been held for over a year. Finally, we show that the appointment of independent U.S. directors to the board and audit committee and the hiring of a big-four auditing firm appear to be important channels through which U.S. institutions affect non-U.S. investees’ financial reporting practices. JEL classifications: G32; G34; G38; M41; M48

Imperfect Accounting and Reporting Bias

Errors and bias are both inherent features of accounting. In theory, while errors discourage bias by lowering the value relevance of accounting, they can also facilitate bias by providing camouflage. Consistent with theory, we find a hump-shaped relation between a firm’s propensity to engage in intentional misstatement and the prevalence of unintentional misstatements in the firm’s industry for the whole economy and a majority of the industries. The result is robust to using firms’ number of items in financial statements and exposure to complex accounting rules as alternative proxies for errors and to using the restatement amount in net income to quantify the magnitude of bias and errors. To directly test for the two effects of errors, we show that, when errors are more prevalent, the market reacts less to firms’ earnings surprises and bias is more difficult to detect. Our results highlight the imperfectness of accounting, advance understanding of firms’ reporting incentives, and shed light on accounting standard setting.

Executive Debt-Like Compensation

While executive compensation in the United States is believed to consist primarily of cash- and equity-based components, a nascent literature argues that compensation accrued by executives under pension and other deferred compensation (DC) plans has debt-like payoffs, and could function as “inside debt”. Inside debt holdings are predicted to counteract the risk-taking incentives created by inside equity holdings, and align top managers closer to outside debtholders vis-a-vis equityholders. Recent empirical studies suggest that pension and DC plan balances serve the role of inside debt to some extent, and are effective at mitigating equityholder-debtholder conflicts in leveraged firms. These findings not only change our understanding of the composition of top executive compensation, but also have implications for the recent debate on reforming executive compensation to mitigate excessive risk-taking by top executives.

The Long-Term Consequences of Short-Term Incentives

This paper shows that short-term stock price concerns induce CEOs to take value-reducing actions. Vesting equity, our measure of short-term concerns, is positively associated with the probability of a firm repurchasing shares, the amount of shares repurchased, and the probability of the firm announcing a merger and acquisition (M&A). When vesting equity increases, stock returns are more positive in the two quarters surrounding both repurchases and M&A, but more negative in the two years following repurchases and four years following M&A. These results are inconsistent with CEOs buying underpriced stocks or companies to maximize long-run shareholder value, but consistent with these actions being used to boost the short-term stock price and improve the conditions for equity sales. Overall, by identifying actions that carry clear value implications, this paper documents the long-term negative consequences of short-term incentives.