Summer 2022|By Laura Counts| Photo: peshkova/stock.adobe.com
The unintended consequences of the JOBS Act
In the decade since the 2012 Jumpstart Our Business Startups (JOBS) Act relaxed initial public offering requirements for companies with revenues under $1 billion, a growing number of them have taken advantage of the option to disclose less financial information in their IPOs.
This reduced-disclosure provision may have helped stimulate the market, but it came at a cost: lower IPO quality and more risk exposure for individual investors, concluded a new study by accounting professors Omri Even-Tov and Panos Patatoukas, with PhD candidate Young Yoon.
“The evidence shows that nearly two-thirds of the reduced-disclosure issuers underperform the market in the three years after they go public,” says Even-Tov. “While we find evidence that institutional investors have the ability to use publicly available information to avoid the worst-performing IPO stocks, individual investors tend to ignore fundamentals when investing in IPO stocks and are more exposed to the risks.”
Based on their findings, the researchers argue that the SEC should require all IPO issuers to disclose at least three years of audited financial information—up from the two years allowed under the JOBS Act.
“We recommend that regulators balance the benefits of increasing the number of IPO registrants against the costs of enabling speculative issuers to go public with reduced financial disclosures,” says Patatoukas, the L.H. Penney Chair in Accounting. “The quality of IPOs is as important, if not more so, than the quantity.”
In Part 2 of this two-part interview, Assoc. Professor Panos Patatoukas shares insights on the SEC’s new rules around the marketing of investment products marketed as socially responsible, as well as disclosure rules around companies’ ESG (environmental, social, and governance) activities. The interview also covers ESG valuation and investing, as well as divestment versus engagement—two different investor approaches to pressuring
Panos N. Patatoukas
The interview follows the Center for Financial Reporting and Management’s (CFRM)annual conference, which brought together high-level ESG investing thinkers with a wide range of perspectives on the direction of the industry. Among them were SEC Commissioner Hester M. Peirce, a Republican appointed by former President Trump; Janine Guillot, CEO of the Value Reporting Foundation and former CEO of the Sustainability Accounting Standards Board (SASB), which has developed the leading framework for ESG data; Andrew Behar, CEO of shareholder advocacy nonprofitAs You Sow, AJ Lindeman, who leads index and ESG quant research at Bloomberg; Karen Wong, who leads ESG & Sustainable Investing for State Street Global Advisors; and Wall Street Journal Senior Columnist James Mackintosh, an ESG investing skeptic.
Haas News: The Securities and Exchange Commission (SEC) is considering a host of new ESG disclosure rules. What will they do?
Panos Patatoukas: There are two new policy proposals (both released in May 2022) that would require additional disclosure regarding ESG strategies in fund prospectuses, annual reports, and adviser brochures. The SEC also proposed amendments to what’s called the fund names rule. Under the proposal, a fund that considers ESG factors alongside non-ESG factors may not be permitted to use ESG or similar terminology in its name, if doing so is materially deceptive or misleading. The idea behind these amendments is to prevent potential greenwashing or ESG lip-servicing, so that Main Street investors will not be deceived or misled.
At the conference, we heard from SEC Commissioner Hester Peirce argued that existing rules already allow the SEC to go after companies for any misrepresentations or omissions of “material” information? Do you agree?
I think it was important to have her perspective. Our conversation with Commissioner Peirce indicated that she is opposed to the rules not because she doesn’t think that greenwashing isn’t happening, but because she thinks we already have the regulatory tools to address it.
One good example of what she is talking about: The SEC recently fined Bank of New York Mellon Capital $1.5 million for misleading investors on false ESG quality reviews of some of the firm’s mutual funds. Of course, the $1.5 million fine is just a slap on the wrist, but it’s a signal that says the SEC can go after fund managers who make ESG claims but aren’t true to their promises. Consistent with the idea that the Bank of New York Mellon Capital case may provide a roadmap for future enforcement cases, the SEC has now taken on a much bigger player, looking into whether some of Goldman Sachs’ mutual funds don’t meet the ESG metrics proclaimed in their marketing materials.
If you scratch the surface of Commissioner Peirce’s argument, we get to the old question of: What’s the point of having rules and more rules if we don’t have sufficient enforcement? Should we allocate more resources creating new rules, or should we allocate those resources on enforcing existing rules—to the extent that the old rules are still relevant and effective?
My view is that the recent SEC proposals on funds and advisers that market themselves as having an ESG focus respond to the need for more transparency. More regulation in this regard might actually facilitate more enforcement. The bottom line is that unless we have both meaningful regulation and enforcement, we’re not going to achieve real progress.
But will these new disclosure rules actually make it easier for investors to, as you say, invest with their values?
In the absence of standardized and informative disclosures, in my opinion, it’s not entirely surprising that an ESG fund could exaggerate its actual consideration of ESG factors. If adopted, the proposed rules would require ESG-focused funds to provide more detailed information in a standardized tabular format. By providing information prominently, in the same location in each fund’s prospectus, the idea is that more disclosure would help improve investors’ understanding of ESG investment strategies and would assist them in comparing ESG-focused funds at a glance. The SEC also proposed amendments to existing rules to address materially deceptive or misleading ESG fund names. This new regulation basically says that fund managers who make ESG claims better be true to their promises. Because if not, that’s the definition of greenwashing.
I believe that a common, standardized disclosure framework tailored to ESG investing makes sense. So overall, I am in favor of providing more standardized disclosures about fund performance, investment strategies,and portfolio characteristics.
But we need to be careful. More disclosure will not automatically level the playing field for individual investors allowing them to make more informed decisions while investing in alignment with their values. If investors don’t have the financial acumen to process the disclosed information, then disclosure on its own may not be as impactful. Remember, while we are all investors, not everyone can access financial education. One of the things that preoccupies me is finding ways to make financial education and the power of financial data more accessible to everyone.
Critics of ESG investing say that it limits the universe of available stocks, which will negatively impact performance. You asked some of the panelists: “Can investors have their ESG cake and eat it too?” Can they do well by doing good?
I asked that question to the representatives from State Street and Bloomberg. State Street has been a leader in the ESG investment sector. They have all kinds of financial products, including scoring models, indices, and fund offerings using ESG data. For example, a key premise of State Street’s “Responsibility-Factor”—or “R-Factor”—scoring model is that it allows investors to identify companies that score higher on material ESG metrics. State Street’s R-Factor is also the ESG scoring model powering the Bloomberg/SASB ESG indices, which are used as ESG investing benchmarks.
My question was whether outperformance, relative to passive benchmarks, is a good measure of the effectiveness of State Street’s ESG scoring model. The response was ideally yes, but in practice, it doesn’t usually work that way and that a better measure of effectiveness might be “do no harm.” In other words, just make sure you don’t underperform the market benchmark, but without necessarily outperforming the benchmark.
This response in my opinion deviates from the way ESG scoring models have been marketed to everyday investors. ESG scoring models have often been promoted on the premise that the resulting ESG scores can help investors select stocks that will generate higher future returns.
