Zhiyan Cao

The Long-Term Performance and Failure Risk of Firms Cited in the US SEC's Accounting and Auditing Enforcement Releases

Abstract:  We investigate 239 firms cited in the SECs Accounting and Auditing Enforcement Releases (AAERs). We document significantly negative abnormal operating performance (measured using both cash-flow-based and earnings-based metrics) in the second and third years following AAERs. We also detect significantly negative abnormal stock returns in up to three years following AAERs. We further find that AAER firms are more likely to fail in the post-AAER period. Taken together, our findings suggest that the negative implications of an AAER citation resulting from egregious financial reporting violations can be long lasting and influence various facets of firm performance and survivability.

Does voluntary corporate citizenship pay? An examination of the UN Global Compact

Purpose - The UN Global Compact (GC) is the worlds largest voluntary corporate social responsibility (CSR) initiative. Signatory companies voluntarily agree to abide by the GC ten principles and explicitly declare compliance with social and human rights, environmental protection, and anti-corruption practices. Participants commit to CSR and are required to publish a yearly report called Communication on Progress (COP). If firms fail to provide a COP for one year they are labeled “non-communicating”, and for two years they are “delisted” from the GC. In 2006, the first list of non-communicating and delisted firms was announced. The purpose of this paper is to investigate the extent by which being a signatory company – that reports COP – reduces information risk, and thus leads to better market returns, lower cost of debt, and lower cost of equity. Design/methodology/approach - The authors studied the period from the launch of the GC until the first list of non-communicating firms was made public, investigating the extent by which being a signatory company – that reports COP – reduces information risk, and thus leads to better market returns, lower cost of debt, and lower cost of equity. Findings - The results suggest that communicating (reporting) firms have statistically significant higher market valuation – lower book to market – than companies that initially agree to participate in the GC but that do not comply with the reporting requirement. Communicating firms also have statistically significant higher ROA, lower cost of debt, lower cost of equity, and lower beta indicating better performance and less risk. The authors also find some evidence that non-communicating firms might be “free riding” and could have joined the GC to improve their corporate image. Originality/value - The paper provides evidence of the value of CSR reporting. It is not enough to disclose compliance with CSR, but it is also necessary to account for this through some sort of formal mechanism such as a CSR report. Voluntary disclosures and narrative statements in annual reports will continue to have questionable information content, but standards of environmental reporting, such as the Global Reporting Initiative, not only improve the way in which social and environmental performance is measured, but they also provide evidence of compliance. This paper also presents evidence of the value of voluntary initiatives such as the GC when these initiatives are supported by formal reporting and when accountability/enforcement measures are in place.

Bankruptcy classification of firms investigated by the US Securities and Exchange Commission: an evolutionary adaptive ensemble model approach

This paper develops an adaptive, rule-based model for bankruptcy classification of firms subject to the SECs Accounting and Auditing Enforcement Release (AAER). In this paper, we use an evolutionary computing method, genetic algorithm (GA), to generate an optimal set of if-then (comprehensible) rules for bankruptcy classification of AAER firms. In particular, we use bagging to improve the models generalisation accuracy; and to develop a doubly controlled fitness function to guide the operations of the (GA) method. Our research contributes to the bankruptcy literature in several ways. First, it fills a gap in bankruptcy classification by developing a domain specific model for AAER firms. Secondly, the derived set of if-then rules used in an expert system adds to the bankruptcy knowledge base. Thirdly, we use bagging to improve generalisation of bankruptcy classification models. Finally, we demonstrate the key role of the fitness function in successful model performance.

DESIGNING AN IF-THEN RULES-BASED ENSEMBLE OF HETEROGENEOUS BANKRUPTCY CLASSIFIERS: A GENETIC ALGORITHM APPROACH

This paper proposes a framework for an ensemble bankruptcy classifier that uses if-then rules to combine the outputs from a heterogeneous set of classifiers. A genetic algorithm GA induces the rules using an asymmetric, cost-sensitive fitness function that includes accuracy and misclassification costs. The GA-based ensemble classifier outperforms individual classifiers and ensemble classifiers generated by other methods. The results of the classifier are in the form of if-then rules. We apply the approach to a balanced dataset and an imbalanced dataset. Both are composed of firms subject to financial distress and cited in the US Securities and Exchange Commissions Accounting and Auditing Enforcement Releases. Copyright

Litigation Risk and Audit Fees: The Impact of Qualitative Factors

Using D&O insurance premia from the 2001-2004 Tillinghast D&O insurance surveys as a proxy for litigation risk, we show that audit fees are positively associated with litigation risk even after controlling for several quantitative risk factors known to influence both the insurance premium and audit fee. We attribute this positive association to the parallel development of risk assessment expertise by both D&O insurers and auditors and to their overlapping sources of qualitative risk information. The significant association between D&O premia and audit fees also provides external validation for the auditor’s risk assessment process. Finally, we partition accounting firms based on their audit methodologies and find that the audit fees charged by risk-based auditors are more strongly associated with litigation risk than those charged by firms using more traditional audit approaches.