Author

Hyo Jin Yoon

Date of Award

Spring 2021

Document Type

Open Access Dissertation

Department

Moore School of Business

First Advisor

Omrane Guedhami

Abstract

Corporate governance broadly refers to the oversight activities undertaken by internal and external actors to assure a fair distribution of cash flows and wealth transfers among the contracting parties. One of the most important functions of corporate governance is to ensure the integrity of the financial reporting process. A substantial body of work highlights the role of corporate governance mechanisms in curtailing earnings management that stems from managerial opportunism. Prior research has also found a direct link between weak corporate governance and financial misstatements and reporting frauds. While the effects of governance mechanisms on corporate reporting quality are well documented in the extant literature, little is known on the how temporary fluctuations in attention and/or monitoring intensity affect this relation. This dissertation contributes to this thread of literature by investigating the role of corporate governance mechanisms in ensuring the reliability of financial reporting in response to macroeconomic uncertainty and institutional investor inattention.

The first essay examines how economic policy uncertainty (EPU) affects accounting quality in a cross-country setting. We find that accounting quality, measured based on Nikolaev’s (2018) model, increases during periods of high policy uncertainty. This relation is confirmed by the negative association between EPU and performance-adjusted discretionary accruals in a multivariate setting, and it extends to various alternative measures of earnings properties. We also find that the positive relation between EPU and accounting quality is more pronounced for government-dependent firms and firms with higher political risk. Additional analyses based on institutional investors’ trading behavior, media freedom, and press circulation suggest that market participants’ attention is a mechanism through which EPU affects accounting quality. Further, we find that the positive relation between policy uncertainty and earnings quality is more pronounced for firms in countries with strong institutions, where market participants can monitor management more effectively, and for firms with a greater need for external capital, which increases managers’ incentives to meet investors’ demand for transparency.

The second essay examines the impact of institutional investor distraction on the costs of debt capital. Using a new measure of shareholder inattention based on exogenous industry shocks to institutional investor portfolios, we document that firms with distracted shareholders are associated with a higher cost of debt financing. This effect is stronger for firms with more powerful CEOs, firms with higher information asymmetry, and those operating in less competitive product markets. Bond covenants, as a mechanism designed to reduce the agency problems inherent in lending, attenuate the increase in bond yield spreads resulting from shareholder distraction. Further testing suggests that the distraction–cost of debt relation is driven by dual holder and non-dual holders. The results are robust to controlling for inattention at the retail investor level and for other external monitors such as credit rating agencies, financial analysts, and Big 4 auditors. Overall, our evidence suggests that shareholder inattention has an incrementally negative effect on bond pricing.

The third essay examines whether and how board cultural diversity affects bond pricing during bad times. Using a novel approach to identify directors’ cultural backgrounds based on their ancestral origins, I find that greater cultural diversity within the board membership and cultural distance between the board—especially the audit committee—and the CEO attenuate the adverse effect of economic policy uncertainty on yield spreads. Further testing shows that the effect of board cultural diversity and cultural distance extends above and beyond the presence of other external monitors such as Big 4 auditors, financial analysts, and long-term institutional investors. I also find corroborative evidence that boards with greater proportion of independent directors, higher female participation and director engagements, and less busy directors moderate the adverse impact of economic policy uncertainty. The results suggest that change in bondholders’ assessment of firm performance during periods of high policy uncertainty is a function of differences in board characteristics.

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