Accounting Faculty Research

GenAI brings us closer to automating investment expertise

Jennifer Anzaldi — Thu, 22 Aug 2024 18:39:34 +0000

GenAI brings us closer to automating investment expertise Jennifer Anzaldi Thu, 08/22/2024 - 14:39

In This Story

Yi Cao

Long Chen

Large language models (LLMs) such as ChatGPT and Google Gemini excel at being trained on large data-sets to generate informative responses to prompts. Yi Cao, an assistant professor of accounting at the Donald G. Costello College of Business at ��AV, and Long Chen, associate professor and area chair of accounting at Costello, are actively exploring how individual investors can use LLMs to glean market insights from the dizzying array of available data about companies.

Long Chen and Yi Cao

Their new working paper, co-authored with Jennifer Wu Tucker of the University of Florida and Chi Wan of University of Massachusetts Boston, examines AI’s ability to identify “peer firms,” or product market competitors in an industry.

Cao explains the significance of selecting peers by relating this process to the real-estate market. “The capital market is similar to the real-estate market in that a firm’s value is partially determined by the value of its peers. In the real-estate market, we price a home based on the value of comparable properties in the neighborhood, or the so-called 'comps.' In our paper, we aim to leverage the power of LLMs to identify comps for evaluating firm value.”

This task is at least as difficult as it is essential. It takes much time, skill and effort to gather, aggregate and manage data to select peers. However, the researchers reasoned that LLMs could do a lot of the heavy lifting of data aggregation and analysis for the individual investors, and produce a list of peers comparable in validity to that identified by human experts.

“The advantage is in the capability to utilize all the information potentially out there so that it is at least performing as well as other traditional methods that can help us investors and researchers,” says Cao.

For the study, Chen and Cao employed Bard from Google, now known as “Gemini,” as their LLM of choice because “Bard has a greater ability to utilize its pre-training data, which is arguably larger than ChatGPT’s and with more parameters,” says Cao.

After defining “product market competition” and forming a prompt for Bard, the researchers instructed Bard to limit its knowledge pool to a specific year within the period 1981-2023, in order to avoid “look-ahead bias,” i.e., future information scrambling the results.

“We need to understand that LLMs are actually a very powerful, new tool, unmatched in their efficiency, ability to process vast amounts of information at a low cost, and accessibility to the general public.”

They limited focal firms to large, publicly listed companies as there is less data out there for smaller or private firms. In all, the data-set comprised over 300,000 focal firm-years.

On average, the LLM could generate about seven peer firms for a focal firm, a number that is similar to the SEC recommendations on how firms should disclose their segments.

The researchers then compared the LLM’s performance to the lists generated by three human experts for a set of 40 leading computer software companies. The average overlap was a little over 40 percent, greater than expected.

They also compared the AI-identified peer lists to two alternative systems for identifying peers: the federal government’s Standard Industrial Classification (SIC) codes and Text-based Network Industry Classification (TNIC), which compares firms based on linguistic similarities in their 10-K filings. The LLM’s output overlapped significantly with TNIC’s. Plus, the peers identified by the LLM were generally a better fit than those from SIC and TNIC, as their monthly stock returns hewed closer to the focal firm.

But TNIC outperformed the LLM in identifying peers for mid-sized firms within the sample, indicating that it is not a clear-cut case of universal LLM superiority.

“It’s especially beneficial for individual investors—as all the cost concerns that we’re talking about are especially relevant for them,” Chen adds.

Regarding the future of LLM, Chen states, “There are always costs and benefits associated with using generative AI. It is uncertain whether current systems will soon be obsolete.” When asked about the SEC adopting an AI tool for investors, Chen emphasizes that users need to understand the pros and cons of using AI to make their informed judgments “because AI cannot be held responsible for the information it provides or for how it is utilized.”

Chen concludes, “We need to embrace this new technology, but we must recognize that it is not yet in a perfect state. Competition to improve the technology is fierce. Our findings might just represent the lower bound of the effectiveness of the technology.”

Topics

Artificial Intelligence

How this summer’s heat waves may impact the economy

Greg Johnson — Tue, 06 Aug 2024 13:39:44 +0000

How this summer’s heat waves may impact the economy Greg Johnson Tue, 08/06/2024 - 09:39

This sweltering summer has brought record-breaking high temperatures to 63 countries, all but cementing 2024’s status as the world’s hottest year on record (even though we’re barely past the halfway point). Such extreme weather trends are bound to have serious implications for the environment, public health, and the economy.

Joseph (Han) Stice

Why, then, aren’t economic indicators flashing bright red? Joseph (Han) Stice, assistant professor of accounting at the Donald G. Costello College of Business at ��AV, has run the numbers on business and climate change. His recent working paper, co-authored by Marcus Kirk of University of Florida and Derrald Stice of University of Hong Kong, paints a picture of profound climate-related disruption underneath the placid-seeming surface of the economy.

