We study the role of borrower accounting quality in debt contracting. Specifically, we examine how accounting quality affects the borrower's choice of private versus public debt market and how the design of debt contracts vary with accounting quality in the two markets. We find that accounting quality affects the choice of the market, with poorer accounting quality borrowers preferring private debt, i.e., bank loans. This is consistent with banks possessing superior information access and processing abilities that reduce adverse selection costs for borrowers. We also find that accounting quality has an economically significant but differential impact on contract design in the two markets consistent with differences in recontracting flexibility across the two markets. In the case of private debt, since there is greater recontracting flexibility, both the price (i.e., interest) and non-price (i.e., maturity and collateral) terms are significantly more stringent for poorer accounting quality borrowers, unlike public debt where only the price terms are more stringent. The impact of accounting quality on interest spreads of public debt is 2.5 times that of the private debt, since the price terms alone reflect the variation in accounting quality.

Gu and Xue (this issue) study the disciplining effect of independent analysts on the accuracy and forecast relevance of the forecasts of non-independent analysts. One of the intriguing results is that while independent analysts issue inferior forecasts, their presence appears to reduce the forecast bias, improve the forecast accuracy and increase the forecast relevance of forecasts issued by non-independent analysts. We explore alternative explanations for the Gu-Xue results. Our evidence of endogenous entry and exit of independent analysts provides a more compelling explanation for the reported results.

We examine the contemporaneous relation between earnings forecast accuracy and recommendation profitability to assess the effectiveness with which analysts translate forecasts into profitable recommendations. We find that, after controlling for expertise, more accurate analysts make more profitable recommendations, albeit only for firms with value-relevant earnings. Next, we show that conflicts of interest from investment banking activities affect the relation between accuracy and profitability. In the case of buy recommendations, more accurate forecasts are associated with more profitable recommendations only for the nonconflicted analysts. For hold recommendations, higher levels of accuracy are associated with higher levels of profitability for conflicted analysts, provided these recommendations are treated as sells. Finally, we find that regulatory reforms aimed at mitigating analyst conflicts of interest appear to have improved the relation between accuracy and profitability. Specifically,the integrity of buy and hold recommendations has improved and the change is more pronounced for analysts expected to be most conflicted.

We examine horizon incentives, features of compensation contracts that influence the decision horizon of managers, and shed light on the role of investor horizon on the design of such incentives. Using new measures of horizon incentives that consider the vesting of equity payments, we focus on a setting where some controlling shareholders have the ability and motivation to influence contract design. Specifically, using a sample of IPO firms we contrast horizon incentives provided to CEOs in firms held by venture capitalists (VCs) with horizon incentives provided to CEOs in non VC-backed firms. VCs have significant ownership and control of the firm and typically have short-horizons subsequent to the IPO. Consistent with investor horizon influencing horizon incentives, we find that VC-backed firms provide compensation contracts with short-horizon incentives that correspond with the anticipated exit of the VC. However, we find that market monitoring through the presence of institutional investors mitigates such short-horizon incentives. Our results are robust to endogenously determined VC financing. We also find that long-run abnormal stock returns are lower for firms in which managers have short-horizon incentives, consistent with these managers sacrificing long-run value to protect prices in the short-run.

Using a unique data set that covers the entire career path of film directors (managers) and contains project-specific measures of performance, we examine intertemporal patterns in managerial performance and turnover, and test the implications of job matching theories. We show that turnover is initially high but declines in the number of films (projects) completed. Further, we show that a performance metric constructed from the entire career history is the appropriate measure of re-hiring decisions, superior to a measure based on only the most recent performance. We estimate the marginal contribution of directors to the economic success of their films, and we find that this ability measure is increasing in the number of films made. Similarly, the budget or scale of the project is increasing in directors' experience. Overall, our evidence supports job matching based on continuously updated ability measures. Our findings also extend a larger literature on managerial turnover.

We examine the impact of insider selling incentives on strategic voluntary disclosure behavior by firms. In order to identify the ex ante selling incentives, we use a sample of IPO firms and examine management forecasts of these firms from the date of going public through the four quarters following the lockup expiration date. Lockup expirations represent the first time that insider shareholders can sell their stock since the IPO and are characterized by a significant increase in trading volume. We contrast the voluntary disclosure behavior of firms during the lockup period, when they are prohibited from selling, with the period post lockup expiration when selling incentives are high. We provide evidence on the propensity to issue forecasts, the bias in these forecasts, and the market reaction to the forecasts. We find that firms delay bad news disclosures until the earnings announcement in the lockup expiration quarter. Firms also bias their forecasts more optimistically when trading incentives are present. We conjecture that the low litigation risk that persists after lockup expiration enables these strategic forecasts. The market does not appear to fully comprehend these incentives.

This paper studies the role of information spillovers across securities of a firm on the overall financing costs and security choice. I model the capital structure choice of firms in a dynamic setting and study the intertemporal patterns in security issuance. The model examines the interaction among information production technologies of different securities and the impact of information spillovers from public securities on the capital structure and long run financing costs of a firm. In the model, I show that firms use bank borrowing initially to minimize the lemons cost. Subsequently, when they meet the feasibility conditions for sustaining a market for their securities, they issue public equity (IPO) and then use either bank borrowing or bonds for subsequent financing rounds. This sequence of securities is optimally chosen to maximize the gains from information spillovers from public equity. Firms trade off the initial lemons cost of issuing information sensitive public equity against the gains from having more informative stock prices arising from endogenous information production in financial markets. The information spillover gains occur through a reduction in (i) bank monitoring costs and (ii) adverse selection costs of future financing. This effect has implications for the sequencing of securities over the life of the firm, and in particular the decision to go public.

This paper provides evidence that financing costs of firms are affected by information spillovers from stock markets. Specifically I show that the firms' bank borrowing costs are decreasing in measures of information production in stock markets. Extending the idea of information externalities of stock prices of Grossman and Stiglitz (1980), this paper tests the hypothesis that information reflected in stock prices should reduce the cost of bank loans for publicly traded firms since the bank can monitor the firm more efficiently by supplementing its own information with publicly available information such as stock prices. The empirical analysis is conducted in two stages: (i)assessing the impact of having publicly traded stock on a firm's borrowing costs, and (ii) cross-sectionally relating the degree of information production in stock markets to the borrowing costs. The empirical tests use data from two types of firms: private firms that go public (IPO sample) and public firms that go private (LBO/MBO firms). After controlling for firm risk, loan characteristics and sample selection issues, I find that the cost of bank borrowing is significantly lower for firms with publicly traded equity relative to private firms. The borrowing costs are also decreasing in proxies for the informativeness of the stock price.

We study the role of conservatism in reported net asset values of borrowers (defined as balance sheet conservatism) on private debt contracting. We hypothesize that conservative reporting of asset values provide lenders greater confidence in the collateral value of the firm’s assets and reduces the risk in the loan (Asset Value Hypothesis). Second, we hypothesize that reporting of conservative asset values constrains the borrower’s ability to reflect adverse economic events in net asset values in future. Therefore debt contracting efficiency is high only when the balance sheet conservatism is not high (Constraint Hypothesis). Using a sample of bank loans we study interest spreads, covenant intensity, covenant slack and reliance on financial covenants and find results consistent with our hypotheses. Our study sheds light on the effects of reporting conservative asset values on debt contracting.