Through the perspectives of accounting, economics, finance and law, the Neel Corporate Governance Center’s research addresses timely topics in corporate governance with a focus on public policy. Located within the Haslam College of Business at the University of Tennessee, Knoxville, its 11 research fellows have finished an impressive year of research, with 16 governance-related publications and more than 20 presentations at conferences or other universities in the United States and abroad.
This year’s research summary includes highlights of awards to Joan Heminway and Linda Myers, the addition of Roy Schmardebeck as a Neel Center research fellow and recently published research examining:
· Audit partner identification in Form AP
· Auditor independence when auditing fair value
· Blockchain and corporate governance
· CEO overconfidence and corporate tax policy
· Company responses to SEC comment letters
· Going concern audit opinions
· Labor protection laws
· Media coverage of corporate taxes
· “Special interest” shareholder activism
Joan Heminway was recognized by the UT’s Office of Research and Engagement as being the most-cited researcher in the College of Law. Her research focuses on benefit corporations, fintech, insider trading and securities fraud.
Linda Myers was awarded the Vallett Family Outstanding Researcher Award, given to the top researcher in the Haslam College of Business. Myers, one of the top five accounting researchers in the world, has recently published several governance-related papers examining audit committee oversight and audit quality.
New Research Fellow
This year, the Center added Roy Schmardebeck, an assistant professor in accounting, to its group of successful research fellows. Schmardebeck’s research focuses on disclosure and financial reporting quality from the perspectives of auditors and audit committees. Currently, he is working on research related to audit committee diversity, auditor materiality and disclosure similarity.
Research Fellow Publication Spotlights
In January 2017, the Public Company Accounting Oversight Board (PCAOB) began requiring audit partners to identify themselves in Form AP, claiming that the identification of the audit partner would increase personal accountability and thus improve audit quality. The identification of the partner outside of the audit opinion was ultimately a compromise compared to requirements in other countries. Lauren Cunningham and her coauthors, Chan Li (University of Kansas), Sarah Stein (Virginia Tech) and Nicole Wright (James Madison University), examine whether audit quality improved in the reporting period following initial audit partner identification. While they do find that audit quality in the United States improved in the first year of partner identification relative to the previous year, they struggle to attribute this improvement to Form AP partner identification specifically and instead attribute it to general trends in improving audit quality. Further research is needed to understand how investors use partner identification in investment decisions.
Auditor Independence and Fair Value Accounting: An Examination of Non‐Audit Fees and Goodwill Impairments, Contemporary Accounting Research
Inadequate testing of fair value accounting estimates, including goodwill, is often cited as an audit deficiency in PCAOB inspection reports, and, in some cases, these deficiencies have led to enforcement actions against the auditor. As a result of these issues, the PCAOB recently proposed a new auditing standard for fair value accounting. While these regulatory actions suggest that auditors are challenged by the fair value regime of accounting for goodwill, they also highlight an area where the auditor could be influenced by their financial ties to a client. In this study, Joe Carcello,Terry Neal and their coauthors Lauren Reid (Wake Forest University) and Jonathan Shipman (University of Arkansas) examine whether non‐audit fees are associated with goodwill impairment decision outcomes. Their results indicate that as the proportion of non‐audit fees paid by an audit client increases, the likelihood of goodwill impairment decreases. This potential lapse in auditor independence is driven by clients who are most incentivized to exert their influence over the auditor, highlighting the importance of audit committee oversight over audit quality.
Blockchains, Corporate Governance and the Lawyer’s Role, Wayne Law Review (forthcoming)
Joan Heminway and her co-author Adam Sulkowski (Babson College) describe blockchains and their potentially expansive use in several aspects of the governance of publicly traded corporations and outline ways in which blockchain technology affects what business lawyers should know and do, now and in the future. The article explores the nature of blockchain technology and ways in which the adoption of that technology may impact shareholder recordkeeping and voting, insider trading and disclosure-related considerations. Reflections are made on the implications for business lawyers and the practice of law in the context of corporate governance.
Overconfidence and Corporate Tax Policy, Review of Accounting Studies
James Chyz and his coauthors, Fabio Gaertner (University of Wisconsin), Asad Kausar (American University) and Luke Watson (Drexel University), find that overly confident CEOs are associated with greater corporate tax avoidance. Their finding contributes to literature previously linking executive overconfidence with riskier investment decisions, aggressive financial reporting and more optimistic forecasting. To measure overconfidence, the authors look at CEO trading activity, because “with vast amounts of personal wealth and human capital tied to a single firm,” holding on to in-the-money stock options longer than expected signals greater confidence in the firm relative to a diversified portfolio.