For the years 1990 to 2020, the researchers compared quarterly sales performance from a large sample of U.S. firms to the temperature data at their base of operations. In this way, they constructed a measure of weather sensitivity, which they termed “weather beta,” for each company in the initial sample. Specifically, they were looking at whether sales either benefited or suffered when local temperatures were higher or lower than the “ideal” of 65 degrees Fahrenheit.

“What they—they being the people who examine temperature—say is that if it’s above 65, you turn on your air conditioning. If it’s below 65, you turn on your heater,” says Stice.

After restricting the sample to only those firms with discernible weather beta, they ended up with a data-set comprising 66,795 firm-quarters.

Across the sample as a whole, the results were a misleading nonstarter. Weather fluctuations did not seem to have an impact on economy-wide sales, one way or the other.

This was no surprise to Stice. Citing past research, he points out that “the overall economic effect is that colder weather is, on average, better. But that’s not true in every single instance. Some industries (i.e., agriculture) benefit from hot weather. And it also depends on what region you’re in, what time of year it is, etc.”

“We need to have a national discussion and a global discussion,” Stice says. “But the people who really matter are the local leaders, as far as climate is concerned. The people you elect on the local level are going to have a much greater impact on how you respond and how your companies can adjust, than whether or not your candidate is in the White House.”

To gauge actual impact, the researchers split the sample by size and geographic concentration, presuming that larger firms with a wider geographic footprint would be less affected by temperature changes at home base. These differences between firms proved to be critical. For the smallest, most localized firms, a swing from the 75th to the 25th percentile in terms of nonideal temperature meant 8.8-15.9% lower sales. The biggest and most sprawling firms saw sales declines of just 4.3-5.6% from an equivalent shift.

Stice clarifies that “we are talking about very small deviations, like percentages of degrees on average per day over an entire quarter. If it were one degree hotter than 65 degrees every day, that would come up in our measure as a 90. The biggest number we have is like a 25 or a 30.”

Also, sales impact tells only part of the story. The sheer size of the data-set allowed Stice and his co-authors to predict quarterly sales performance for individual firms, based on the weather and firm characteristics. On average, actual sales declines were about half as severe as predicted. The researchers speculate that firms were able to soften the blow of immoderate temperatures by adjusting their business practices. The time and resources spent on these adaptations are part of the hidden economic costs of climate volatility.

If firm managers can anticipate how the weather can impact business outcomes, you would expect financial analysts to be at least as attentive to climate effects. However, the researchers found that sales forecasts made shortly before earnings announcements were thrown off by abnormal temperatures in the previous quarter, with 7.4% inaccuracy in the mean. Similarly, the researchers found that weather impact was positively correlated with announcement-period stock market returns. Apparently, even professional investors are being caught off guard by the subtle but costly interactions between climate and economic activity.

For more accurate appraisals, Stice suggests we should turn to the local level. He notes that his measures of firm-specific weather sensitivity happen to line up fairly neatly with municipal self-assessments made by local governments as part of the Carbon Disclosure Project.

Empower your future with Costello College of Business

In This Story

Han Stice

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In Silicon Valley, human capital trumps intellectual capital

Marianne Klinker — Mon, 22 Jan 2024 16:23:12 +0000

In Silicon Valley, human capital trumps intellectual capital Marianne Klinker Mon, 01/22/2024 - 11:23

To stay competitive in the war for talent, tech companies must weigh secrecy against specificity when crafting job ads. Are they disclosing too much?

Job postings are a key tool for attracting qualified tech workers. However, companies face a dilemma: on the one hand, they want to provide enough information to attract the right candidates; on the other hand, they want to keep the information about their product development and planning private. Sometimes it is just hard to get both.

Yi Cao

In a recent paper for Contemporary Accounting Research, accounting professor Yi Cao of the Donald G. Costello College of Business at ��AV argues that highly competitive companies are more likely to post specific job requirements in order to find qualified workers even at the cost of potentially leaking proprietary trade secrets. (The paper was co-authored by Shijun Cheng of Shanghai Jiao Tong University, Jenny Wu Tucker of the University of Florida, and Chi Wan of the University of Massachusetts Boston.)

Generally, companies reveal less information during fierce competition to avoid giving their competitors an advantage. However, Cao finds that “when the technological competition is more fierce, companies provide more information into the labor market because they have to do this in order to attract talents, which is the essential driving force of innovation. They're balancing the trade-off between not leaking secrets but not hiring the matching candidates, versus leaking some of the trade secrets while more likely to hire matching employees. So between these two trade-offs, obviously, we find that companies choose to bear the risk of leaking information in order to acquire talents.”

