U.S. GAAP currently mandates that convertible debt be reported as a liability in its entirety, despite the hybrid nature of convertibles. I examine the degree to which financial reporting for convertible debt is consistent with the views of market participants, and effects debt contracting outcomes. In the first essay I use market measures to determine whether three different approaches to convertible debt accounting correspond with views of shareholders and creditors: 1) liability measured at fair value FV), 2) the debt component measured as comparable non-convertible debt and the incremental conversion option value as equity FC), and 3) debt and equity components measured using probability-weighted discounted debt and equity settlement values PB). My tests relating leverage to credit risk suggest that creditors view convertible debt consistent with the FC method. In contrast, my tests linking leverage to systematic equity risk suggest the PB method corresponds best with shareholder perceptions. My results suggest that neither creditors nor shareholders view convertible debt as a homogeneous liability. Instead, investors recognize the debt and equity components of convertible debt differently according to their different purposes for distinguishing liabilities and equity. The evidence suggests supplemental disclosures can improve convertible debt accounting by helping investors more accurately and efficiently estimate the debt and equity components of convertible debt. Current reporting requirements for convertible debt assign the value of the conversion option to debt, and as a result distort both the firms cost of debt and measures of debt and equity. In the second essay, I test whether these distortions affect two aspects of debt contracting: pricing and covenant selection. I analyze a large sample of private debt contracts and find that after controlling for firm, issue, and macroeconomic risk factors, interest rates for borrowers with outstanding convertible debt are lower than those for borrowers with no convertible debt. The result is stronger for high credit risk firms, and firms that rely more heavily on convertible debt financing. Also, the results hold after controlling for the higher growth options, lower cash interest payments, and lower relative seniority generally associated with convertible debt issuance. These findings are consistent with creditors taking into account the equity characteristics of convertible debt when determining loan pricing. Lastly, I analyze the effects of post-loan-issuance increases in covenant slack caused by conversion, and find that loans to firms with convertible debt at loan issuance have more financial covenants, specifically those covenants that rely on debt and equity measures. Overall, I find that lenders do not rely solely on financial reports, but rather incorporate additional information when measuring firm credit risk, and designing loan contracts for borrowers with convertible debt.

This study explores how accounting information available to lenders at the contracting date shapes debt contracts by facilitating lenders’ assessment of loss given default (LGD). LGD, defined as the percentage loss experienced per $1 of debt if default occurs, is closely related to the notion of liquidation value which is central to debt contracting theories. LGD, together with probability of default, determines expected credit loss and as such is a critical component of debt contract design. While a large literature examines probability of default, much less is known about the impact of expected LGD on contract design and the information set relevant to lenders in assessing LGD at debt origination. Using a sample of defaulted bonds, I find that a select set of accounting measures available at contract initiation, which is 47 months on average before the default event in my sample, possess significant power for predicting actual creditor losses at the subsequent default date. I then exploit this prediction model to construct an accounting-based measure of expected LGD for a large sample of bond issuances. I find that a one standard deviation increase in this measure is associated with a 58 basis point increase in the issuance date interest rate spread, incremental to probability of default. The positive relation between expected LGD and spread is higher when probability of default and managerial entrenchment are higher. Expected LGD is also associated with an increased probability of the debt being secured, having shorter debt maturity, and having a smaller debt size. These relations also hold for a sample of private loan issuances after controlling for financial covenant strictness, where I also find that higher expected LGD is associated with stricter financial covenants. Moreover, I find evidence that accounting systems that provide more precise information about equity value also provide more precise information about LGD, where the opposite holds for more conservative accounting.

The majority of family-owned restaurants go out of business within the first 4 years of operations. This is financially disruptive to families and communities. The purpose of this explanatory study was to examine the effect of cash management on the liquidity and longevity of family-owned restaurants. This quantitative research study was based on literature from entrepreneurship, the family firm, cash management, and financial reporting. A self-administered questionnaire was used to collect data on cash management practices and financial performances from 102 family-owned restaurants in a Midwestern U.S. suburb. Based on the principles of cash management practices among publicly traded companies which include monitoring the cash cycle of a business, preparing a cash budget with the basic financial statements, and applying standard debt management and longevity tools, data were gathered to determine if these principles applied to family-owned non-franchised restaurants. The data were analyzed with the use of the t-test to determine if there is a relationship between cash management and liquidity and cash management and longevity of business operations. The results of this study support the hypotheses that a relationship exists between the independent variable, cash management, operationalized as good cash management/poor cash management, and each of the dependent variables, liquidity and longevity (p&lt；.001). This study contributes to positive social change by showing that restauranteurs who incorporate proper cash management practices can significantly improve the liquidity and longevity of their businesses； thereby bringing greater economic stability to families in the communities in which they are located.