In fact, the premise that you can “have the ESG cake and eat it too” has proven to be a highly effective narrative for the marketing of ESG funds and indices. Reflecting on these dynamics, I believe that there is a need for caution and more transparency on the part of ESG index providers and fund managers when marketing ESG scoring models and indices to everyday investors.
One of the most interesting discussions of the day centered on ESG strategies of engagement versus divestment. Let’s say we have good data to identify “brown” companies. Does removing them from a portfolio drive change?
The issue of engagement versus divestment is one of the most important, because I think that’s the one that can have immediate, real implications. The goal of ESG investing is not just to make money for ESG-motivated investors but also to change companies’ behavior through engagement and divestment. For example, divestment involves selling fossil fuel companies that have negative environmental impacts and buying “green” companies in other sectors. The idea behind divestment is that it raises the cost of capital for fossil fuel companies, thereby impeding their growth, while helping green companies grow. Based on this, several ESG-motivated investors have called for complete divestment from the fossil fuel sector.
For example, the University of California made the decision to remove all companies that own fossil fuel reserves from the UC Retirement Savings Program (RSP) fund. As of today (June 30, 2022), they sold existing holdings from RSP core funds and will no longer invest in fossil fuel companies.
The UC retirement fund is a relatively small fraction of the total market, and when UC RSP sold stocks of fossil fuel companies, somebody else bought that stock. Nevertheless, it does raise the question: Will divesting from fossil fuel companies accelerate the path to decarbonization of the economy? Where will the technology that will change our lives come from? Will it come from an entirely different sector, or could it also come from leading companies in this sector?
Outright divesting should be contrasted to an alternative approach, let’s call it selective divesting. Consider the fossil fuel sector as a whole. Within the sector, there are leading companies that are innovating, investing in new technologies, and there are lagging companies that are falling behind and continuing their dirty practices. Divesting from all of them is one possibility. An alternative would be to divest only from the laggards and reallocate this capital to the leaders. This approach of selective divesting and tilting may be desirable for an ESG-motivated investor because (a) it would reward companies that invest in transformative technologies and (b) it would penalize companies that do not adopt. This approach effectively blends divestment with engagement. The bottom line: Is indiscriminate divestment from fossil fuel the best way to accelerate progress or is the alternative approach of selective divesting and rewarding change a more effective approach to realizing our sustainability goals?
Wall Street Journal columnist James Mackintosh argued an investor’s role is to make a return within an acceptable level of risk, not push for change. He said it’s more effective to push change at companies through consumer actions, through buying power, or through government. What do you think?
Consumers and investors can be a force for change. ESG-motivated investors are asking for more transparency and verifiable data that they can use to make more informed investment decisions. Consumers are also asking for more transparency, and more reliable, verifiable and standardized data to inform their consumption choices. I believe that change could come from anywhere.
With respect to lawmakers, I agree that they have the power to drive change. For example, as many economists have been arguing for years, introducing a carbon tax in the corporate tax code would effectively change the incentives and behavior of companies by internalizing the negative externalities of carbon emissions. But still, measurement issues may hamper the effectiveness. Suppose we introduce a carbon tax, we still need to measure carbon emissions. Should the measure of carbon emissions include only direct emissions and emissions resulting from the company’s energy use—known as Scope 1 and 2 emissions? Or, should the measure also include Scope 3 emissions, those resulting from activities that the organization indirectly impacts in its value chain? While Scope 3 emissions often account for the biggest part of a company’s emissions, they are also the hardest to measure.
What are you most optimistic about right now in terms of ESG investing?
I think over time, we will have more transparency and more tools that will allow everyday investors to invest with their values and to be more aware of what they’re investing in. And we’re going to have more and better data that will allow us to overcome the measurement challenges, monitor corporate impact, align management incentives with long-term sustainability goals, and facilitate the allocation of capital in ideas and technologies that will drive change for good.
I also think we’ll have the technology required for individual investors to be more active participants in corporate decision-making. For example, I think it’s a matter of time before pass-through voting becomes available to every individual investor. A bit of context: Many of us individual investors participate in the stock market through index funds offered by large asset managers. Stock indexing has enabled us to get access to diversified portfolios at a low cost. The Big 3 asset managers—Vanguard, BlackRock, and State Street—dominate the field, with a collective >80% share of index fund assets. The Big 3 alone manage $20 trillion in assets.
One key implication of the growth in stock indexing among the largest asset managers is the voting power they have amassed over time, since they typically vote on behalf of individual investors. Giving every individual investor the option to participate in the proxy voting process can help them amplify their impact collectively on the issues that matter to them the most. This is an exciting prospect compared to today’s reality where a small set of individuals representing the top asset managers gets to decide on our behalf.
It’s about time to ensure that the voices of everyday investors are being heard.
As investors pay increasing attention to companies’ track records on environmental, social, and governance issues such as executive compensation, trillions of dollars have flowed into the ESG investing industry.
Assets in so-called ESG funds have risen 38% globally in the past year alone, to $2.7 trillion by the end of March, according to Morningstar Direct. While Europe still dominates with 82% of the market, a burgeoning class of U.S. financial products promises investors an ROI aligned with their values.
Yet as the SEC considers new regulations, a backlash is growing against the sustainable investing industry, disparaged by some political and business leaders as “woke capitalism” and even a “scam.”
This month, the Center for Financial Reporting and Management’s (CFRM)annual conference brought together high-level ESG investing thinkers with a wide range of perspectives on the direction of the industry. Among them were SEC Commissioner Hester M. Peirce, a Republican appointed by former President Trump; Janine Guillot, CEO of the Value Reporting Foundation and former CEO of the Sustainability Accounting Standards Board (SASB), which has developed the leading framework for ESG data; Andrew Behar, CEO of shareholder advocacy nonprofitAs You Sow, AJ Lindeman, who leads index and ESG quant research at Bloomberg; Karen Wong, who leads ESG & Sustainable Investing for State Street Global Advisors; and Wall Street Journal Senior Columnist James Mackintosh, an ESG investing skeptic.
Panos N. Patatoukas
“I wanted to bring all these perspectives together and have a structured discussion around ESG disclosures in order to gain new understanding and figure out how to move forward,” said Associate Professor Panos Patatoukas, L.H. Penney Chair in Accounting and faculty director of CFRM, who organized the ESG accounting conference.
In Part 1 of this two-part interview, we asked Patatoukas to synthesize some of the major discussion points around ESG measurement and disclosure, as well as reporting standards and assurance by external auditors.
Part 2 of the interview, publishing July 1, will address the SEC’s proposed ESG rules, valuation and investing, as well as divestment versus engagement—two different investor approaches to pressuring companies to change their ways.
Haas News: There’s a growing backlash against ESG investing. Recently, some politicians and business and financial leaders are dismissing ESG as “woke capitalism” and even “a scam” (Elon Musk). They argue these issues aren’t relevant to investors, whose job is to maximize returns. Is this an existential threat to the industry?