The benefits of quickly attracting desired tech talent outweigh the potential costs of revealing proprietary information.

To examine the relationship between technological competition and skill specificity in job postings for tech positions, the researchers used a novel job posting database provided by Burning Glass Technologies (BGT). They calculated the skill-specificity scores of the job ads based on the level of information disclosed in the skill-requirements of the job postings and the taxonomy of skills, and then aggregated it annually by firm. Cao’s paper is the first to propose a taxonomy theory-based measure of term specificity in the business field. This provides companies with a handy tool for measuring the specificity of textual documents and precisely determining how much information to disclose.

Cao uses the example of a company looking for workers with AI experience to demonstrate how the measure works. The company could post a job listing that simply says, "We are looking for someone to build machine learning tools." This is a relatively vague job posting that would not provide job seekers with detailed information about the specific skills that the company is looking for. The company could also reword the post more specifically, e.g. "We are looking for someone to use Python and decision tree algorithms for credit card risk." Alternatively, they could be even more specific with language like, "We are looking for someone who have experience with random forest algorithms to specifically apply a portfolio level of prediction of credit card defaults." This description provides job seekers with detailed information about the specific tasks and skills that the company is looking for, while at the same time revealing information about existing technology.

Cao found that on average, firms disclose an additional 27 specific skills in their job ads when facing intense technological competition. The results reveal that the benefits of quickly attracting desired tech talent outweigh the potential costs of revealing proprietary information.

The findings did not apply to job advertisements for lower-level non-tech positions, such as food preparation and cleaning staff. However, they were observable for senior non-tech positions, e.g. directors of marketing or finance. These nuances suggest that both tech and managerial talent were valuable enough to motivate a higher degree of disclosure from employers.

Additionally, the effect on disclosure was much stronger for incremental innovators—firms whose patents tended to build on past knowledge, rather than strike out in new technological directions. The researchers speculate that breakthrough innovators would have too much to lose if they were to signal their plans through job postings.

While more detailed job postings can be helpful for finding qualified workers, they also could reveal proprietary information about the company's products and strategies. Cao emphasizes, “[Companies are] basically telling the world what [they’re] trying to create. With higher level of detail you’re trying to describe, you're disclosing more information to potentially everyone. And that information is beneficial in terms of labor demand because it attracts the right employee. But it's a concern in terms of competition because you basically show cards to your opponents.”

As an accounting scholar, Cao is intrigued by the possibilities inherent in the discovery that labor-market pressures can force employers to divulge potentially compromising information. “In financial reporting, we don’t capitalize human capital; we consider it an expense,” he says. “But that’s not necessarily the case when the labor market is tight and when the labor is essential in productivity. Our paper shows how the labor market, product market, and capital market are not segregated, but connected.”

Topics

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Do former regulators improve the quality of audits?

Marianne Klinker — Mon, 08 Jan 2024 13:44:01 +0000

Do former regulators improve the quality of audits? Marianne Klinker Mon, 01/08/2024 - 08:44

A ��AV professor unpacks the complex, nuanced impact of the “revolving door” between industry and regulators in the accounting world.

In their auditing capacity, accounting firms, such as the “Big Four”—Deloitte, EY, KPMG and PWC—function as watchdogs for publicly traded companies. They’re tasked with ensuring financial disclosures are accurate and above board. But who watches the watchdogs?

The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board (PCAOB), whose mandate is to monitor and inspect firms conducting audits of public companies and report its findings to the public. Yet, in a pattern familiar from other government-industry configurations, the border between regulator and regulated is often less a brick wall than a revolving door. Large accounting firms, including the Big Four, have been hiring more and more PCAOB employees, especially since 2010, when the board expanded its remit to include internal control audits.

Steve Maex

“Firms began moving in the direction of hiring significant numbers of PCAOB employees after a string of weak inspection reports in the early 2010s, ostensibly to get a sense of what they could do to better comply with auditing standards,” says Steve Maex, an assistant professor of accounting in the Donald G. Costello College of Business at ��AV.

Maex’s recently published paper in Review of Accounting Studies, co-authored with Jagan Krishnan and Jayanthi Krishnan from Temple University, evaluates the effects of such hiring. The researchers tracked the audit quality of large accounting firms over the period in which this hiring emerged and explored the relationship between the hiring and a variety of audit outcomes.

“There’s no single proxy that can be used to capture the many dimensions of audit quality,” Maex points out. So, the team used various indicators, including clients’ financial restatements, discretionary accruals (disparities between reported income and cash flow), the accuracy of internal control opinions issued by the auditor, and audit fees.