The literature on International Diversification suggests that investors and analysts value foreign earnings differently than domestic earnings. Prior studies also show an overall “valuation discount” for firms with foreign operations. To my knowledge, no study has empirically tested and found there to be differences in earnings quality for these firms. This study investigates differences in the quality of earnings for U.S. firms with foreign operations using a direct measure discretionary accruals) and an indirect measure investor perception of earnings). I also consider the impact of audit quality on each measure of earnings quality. In the first part of my dissertation I find firms with foreign operations report lower discretionary accruals than firms with only domestic operations. This indicates that auditors, similar to investors and analysts, report more conservatively for firms with foreign operations. My results show that audit quality further reduces the absolute value of reported accruals, and I find a higher level of reported “income decreasing” accruals for these firms. In the second section of my dissertation I consider the impact of audit quality on investor perception of earnings. Similar to earlier papers I find that foreign earnings changes are more highly associated with changes in firm value than domestic earnings changes, and this larger earnings response is attributed to negative changes in foreign earnings. I also find that audit quality improves investor perception of foreign earnings for firms with foreign operations. While there are ample studies demonstrating that firms with foreign operations are valued differently than firms with purely domestic operations, my study is the first to provide empirical evidence about how audit quality impacts financial reporting, the quality of earnings, and investor perception of earnings for firms with foreign operations.

I examine the association between CEOs’ after-tax incentives and their firms’ levels of tax avoidance. Economic theory holds that firms should compensate CEOs on an after-tax basis when the expected tax savings generated from incentive alignment outweigh the incremental compensation demanded by CEOs for bearing additional tax-related compensation risk. Using publicly available data, I estimate CEOs’ after-tax incentives and find a negative relation between the use of after-tax incentives and effective tax rates. While the results suggest that greater use of after-tax measures in CEO compensation leads to higher tax savings, it is possible that these savings will lead to lower pre-tax returns, or implicit taxes. Therefore, I also examine the association between the use of after-tax incentives and implicit taxes and find a positive association between the two. Finally, I find a significant positive relation between after-tax incentives and total CEO compensation, suggesting that CEOs who are compensated after-tax demand a premium for the additional risk they bear.

Prior accounting research i.e., Dechow, et al. 1994； Duru et al. 2002； Adut et al. 2003 and Cheng 2004) demonstrates that compensation committees CC) commonly shield executive CEO) cash compensation Salary and Bonus) from the deleterious effects of value enhancing expenditures. In this dissertation, I extend the research by examining if compensation committees use bonus shielding to calibrate R&D investment. To test the hypotheses/research questions developed in this dissertation, I utilize a sample of firms from Execucomp for the time period 1992-2008, in both cross-sectional and temporal tests. Sensitivity tests are conducted using hand collected data from Forbes for the time period 1972-2008. The results of this dissertation are summarized as follows. With respect to R&D productivity I find that firms with negative mean abnormal R&D i.e. firms that underspend in R&D) have higher R&D productivity than firms with positive mean abnormal R&D i.e. firms which overspend in R&D). Further, in temporal tests I find that firms increase decrease) actual R&D spending in response to increases decreases) in target R&D. Furthermore, I find that shielding increases actual R&D sensitivity to target R&D compared to non-shielding firms. Additionally, I find that corporate governance mechanisms do not impact R&D investment in either cross sectional tests or temporal tests. Finally, sensitivity analysis provides more robust results with respect to both 1) R&D productivity of mean negative abnormal R&D firms over mean positive abnormal R&D firms, and 2) temporal tests of target R&D influences on actual R&D.

