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We study price and non-price provisions of debt contracts to gauge how creditors evaluate changes in senior executives’ personal income taxes (“managerial taxes”) of their borrowers. Because managers’ personal income taxes can exacerbate conflicts of interest with their firms’ capital providers (e.g., creditors and shareholders)—as well as those between them—they should influence the design of these contracts. We argue that an increase in personal taxes affects how managers evaluate risk-return trade-offs and encourages them to take more risk. Specifically, by enabling risk-sharing with the government, taxes reduce the disincentive of a risk-averse managers to pursue risky projects by reducing the disutility they associate with them. Our evidence demonstrates that loans issued following arguably exogenous increases in managerial taxes are costlier for borrowers and are more likely to include performance rather than capital covenants. Subsequent cross-sectional tests corroborate this inference and provide further insight by showing that the effect of managerial taxes on loan terms is more pronounced when managers have greater incentives to take risks, and when creditors are more likely to closely monitor managers’ risk-taking behavior. Collectively, these and other findings show how changes in managerial taxes—and, in turn, managers’ preferences for risk and return—influence the terms and structure of their firms’ debt contracts.

Relative to sales, the average operating lease commitments of hospitality firms are 4 times larger than those of other publicly traded firms. In response to the recently enacted accounting standards update No. 2016-02 (ASU 2016-02) that requires lessees to recognize operating leases on their balance sheet, hospitality firms decreased their use of operating leases, switching to shorter-term off-balance sheet leases. We find that this change did not have negative consequences on firm performance, shareholders, or employees. The only significant effect we do find is an improvement in credit ratings for firms that reduced operating leases in response to the new standard. Our findings are inconsistent with the concerns some hospitality managers and academics expressed prior to the introduction of the standard.

ABSTRACT We examine how firms’ contractual relationships with their employees affect the design of their debt contracts, and the use of financial covenants in particular. Viewing the firm as the nexus of both explicit and implicit contractual relationships, we argue that managers cater to their employees’ preferences when negotiating contractual terms with creditors. We argue that an increase in unemployment-insurance benefits reduces employees’ cost of job loss, which, in turn, allows managers to take more risk. First, we show that more generous benefits are associated with a higher operating leverage, operating cash flow volatility, and product-development frequency. We then find that loans initiated following an increase in unemployment-insurance benefits include a higher proportion of performance, rather than capital covenants. Overall, our study demonstrates how the design of debt contracts changes in response to arguably exogenous changes in employees’ collective tolerance—and, in turn, managers’ preferences—for risk. JEL Classifications: M41; G32; J60.

We study firms that engage in strategic alliances and investigate the link between a firm’s investment and the accounting quality of its partners. Given the view of the firm as a nexus of contractual relationships, we expect that alliance partner information will help investors monitor the firm. In line with this expectation, we show that partner firms’ accounting quality reduces both over- and underinvestment in the focal firm. We also test the role of partner firms’ accounting quality in multisegment firms, in which agency conflicts are more acute. We find that the accounting quality of partner firms reduces the diversification discount in these firms.

ABSTRACTWe examine whether resource adjustment costs, such as installation and disposal costs for fixed assets, or hiring and firing costs for employees, impede value creation in mergers and acquisitions (M&A). We focus on M&A deals because they are major corporate investment decisions. As a proxy for adjustment costs, we use a firm‐level measure of cost stickiness. We predict that acquirers with high adjustment costs have less flexibility in restructuring resources following the acquisition and will find it more costly to merge the target firm's operations. Consistent with this prediction, we find that the acquirer's adjustment costs are negatively associated with abnormal returns around the acquisition announcement. Additionally, adjustment costs are also negatively associated with deal synergies. Relatedly, we find that acquirers with high adjustment costs purchase targets with high adjustment costs. In accordance with this finding, we show that acquirers with high adjustment costs purchase intangible‐intensive targets. Collectively, our results highlight the important implication of adjustment costs in M&A deals for managers and capital market participants.

We examine whether resource adjustment costs, such as installation and disposal costs for fixed assets, or hiring and firing costs for employees, impede value creation in mergers and acquisitions (M&A). We focus on M&A deals because they are major corporate investment decisions. As a proxy for adjustment costs, we use a firm-level measure of cost stickiness. We predict that acquirers with high adjustment costs have less flexibility in restructuring resources following the acquisition and will find it more costly to merge the target firm's operations. Consistent with this prediction, we find that the acquirer's adjustment costs are negatively associated with abnormal returns around the acquisition announcement. Additionally, adjustment costs are also negatively associated with deal synergies. Relatedly, we find that acquirers with high adjustment costs purchase targets with high adjustment costs. In accordance with this finding, we show that acquirers with high adjustment costs purchase intangible-intensive targets. Collectively, our results highlight the important implication of adjustment costs in M&A deals for managers and capital market participants.

