Abstract: When emerging market firms disclose relationship-based transactions, they face a tradeoff in which greater transparency may help lower their cost of capital at the cost of revealing proprietary information. We find that firms overcome this challenge by relying on analysts within their private networks (i.e., connected analysts) who, through repeated interaction with the firm, can better verify relationship-based transactions. Using Chinese firms, we show that firms with more connected analysts have more accurate consensus forecasts and lower forecast dispersion. When a connected analyst departs and stops covering a firm, the accuracy and informativeness of the unconnected analysts’ forecasts decrease, suggesting that information spills over from the connected analyst to analysts outside the network. We find a potential mechanism for this information spillover: communication through common institutional clients. The findings suggest that embedded financial analysts—those who share close connections with firms and analysts—serve as a channel for disseminating proprietary, hard-to-verify information.

Featured in Bloomberg
China’s Surprising Insider Tip

Abstract: We examine how a manager’s ethnic cultural background affects their communication with investors. Using a sample of earnings conference call transcripts with 24,901 executives from 42 countries, we find that managers from ethnic groups that have a more individualistic culture use a more optimistic tone and exhibit greater self-reference in their disclosure narratives. Managers’ ethnic culture has a lasting effect on their narratives, an effect that persists even for executives whose work experience later exposes them to different ethnic cultures. The effect of ethnic heritage is observed in dialogues that reflect real time interactions (i.e., Q&As) and is less pronounced in the scripted, less spontaneous portion of the calls (i.e., management discussion). Analysts respond positively to an optimistic tone, but only those who share the manager’s ethnic background adjust their earnings forecasts for the cultural component of managerial tone. The findings suggest that managers’ ethnic background has a significant effect on how they communicate with the capital market and how the market responds to a disclosure event.

Featured in Harvard Law School Forum on Corporate Governance and Financial Regulation
Managers’ Cultural Background and Disclosure Attributes

Abstract: We examine how directors’ reputations are managed through disclosure choices. We focus on disclosures in the director biographies in proxy statements filed with the SEC. We find that a directorship on another board is more likely to be undisclosed when the other firm experienced an adverse event during the director’s tenure. Withholding such information is associated with a more favorable stock price reaction to the director’s appointment and the loss of fewer subsequent directorships. These findings suggest that the concerns about the reputations of corporate directors lead to strategic disclosure choices that have real consequences in capital and labor markets.

Featured in Harvard Law School Forum on Corporate Governance and Financial Regulation
Managing Reputation: Evidence from Biographies of Corporate Directors

Abstract: We examine how language barriers affect the capital market reaction to information disclosures. Using transcripts from non-U.S. firms’ English-language conference calls, we find that the calls of firms in countries with greater language barriers are more likely to contain non-plain English and erroneous expressions. For non-U.S. firms that hire an English-speaking manager, we find less use of non-plain English and fewer erroneous expressions. Calls with a greater use of non-plain English and more erroneous expressions show lower intraday price movement and trading volume. The capital market responses to non-plain English and erroneous expressions are more negative when the firm is located in a non-English-speaking country and has more English-speaking analysts participating in the call. Our results highlight that, when disclosure happens verbally, language barriers between speakers and listeners affect its transparency, which in turn impacts the market’s reaction.

Abstract: We study the frequency of restatements by foreign firms listed on US exchanges. We find that the restatement rate of US listed foreign firms is significantly lower than that of comparable US firms and that the difference depends on the firm’s home country characteristics. Foreign firms from countries with a weak rule of law are less likely to restate than are firms from strong rule of law countries. While the lower rate of restatements can represent an absence of errors, it can also indicate a lack of detection and disclosure of errors and irregularities. We infer the effect of detection and disclosure by associating the frequency of restatements with the quality of the firm’s internal control system. We find that only US firms and foreign firms from strong rule of law countries show a positive association between restatement frequency and internal control weaknesses. Firms from weak rule of law countries show no significant association. We interpret these findings as home country enforcement affecting firms’ likelihood of detecting and reporting existing accounting misstatements. This suggests that for US listed foreign firms, less frequent restatements can be a signal of opportunistic reporting rather than a lack of accounting errors and irregularities.

