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Rule 10b5-1

Summer Conf

Speaker Series



Alan Jagolinzer, EKS&H Faculty Fellow and Associate Professor of Accounting

Research and Publications



Mandatory IFRS Adoption and Financial Statement Comparability

(with Francois Brochet and Eddie Riedl)

forthcoming in Contemporary Accounting Research



This study examines the effect of mandatory International Financial Reporting Standards (IFRS) adoption on financial statement comparability. To isolate the effects of changes in comparability, we examine changes to information asymmetry for firms domiciled in the UK. UK domestic standards that preceded IFRS adoption are considered very similar to IFRS (Bae et al. 2008); accordingly, we use the UK as a setting to isolate changes to the information environment relating to IFRS adoption that more likely to reflect changes in comparability versus information quality. If IFRS adoption improves financial statement comparability across firms, we predict this should reduce private information benefits. Empirical results confirm these predictions. Specifically, abnormal returns to two proxies for private information (insider purchases and analyst recommendation upgrades) are reduced following IFRS adoption. Similar results are obtained for subsamples that further isolate the reduction in private information as attributable to increases in comparability: firms having low amounts of reconciling items between UK GAAP and IFRS, and firms having ex ante high quality information environments. Together, the results are consistent with mandatory IFRS adoption leading to enhanced comparability.



Corporate Governance and the Information Content of Insider Trades

(with David Larcker and Dan Taylor)


Journal of Accounting Research, December 2011



Most corporate governance research has focused on the behavior of executive officers, board members, institutional shareholders, and other similar parties. However, little research has focused on the impact of executives whose primary responsibility is to enforce and shape corporate governance inside the firm. This study examines the role of the General Counsel in restricting insider trading by corporate officers during the blackout window specified by corporate insider trading policies. We find that abnormal returns to trades within mandatory blackout windows are statistically higher than abnormal returns to trades outside such windows, by 15.48% over a 180-day period. However, when General Counsel approval is required to execute a trade, abnormal returns to trades within these windows are statistically lower than abnormal returns to trades outside these windows by 5.26% over a 180-day period. Thus, when given the authority, it appears the General Counsel can effectively limit the extent to which officers use their private information to extract rents from shareholders.



Chief Executive Officer Equity Incentives and Accounting Irregularities

(with Christopher Armstrong and David Larcker)


Journal of Accounting Research, May 2010


This study examines whether Chief Executive Officer (CEO) equity-based holdings and compensation provide incentives to manipulate accounting reports.  While several prior studies have examined this important question, the empirical evidence is mixed and the existence of a link between CEO equity incentives and accounting irregularities remains an open question.  Because inferences from prior studies may be confounded by assumptions inherent in research design choices, we use propensity-score matching and assess hidden (omitted variable) bias within a broader sample.  In contrast to most prior research, we do not find evidence of a positive association between CEO equity incentives and accounting irregularities after matching CEOs on the observable characteristics of their contracting environments.  Instead, we find some evidence that accounting irregularities occur less frequently at firms where CEOs have relatively higher levels of equity incentives.



Market Reaction to the Adoption of IFRS in Europe

(with Christopher Armstrong, Mary Barth, and Edward Riedl)


EKS&H Research Award, University of Colorado, 2011


The Accounting Review, January 2010



This study examines European stock market reactions to sixteen events associated with the adoption of International Financial Reporting Standards (IFRS) in Europe.  European IFRS adoption represented a major milestone towards financial reporting convergence yet spurred controversy reaching the highest levels of government.  We find an incrementally positive reaction for firms with lower quality pre-adoption information, which is more pronounced in banks, and with higher pre-adoption information asymmetry, consistent with investors expecting net information quality benefits from IFRS adoption.  We find an incrementally negative reaction for firms domiciled in code law countries, consistent with investors’ concerns over enforcement of IFRS in those countries.  Finally, we find a positive reaction to IFRS adoption events for firms with high quality pre-adoption information, consistent with investors expecting net convergence benefits from IFRS adoption.



SEC Rule 10b5-1 and Insiders' Strategic Trade


Management Science, February 2009



The SEC enacted Rule 10b5-1 to deter insiders from trading with private information, yet also protect insiders' preplanned, non-information-based trades from litigation. Despite its requirement that insiders plan trades when not privately informed, the Rule appears to enable strategic trade. Participating insiders' sales systematically follow positive and precede negative firm performance, generating abnormal forward-looking returns larger than those earned by non-participating colleagues. The observed association does not appear to be explained by market transaction disclosure response, “predictable” reversion following positive performance, or general periodic price declines. There is evidence, however, that a substantive proportion of randomly drawn plan initiations are associated with pending adverse news disclosures. There is also evidence that early sales plan terminations are associated with pending positive performance shifts, reducing the likelihood that insiders' sales execute at low prices. Collectively, this suggests that, on average, trading within the Rule does not solely reflect uninformed diversification.