The researchers found that clients of firms that hired ex-PCAOB employees issued fewer restatements in general, which suggests fewer egregious errors on the part of the auditor. Further, for clients that would be more pre-disposed to misstating their financials, this quality-enhancing effect was also identified in terms of lower discretionary accruals, higher accuracy of internal control audit opinions, and higher fees that clients were willing to pay. In other words, the former PCAOB personnel seemed to help their firms focus on the highest risk issues and clients in their portfolios.

The researchers found that clients of firms that hired ex-PCAOB employees issued fewer restatements in general, which suggests fewer egregious errors on the part of the auditor.

Maex and his coauthors surmise that these professionals, during their experience with PCAOB, acquired “regulatory audit quality expertise” that would not be as easily accessible to those without such experience. “The practitioners we interviewed said that [at the PCAOB] you get exposed to a variety of different audit practices and processes and develop an understanding of what works and does not work well. This contrasts with many audit firm partners who start and finish their career in the same accounting firm and therefore may only be exposed to their own firm’s methodology and a handful of clients that they support,” he explains.

This broad-based, generalizable skillset involves a greater aptitude for gauging and addressing risk. “To the extent that they can help the firm identify high-risk clients, that right off the bat can help them allocate resources intelligently. These individuals are going to be really good at finding strategies, solutions, and methodologies to handle the firm’s high-risk clients more effectively.”

For Maex, these findings form part of an active stream of accounting research studying the role of regulatory oversight on auditing firms. Furthermore, the work is relevant in light of recent events in which ex-PCAOB auditors at KPMG tipped off the firm about the board’s inspection plans. The ensuing scandal sparked debate about possible misconduct enabled by the revolving door.

Maex’s research highlights that the movement of former regulators to accounting firms offers potential upsides for audit quality notwithstanding these ethical considerations. Rather than seeking to inhibit transfers on ethical grounds, regulators could explore different types of talent exchanges with firmer guardrails against misconduct. The SEC’s Professional Accounting Fellows program, which admits experienced accounting professionals for a limited period of time and under fixed parameters, could serve as a model.

“The goal of the regulators, we like to think, is the same as the audit firms: to ensure audit quality is as strong as it could be,” Maex says. “If there were no conversations about how to achieve that between the two, that could be problematic. The challenge is balancing that against the negative outcomes, which receive significant publicity when they occur.”

Topics

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Accounting prof Steve Maex wins coveted dissertation award

Marianne Klinker — Wed, 23 Aug 2023 13:53:23 +0000

Accounting prof Steve Maex wins coveted dissertation award Marianne Klinker Wed, 08/23/2023 - 09:53

Steve Maex, an assistant professor of accounting at ��AV School of Business, recently received the American Accounting Association (AAA)’s Outstanding International Accounting Dissertation Award.

The International Accounting Section of the AAA seeks to be “the sought-after partner for thought leadership on international accounting related issues” and “serve as a point of entry into AAA for international faculty and doctoral students,” according to the group’s website.

The Outstanding International Accounting Dissertation Award for 2023 was open to doctoral dissertations on topics related to international accounting that were successfully defended during the 2022 calendar year.

The winning dissertation, “Modern Privacy Regulation, Internal Information Quality, and Operational Efficiency: Evidence from the General Data Protection Regulation,” examines the business impact of the European Union’s sweeping 2016 laws on data privacy.

Steve Maex

Maex’s choice of topic was influenced by his professional experience as an IT auditor and data analytics specialist at KPMG LLP, prior to pursuing a PhD in accounting from Temple University.

As he tells it, “I was thinking back to experiences consulting with clients faced with prospects of needing to comply not only with this EU-focused regulation, but by similar privacy regulations under consideration by some U.S. states–California in particular.”

Unsurprisingly, corporate leaders mainly viewed the prospect of impending legislation in terms of its challenges and costs. For example, in its 2018 10-K filing with the SEC, Alphabet cited the “substantial costs” of GDPR compliance and opined that “it is possible that despite our efforts, governmental authorities or third parties will assert that our business practices fail to comply.”

To Maex, however, here was an impetus for firms to finally get the data side of their business under control. “At the time, we were advising clients to use this opportunity to implement a governance program over their information that would allow for compliance with privacy regulations while also allowing for other strategic benefits,” he says. This course of action would allow firms to “fully grasp what data and information they held and take the steps necessary to manage their information risks.”

Maex hypothesized that as companies improved the quality of their internal information as a result of GDPR compliance, they would increase their operational efficiency. In other words, they would be able to make smarter resource allocation decisions.

And that is indeed what Maex found after identifying U.S.-based firms with exposure to GDPR and tracking their internal information quality and operational efficiency using widely accepted proxies from prior literature. “The quality of affected firms’ information appears to have improved bringing with it operational benefits,” Maex summarizes.