Abstract: We examine how cross-country differences in product, capital, and labor market competition, and earnings management affect mean reversion in accounting return on assets. Using a sample of 48,465 unique firms from 49 countries, we find that accounting returns mean revert faster in countries where there is more product and capital market competition, as predicted by economic theory. Country differences in labor market competition and earnings management are also related to mean reversion in accounting returns – but the relation varies with firm performance. Country labor competition increases mean reversion when unexpected returns are positive, but dampens it when unexpected returns are negative. Accounting returns in countries with higher earnings management mean revert more slowly for profitable firms and more rapidly for loss firms. Thus, earnings management incentives to slow or speed up mean reversion in accounting returns are accentuated in countries where there is a high propensity for earnings management. Overall, these findings suggest that country factors explain mean reversion in accounting returns and are therefore relevant for firm valuation.

Abstract: We provide one of the first empirical evidence consistent with recent macro global-game crisis models, which show that the precision of public signals can coordinate crises (e.g., Angeletos and Werning 2006; Morris and Shin 2002, 2003). In these models, self-fulfilling crises (independent of poor fundamentals) can occur only when publicly disclosed signals of fundamentals have high precision; poor fundamentals are the sole driver of crises only in low precision settings. We find evidence consistent with this proposition for 68 currency and systemic banking crises in 17 countries from 1983-2005. We exploit a key publicly-disclosed signal of fundamentals that drives financial markets, namely accounting data, and find that pre-crisis accounting signals of fundamentals are significantly lower only in low precision countries.

Abstract: Do differences in countries’ accounting standards affect global investment decisions? We explore this question by examining how accounting distance, the difference in the accounting standards used in the investor’s and the investee’s countries, affects the asset allocation decisions of global mutual funds. We find that investors tend to underweight investees with greater accounting distance. Using the mandatory adoption of International Financial Reporting Standards (IFRS) as an event that changed the accounting standards of various country-pairs, we examine how two sources of changes in accounting distance – (i) change due to IFRS adoption of the investee and (ii) change due to IFRS adoption in the investor’s country – affect global portfolio allocation decisions. We find that the tendency to underinvest in investees with greater accounting distance significantly weakens when accounting distance is reduced either from an investee’s IFRS adoption or from IFRS adoption in the investor’s country. The latter finding holds despite the fact that IFRS adoption in the investor’s country had no impact on the accounting standards under which the investee firms present their financial information; the only change is in the investor’s familiarity with these standards. This suggests that differences in accounting standards affect investor demand by imposing greater information-processing cost on those less familiar with the reporting standards.

Abstract: This paper examines how the external information environment in which foreign subsidiaries operate affects the investment decisions of multinational corporations (MNCs). We hypothesize and find that the investment decisions of foreign subsidiaries in country-industries with more transparent information environments are more responsive to local growth opportunities than are those of foreign subsidiaries in country-industries with less transparent information environments. Further, this effect is larger when (i) there are greater cross-border frictions between the parent and subsidiary, and (ii) the parents are relatively more involved in their subsidiaries’ investment decision-making process. Our results suggest that the external information environment helps mitigate the agency problems that arise when firms expand their operations across borders. This paper contributes to the literature by showing that the external information environment helps MNCs mitigate information frictions within the firm.

Abstract: The returns of hedge fund investors depend not only on the returns of the funds they hold but also on the timing and magnitude of their capital flows in and out of these funds. We use dollar-weighted returns (a form of IRR) to assess the properties of actual investor returns on hedge funds and compare them to buy-and-hold fund returns. Our main finding is that annualized dollar-weighted returns are on the magnitude of 3 to 7 percent lower than corresponding buy-and-hold fund returns. Using factor models of risk and the estimated dollar-weighted performance gap, we find that the real alpha of hedge fund investors is close to zero. In absolute terms, dollar-weighted returns are reliably lower than the return on the S&P 500 index, and are only marginally higher than the risk-free rate as of the end of 2008. The combined impression from these results is that the return experience of hedge fund investors is much worse than previously thought.

Featured in:
The New York Times
Buying High and Selling Low
The New Yorker
How do Hedge Funds Get Away With It? Eight Theories
Wall Street Journal, Weekend Investor
Is it Time to Buy a Hedge Fund?
Financial Times, Opinion Markets 
Hedge Funds Struggle to Justify Star Rating
The New York Times 
Buying High and Selling Low