We provide evidence that credit investors do not fully impound the implications of firms' cost structure (or operating leverage) when pricing credit default swaps. Information about firms' cost structure is not disclosed and needs to be estimated. Furthermore, the performance implications of firms' cost structure depend on the expected macroeconomic conditions. We focus on the debt market because of the strong emphasis of this market on downside risk. To measure expected aggregate macroeconomic conditions, we employ the change in the anxious index (AI), which is the probability of a decline in real GDP provided by the SPF-the survey of professional forecasters. We find that the interaction between the firm's cost structure and change in AI predicts one-quarter-ahead CDS spreads. Portfolio-level analysis confirms this result.

We examine whether resource adjustment costs, such as installation and disposal costs for fixed assets, or hiring and firing costs for employees, impede value creation in mergers and acquisitions (M&A). We focus on M&A deals because they are major corporate investment decisions. As a proxy for adjustment costs, we use a firm-level measure of cost stickiness. We predict that acquirers with high adjustment costs have less flexibility in restructuring resources following the acquisition and will find it more costly to merge the target firm’s operations. Consistent with this prediction, we find that the acquirer’s adjustment costs are negatively associated with abnormal returns around the acquisition announcement. Additionally, adjustment costs are also negatively associated with deal synergies. Relatedly, we find that acquirers with high adjustment costs purchase targets with high adjustment costs. In accordance with this finding, we show that acquirers with high adjustment costs purchase intangible-intensive targets. Collectively, our results highlight the important implication of adjustment costs in M&A deals for managers and capital market participants.

We examine the information content of aggregate cost structure (ASTR) and compare it to aggregate cost stickiness (ASTK). Using business-level job flows from the Business Employment Dynamics dataset, which has recently been made available by the Bureau of Labor Statistics, we find that, after accounting for GDP growth and other macroeconomic factors, ASTR explains gross job inflows, but only explains gross job outflows in periods of low employee retention. Moreover, ASTK explains gross job outflows, but not gross job inflows, consistent with resource retention decisions affecting job losses more than gains. When we include both ASTR and ASTK in a regression model, both are significant but with opposite signs, and the information content of ASTR is greater. Similar patterns hold in vector autoregression (VAR) models. Finally, we consider the performance of aggregate cost structure estimated from the traditional linear model, which assumes a symmetric relation between change in costs and both increases and decreases in sales (ASTRSYM). We find larger predictive ability and explanatory power of models that include ASTR and ASTK as compared to ASTRSYM.

This paper modifies the standard returns-earnings regression in accounting research to show that financial reports convey both cash-flow news and discount-rate (expected-return) news. The paper points to the realization principle, associated as it is with the resolution of risk, as the accounting feature that conveys expected-return news. The modified returns-earnings regressions indicate that the information so conveyed pertains to priced risk. In corroboration, the paper also shows that the identified expected-return news forecasts changes in both stock return betas and earnings betas, and expected-return news predicts future returns, whereas cash-flow news does not. The analysis yields a number of additional insights: financial statements distinguish expected-return news associated with operations from that associated with financing activities; given accounting information, there is not much news in dividends; and, in comparing the information content of earnings versus cash flows, cash flows largely convey expected-return news rather than cash-flow news. In sum, the paper shows that the objective of the Financial Accounting Standards Board and International Accounting Standards Board to provide information about the amount and uncertainty of future cash flows is (as least, partially) satisfied by accounting principles underlying current financial reporting. This paper was accepted by Suraj Srinivasan, accounting.

We examine whether aggregate cost stickiness predicts future macrolevel unemployment rate. We incorporate aggregate cost stickiness into three different classes of forecasting models studied in prior literature, and demonstrate an improvement in forecasting performance for all three models. For example, when adding cost stickiness to an OLS regression, which includes a battery of macroeconomic indicators and control variables, we find that a one-standard-deviation-higher cost stickiness in recent quarters is followed by a 0.23 to 0.26-percentage-point-lower unemployment rate in the current and following quarter. In out-of-sample tests, we find significant reductions in the root-mean-squared-errors upon incorporation of cost stickiness for all three models. Additional tests suggest that professional macro forecasters, particularly those employed in nonfinancial industries, do not fully incorporate the information contained in cost stickiness. Finally, we find a stronger predictive power of cost stickiness towards the end of recessionary periods; we also assess cross-sectional variation of this predictive ability.