GDPR still appears to have had a negative net effect on operational efficiency, likely due to the catch-up costs involved in compliance with such sweeping regulations. But in the long run, Maex anticipates that these costs may be offset by the benefits borne by improved information quality.

Maex suggests that since stricter privacy regulations–for most of the world’s population, anyway–appear to be a fait accompli, the only choice companies have is whether to take a purely box-ticking approach to compliance or to make broader investments that would withstand the evolving regulator landscape.

Regarding the dissertation award, which was presented at the AAA annual meeting in August, Maex has words of fulsome thanks for his PhD advisors, Jagan Krishnan and Jayanthi Krishnan, at Temple University. “The dissertation process can be a lonely endeavor without the support of those that assist and motivate along the way. I was lucky to have two advisors, and a broader dissertation committee, from which I benefited immensely, and without which, I would not have been able to bring the dissertation to fruition,” he says.

“It’s an incredible honor to receive such an award,” Maex further states. “When you consider the other papers and authors that have received this award in the past, it’s humbling to be in their company.”

Topics

Costello College of Business Dean's Teaching and Faculty Awards

In This Story

Steve Maex

How large is the U.S. “green economy”?

Marianne Klinker — Wed, 10 May 2023 14:45:01 +0000

How large is the U.S. “green economy”? Marianne Klinker Wed, 05/10/2023 - 10:45

A ��AV professor is the sole academic working with the U.S. government in an unprecedented effort to measure environmental-economic activity.

One way to gauge a country’s attention to the environment may be measuring how much of its economy is devoted to protecting, rehabilitating, and preserving the natural environment. While the U.S. has made prior attempts at tracking “green jobs” and “green goods and services,” the U.S. government does not currently account for this sector.

Kelly Wentland

Kelly Wentland, an assistant professor of accounting at ��AV School of Business, is helping to fill this data gap. She is the sole academic working with the U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) to develop a pilot account tracking the environmental, goods and services (EGSS) sector of the U.S. economy. (The UN defines ESGG as “compris[ing]…the economic activities that result in products for environmental protection and resource management”.)

Wentland and the BEA team have produced a pilot EGSS account, along with preliminary results that formed the basis of a recent working paper, presented at the March 2023 NBER-CRIW conference.

“What we’re doing is, we’re developing a national account based on the supply side of our economy,” Wentland explains.

Ninety countries have introduced their own environmental-economic accounts based on frameworks from the UN Statistical Commission. The challenge for Wentland and the BEA team was to design their pilot account so that it would be comparable to those of other countries while aligning with established approaches from the U.S. federal government. This involved making a huge number of close comparisons between European and American product and industry classification standards to identify shared data points that mapped to UN guidelines.

After carefully selecting for relevant economic activity during the years 2015 and 2019, the team used the BEA’s supply-use tables–extremely detailed compilations of economic inputs and outputs for more than 5,300 product categories–to build their estimates.

So far, the reaction to Wentland’s work from government-affiliated economists has been markedly positive.

They found that EGSS accounted for $620.6 billion in 2015, and $724.5 billion in 2019. The top four categories were responsible for about 70 percent of the total. These were: waste management (far and away the top category, comprising one-quarter of the entire sector), management of water, wastewater management and protection of biodiversity and landscapes. This roughly matches up with equivalent studies in the EU, which also have waste management as the largest environmental-economic category, with 26-27 percent of the total.

Wentland and her collaborators also divided EGSS activity into private- and public-sector output. In 2015, the government portion of environmental output stood at 28.3 percent, and the private-sector contribution at 71.7 percent. By 2019, the balance had shifted slightly, with 27.2 percent attributed to government spending, and 72.8 percent to commerce.

Wentland stresses that the account is very much a work in progress. “It’s very important to point out that it is not an official BEA national account. It is purely a pilot effort to see how far we can get with the data the U.S. already has.” Part of the purpose of the pilot is to identify gaps in the current data available as future avenues to improve estimates. Environmental research and development (R&D) is one potentially significant area where data were inaccessible.

“A lot of companies are putting out sustainability reports, but when you get down to what percentage of them actually include an annual dollar value attached to their activity, it’s very low,” Wentland says. She notes that the SEC’s proposals for mandated environmental reporting–which may be scaled down amid strong corporate pushback–could help fill this void. “The alternative is likely adding questions to other lengthy surveys the BEA collects from these companies.”

So far, the reaction to Wentland’s work from government-affiliated economists has been markedly positive. “The main critique had to do with the international guidelines for product classifications themselves, rather than our methodology,” Wentland reports.

As of this writing, further development of the EGSS pilot account hinges upon the progress of President Biden’s budget for 2024. “It’s formally listed in the budget that they have an increase allocated to this as part of the increase in the BEA’s budget. Obviously, we’ll have to see how things pan out in terms of whether the budget moves forward.”

