Corporate sustainability reporting will move forward despite uncertainty, experts say

Viviana Alvarez Sanchez, former head of sustainability for Unilever North America, moderates the opening panel at the CFRM conference.

With the Securities and Exchange Commission’s long-awaited climate-disclosure rules blocked by litigation, public companies will continue to operate with a patchwork of laws and standards on sustainability reporting for the near future. 

But the consensus among the investors, corporate sustainability officers, accountants, CFOs, and standard setters who gathered at Haas in March was that markets have already moved,  with thousands of companies already disclosing information about their carbon emissions and climate risk exposures. In fact, many public and private companies are subject to new reporting regulations in California and the European Union, and investor pressure for increased transparency on climate risk disclosures and other sustainability issues will only continue. 

“We’re in a time of regulatory and macroeconomic uncertainty, but that does not mean corporate sustainability reporting is not marching forward,” said Professor Panos N. Patatoukas in his opening remarks at the CFRM 27th Conference on Financial Reporting. “What we measure is what we treasure. My hope is that improved measurement will lead to more efficient allocation of capital in society, which could, hopefully, accelerate the transition to a more sustainable economy.”

Professor Panos N. Patatoukas, faculty director of the Center of Financial Reporting Management (CFRM) and co-faculty director of the Sustainable and Impact Finance Initiative at Berkeley Haas.

The March 20 conference, organized by the Center for Financial Reporting and Management, was titled “Corporate Sustainability Measurement & Reporting: From Whether, to How.” It was co-hosted by the Sustainable & Impact Finance (SAIF) initiative. 

Former Haas dean and Professor Laura Tyson, former chair of the Council of Economic Advisers and a senior advisor to SAIF, gave opening remarks that stressed the importance of consistency for both companies and investors. 

 “This is incredibly important and it’s all happening right now,” Tyson said. 

Laura D. Tyson, professor of the graduate school and former Berkeley Haas dean

Tyson noted that in the United States, the discussion tends to be about actions that companies take that may have a financial consequence for investors—known as financial materiality. While materiality is the focus of the SEC’s proposed rules, it’s just one part of the discussion, she noted: The second part is non material items that may be important to society or shareholders.

“We have had for a very long time, organizing our financial markets, a set of acceptable standards for traditional financial measures,” Tyson said. “Every firm has to apply them. Every accounting firm has to make sure firms apply them. We need something like that in the standards for sustainability. I think we’ll get there, but Europe may get there before us.”

 The company perspective

The first panel of the day focused on companies’ perspective, featuring Joe Allanson of Salesforce, Claire Boland of Joby Aviation, R. Paul Herman, CEO of impact investing firm HIP Investor, Sydney Lindquest, ESG director for energy services company SLB, and Douglas Sabo, former chief sustainability officer for Visa.

“Concerns by society quickly turn into shareholder concerns,” Allanson, Salesforce’s EVP of Finance ESG, noted. 

One effect of the increased focus on sustainability disclosure is that accountants have had to move outside their traditional silos, communicating across companies more widely. He joked that the array of new rules from the SEC, California, and the EU amounts to a “full employment act for accountants.”

Assurance and verification

A panel on assurance included (from left to right) Anita Chan of KPMG, Marie Hache, ESG Partner at PwC, Deloitte Partner Laura McCracken, Mallory Thomas of Baker Tilly, and (not pictured) Trip Borstel of EY. They emphasized the importance of building trust through reporting that is relevant, reliable, and verifiable. 

The panelists emphasized the need to restore trust with a global baseline of corporate sustainability reporting that uses standardized measurements and definitions. 

“We’ve been on a journey, and the next five-to-eight years are going to be really interesting in terms of what happens with the SEC rules and the legal issues,” McCracken said.

Chan echoed Patatoukas’ remarks: “You can’t manage what you can’t measure.”

The panel discussion also highlighted the need for corporations to develop processes, incentives, and governance mechanisms that integrate traditional financial reporting with sustainability reporting.  

Andy Behar, CEO of As You Sow (above left), served as moderator. “Hope is not a strategy. We are starting to get action,” he said. 

Setting standards

Berkeley Law Professor Stavros Gadinis moderated a discussion on standard setting that included Verity Chegar of the International Sustainability Standards Board (ISSB), former U.S. Department of Energy advisor Kate Gordon, and Katie Schmitz Eulitt, of the International Financial Reporting Standards (IFRS) Foundation.

Despite the fear that we’ll end up with separate sustainability reporting standards—imposed by the SEC, the EU, and California—the panelists agreed that convergence on reporting standards is in everyone’s interest.  

“This is a global issue that doesn’t happen within boundaries,” said Gordon, who served as senior advisor to both U.S. Energy Secretary Jennifer Granholm and California Gov. Gavin Newsom. “There does need to be consistency for companies since they can’t parse the different rules.