Panos Patatoukas: Will political rhetoric get in the way of progress and meaningful change? I just don’t believe that. ESG becomes de facto relevant when you have so many investors who want to invest with their values and don’t want to be misled. The reality is that this growth has been driven by demand from investors. With respect to ESG disclosures, improved access to higher quality data will allow investors, especially individual investors, to invest with their values and will mitigate the risk of greenwashing.
What is greenwashing, in terms of financial products?
Greenwashing is the result of the lack of clarity in the ESG setting. Let’s say you have a preference for “green” companies and you are willing to pay a premium to get access to a green fund. Let’s now consider the possibility that the index fund manager is actually deviating from the presumed investment objective and they are actually investing in green and not-so-green stocks. Labeling the fund as a green fund could be misleading, especially for individual investors that are not fully attuned to fund characteristics and may not be fully aware of what they actually own when they invest in this particular fund. This goes to the core of greenwashing issues. And the problem is that many of these ESG products are marketed to individual investors as a way for fund managers and advisers to charge management fees in excess of what they would make in a plain vanilla, non-ESG product. But because of bad data or limited access to good data, investors effectively may be getting the same old thing packaged in a different way. Transparent financial products that allow you to invest in alignment with your values at low management fees should be accessible to everyone, but we are not there. Not just yet.
Why is it so hard to get there?
Let’s first talk about E+S+G measurement. I think everybody understands that environmental activities are very important, corporate governance matters, and social issues are becoming increasingly important. Where people really disagree is: How do we define, measure, and verify the different types of carbon emissions? What are the corporate activities that fall under the “S” of ESG and how should we measure those? What is important to measure on governance and what constitutes good or bad governance?
Because there’s a disagreement in terms of what adds up to ESG, there is disagreement on the measurement of those dimensions. That shows up in the weak correlation on ESG ratings across rating agencies. If it was 100% clear as to what it is we’re trying to measure, the correlation across agencies would be much higher.
Some people argue that E, S, and G issues cover so many different things as to be meaningless. What do you think?
Pooling environmental, social, and governance together into one single measure is problematic. These are different things that might be interacting with each other and that may even trade-off against each other. For example, you could think of a company with “bad” governance, with an entrenched CEO who has all the power and the shareholders who don’t have much voting power, but on the other hand, that same CEO might prioritize reducing the carbon footprint of the organization. So those things would be in opposition. And within each one of these dimensions—environment, social issues, and governance—there are going to be strengths and weaknesses. It’s not always the case that you can offset a negative in one area by doing something good in another. The practice of pooling different activities together to generate a single ESG score is a bad practice, in my opinion, since it’s missing the granularity of the underlying data.
So all this uncertainty about measurement must also make it difficult to define what companies should be required to disclose.
There are different views not only on how much companies should be required to disclose, but who should be responsible, and to what extent, for the assurance of the reliability of these disclosures. What I mean by assurance is external auditors attesting to the validity of the data, which is already happening when it comes to financial activities. Disclosures without assurance may not be reliable. What’s going to change the game is assurance of ESG data, because when auditors attest to the validity of the data, they can be held liable and take on the risk that what they’re signing off on is actually true and verifiable.
What became clear in our discussion is that there is real demand for more consistent, comparable and decision-useful information. We call that “material’ information, which means any information that may impact a reasonable investor’s decision making. Material ESG data need to be verifiable and audited. If we can agree on the definitions, and we agree on the measurement, and we have external auditor assurance, that will completely change the field. That will be a real revolution, or an evolution, depending on how you want to see it. We can end up in a market setting where everyday investors will have access to more accurate data based on which they can make informed decisions and invest with their values. The accounting firms can play a significant role in the transformation that’s happening and accelerate the convergence of policy, regulation, and technology that’s rewriting the ESG investing playbook.
At the conference, Janine Guillot, CEO of the Value Reporting Foundation and former CEO of the Sustainability Accounting Standards Board (SASB), explained that they’ve merged with others to create a global baseline of ESG standards through the International Sustainability Standards Board (ISSB). These standards have already been adopted by 65% of S&P 500 companies. Is this getting us closer to standardization?
The SASB started a decade ago as a private, nonprofit organization with the mission to develop and disseminate industry-specific sustainability accounting standards that help businesses “disclose material, decision-useful information to investors.. This is the framework that seems to be the frontrunner, and stewardship of the SASB Standards is now passing to the International Sustainability Standards Board.
However, the SASB framework is, in essence, a disclosure template that has helped companies and investors develop a common language around ESG issues. So adopting the SASB standards doesn’t necessarily mean that the data that companies disclose is meaningful. The point here is that a higher adoption rate of a sustainability reporting framework, like the one developed by SASB, is not necessarily a measure of success of the sustainability accounting standard-setting process.
So how do we define success in sustainability standard-setting? Well, it would be interesting to systematically evaluate whether the adoption of sustainability standards will ultimately have a real impact on emissions, new technologies, productivity, and social welfare. Higher adoption rates among corporations and fund managers and more licensing fees to private standard-setting organizations for using their sustainability reporting framework does not necessarily translate into a more sustainable and equitable future for everyone.
From top row, left to right: New Berkeley Haas assistant professors Tanya Paul, Ali Kakhbod, Carolyn Stein; Sa-Kiera Hudson, Ambar La Forgia, Sytkse Wijnsma, Sarah Moshary, Matthew Backus, and Valerie Zhang.
Nine new assistant professors have joined the Haas School of Business faculty this year, with cutting-edge research interests that range from illicit supply chains to unequal social hierarchies; from financial crises to the incentives that shape innovation; and from health care management to decentralized finance to marketing and the demand for firearms.
The nine tenure-track hires are the result of a concerted effort by Dean Ann E. Harrison and other Haas leaders to expand and diversify the faculty.
“We are thrilled to welcome this wonderful, diverse new group of academic superstars to Berkeley Haas,” says Dean Ann E. Harrison. “We clearly are bringing the best to Haas, increasing the depth and breadth of our world-renowned faculty, and reinforcing our place among the world’s best business schools.”
The new faculty members have hometowns throughout the U.S. and around the world, including Texas, New York, Massachusetts, and Illinois; Iran, the Dominican Republic, China, and the Netherlands. Seven of them are women; one is Black, and one is Latinx.
“This is our most diverse cohort of new faculty ever, each one a rock star in their own right,” says Jennifer Chatman, Associate Dean for Academic Affairs and the Paul J. Cortese Distinguished Professor of Management. “We are very proud that we were able to lure them to Berkeley Haas.”
The new faculty members start on July 1, with most beginning to teach in spring 2023. They bring the total size of the ladder faculty to 88, up from 78 in 2020-2021.
Meet the faculty
Matthew Backus
Assistant Professor Matthew Backus, Economic Analysis & Policy
(he/him)
Hometown: Chicago, Ill.