As Wentland sees it, calculating the dollars and cents that go into the “green economy” would enable granular, impact-focused policy debate on climate issues. “You could think about research or policy that wants to say, ‘When we spend more on EGSS, do we see emissions change or which types of investment have more impact than others?’ You have to be able to measure both the effort and the outcome, in order to be able to say something about its effectiveness.”

Topics

Institute for a Sustainable Earth (ISE)

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Risky investment choices, not COVID, put U.S. hospitals in the red

Marianne Klinker — Thu, 02 Mar 2023 15:49:57 +0000

Risky investment choices, not COVID, put U.S. hospitals in the red Marianne Klinker Thu, 03/02/2023 - 10:49

Financially troubled U.S. hospitals are petitioning for more support from the federal government, but handouts won’t fix the underlying problem.

As the United States takes steps to move past the pandemic, its health care system is in a fragile financial state. At the end of 2022, about half of U.S. hospitals were in the red—making it the worst year for the industry since the start of the pandemic. No wonder, then, that hospitals are petitioning Congress for help and protesting the pending cessation of COVID funding from the federal government.

At first glance, the industry’s pleas appear justified. After all, COVID hit hospitals like a tidal wave, filling beds with patients requiring arduous, expensive care. At the same time, hospitals suffered from the same supply chain and workforce issues as virtually every other public-facing facility. And since the vaccine rollout, COVID’s waning lethality has produced an influx of patients who had delayed seeking treatment during the height of the pandemic—and whose health problems may have worsened in the interim.

Seb Demirkan

However, Sebahattin Demirkan, an associate professor of accounting at ��AV, says that the true source of the industry’s financial woes may lie beyond COVID. For Health Affairs Forefront, Demirkan and co-authors Ge Bai of Johns Hopkins University and Christopher M. Whaley of RAND Corporation took a deep dive into the most recent financial reports issued by ten of the U.S.’s largest nonprofit health care systems.

Contrary to the COVID-caused-it narrative, they found that, on average, revenue from patient care actually increased (albeit by less than 1 percent) between 2021 and 2022. Investment revenue, on the other hand, declined by a disastrous 185 percent over the same period. These are heavy but not totally surprising losses, seeing as how 2022 was the worst year for financial markets since the Great Recession. However, they cast doubt on the contention that hospitals’ financial struggles are primarily due to operational challenges brought on by the pandemic.

Without understanding the primary driver of hospitals’ financial strain, policymakers cannot make evidence-based decisions that benefit hospitals and patients in the long run.

For Demirkan, getting the origin story right is critical for policymakers weighing the current situation. As the article states, “Without understanding the primary driver of hospitals’ financial strain, policymakers cannot make evidence-based decisions that benefit hospitals and patients in the long run.” Clearly, if the health care system’s exposure to downside risk is to blame, more federal funding alone wouldn’t resolve the issue. Even if federal bailout money were restored to 2020 levels, hospitals would be in danger of yet further losses via their investment portfolio.

Demarkan’s main concern is for the taxpayers who may be stuck with the bill, through increased taxes and/or rising patient fees and insurance premiums. “While hospitals are critical for patients and communities, resources used to pay for hospital care come from those same patients and communities,” the article states.

He points to a possible contradiction between the non-profit status of these institutions and their investment strategy, which he says resembles that of a hedge fund. Such an approach is likely to reap outsized gains in bull markets—in bear markets (as in 2022), above-average losses. “If they behave like any other for-profit company or financial company, then it is not going to serve the entire nation, the taxpayers or people. All stakeholders will be hurt, basically,” Demirkan says.

As one possible remedy, he suggests regulators could insist that non-profit hospitals limit risk exposure across their portfolio as a precondition for public assistance. “They may say, ‘if you want to invest extra cash, invest in ETFs or mutual funds. FedEx, Amazon etc.—less volatile and less risky financial instruments and stocks.” Still, Demirkan acknowledges that attempts to ratchet up oversight or accountability would run afoul of the influential health care lobby.

At the very least, therefore, he advises the government not to “with blind eyes, give away money to these hospitals, and just look at how they use that money if they are nonprofit hospitals. And basically, use your judgment accordingly.”

Topics

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Mason researcher helps the SEC walk the talk

Marianne Klinker — Tue, 31 Jan 2023 14:37:09 +0000

Mason researcher helps the SEC walk the talk Marianne Klinker Tue, 01/31/2023 - 09:37

Research by Mason Accounting Professor Bret Johnson, a former SEC staff accountant and academic fellow, shows how seemingly mundane intra-agency policies can have unintended effects that benefit Wall Street over Main Street.

