Working Papers
"An Unintended Benefit of Risk Factor Mandate of 2005" (with Allen Huang, and Jianghua Shen).
Best Paper Award (First Place) at the 2018 MIT Asia Conference in Accounting
The risk factor disclosure mandate effective in 2005 was intended to provide the market with useful information on firm risk. Recently, investors and regulators have expressed concerns that this section has become “boilerplate.” However, because mandatory risk factor disclosure can be used as “meaningful cautionary language” under the safe harbor provision of the Private Securities Litigation Reform Act, the mandate results in an exogenous increase in the legal protection of forward-looking statements made by firms that started to provide risk factors disclosure due to the mandate. Using a difference-in-differences design, we find that after the 2005 risk factor mandate, these firms are more willing to provide forward-looking statements, particularly positive ones, in the Management’s Discussion and Analysis section of their 10-K filings, and that they are more willing to provide management forecasts, their earnings forecasts have higher precision, and have longer horizons, compared to other firms, all of which are consistent with reduced managerial concern about litigation risks from voluntary disclosure. Cross-sectional tests show that the increase in forward-looking disclosure is greater at firms in which forward-looking statements are more susceptible to potential litigation. Further analyses indicate that firms that started to provide risk factors due to the mandate have experienced a decrease in analyst forecast errors and dispersion, and a decrease in bid-ask spreads. Overall, our study suggests that the 2005 risk factor mandate has an unintended benefit—it has spurred the voluntary disclosure of forward-looking information.
Best Paper Award (First Place) at the 2018 MIT Asia Conference in Accounting
The risk factor disclosure mandate effective in 2005 was intended to provide the market with useful information on firm risk. Recently, investors and regulators have expressed concerns that this section has become “boilerplate.” However, because mandatory risk factor disclosure can be used as “meaningful cautionary language” under the safe harbor provision of the Private Securities Litigation Reform Act, the mandate results in an exogenous increase in the legal protection of forward-looking statements made by firms that started to provide risk factors disclosure due to the mandate. Using a difference-in-differences design, we find that after the 2005 risk factor mandate, these firms are more willing to provide forward-looking statements, particularly positive ones, in the Management’s Discussion and Analysis section of their 10-K filings, and that they are more willing to provide management forecasts, their earnings forecasts have higher precision, and have longer horizons, compared to other firms, all of which are consistent with reduced managerial concern about litigation risks from voluntary disclosure. Cross-sectional tests show that the increase in forward-looking disclosure is greater at firms in which forward-looking statements are more susceptible to potential litigation. Further analyses indicate that firms that started to provide risk factors due to the mandate have experienced a decrease in analyst forecast errors and dispersion, and a decrease in bid-ask spreads. Overall, our study suggests that the 2005 risk factor mandate has an unintended benefit—it has spurred the voluntary disclosure of forward-looking information.
"Hardening Soft Information: Analyst Conservative Bias" (with Kerry Xiao).
In this paper, we examine whether sell-side financial analysts show a bias when translating their soft information into a hard format. Sell-side analysts produce both soft research output, in the form of a textual report, and hard research output, including earnings forecasts, target prices, and stock recommendations. In our study, we find evidence that analysts’ hard outputs undershoot the neutral implication of their own soft output. Furthermore, our cross-sectional results show that our observed conservative bias increases when the underlying information signals are of poorer quality, which we measure by the forecast horizon, linguistic cues in the report, and characteristics of the firms’ information environments. Consistent with the well-known analyst optimism, we find that hard outputs assimilate analysts’ soft output more conservatively when their soft output conveys bad news. Our findings suggest that the fundamental distinctions between soft and hard information lead to a predicable bias when analysts harden their soft information.
In this paper, we examine whether sell-side financial analysts show a bias when translating their soft information into a hard format. Sell-side analysts produce both soft research output, in the form of a textual report, and hard research output, including earnings forecasts, target prices, and stock recommendations. In our study, we find evidence that analysts’ hard outputs undershoot the neutral implication of their own soft output. Furthermore, our cross-sectional results show that our observed conservative bias increases when the underlying information signals are of poorer quality, which we measure by the forecast horizon, linguistic cues in the report, and characteristics of the firms’ information environments. Consistent with the well-known analyst optimism, we find that hard outputs assimilate analysts’ soft output more conservatively when their soft output conveys bad news. Our findings suggest that the fundamental distinctions between soft and hard information lead to a predicable bias when analysts harden their soft information.
Publications
"Analyst Information Discovery and Interpretation Roles: A Topic Modeling Approach" Management Science, June 2018, Vol. 64, Iss. 6, pp. 2833-2855. (with Allen Huang, Reuven Lehavy, and Rong Zheng).
This study examines analyst information intermediary roles using a textual analysis of analyst reports and corporate disclosures. We employ a topic modeling methodology from computational linguistic research to compare the thematic content of a large sample of analyst reports issued promptly after earnings conference calls with the content of the calls themselves. We show that analysts discuss exclusive topics beyond those from conference calls and interpret topics from conference calls. In addition, we find that investors place a greater value on new information in analyst reports when managers face greater incentives to withhold value-relevant information. Analyst interpretation is particularly valuable when the processing costs of conference call information increase. Finally, we document that investors react to analyst report content that simply confirms managers’ conference call discussions. Overall, our study shows that analysts play the information intermediary roles by discovering information beyond corporate disclosures and by clarifying and confirming corporate disclosures.