Education:
PhD, Economics, University of Michigan, Ann Arbor
MA, Economics, University of Toronto
BA, Economics and Philosophy, American University
Research focus: Industrial organization
Introduction: I’m an economist with broad interests. Most recently, I’m interested in how we can use the tools developed by the industrial organization community to understand inequality and the distributional effects of policy.
Teaching: Microeconomics and Antitrust Economics (MBA)
Most excited about: After spending a year visiting, I’m most excited about the economics community at Berkeley.
Fun fact: I have a border collie, who is in training as a herding dog.
Sa-Kiera Hudson
Assistant Professor Sa-kiera (Kiera) Tiarra Jolynn Hudson, Management of Organizations
(she/her)
Hometown: Albany, NY
Education:
PhD/MA, Social Psychology, Harvard University
BA, Psychology and Biology, Williams College
Research focus: I study the psychological processes involved in the formation, maintenance, and intersections of unequal social hierarchies, with a focus on empathic/spiteful emotions, stereotypes, and legitimizing myths.
Introduction: I am a social psychologist by training, focusing on the nature of intergroup relations as dominance and power hierarchies. I have studied several psychological processes, including the role of legitimizing myths in justifying unequal societal conditions, the role of group stereotypes in the experience and perception of prejudice, and the role of empathic and spiteful emotions in supporting intergroup harm. My work is multidisciplinary, incorporating quantitative as well as qualitative methods from various disciplines such as political science, sociology, and public policy.
I am a fierce advocate for building community, providing mentorship, and supporting authentic inclusion for everyone. I believe it is a moral imperative to be present as a vocal, queer-identified Black women in academe, given the lack of representation, and I’m excited to see how I can contribute to diversity, equity, and inclusion efforts at Haas.
Teaching: Core Diversity, Equity, and Inclusion (MBA)
Most excited about: I identify UC Berkeley as my intellectual birthplace. It was during a summer internship program through the psychology department in 2010 where I first became interested in studying power structures and intergroup relations simultaneously. My overall research interests haven’t changed since that fateful summer. Being a faculty member here is truly a dream come true!
Fun fact: I love organizing and planning, so much so I taught myself how to use Adobe InDesign to create my own planner. I am also an avid foodie and cannot wait to check out the Bay’s food and wine scenes.
Ali Kakhbod
Assistant Professor Ali Kakhbod, Finance
(he/him)
Hometown: Isfahan, Iran
Education:
PhD, Economics, MIT
PhD, Electrical Engineering & Computer Science (EECS), University of Michigan
Research focus: Information frictions; liquidity; market microstructure; big data; and contracts
Introduction: I am a financial economist with research interests in financial intermediation, liquidity, contracts, big (alternative) data, banking and financial crises. A common theme of my research agenda is to study various informational settings and their financial and economic implications. For example: When does securitization lead to a financial crisis? Why is there heterogeneity in the means of providing advice in corporate governance? How does information disclosure in OTC (over-the-count) markets affect market efficiency? My research has both theory and empirical components with policy implications.
Teaching: Deep Learning in Finance (MFE)
Most excited about: Berkeley Haas is the heart of what’s next with world-class faculty working on exciting and innovative research. Given that my interdisciplinary research interests span finance, economics and big data issues, I could not ask for a better fit.
Fun fact: In my free time, I like to ski, sail, hike, and enjoy the outdoors.
Ambar La Forgia
Assistant Professor Ambar La Forgia, Management of Organizations
(she/her)
Hometown: I was born in Santo Domingo, Dominican Republic, but I grew up in Washington, DC and São Paulo, Brazil.
Education:
PhD, Applied Economics and Managerial Science, The Wharton School, University of Pennsylvania
BA, Economics and Mathematics, Swarthmore College
Research focus: Health care management; mergers and acquisitions; firm performance
Introduction: My research studies the relationship between organizational and managerial strategies and performance outcomes in the health care sector. In particular, I use quantitative methods to study how the strategic decisions of corporations to merge, acquire, or partner with other organizations can change managerial processes in ways that impact both financial and clinical performance. A secondary research strand studies how health care organizations adapt their service delivery and prices following changes in state and federal legislation.
Before joining UC Berkeley, I was an assistant professor of health policy and management at Columbia University’s Mailman School of Public Health. I am excited to continue to explore issues of healthcare quality, equity, and cost, while digging deeper into the management practices and organizational structures that could influence these outcomes.
Teaching: Leading People (EWMBA)
Most excited about: It is an honor to join the world-class faculty at Haas, and I am so excited to learn from and collaborate with my MORs colleagues on both the macro and micro side. Since my research is interdisciplinary, I also look forward to connecting with scholars in the School of Public Health.
As a self-proclaimed “city girl,” I am excited to get out of my comfort zone and explore the natural beauty of Northern California.
Fun fact: My hobbies include yoga, urban gardening, adopting animals and stand-up comedy.
Sarah Moshary
Assistant Professor Sarah Moshary, Marketing
(she/her)
Hometown: New York City, NY
Education:
Phd, Economics, MIT
AB, Economics, Harvard College
Research focus: Marketing and industrial organization
Introduction: My research interests span quantitative marketing, industrial organization, and political economy. I am currently working on projects related to paid search advertising, the pink tax (price gap in products targeted to women), and the demand for firearms. Before joining Haas, I worked at the University of Chicago Booth School of Business and at the University of Pennsylvania.
Teaching: Pricing (MBA)
Most excited about: I am excited to get to know my future colleagues!
Fun fact: My two hobbies are running and pottery—though I am more enthusiastic than talented at either :).
Tanya Paul
Assistant Professor Tanya Paul, Accounting
(she/her)
Hometown: Murphy, Texas
Education:
PhD, Accounting, The Wharton School, University of Pennsylvania
BS, Economics, Statistics and Finance, The Wharton School, University of Pennsylvania
Research focus: Standard-setting and financial reporting; the determinants and consequences of voluntary disclosures
Introduction: After getting my PhD, I spent a year at the Financial Accounting Standards Board learning about contemporary accounting issues and understanding the types of questions that standard setters are grappling with. I hope to continue working on research that is helpful to standard setters in coming up with standards that ultimately improve financial reporting.
Teaching: Corporate Financial Reporting (MBA)
Most excited about: I love how interconnected the area groups are within Haas. There are so many potential learning opportunities, especially for a newly minted researcher like me.
Fun fact: In my free time, I love to read and play the piano—I had learned it as a child and am trying to relearn it now as an adult.
Carolyn Stein
Assistant Professor Carolyn Stein, Economic Analysis & Policy
(she/her)
Hometown: Lexington, Mass.
Education:
PhD, Economics, MIT
AB, Applied Mathematics and Economics, Harvard College
Research focus: Economics of science, innovation, and applied microeconomics
Introduction: I study the economics of science and innovation. My research combines data and economic theory to understand the incentives that scientists face and decisions that they make, and how this in turn shapes the production of new knowledge.