The U.S. Securities and Exchange Commission (SEC) has long seen itself as a friend to the retail investor, doing everything it can to ensure that financial markets offer both large and small players roughly equal opportunity to succeed. Most recently, that mandate provided the rationale for a slate of sweeping rule changes that would, among other things, shine a light on the opaque business arrangements between wholesale brokers and trading apps such as Robinhood. It adds up to what some industry insiders are calling the largest-scale SEC intervention in nearly 20 years.

Bret Johnson

To its credit, the SEC is just as committed to promoting fairness and transparency in-house as it is to ambitious industry reforms. The agency even invites accounting academics to research its inner workings via the SEC Academic Fellowship Program. ��AV School of Business accounting professor and former SEC staff accountant Bret Johnson was selected for the year-long program starting in August 2020.

Johnson says, "My role was to be a liaison between the SEC and the academic community…Often, my research uncovers some problem or something they can improve on, some inefficiencies. And I found they are very open to embracing this type of research."

For example, Johnson's recent research paper in Review of Accounting Studies co-authored by Michael Iselin of the University of Minnesota, Jacob Ott of the London School of Economics, and Jacob Raleigh of Monash University, finds that while the SEC's monitoring arm – the Division of Corporation Finance (DCF), where he worked for six years – seems to focus less on firms with a high percentage of retail ownership, the Division of Enforcement (DOE) appears to take a harder line with these firms. In other words, irregularities are less likely to be spotted early and addressed through non-punitive means when the firm in question has a larger proportion of retail investors.

"My role was to be a liaison between the SEC and the academic community…Often, my research uncovers some problem or something they can improve on, some inefficiencies. And I found they are very open to embracing this type of research." - Bret Johnson

The SEC's enforcement-heavy approach may disadvantage retail investors because once the enforcement action becomes common knowledge, the "Main Street" investors who hold disproportionate stock in the target company will lose out when the share price falls. In this way, the SEC does not seem to be acting in accordance with its stated mission to protect mom and pop investors.

Johnson can only guess at what's going on here. He speculates that firms that attract retail investors may share other characteristics that cause the SEC to flag them for enforcement rather than monitoring. For instance, the paper finds that retail ownership was positively associated with firm visibility and performance volatility, and negatively associated with external monitoring and structural complexity. The discrepancy may also have to do with how resources are distributed between the DOE and DCF.

In other cases, the agency's good-faith attempts to increase market transparency on behalf of less savvy investors can backfire. Based on analytics from the publicly available filings database on the SEC website, Johnson's 2020 paper in The Accounting Review, co-authored by Michael S. Drake and Jacob R. Thornock of Brigham Young University, and Darren T. Roulstone of The Ohio State University, concluded that institutional users (e.g. investment banks, hedge funds, asset managers, and financial institutions) were profiting handsomely from their search activities on the online resource, while retail investors saw little to no benefit. Abnormal search volume from Wall Street was associated with future returns for the focal firms of up to 10.5 percent. No such pattern was seen on Main Street.

In addition, how the SEC balances the need for transparency against its relationships with companies can have unintentional knock-on effects. Johnson’s 2022 paper in Management Science, co-authored by Marshall A. Geiger and Abdullah Kumas of the University of Richmond, and Keith L. Jones of the University of Kansas, found that for companies that had just received an SEC comment letter, there was a sizeable uptick in sell-offs among mutual funds and other major players during the short period (initially 45 days, then shortened to 20 days) before the letter went public. The best explanation was that high-ranking executives were sharing non-public information with investors close to the company concerned.

The 20-day privacy window is meant to prevent companies’ confidential information from being accidentally released through an over-hasty process. But it may also create information asymmetry that benefits industry insiders at the expense of retail investors – the very favoritism that the agency intends to combat.

There are no simple answers to the questions posed by Johnson’s research. Even seemingly mundane intra-agency decisions, such as resource allocations and the length of the confidentiality window for comment letters, can have complicated ripple effects. Sometimes, it takes an informed outsider to trace these ripple effects and draw evidence-based conclusions. "I am happy to see that the SEC continues to solicit – and take seriously – academic research into its policies and practices," Johnson says. After all, sweeping industry reforms may make headlines, but fine-tuning how the agency itself functions is a quieter but no less material way of promoting fairness and transparency in financial markets.

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In This Story

Bret Johnson

The de-globalization of financial reporting

Jennifer Anzaldi — Wed, 28 Sep 2022 13:34:04 +0000

The de-globalization of financial reporting Jennifer Anzaldi Wed, 09/28/2022 - 09:34

Jenelle Conaway

Remember when the world was flat? During globalization’s peak era–from the collapse of the Soviet Union to around the time of the 2008 financial crisis, let’s say–there was general agreement that the world was on a path toward economic and political convergence. We were told that in the future there would be fewer serious structural barriers impeding the free flow of money, goods, and people across borders. From the standpoint of financial investments, hopes of global convergence rested largely upon the expectation that global companies were moving toward unified standards for financial reporting.

