Two essays on the externalities of corporate financial reporting

Abstract

This thesis consists of two chapters that investigate the externalities of corporate financial reporting from the aspects of local entrepreneurship and bank loans, respectively. Corporate misreporting not only reflects management negligence or even a lack of ethical commitment on the part of the company involved, but also generates significant externalities of misreported information, leading to misjudgements among other economically-connected entities. Specifically, in the first chapter I investigate whether public firms’ accounting overstatements, identified through ex post non-reliance over-restatements and SEC investigations, have any effects on the quantity and quality of entrepreneurship in the same region and industry. Using data from a survey of U.S. labour forces, I find a significant positive association between accounting overstatements and the likelihood of local entrepreneurs starting their businesses in the same state-industry. Following the instrumental-variable approach, I use firm’ geographical proximity to SEC offices as the instrumental variable (IV) and find that the positive association survives the test of causal inference. Consistent with the notion that overstated firm performance inflates perceived entrepreneurial returns via information intermediaries and enhances local entrepreneurs’ access to external financing, the positive association between firm’s overstatements and local entrepreneurship is more pronounced when these overstatements imply higher potential returns for entrepreneurs, the dissemination of overstated accounting information is more extensive, or growth in external financing is greater. In additional analyses, I provide suggestive evidence that local entrepreneurs are misled by public firms’ overstatements. In particular, those ventures established during the periods of overstatements tend to have lower growth potential, leading to the deteriorated growth of local GDP in the subsequent periods. Accordingly, local entrepreneurs significantly slow down their pace to establish new business after the revelation of public firm’s accounting overstatements. Collectively, these findings underscore the negative externalities of overstated firm performance for local entrepreneurship and local regions’ long-term economic developments.

The second chapter of this thesis is based my co-authored work that examines whether private firms’ disclosure affects the loan-pricing for public firms in the same country-industry. Using global syndicated loan data, we find a reduced loan spread for public firms with more disclosures made by private firms in the same country-industry. This finding is consistent with the view of positive spillover effects of private firms’ financial reporting, suggesting that private firms’ disclosure helps banks ex ante evaluate public firms’ credit risk and reduce the information asymmetry between lenders and borrowers. The positive effect is more pronounced when the disclosing private firms have greater economic importance in the industry or have greater economic similarity as the focal public firm. Moreover, consistent with the notion that banks rely more on private firm disclosure when these banks lack the access to the focal public firm’s information, we show that the effect of private firm disclosure on loan spreads is more pronounced for those banks with less prior lending experience in the borrower’s industry, for those banks with lower monitoring intensity, and for those public firms with greater information opacity. Overall, these findings support the view that private firm disclosure generates positive externalities for the loan market by reducing the information asymmetry between the public firms and lending banks.