One thing I love about economics is that it’s less of a narrow subject area, and more a set of tools and principles that apply to a stunningly wide array of topics. I’m excited to work with Haas students to help them understand how economic principles can improve their decision-making, both in their careers and in other areas of their lives—maybe even in ways that surprise them!
Teaching: Microeconomics (EWMBA)
Most excited about: I’m excited to be part of a large and superb applied microeconomics community—at Haas, and more broadly at Berkeley as a whole.
Fun fact: I am an avid cyclist and skier, and I was on the cycling team at MIT. Since moving to the Bay Area, I’ve loved the hills and mountains in the area. I’m working on taking my riding off road (gravel and mountain biking) and skiing off-piste (backcountry).
Sytske Wijnsma
Assistant Professor Sytkse Wijnsma, Operations and IT Management
(she/her)
Hometown: Amsterdam, the Netherlands
Education:
PhD, Management Science and Operations, Judge Business School, University of Cambridge
MPhil, Management Science and Operations, Judge Business School, University of Cambridge
BSc & MSc, Economics and Finance, VU University, Amsterdam
Research focus: My primary research interest is designing supply chain and policy interventions that help solve real-world challenges with social and environmental impact.
Introduction: I am very excited about my projects on illicit supply chains and how they undermine social and environmental goals. The context of these projects spans a wide range of areas, from illicit waste management to illegal deforestation. I am also excited to deepen and expand ongoing research collaborations with governments and industry to investigate these issues.
Teaching: Sustainability in Business (Undergraduate)
Most excited about: Many things! Berkeley Haas, being at the forefront of sustainability, has a unique position that combines the same ideals that drive my research with opportunities for collaborative research with serious impact. The amazing colleagues and close connections to industry make it even more exciting to join this community!
Fun fact: My first and last name originate from Fryslân, a northern province in the Netherlands, where it is still tradition to name your children after family members. So although my name is quite rare in the rest of the world, in our family it crops up in every generation!
Valerie Zhang
Assistant Professor Valerie Zhang, Accounting
(she/her)
Hometown: Shanghai, China
Education:
PhD, Northwestern Kellogg School of Management
MA, Economics, University of Toronto
BCom, Finance and Economics, University of Toronto
Research focus: Information dissemination; information cascades on social media; retail investor behavior; decentralized finance
Introduction: I am passionate about doing research or working on personal projects that can express my creativity. I enjoy merging disjointed ideas and working on interdisciplinary research. My dissertation combines two literatures: one in computer science on information cascades on social media, and another in finance and accounting on the effects of disseminating financial news. I am also very curious about emerging technologies that are reshaping the financial industry. Since I work on areas that are new to the research community, I sometimes feel like a lone traveler exploring completely new territories. It is terrifying but also extremely rewarding!
Teaching: Financial Accounting (Undergraduate)
Most excited about: I look forward to inspiring my students to be entrepreneurial and to come up with creative business ideas or projects.
Fun fact/hobby: I write short stories. The one I am working on has an alien and a squirrel in it.
Clockwise from top left: Cheit Award winners Ricardo Perez-Truglia, Panos Patatoukas, Veselina Dinova, Richard Huntsinger, Eric Reiner, Ned Augenblick, Max Auffhammer
Seven faculty members and five Graduate Student Instructors (GSIs) were honored at 2022 commencements for excellence in teaching.
Students in each degree program choose faculty each year to receive the Cheit Award, named after Dean Emeritus Earl F. Cheit, who made teaching excellence one of his top priorities.
This year’s winners include:
Evening & Weekend MBA program: Max Auffhammer (evening cohort), for Data and Decisions, and Ricardo Perez-Truglia (weekend cohort), for Macroeconomics
Full-time MBA program: Associate Professor Ned Augenblick, for Strategic Leadership
Undergraduate program: Distinguished Teaching Fellow Richard Huntsinger
PhD program: Accounting Professor Panos Patatoukas
Master of Financial Engineering (MFE): Finance Lecturer Eric Reiner
Executive MBA program: Distinguished Teaching Fellow Veselina Dinova
Graduate student instructors (GSIs): Paige Wahoff (undergraduate) Griffin Grail-Binghman (FTMBA), Kimberlyn George (EWMBA), Nicolas Corthorn (MFE), Jonathan Wong (EMBA)
As regulators wrestle with disclosure standards for the burgeoning $35 trillion ESG investing industry—named for its focus on corporations’ environmental, social, and governance activities—a group of influential thought leaders is gathering at Berkeley Haas to share their expertise.
“The timing and the content of the conference are unique,” says Panos Patatoukas, associate professor of accounting at Berkeley Haas and faculty director of the Center for Financial Reporting and Management (CFRM), which organized the event. “Our set of panelists and moderators are at the cutting edge of the ESG investing world and represent a wide range of perspectives, including ESG strategies, scoring and indexing, investing, regulation, and sustainability reporting standards.”
The importance of measurement, standardization, and verification is becoming more urgent as ESG investing grows, and the amount of capital allocated in ESG indices and financial products has exploded. For example, the SEC recently fined Bank of New York Mellon over misleading claims about funds that use environmental and social criteria to pick stocks. A transparent standard setting process can play a crucial role in advancing the clarity that investors and businesses are asking for in the area of ESG disclosures, Patatoukas says.
ESG from four angles
The conference will approach ESG accounting from four main angles, Patatoukas says: disclosure, assurance, standardization, and valuation and investing. After an introduction from Dean Ann Harrison, the first panel will focus on measurement and disclosure, and will be moderated by James Webb, executive director of the CFRM.
Next, Andrew Behar, CEO of As You Sow, a nonprofit that uses shareholder advocacy to “create lasting change by protecting human rights, reducing toxic waste, and aligning investments with values,” will lead a discussion on ESG advisory and auditing, with partners from PwC, KPMG, Deloitte, and Moss Adams.
Berkeley Law Professor Stavros Gadinis will moderate two keynote addresses: SEC Commissioner Hester M. Peirce will speak on ESG reporting regulations, and Janine Guillot, CEO of the Value Reporting Foundation, will speak on reporting standards.
The afternoon discussion of ESG valuation and investing will feature AJ Lindeman, Bloomberg’s head of Index and ESG Research; Wall Street Journal Senior Columnist James Mackintosh, and Karen Wong, head of ESG & Sustainable Investing for State Street Global Advisors. Patatoukas will moderate.
The event, which is the 26th annual Conference on Financial Reporting, will run from 9 a.m. to 4 p.m. in Chou Hall’s Spieker Forum on the Haas campus.Registration is open to all. Attendees can receive CPA Continuing Education credits.
It’s been a decade since the Jumpstart Our Business Startups (JOBS) Act relaxed initial public offering requirements for companies with revenues under $1 billion, and a growing number of them have taken advantage of the option to disclose less financial information in their IPOs.