In December 2006, the SEC issued new rules requiring enhanced disclosure by public U.S. firms of perquisites granted to their executives. The rules applied to perquisites granted in fiscal year 2006 and thereafter. Because the rules were implemented quickly, the perks disclosed for 2006 reflect the arrangements firms made under prior disclosure rules: firms could not revise perks to reflect the new rules until 2007. For firms that disclose for the first time in 2006, we predict and find that perks decrease in 2007, reflecting both the costs of increased disclosure and enhanced monitoring. This decrease in perks is offset by higher levels of non-perk compensation, however. We also predict and find that the effect of perk disclosure by formerly non-disclosing firms in 2006 leads to higher perks in 2007 for firms that were disclosing perks prior to the rule change.

Using a large dataset of news releases, we study instances of investors’ mistaken reaction, or misreaction, to news. We define misreaction as stock prices moving in the direction opposite to the news when it is released. We find that news tone predicts returns in the cross-section only upon the occurrence of misreaction. Stocks that are larger, more liquid, more visible, and more covered, by analysts or by the media, are less likely to exhibit misreaction. On the other hand, the ambiguity and complexity of news content, and variables that proxy for investor distraction, are all associated with more misreaction and greater predictability.

This paper employs the firm life-cycle concept to extend our understanding of the mispricing of accrual and cash flow information by the stock market. We find that accruals and free cash flows are strongly (negatively) correlated in the maturity and decline stages of a firm's life cycle but not in the growth stage, suggesting that they capture unique information in the growth stage of the firm's life cycle but more correlated information in the later stages. Consistent with this finding, we show that the cash flows anomaly subsumes the accruals anomaly in maturity and decline stages, but not in the growth stage. Our findings contribute to the debate regarding the overlap between the two anomalies.

Using a novel dataset that includes estimates of the fair value of the targets’ purchased tangible and intangible assets, we demonstrate that private targets have significantly more intangible assets than do public targets. We then develop a valuation model that is based on the fair values of the targets’ tangible and intangible assets and show that relative to public targets, private targets generate higher synergies in the acquisitions. However, the higher synergies in private target acquisitions are not the result of the target status but are driven by the larger amount of intangible assets acquired in those deals. We also find that the variance of synergies in private targets is much larger than that in acquisitions of public targets. Finally, our results are robust for known effects such as mode of payment and expected growth.

Asymmetric verification takes into account both the type of news (i.e., good versus bad news) and the level of uncertainty regarding that news. Good news should be more certain (i.e. more verifiable) before it is reflected in earnings than bad news. To test this principle, we use data from Thomson Reuters News Analytics to construct a measure of uncertainty based on news articles on public firms. These articles are measured at the firm level and are assigned positive, negative, and neutral scores that sum to a total of one. If the positive score is largest, then the article is coded as good news (bad news articles are coded similarly). We then create a dispersion measure for each article where higher numbers represent more polarized news. Overall, we find that good news is more highly associated with earnings when uncertainty is low consistent with asymmetric verification. In contrast, we find no such association between bad news and uncertainty (as we would expect).

I examine whether conditional conservatism, and particularly timely loss recognition, is associated with a firm’s decision to form alliances. I adopt the view of alliances as a commitment technology that helps a company’s CEO overcome problems concerning her inability to motivate division managers. I find a strong and significant association between timely loss recognition and alliance formation. This relation is more pronounced when the firm’s internal capital markets are inefficient (conglomerates), when the industry the firm operates in is more concentrated (i.e., low product market competition), and when a project is less risky. I further examine whether conservative firms are better able to reap the benefits of alliance strategy. I demonstrate that conservative firms are involved in more profitable alliances.

Acquirers, on average, earn higher announcement‐period returns when their targets are privately held than when their targets are publicly traded. We show that private targets have significantly more intangible assets than do public targets. We then develop a valuation model that is based on the fair values of the targets' tangible and intangible assets and demonstrate that relative to public targets, private targets, while commanding higher premiums over their stand‐alone values, also generate higher synergies in the acquisitions. However, the higher synergies in private target acquisitions are not the result of the target status but are driven by the larger amount of intangible assets acquired in those deals. We also find that the variance of synergies in private targets is much larger than that in acquisitions of public targets. Finally, our results are robust for known effects such as mode of payment and expected growth.

We investigate the conditions under which the accounting-based acquisition goodwill represents an economic asset. Analysis of the stock market reaction to 2123 acquisitions suggests that although investors perceive 41% of the acquisitions to have a negative net present value consistent with overpayment for the target, the acquirer records positive accounting goodwill. Adjusting the goodwill to eliminate any overpayment results in a better prediction of future operating performance. As a thought experiment, we also increase the recognized accounting goodwill for the remaining 59% of the sample. Again, we show that this goodwill construct is a better predictor of future operating performance.