The Readability of Company Responses to SEC Comment Letters and SEC 10-K Filing Review Outcomes, Review of Accounting Studies (forthcoming)
Lauren Cunningham and her coauthors, Cory Cassell (University of Arkansas) and Ling Lisic (Virginia Tech), use a large sample of SEC 10-K filing reviews between 2004 and 2014 to examine how the language used by registrants is associated with the outcome of the SEC filing review process. The authors find that when corporate filers use unnecessarily complex language in their response letters to the SEC, the SEC takes longer to write back and more often rejects the company’s responses, leading to future amendments or restatements. The authors cannot determine whether companies are purposefully obfuscating their responses or if this is an unintentional writing choice after involvement from audit firms and lawyers. Their findings do suggest that corporate filers should be cognizant of the way they respond to SEC comment letters.
Measuring the Market Response to Going Concern Modifications: The Importance of Disclosure Timing, Review of Accounting Studies
A significant decision undertaken by auditors of clients in financial distress is whether to issue a going concern opinion. Linda Myers and her coauthors, Jonathan Shipman (University of Arkansas), Quinn Swanquist (University of Alabama) and Rob Whited (North Carolina State University), investigate how shareholders respond to the announcement of an auditor’s going concern opinion. A key innovation in their study is recognizing that many going concern opinions are issued contemporaneously with other disclosures by management (for example, earnings announcements), making it very difficult to isolate the market reaction to going concern opinions. Their tests suggest that after taking these contemporaneous disclosures into account, the incremental market response to going concern audit opinions is statistically weak and much smaller in economic magnitude than is suggested by prior research. Their study is based on the pass/fail auditor-reporting model, so further research is needed as auditors begin expanded reporting of critical audit matters for fiscal years on or after June 30, 2019.
Employment Protection, Investment, and Firm Growth, Review of Financial Studies
Matthew Serfling and his coauthors, John (Jianqiu) Bai (Northeastern University) and Douglas Fairhurst (Washington State University), study the adoption of state-level labor protection laws in the U.S. They find that, following the adoption of these laws, capital expenditures decrease and sales growth slows down. They attribute their findings to theories predicting that greater employment protection discourages corporate investment by making projects more irreversible. Supporting this theory, when performance declines, firms are less likely to downsize operations in states that have adopted labor protection laws and more likely to downsize in states that have not adopted labor protection laws. Their findings should be of interest to states considering the adoption of labor protection laws by highlighting a potential unintended consequence on corporate investment and growth.
Media Coverage of Corporate Taxes, The Accounting Review
Corporate governance represents a complex web of processes and relationships with internal and external stakeholders in an effort to provide oversight for a company. A powerful yet often overlooked influencer of corporate decision making is the media. Kathleen Schuchard and her coauthors, Shannon Chen (University of Arizona) and Bridget Stomberg (Indiana University), examine the determinants and consequences of U.S. media coverage of corporate tax policies. They find that media coverage for firms that “underpay” their income tax is greater for larger companies than it is for smaller companies and is more likely during economic recessions than stronger economic periods. In contrast to the significant influence that other stakeholders may have (e.g., proxy advisory firms or institutional investors), firms do not respond to media attacks with higher tax payments, suggesting that the media has a weaker influence over corporate policy than might be expected.
Can Strong Corporate Governance Selectively Mitigate the Negative Influence of ‘‘Special Interest’’ Shareholder Activists? Evidence from the Labor Market for Directors, Journal of Financial and Quantitative Analysis
Tracie Woidtke and co-author Diane Del Guercio (University of Oregon) examine whether market-based corporate governance mechanisms can curb efforts by certain shareholders to pressure firms and promote their own private agenda at the expense of other shareholders (e.g., labor union pension funds leveraging their rights as a shareholder to pressure management in order to gain extra concessions for the firm’s unionized workers). The authors find results consistent with the labor market for corporate directors selectively punishing only those directors whose ﬁrms succumb to pressure from shareholders with private agendas and providing incentives to directors to be vigilant in resisting such pressure. These results have important policy implications. While recent policy considerations to curb special interest shareholder activism would presumably deter proposals sponsored by shareholders with private agendas, their across-the-board reduction of shareholder power would also deter many others, including the value-enhancing variety. The results indicate that market-based corporate governance mechanisms can mitigate special interest shareholder activism without deterring value-enhancing shareholder activism.