But while this reduced-disclosure provision may have helped stimulate the market, it came at the cost of lower IPO quality and more risk exposure for individual investors, suggests a new study by Berkeley Haas professors Omri Even-Tov and Panos Patatoukas, along with PhD candidate Young Yoon.
“The evidence shows that nearly two-thirds of the reduced-disclosure issuers underperform the market in the three years after they go public,” said Even-Tov, an assistant professor of accounting. “While we find evidence that institutional investors use publicly available information to avoid the worst-performing IPO stocks, individual investors tend to ignore fundamentals when investing in IPO stocks and are more exposed to the risks.”
Even as Senate Republicans have unveiled a new set of relaxed rules dubbed JOBS Act 4.0 to spur business and ensure retail investors have access to young ventures, “the evidence questions that the SEC’s objective to increase the quantity of IPOs came at the expense of quality,” said Patatoukas, associate professor and L.H. Penney Chair in Accounting. Based on their findings, the researchers argue that the SEC should ratchet back and require all IPO issuers to disclose at least three years of audited financial information—up from the two years allowed under the JOBS Act.
“We recommend that regulators balance the benefits of increasing the number of IPO registrants against the costs of enabling speculative issuers to go public with reduced financial disclosures,” Patatoukas said. “With respect to investor protection in the IPO aftermarket, the quality of IPOs is as important, if not more so, than the quantity.”
Stimulating the IPO market
When the JOBS Act was signed into law on April 5, 2012, the goal was to invigorate the IPO market by making the process less risky and burdensome for smaller companies. The Act created a new category called emerging growth companies (EGCs), defined as issuers with pre-IPO revenues of less than $1 billion.
The new rules gave companies the option of presenting just two years of audited financial statements and selected financial data in their IPO filing, rather than the three years of audited financials and five years of selected financial data required previously.
By the end of 2015, almost half of emerging growth companies with an operating history of more than two years opted for reduced disclosures. By 2018, it was over 80%.
Quantity vs. quality
While prior studies have found that the JOBS Act did lead to an increase in the number IPOs—which had dropped off following the dot-com bust—the Berkeley Haas researchers questioned their quality.
They looked closely at EGCs that went public before and after the JOBS Act took effect, and also compared them to companies with revenues over $1 billion that went public during the same time period and did not have the option of reduced disclosures.
The EGCs that had been operating more than two years, yet opted to release only two years of financials, had more speculative valuation profiles and lower institutional ownership, they found. These companies’ stocks tended to become overpriced in the aftermarket, and after three years, 66% of them underperformed a broad market index—compared with 49% of emerging growth companies that chose to disclose three years of financials.
They also found that individual investors were more attracted than institutions to the speculative, “lottery-type” companies that went public under the new rules, implying that individual investors were more exposed to the downsides.
Their findings contradict prior research suggesting that the Act led smaller companies to underprice their IPOs. Rather, the analysis found that the bigger average jumps in share prices relative to offering prices after the Act was passed were due to overall market conditions, and weren’t limited to EGCs.
Policy recommendations
Enhancing companies’ access to the public capital market, and their ability to conduct successful IPOs, gives investors more opportunities to invest in public companies, the researchers agreed. Yet the increased risk that the reduced accounting rule brings to individual investors led them to recommend that the SEC remove the provision and require issuers to disclose at least three years of audited financial statements.
“Having three years of data rather than two will enable investors to gauge the trend in company growth leading to the IPO,” Even-Tov said. “This has the potential to help level the playing field for Main Street investors, and the incremental cost to companies of providing another year of historical information should be small.”
Patatoukas added that the findings have direct relevance for both the SEC and for retail investors.
“Our evidence that individual investors may have been disproportionately exposed to shareholder value destruction post-JOBS Act could inform the SEC’s efforts to facilitate capital formation while protecting the interests of Main Street investors,” he said. “On the part of Main Street investors, our evidence calls attention to the risks of actively targeting IPO stocks with speculative valuation profiles.”
Spring 2022|By Katie Gilbert| Photo: GUY OLIVER/ALAMY STOCK PHOTO
The impact of sourcing responsible minerals
An ambitious change in U.S. accounting rules appears to be helping reduce violent conflicts in Africa, according to a new study.
The conflict minerals disclosure rule, or Dodd-Frank’s Section 1502, has required companies as of 2014 to publish detailed reports on their sourcing of tantalum, tin, tungsten, and gold. These so-called 3TG, or “conflict minerals,” used in smartphones, laptops, electric vehicles, and other devices, have fueled a humanitarian crisis by serving as a major source of revenue for armed groups in Central Africa.
“With Dodd-Frank, the SEC made an unprecedented move by requiring disclosures intended to tackle issues outside of the shareholder-protection realm,” says Assistant Professor Omri Even-Tov, co-author of the study.
Panning for gold near Iga Barrière, Ituri Province, Democratic Republic of Congo. Photo: Guy Oliver/Alamy Stock Photo.
The U.S. government’s response focused on transparency rather than sanctions. The hope was that if consumers, investors, employees, and other stakeholders knew more about the conflicts linked to the mining of minerals in the devices they use every day, they would push companies to change their supply chains and, more importantly, that the changes in companies’ mineral-sourcing decisions would help alleviate the conflicts.
It seems to be working, Even-Tov found.
Analyzing data from the first four years after the disclosure requirement was enacted, Even-Tov, along with Seoul National University Professor Bok Baik and others, found that companies became substantially more responsible in sourcing minerals. What’s more, their analysis found that the number of conflicts decreased.
The researchers collected data from over 4,000 minerals disclosure reports published by more than 1,000 companies between 2014 and 2018. Over the four-year period, responsible sourcing nearly doubled, increasing from 45% to almost 82%.
Even though companies were not penalized for continuing to buy conflict minerals, the researchers found that public attention made companies more committed to responsible sourcing. For every 100 downloads of a company’s disclosure report, they noted a 1.2% increase in the percentage of conflict-free smelters and refiners and a 4.5% increase in the likelihood that a company would put in place a policy for avoiding conflict minerals.
Market reaction also appeared to play a role. In the five days surrounding the publication of a disclosure report, Even-Tov found that a one standard-deviation increase in the number of conflict-free smelters and refiners that companies sourced from (which amounted to a 24% overall increase) was associated with a bump of about 0.6% in market value, which equates to $66 million for the average company in the sample.
To determine the humanitarian impact, the researchers drew from the Armed Conflict Location & Event Database to obtain the dates, locations, and types of conflict events between 2010 and 2019.
They found that the number of conflicts decreased by 15% in the mining regions of the Democratic Republic of Congo and the nine neighboring countries covered by the disclosure rule, relative to countries not covered. They also found that conflicts had not spilled over into non-mining areas.
“I don’t want anyone to think that the conflict minerals disclosure rule is a panacea; it’s not,” says Even-Tov. “But our results show that increased transparency is effective at nudging companies toward responsible actions that are having a real impact.”