Then as now, there were two standards-setting bodies with enough international prominence to guide this convergence. One was the Financial Accounting Standards Board in the United States, responsible for codifying the Generally Accepting Accounting Principles (U.S. GAAP), which homegrown firms listed on U.S. stock exchanges are required to use. The other was the International Accounting Standards Board (IASB), whose rules for financial reporting are known as International Financial Reporting Standards (IFRS).

The stated intention of both boards was to steadily increase comparability, until U.S. GAAP and IFRS became sufficiently identical to make the merger official with little disruption to companies. Additionally, it was hoped that the existence of a single set of standards would exert pressure on holdout economies that maintained local reporting regimes. The resulting uniformity would provide the transparency needed to knit together a truly global marketplace.

As Jenelle Conaway, assistant professor of accounting at ��AV School of Business, explains, “Being able to compare companies more easily makes for more efficient investment choices. And that scales from the individual level up to banks choosing who they lend to, and companies choosing who they want to merge with and acquire.”

But in the years since 2008, as globalization’s allure has dimmed, comparability trends have grown more complicated, Conaway’s recent research finds. Her paper in Contemporary Accounting Research tracks financial reporting data for more than 20,000 firms–categorized into subsamples according to the accounting standards used by each firm–across the 36 largest economies. Her observations span two time horizons: 1990-2001 and 2002-2018. Juxtaposing these two periods enabled Conaway to isolate the impact of concerted regulatory action in 2002, a banner year for the global-convergence campaign.

Conaway measured comparability by analyzing how similar economic events were reflected in the various companies’ financial statements. As Conaway points out, comparability should never be taken for granted, even when the companies concerned ostensibly have much in common.

“A lot of people think accounting is black and white, but there is a lot of discretion involved,” she says. “By and large, comparability is going to be greater among companies applying the same accounting rules. But it will likely never be perfectly comparable because of the judgement involved in financial reporting decisions.” By extension, it’s also possible for companies located in different countries–and therefore following separate accounting standards–to be more comparable than expected in some areas.

These ambiguities surrounding comparability show up in Conaway’s findings. Her results reveal that the 2002 regulatory push worked as intended, accelerating convergence of accounting practices over the following 16 years. However, the improvements in comparability were not universal. Comparability plateaued among companies using U.S. GAAP and IFRS, mainly owning to these regulators having stalled in their progress toward the single-standard goal. Simultaneously, countries with their own financial reporting standards–including major economies such as India and China–started to drift in an international direction, without officially signing onto either IFRS or U.S. GAAP.

For Conaway, the reasons boil down to costs and benefits. For the large multinationals that are long-term adherents to IFRS and U.S. GAAP, the ideal of perfect comparability may compromise the company’s ability to present its financials in the most relevant and reliable light. Past their current standard of compliance that satisfies both regulators and investors, these major players seem to have no pressing incentive to further improve comparability.

Local-standard companies outside the U.S. and Europe, however, are still edging toward their cost/benefit sweet spot. Despite the U.S.’s outsized influence, representing as it does over 40 percent of global equity market capitalization, Conaway’s findings show that IFRS serves as a more congenial (if unofficial) role model for them. “Those firms are still technically following their countries’ accounting rules, but they are interpreting them or applying them in a way that makes the resulting financial statements more comparable to those of IFRS firms only,” says Conaway.

IFRS’ international origins help explain its advantage over U.S. GAAP. Conaway says that “the IASB standard-setting process has always taken into consideration the needs of a diverse set of constituents, whereas the FASB is mostly concerned with investors in the U.S.” For countries seeking the advantageous mix of high quality standards and strong network effects, IFRS is a more appealing platform. Similarly, companies using local standards are internationalizing their reporting in line with IFRS to reap these benefits, while stopping short of official adoption.

This study points to IFRS as the de facto global standard–a trajectory Conaway finds noteworthy. “The development of U.S. GAAP dates back to the 1930’s, long before IFRS picked up momentum in the early 2000’s.” Because of the costs involved in switching accounting standards, “Any change is a really slow process, which is why it is remarkable how widespread IFRS has become over the past two decades.”

Conaway suggests that while internationalization is increasing among firms that haven’t yet signed onto either standard, the ebbing of enthusiasm for global comparability among regulators should concern U.S. investors. “Many retail investors are not aware of the intricacies of U.S. GAAP compared to IFRS. If the global market is shifting towards IFRS, and U.S. GAAP and IFRS are not becoming more comparable with each other, then information processing costs will be greater for investors unfamiliar with IFRS.”

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