This dissertation is dedicated to identify the effect of (the first paper) and the demand for certain earnings characteristics (the second and third paper). My first paper examines the effect of earnings quality on information flow and equity prices in the Chinese domestic A- and foreign B-share markets. I find that both the ability of A-share returns to predict B-share returns and the B-share discount are negatively correlated with various measures of earnings quality, suggesting that earnings quality can reduce information asymmetry between domestic and foreign investors in the Chinese stock market. Given that information asymmetry between domestic and foreign investors can deter foreign investment, my results suggest providing high quality accounting information can facilitate foreign investment. The second (coauthored with Richard Frankel, Bong Hwan Kim, and Xiumin Martin) and third paper (co-authored with Xiumin Martin) examine how debt holders affect borrowing firms’ earnings characteristics. I find that after the initiation of loan contracts requiring the provision of aging schedules, borrowing firms’ bad debt expense recognition increases significantly. Debt holders also demand more timely recognition of losses than gains when borrowing firms’ CEO compensation induce high preference for risk. Both sets of results are consistent with the notion that debt holders prefer conservative accounting policy. The combined results indicate that accounting information is useful in reducing information asymmetry among equity holders and as well as in mitigating agency costs between equity holders and debt holders.

This study investigates whether or not the incidence of analysts’ cash flow forecasts mitigates the accrual anomaly. I employ an accrual-based trading strategy hedge return test and a regression-based test to compare the accrual anomaly for a group of firms whose analysts provide both cash flow forecasts and earnings forecasts, and for a group of firms whose analysts provide only earnings forecasts. The results show that the accrual-based trading strategy yields no positive hedge returns for firms with cash flow forecasts, while it results in a hedge return of eight percent for firms without cash flow forecasts. The results suggest that analysts’ cash flow forecasts can redirect investors’ attention to the accrual components of earnings and attenuate the accrual anomaly documented in the prior literature.

There are four primary objectives of this study. First, it examines the association between the disclosure of the Internal Control Deficiencies ICDs), as a proxy for the internal control quality, and information asymmetry IA) in the secondary loan market. Second, it identifies which types of ICDs exacerbate conditions of information asymmetry in the secondary loan market. Third, it investigates whether firms that remediate or take corrective actions to address ICDs lead to a reduction in information asymmetry in the market. Finally, it examines the effect of the loan specific characteristics such as debt covenants, credit rating and number of lenders syndication) in the secondary loan market on the association between ICDs and IA. Results suggest that firms that disclose ICDs have significant positive association with IA and that ICDs reported under section 302 have significant positive association with IA. Although results on the association between the severity rank of ICDs by using Internal Control Material Weaknesses ICMWs) as a proxy and IA are not supported, the use of Company Level CL) internal control as a proxy for the severity rank of ICDs shows a significant positive association with IA. Overall, firms that remediate their ICDs have significant negative association with IA. Overall, there is a statistical negative association between the interaction term of ICDs and number of lenders syndication) and IA. Same negative significant association is documented between the interaction term of ICDs and credit rating, and IA and the interaction term of ICDs and debt covenants and IA. The latter result suggests that the secondary loan market unique characteristics mitigate the negative consequences of the disclosure of ICDs and reduce the information asymmetry between lender and multiple arrangers. My results are consistent with prior studies Bryan and Lilien, 2005； Ge and McVay, 2005； Doyle, Ge and McVay 2007 a,b； Ashbaugh-Skaife, Collins, and Kinney, 2007, Ashbaugh-Skaife, Collins, Kinney, and LaFond, 2008), which suggest that firms with reported ICDs are generally small, poor performing, financially weaker, and characterized by higher market risk than firms with effective internal control system.

Two influential papers in the tax avoidance literature (Desai and Dharmapala 2006 and Desai et al. 2007) argue that tax avoidance can be used to facilitate managerial rent extraction from shareholders. The most direct large sample empirical evidence in support of this theory comes from Russia, which has a much different regulatory and corporate governance environment than the United States, but subsequent studies relying on this theory focus on US firms. I test for large sample evidence that tax avoidance is associated with economically significant managerial rent extraction from shareholders in the US. I am unable to provide evidence that tax avoidance is related to managerial rent extraction on average. I conclude that researchers should exercise care when making predictions that assume a relation between rent extraction and tax avoidance by carefully considering whether this theory is appropriate for the firms in their sample.