He even thinks that the policy should be applied more broadly. For example, the Democratic Republic of Congo supplies most of the world’s cobalt, a mineral not currently mentioned in the rule. He believes it should be added.
Still, Even-Tov acknowledges the need for policymakers to strike a delicate balance with laws requiring more disclosure. “It’s easy to ask companies to disclose more,” he adds, “but what’s crucial is to measure the impact the disclosures have. That’s what we, as accountants, are endeavoring to do.”
Mushamua Mweze at work in the Zola Zola mine, Bukavu, Congo, in 2016. Photo by: J’rgen B’tz/picture-alliance/dpa/AP Images
An ambitious change in U.S. accounting rules appears to be helping to reduce violent conflicts in Africa, according to a new study.
The conflict minerals disclosure rule, or Dodd-Frank’s Section 1502, required companies as of 2014 to publish detailed reports on their sourcing of tantalum, tin, tungsten, and gold. These so-called “conflict minerals,” used in smartphones, laptops, electric vehicles, and other devices, have fueled a humanitarian crisis by serving as a major source of revenue for armed groups in Central Africa.
“With Dodd-Frank, the SEC made an unprecedented move by requiring disclosures intended to tackle issues outside of the shareholder-protection realm,” says Omri Even-Tov, an assistant professor of accounting at the Haas School of Business, University of California Berkeley, and co-author of the study.
The hope was that if consumers, investors, employees, and other stakeholders knew more about the conflicts linked to the mining of minerals in the devices they use every day, they would push companies to change their supply chains—and more importantly, that the changes in companies’ mineral-sourcing decisions would reduce funding streams and help alleviate the conflicts.
That seems to be the case. Based on data from the first four years after the conflict minerals disclosure requirement became effective, Even-Tov and colleagues found that companies became substantially more responsible in sourcing minerals. What’s more, their analysis found that the number of conflicts decreased by 15% in the mining regions of the Democratic Republic of Congo and the nine neighboring countries covered by the disclosure rule, relative to those of countries not covered.
“I don’t want anyone to think that the conflict minerals disclosure rule is a panacea; it’s not,” says Even-Tov, who conducted the study with Bok Baik, a professor at Seoul National University, and PhD students Russell Han, of the University of Illinois at Urbana-Champaign, and David Park, of Seoul National University. “But our results show that increased transparency is effective at nudging companies towards responsible actions that are having a real impact.”
Shifting toward “conflict-free”
The Enough Project, a nonprofit that advocated for Section 1502, estimates that in 2008, a couple of years before the disclosure rule was passed, armed groups in Central Africa earned $185 million from gold as well as tantalum, tin, and tungsten—together known as 3TG minerals.
Rather than impose sanctions on any country or industry, or directly penalize companies sourcing conflict minerals, the U.S. Congress opted to ratchet up transparency. Section 1502 requires SEC-listed firms to file conflict minerals disclosure reports that reveal whether they source 3TG minerals from the Democratic Republic of Congo or any of its nine neighboring countries.
The researchers collected data from over 4,000 minerals disclosure reports published by more than 1,000 companies between 2014 and 2018. Because of the conflict minerals disclosure rule, operators of smelters and refiners tend to know about the origins of the minerals they work with and third-party auditors can flag them for links to conflicts or label them as “conflict-free.” Companies are required to conduct due diligence on their supply chains and disclose their findings such as the proportion of conflict-free smelters and refiners in their supply chains.
Responsible sourcing—as measured by the percentage of conflict-free smelters and refiners—improved every year, the researchers found. Over the four-year time period, it nearly doubled, increasing from 44.6% to almost 82%.
Protecting against reputational costs
That raised another important question: Without an enforced penalty for companies that continued to source conflict minerals, what explains such a dramatic shift in behavior?
“We thought it was possible that this came down to perceived reputational cost, which means that employees of the company, customers of the company, and shareholders of the company could be applying pressure,” Even-Tov says.
The researchers found that the more public attention a company’s conflict minerals report garnered, the stronger its commitment to responsible sourcing became. For every 100 downloads of a company’s conflict minerals report, they noted a 1.2% increase in the percentage of conflict-free smelters and refiners and a 4.5% increase in the likelihood that a company would put in place a policy to disassociate from conflict minerals that fund armed groups.
Market reaction also appeared to play a role. Looking at market value over the five days surrounding the publication of a disclosure report, Even-Tov and colleagues found that a one standard-deviation increase in the percentage of conflict-free smelters and refiners that companies sourced from (which amounted to a 24.2% increase the proportion of conflict-free smelters/refiners they used) was associated with a bump of about 0.6% in market value. That equates to $66 million boost for the average company in the sample.
The humanitarian impact
The next question they dug into was whether the new rule was having any bearing on its humanitarian goal of reducing bloodshed. To find out, the researchers drew from the Armed Conflict Location & Event Database to obtain the dates, locations, and types of conflict events between 2010 and 2019.
They divided the entire continent of Africa into roughly ten thousand subnational units and compared changes in conflict incidence around mining areas within covered countries to those in countries not covered by the rule. Conflicts in covered countries’ mining regions fell by an average of about 15% after the disclosure rule went into effect, relative to non-covered countries’ mining regions. They also found that conflicts had not spilled over into non-mining areas.
Transparency’s Delicate Balance
Even-Tov points to these results as robust evidence that the conflict minerals disclosure policy works—and that it should be applied more broadly. For example, the Democratic Republic of Congo supplies most of the world’s cobalt, a mineral not currently mentioned in the rule. He believes cobalt should be added as a conflict mineral.
Still, he acknowledges the need for policymakers to strike a delicate balance with laws requiring more disclosure.
“The problem is that disclosure rules don’t come without costs,” Even-Tov says. “There’s the cost of disclosure for companies and that trickles down to consumers. I think we need to consider the costs when we ask for more disclosures.”
“It’s easy to ask companies to disclose more,” he adds, “but what’s crucial is to measure the impact the disclosures have. That’s what we, as accountants, are endeavoring to do.”
The average transaction fee paid by retail investors to buy or sell corporate bonds fell 5% after regulators forced brokers to disclose these fees, according to new research co-authored by Berkeley Haas Asst. Prof. Omri Even-Tov.
The fee disclosure, which brokerage firms fought for about two decades, finally took effect for some corporate and municipal bond trades in 2018. This paper is the first academic research to examine its impact on trading costs for corporate bonds, and the findings highlight the need for regulators to provide better disclosures to retail investors, Even-Tov said.
“If their fees were fair before this, we shouldn’t have seen any effect, but we do find a reduction,” he said. “They were charging higher fees than they should have been.”
If their fees were fair before this, we shouldn’t have seen any effect, but we do find a reduction…They were charging higher fees than they should have been. —Asst. Prof. Omri Even-Tov
Hidden markups
When companies sell bonds to investors, they are borrowing money. After they have been issued, these bonds are bought and sold “over the counter,” between broker-dealers who trade them with their clients. When a broker charges a client more than the prevailing market price, it’s known as a markup. The difference represents the broker’s profit and the client’s trading cost—akin to a commission.
