Managerial Ability and Earnings Quality
TL;DR: This article examined the relation between managerial ability and earnings quality and found that more able managers are associated with fewer subsequent restatements, higher earnings and accruals persistence, lower errors in the bad debt provision, and higher quality accrual estimations.
Abstract: : We examine the relation between managerial ability and earnings quality. We find that earnings quality is positively associated with managerial ability. Specifically, more able managers are associated with fewer subsequent restatements, higher earnings and accruals persistence, lower errors in the bad debt provision, and higher quality accrual estimations. The results are consistent with the premise that managers can and do impact the quality of the judgments and estimates used to form earnings. Data Availability: Data are publicly available from the sources identified in the text.
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TL;DR: A measure of managerial ability, based on managers' efficiency in generating revenues, which is available for a large sample of firms and outperforms existing ability measures is proposed, and it is found that the negative relation between equity financing and future abnormal returns documented in prior research is mitigated by managerial ability.
Abstract: We propose a measure of managerial ability, based on managers' efficiency in generating revenues, which is available for a large sample of firms and outperforms existing ability measures. We find that our measure is strongly associated with manager fixed effects and that the stock price reactions to chief executive officer (CEO) turnovers are positive (negative) when we assess the outgoing CEO as low (high) ability. We also find that replacing CEOs with more (less) able CEOs is associated with improvements (declines) in subsequent firm performance. We conclude with a demonstration of the potential of the measure. We find that the negative relation between equity financing and future abnormal returns documented in prior research is mitigated by managerial ability. Specifically, more able managers appear to utilize equity issuance proceeds more effectively, illustrating that our more precise measure of managerial ability will allow researchers to pursue studies that were previously difficult to conduct.
This paper was accepted by Mary E. Barth, accounting.
830 citations
TL;DR: This paper examined whether accounting choices are influenced by differences in CFOs' individual characteristics that arise from numerous factors including their dispositions, personal situations and prior experiences, and examined whether CFO style impacts accounting choices.
Abstract: What factors impact the accounting choices of a firm? Numerous prior studies in accounting have examined this question, focusing on various firm-level (e.g., Klein 2002) and marketlevel characteristics (e.g., Leuz, Nanda, and Wysocki 2003) that impact accounting outcomes (see Fields, Lys, and Vincent 2001). The purpose of this paper is to consider another potential influence on accounting choices: manager-specific factors. In particular, we focus on chief financial officers (CFOs) because the CFO typically oversees the firm’s financial reporting process and therefore he ⁄ she likely has the most direct impact of all the senior managers on the accounting related decisions of the firm, such as choosing accounting methods and making accounting adjustments (Mian 2001; Geiger and North 2006; Gore, Matsunaga, and Yeung 2008). We examine whether accounting choices are influenced by differences in CFOs’ individual characteristics that arise from numerous factors including their dispositions, personal situations and prior experiences. Certainly the opening quote of the paper would suggest such a possibility. For expositional purposes, we label these differences CFO style and examine whether CFO style impacts accounting choices. Built on the premise of bounded rationality, research in judgment and decision making has long recognized that individual characteristics play a role in decision outcomes (Bonner
531 citations
TL;DR: This paper examined the impact of financial disclosure narrative on bond market outcomes and found that less readable financial disclosures are associated with less favorable ratings, greater bond rating agency disagreement, and a higher cost of debt.
Abstract: Prior research on the determinants of credit ratings has focused on rating agencies’ use of quantitative accounting information, but the there is scant evidence on the impact of textual attributes. This study examines the impact of financial disclosure narrative on bond market outcomes. We find that less readable financial disclosures are associated with less favorable ratings, greater bond rating agency disagreement, and a higher cost of debt. We improve causal identification by exploiting the 1998 Plain English Mandate, which required a subset of firms to exogenously improve the readability of their filings. Using a difference-in-differences design, we find that the firms required to improve the readability of their filings experience more favorable ratings, lower bond rating disagreement, and lower cost of debt. Collectively, our evidence suggests that textual financial disclosure attributes appear to not only influence bond market intermediaries’ opinions but also firms’ cost of debt.
229 citations
TL;DR: In this article, the authors investigate whether executives with superior ability to efficiently manage corporate resources engage in greater tax avoidance and find that moving from the lower to upper quartile of managerial ability is associated with a 3.15% reduction in a firm's one-year (five-year) cash effective tax rate.
Abstract: Most prior studies model tax avoidance as a function of firm-level characteristics and do not consider how individual executive characteristics affect tax avoidance. This paper investigates whether executives with superior ability to efficiently manage corporate resources engage in greater tax avoidance. Our results show that moving from the lower to upper quartile of managerial ability is associated with a 3.15% (2.50%) reduction in a firm’s one-year (five-year) cash effective tax rate. We examine how higher-ability managers reduce income tax payments and find that they engage in greater state tax planning activities, shift more income to foreign tax havens, make more research and development credit claims, and make greater investments in assets that generate accelerated depreciation deductions. Identifying a manager characteristic related to firms’ tax policy decisions adds to our understanding of the factors that explain the substantial variation in corporate income tax payments across firms. This pape...
181 citations
TL;DR: In this article, the effect of CFO narcissism, as measured by signature size, on financial reporting quality was investigated, and it was shown that narcissism predicts misreporting behavior, and that signature size predicted misreporting through its association with narcissism.
Abstract: We investigate the effect of CFO narcissism, as measured by signature size, on financial reporting quality. Experimentally, we validate that narcissism predicts misreporting behavior, and that signature size predicts misreporting through its association with narcissism. Empirically, we examine notarized CFO signatures and find CFO narcissism is associated with more earnings management, less timely loss recognition, weaker internal control quality, and a higher probability of restatements. The results are consistent for within-firm comparisons focusing on CFO changes and are robust to controlling for CFO overconfidence and CEO narcissism. The results highlight the importance of CFO characteristics in the domain of financial reporting decisions.
167 citations
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TL;DR: In this article, the authors examine the different methods used in the literature and explain when the different approaches yield the same (and correct) standard errors and when they diverge, and give researchers guidance for their use.
Abstract: In both corporate finance and asset pricing empirical work, researchers are often confronted with panel data. In these data sets, the residuals may be correlated across firms and across time, and OLS standard errors can be biased. Historically, the two literatures have used different solutions to this problem. Corporate finance has relied on clustered standard errors, while asset pricing has used the Fama-MacBeth procedure to estimate standard errors. This paper examines the different methods used in the literature and explains when the different methods yield the same (and correct) standard errors and when they diverge. The intent is to provide intuition as to why the different approaches sometimes give different answers and give researchers guidance for their use.
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