An Analysis of Insiders' Use of Prepaid Variable Forward Transactions
(with Steve Matsunaga and Eric Yeung)

Journal of Accounting Research, December 2007

This study examines firm performance surrounding insiders' Prepaid Variable Forward (PVF) transactions to infer insiders' information when they enter these off-market contracts. PVFs allow insiders to hedge downside risk, share performance gains, and obtain immediate large-sum cash payments for investment or consumption. On average, PVF transactions cover 30% of a sample insider's firm-specific wealth ($22 million), which is substantially larger than a typical open-market sale. PVFs systematically follow strong firm performance and precede degraded stock and earnings performance. PVFs also precede periods of negative abnormal returns relative to potential alternative investments. The documented association between PVFs and performance declines does not appear to result from the market's response to transaction disclosure, participant self-selection, or general price reversals. Thus, evidence suggests that insiders use PVFs to diversify firm-specific holdings in anticipation of performance declines. 


Selected Working Papers

Performance-Based Incentives for Internal Monitors

(with Christopher Armstrong and David Larcker)


This study examines the use of performance-based incentives for internal monitors (general counsel and chief internal auditor) and whether these incentives impair monitors’ independence by aligning their interests with the interests of those being monitored. We find evidence that incentives are greater when monitors’ job duties contribute more to the firm’s production function, when other top managers receive greater incentives, and when a firm has lower expected litigation risk. We also find evidence that firms provide more incentives when there is greater demand for internal monitoring. We find no evidence that internal monitor incentives impair the monitoring function. Instead, our results suggest that adverse firm outcomes (e.g., regulatory enforcement actions and internal-control material-weakness disclosures) occur less frequently at firms that provide greater monitor incentives.



Hiding in Plain Sight: Can Disclosure Enhance Insiders' Trade Returns?

(with M. Todd Henderson and Karl Muller)



Can voluntary disclosure be used to enhance insiders’ strategic trade while providing legal cover?  We investigate this question in the context of 10b5-1 trading plans.  Prior literature suggests that insiders lose strategic trade value if their planned trades are disclosed.  But disclosure might enhance strategic trade because courts can only consider publicly available evidence from defendants at the motion to dismiss phase of trial.  This practice can enhance legal protection for firms that disclose planned trades, especially those disclosing detailed information.  Consistent with increased legal protection, we find that voluntary disclosure of planned trades increases with firm litigation risk and potential gains to insiders’ trades.  We also find that insider sales and abnormal returns are higher for disclosed plans, especially those that articulate specific plan details.  This suggests that voluntary disclosure, which is conventionally thought to reduce information asymmetries, can create legal cover for opportunistic insider trading.



Governance, Incentives, and Tax Avoidance

(with Christopher Armstrong, Jennifer Blouin, and David Larcker)



This paper provides a comprehensive examination of the link between corporate governance (including CEO incentives) and tax avoidance. Previous studies have examined elements of this relationship; however, inferences from these studies are limited because they do not consider concavity in net benefits to tax avoidance.  We draw inferences from quantile regression that allows us to assess the relationship between governance characteristics and tax avoidance at the tails of the tax avoidance distribution and whether these relationships shift across the distribution.  After controlling for fundamental economic determinants of tax avoidance, we find evidence that more sophisticated boards encourage more aggressive tax positions when there are likely positive net benefits and discourage more aggressive tax positions where the costs may exceed the benefits. We also observe that boards with more independent directors exhibit a larger positive relationship with tax avoidance at the upper end relative to the lower end of the tax avoidance distribution. This is consistent with independent directors having less firm-specific institutional knowledge and therefore being less able to recognize when there may no longer be marginal net benefits to more tax avoidance. Finally, we find evidence that firms at which CEOs have greater incentives to increase stock price and increase risk exhibit a larger positive relationship with tax avoidance at the upper end relative to the lower end of the tax avoidance distribution. This suggests that the effect of CEO incentives on tax avoidance is stronger at the highest levels of the tax aggressiveness distribution.  Collectively, our evidence indicates that there can be considerably different relationships between governance and tax avoidance across the tax avoidance distribution. More importantly, our evidence suggests that any impact of corporate governance on firms’ tax avoidance appears to be most pronounced in the tails of the tax avoidance distribution, which is arguably the area of most interest to researchers and regulators.



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