Internet Appendix to Huang, Lehavy, Zang and Zheng 2018 Management Science
This study examines analyst information intermediary roles using a textual analysis of analyst reports and corporate disclosures. We employ a topic modeling methodology from computational linguistic research to compare the thematic content of a large sample of analyst reports issued promptly after earnings conference calls with the content of the calls themselves. We show that analysts discuss exclusive topics beyond those from conference calls and interpret topics from conference calls. In addition, we find that investors place a greater value on new information in analyst reports when managers face greater incentives to withhold value-relevant information. Analyst interpretation is particularly valuable when the processing costs of conference call information increase. Finally, we document that investors react to analyst report content that simply confirms managers’ conference call discussions. Overall, our study shows that analysts play the information intermediary roles by discovering information beyond corporate disclosures and by clarifying and confirming corporate disclosures.
Internet Appendix to Huang, Lehavy, Zang and Zheng 2018 Management Science
"Evidence on the Information Content of Text in Analyst Reports" The Accounting Review, November 2014, 89 (6): pp. 2151-2180. (with Allen Huang and Rong Zheng)
We document that textual discussions in a sample of 363,952 analyst reports provide information to investors beyond that in the contemporaneously released earnings forecasts, stock recommendations, and target prices, and also assist investors in interpreting these signals. Cross-sectionally, we find that investors react more strongly to negative than to positive text, suggesting that analysts are especially important in propagating bad news. Additional evidence indicates that analyst report text is more useful when it places more emphasis on nonfinancial topics, is written more assertively and concisely, and when the perceived validity of other information signals in the same report is low. Finally, analyst report text is shown to have predictive value for future earnings growth in the subsequent five years.
We document that textual discussions in a sample of 363,952 analyst reports provide information to investors beyond that in the contemporaneously released earnings forecasts, stock recommendations, and target prices, and also assist investors in interpreting these signals. Cross-sectionally, we find that investors react more strongly to negative than to positive text, suggesting that analysts are especially important in propagating bad news. Additional evidence indicates that analyst report text is more useful when it places more emphasis on nonfinancial topics, is written more assertively and concisely, and when the perceived validity of other information signals in the same report is low. Finally, analyst report text is shown to have predictive value for future earnings growth in the subsequent five years.
"Evidence on the Trade-Off between Real Activities Manipulation and Accrual-Based Earnings Management" The Accounting Review, March 2012, 87 (2): pp. 675-703.
I study whether managers use real activities manipulation and accrual-based earnings management as substitutes in managing earnings. I find that managers trade off the two earnings management methods based on their relative costs and that managers adjust the level of accrual-based earnings management according to the level of real activities manipulation realized. Using an empirical model that incorporates the costs associated with the two earnings management methods and captures managers’ sequential decisions, I document large-sample evidence consistent with managers using real activities manipulation and accrual-based earnings management as substitutes.
I study whether managers use real activities manipulation and accrual-based earnings management as substitutes in managing earnings. I find that managers trade off the two earnings management methods based on their relative costs and that managers adjust the level of accrual-based earnings management according to the level of real activities manipulation realized. Using an empirical model that incorporates the costs associated with the two earnings management methods and captures managers’ sequential decisions, I document large-sample evidence consistent with managers using real activities manipulation and accrual-based earnings management as substitutes.
"What Determine Financial Analysts' Career Outcomes During Mergers?" Journal of Accounting and Economics, March 2009, 47 (1-2): pp. 59-86. (with Joanna Shuang Wu).
We investigate the effects of mergers on the career outcomes of financial analysts. We hypothesize and find that analysts with good earnings forecast performance experience higher turnover during mergers, target analysts are more likely to turnover and the existence of a competing analyst in a merger counter party also increases analyst turnover. We analyze the promotion of analysts to research executive positions and find that analysts with greater experience and especially experienced stars are more likely to be promoted. Finally, we document that analyst turnover is associated with decreases in research quality at the merged firms post-merger.
We investigate the effects of mergers on the career outcomes of financial analysts. We hypothesize and find that analysts with good earnings forecast performance experience higher turnover during mergers, target analysts are more likely to turnover and the existence of a competing analyst in a merger counter party also increases analyst turnover. We analyze the promotion of analysts to research executive positions and find that analysts with greater experience and especially experienced stars are more likely to be promoted. Finally, we document that analyst turnover is associated with decreases in research quality at the merged firms post-merger.
"CEO Reputation and Earnings Quality" Contemporary Accounting Research, Spring 2008, 25 (1): pp. 109-147. (with Jennifer Francis, Allen Huang, and Shivaram Rajgopal.)
We examine the relation between CEO reputation and measures of the firm’s earnings quality. Using press coverage (media counts) to proxy for CEO reputation, we find that more reputed CEOs are associated with poorer earnings quality. This finding is inconsistent with an efficient contracting view, which predicts that reputed CEOs take actions that result in good earnings quality. This seemingly counterintuitive result is, however, consistent with two other theories: a rent extraction hypothesis (which predicts that reputed managers are more likely to use their discretion to manipulate earnings in order to manage labor and stock market perceptions) and a matching hypothesis (which predicts that selection on the part of firms gives rise to a demand for reputed CEOs for firms where earnings quality is inherently poor). Further analyses provide little support for the rent extraction explanation and some support for the matching explanation.
We examine the relation between CEO reputation and measures of the firm’s earnings quality. Using press coverage (media counts) to proxy for CEO reputation, we find that more reputed CEOs are associated with poorer earnings quality. This finding is inconsistent with an efficient contracting view, which predicts that reputed CEOs take actions that result in good earnings quality. This seemingly counterintuitive result is, however, consistent with two other theories: a rent extraction hypothesis (which predicts that reputed managers are more likely to use their discretion to manipulate earnings in order to manage labor and stock market perceptions) and a matching hypothesis (which predicts that selection on the part of firms gives rise to a demand for reputed CEOs for firms where earnings quality is inherently poor). Further analyses provide little support for the rent extraction explanation and some support for the matching explanation.