Until recently, investors had no easy way to know how much they were paying their brokers because the markup was not disclosed; it was embedded in the bond’s price. For example, an investor might have seen that they paid $102.50 for the bond, but not that the firm had purchased it for only $100.
Knowledgeable investors could estimate the markup by looking up the bond’s trading history in a database known as Trace—short for Transaction Reporting and Compliance Engine. They could then negotiate with their broker for a lower markup.
“However, estimating markups imposes information processing costs on investors, potentially creating information asymmetry between unsophisticated investors and bond-market professionals,” wrote the authors, who include Christine Cuny of New York University’s Stern School of Business and Edward Watts from the Yale School of Management.
New disclosure rule
In 2016, the Financial Industry Regulatory Authority, Wall Street’s self-regulator, adopted a rule that required broker-dealers to disclose their markups when they buy corporate bonds and sell them to retail (non-institutional) investors the same day. Brokerage firms take little risk of losing money on same-day trades. The disclosure applied to such trades starting in May 2018.
These markups appear in the confirmation investors receive after they’ve made the trade. That’s too late to negotiate a lower commission, but it could lead customers who previously didn’t know how big these markups are “to reevaluate their brokerage relationship.” Even-Tov and his co-authors wanted to know whether this had led brokers to reduce markups on trades subject to the disclosure.
To test this hypothesis, they used Trace to examine retail-size trades—which they defined as trades of $100,000 or less—during the six months before and six months after the rule took effect. They calculated the markup as the total cost that investors would incur to buy and sell a bond.
On average, they found the markup on same-day retail trades declined by about 5% compared to trades not subject to the disclosure, or from about $431 to $409 on a $50,000 trade, Even-Tov said.
The reduction was larger than average for the smallest trades. “These trades are likely executed by unsophisticated investors who have a limited supply of information processing capacity,” the authors wrote. They also found that the reduction in markups was more pronounced for less-liquid bonds, such as high-yield, long-duration and smaller issues.
Lower costs for consumers
Consumer groups had argued that this long-overdue rule change would give retail investors more information to make better decisions and foster increased price competition. The securities industry had contended that the implementation costs would be significant and passed on to investors. The authors said the 5% savings they observed was after any costs passed to customers.
Markups are large “because frictions in the over-the-counter bond market enable market professionals to take advantage of uninformed investors,” the authors wrote.
“Our findings show that disclosure requirements function as a regulatory tool, and constrain financial professionals’ opportunistic behavior,” Even-Tov said.
The paper, entitled “From implicit to explicit: The impact of disclosure requirements on hidden transaction costs,” is forthcoming in the March edition of the Journal of Accounting Research. Read it online here.
The iconic Charging Bull statue stands in the Financial District of Lower Manhattan, NYC. (AP File Photo by: zz/STRF/STAR MAX/IPx 2020 6/14/20)
A new study has found compelling evidence that some credit rating analysts leak information about upcoming rating changes to Wall Street to advance their careers.
The paper, co-written by Omri Even-Tov of Berkeley Haas and Naim Bugra Ozel of the Wharton School and the University of Texas at Dallas, highlights a potential concern for investors, credit issuers, and the Securities and Exchange Commission, tasked with ensuring fair rating information to all market participants. The paper is forthcoming in the Review of Accounting Studies.
“Our evidence suggests that some rating analysts share confidential information about upcoming rating changes with institutional investors, for whom they later go to work,” said Even-Tov. “This is not only problematic for investors whose trades may be front-run by those with advance knowledge of rating changes, but also for credit issuers who share private information with the credit agencies, since it may not stay private for long.”
Our evidence suggests that some rating analysts share confidential information about upcoming rating changes with institutional investors, for whom they later go to work.
Price movements before announcements
Even-Tov and Ozel examined how companies’ stock prices fluctuate before public announcements of their credit ratings. They found that stock prices start moving in the direction of upcoming downgrade announcements even when there is no other news about the stock.
“Before rating agencies make public announcements about rating changes, they first privately notify the issuing company,” Even-Tov says. “We set out to study whether there is informed trading between the private notification and the public announcement, which is typically no more than 48 hours.”
The researchers examined more than 1,000 credit rating change announcements from the three major reporting agencies—S&P, Moody’s, and Fitch—between 2001 to 2017. They combined this with data on intraday stock returns, which allowed them to see how stock prices fluctuated within short time periods.
In line with prior research, they found significant, but modest, stock price changes immediately after credit rating announcements, particularly for rating downgrades. In the two hours following a downgrade announcement, stock prices declined by between 0.1% and 0.9%. Stock prices increased by about 0.1% to 0.2% following a rating upgrade.
Interestingly, these returns were modest in part because of large stock movements that came before the official rating was publicly announced. In the 48 hours before an announcement—a period when the rating report is typically finalized and forwarded to credit issuers for review before publication—they found that stock prices declined by up to 1.5% for a rating downgrade and increased by up to 0.4% for a rating upgrade. Institutional investors tend to be net sellers in the 48 hours ahead of downgrades.
Even-Tov and Ozel looked at the factors that might explain these pre-announcement stock returns and whether there was any evidence of informed trading. Many rating announcements occur after other important corporate news events, such as earnings or merger announcements, which could drive stock price changes. When the authors removed such announcements from their data, they still found significant price changes within the 48-hour pre-announcement window (and not prior to that period).
They then looked at whether investors may have anticipated credit rating announcements based on other publicly available information. They found that corporate news and investor anticipation explained pre-announcement movements for rating upgrades, but still could not fully explain stock movements before rating downgrades.
Looking for signs of informed trading
A third explanation for stock movements immediately prior to rating announcements is that some form of informed trading is occurring. This is of course illegal, and insider trading can lead to financial penalties or jail time.
Even-Tov and Ozel scrutinized the analysts named in credit announcements and whether they possibly passed along information to institutional investors. They separated out those who stayed with their credit agencies from those who later switched jobs to an asset management firm. They found that pre-announcement returns are significantly stronger when one or more of the credit analysts who prepared the report later pursues a career in the asset management industry. In those cases, stock returns were 2% lower in the 48-hours before the downgrade announcement. Moreover, they also found that institutional investors are those who benefit in these cases—they are net sellers. In contrast, they found insignificant returns if the analyst stayed with the reporting agency.
In contrast, they did not find any evidence that insiders from the issuers traded on information about upcoming rating changes—in fact, they found that insiders generally reduce their trading in the sensitive period ahead of downgrades, perhaps out of fear of running afoul of regulators. That further implies that the leaked information from analysts drives stock returns.
Our paper shows yet another example of the revolving door on Wall Street, which should draw the attention of the SEC and credit agencies.
“Our paper shows yet another example of the revolving door on Wall Street, which should draw the attention of the SEC and credit agencies,” says Even-Tov.