Asked why climate risks should be singled out in audit reports above other risks—such as cyber threats or policy changes—Gordon emphasized that “climate risk is different because the risks are known, and they are predictable. They are already in the atmosphere from things we did 50 years ago or more.”

Even the election outcome won’t likely turn back the movement toward more disclosure, Schmitz Eulitt said. “Let’s just inhabit a world where the climate rule gets thrown out. My instinct is that if it’s a material issue, you have to disclose it. Investors are asking for it,” she said.

Gordon (center), with Chegar (left) and Schmitz Eulitt (right)

Investors’ perspective

The last panel of the day focused on the investors’ perspective and included Nuveen Senior Director Anthony Mark Garcia, Jonathan Hudacko, MBA 01, personal investing principal at Vanguard, Jamie Nulph, MSCI’s executive director of climate and sustainability, Anne Simpson, Franklin Templeton’s global head of ESG, and State Street’s Karen Wong, global head of ESG investing.  Patatoukas served as moderator.

Patatoukas emphasized that “climate risk, which includes both physical risks from environmental changes and transition risks related to moving towards a lower-carbon economy, is increasingly acknowledged as a significant investment risk.”

Wong said reporting standards are critical as more investors ask to incorporate sustainability metrics explicitly into their portfolios. “We have some investors who really care about climate change risk,” she said. “I think it’s important to provide a choice for investors. It’s their money, not ours.”

Asked about the strategy of divestment versus engagement, Simpson, who also teaches MBA, MFE and undergraduate classes at Haas, encouraged students who want change to embrace the complexity of the moment. “If you want to feel pure, roll up your sleeves and walk away,” she said. “If you want real change, you have to roll your sleeves up and get involved.”

Meredith Albion, FTMBA24 (right), worked for a credit ratings firm before attending Haas. She has focused much of her time at Haas on sustainable investing. She is currently a student principal of the Haas Sustainable Investment Fund and is a member of the SAIF Student Advisory Board.

U.S. News ranks Berkeley Haas FTMBA Program #7 in 2024

The Berkeley Haas Full-Time MBA Program claimed the #7 spot among full-time programs in the 2024 U.S. News & World Report Best Business Schools ranking.

The FTMBA program moved up four slots to tie for #7 with the Yale School of Management and NYU’s Stern School of Business. Except for 2021 and 2023, the FTMBA has ranked #7 since 2019.

Meanwhile, the Evening & Weekend Berkeley MBA Program ranked #2 this year among part-time MBA programs. The Berkeley Haas MBA for Executives Program placed #7 among EMBA programs and is now the top executive MBA program at a public university in the nation. This ranking is based solely on ratings by business school deans and directors. 

The 2024 FTMBA ranking, released today, reflects positive changes that U.S. News made to its rankings methodology, said Haas Dean Ann Harrison. 

The ranking reflects all of the work Haas is doing to strengthen its programs and reputation, she said. “There are many different ways of evaluating a school, and rankings go up and down for all of us,” she said. “The change in the U.S. News methodology, with less emphasis on starting salary upon graduation, is a positive step.”

A few details on the rankings methodology used this year:

  • Employment rates at graduation – 7% weighted  (previously 10%)
  • Employment rates three months after graduation – 13% (previously 20%)
  • Mean starting salary and bonus – 20%
  • Ranking salaries by profession – 10%
  • Peer assessment score – 12.5%

Haas ranked #5 in salaries, which were ranked this year by profession (tied with Chicago Booth). Harrison noted that alumni accept jobs in a variety of industries, which logically means a variety of pay scales. 

“This is true for Haas, as well, where graduates prioritize where they can make the biggest impact, whether that is in consulting, product management, fintech, or by founding a new company,” she said. “I applaud U.S. News for taking into account the reality of the wealth of opportunities for a b-school graduate and comparing apples to apples across all the schools it surveys.”

Assessment by the school’s FTMBA peers was strong this year, at #7 (tied with Columbia) and the school ranked #9 for its recruiter assessment. Haas also had the highest GMAT score, tied at #1 with Stanford, Harvard, Wharton, Kellogg, and Columbia.

In specialty rankings, based solely on peer assessments, U.S. News ranked the full-time MBA program:

  • #4 in nonprofit
  • #4 in entrepreneurship
  • #4 in real estate
  • #7 in business analytics
  • #7 in management
  • #8 in finance
  • #10 in marketing

Research challenges relevance of popular ESG scoring models for investment returns

Photo illustration shows a woman's hands typing on laptop and pointing to a checklist labeled environmental, social, governance.
Image credit: AdobeStock

The ESG investing industry has attracted trillions of dollars, in part through marketing that tells investors they can “do well by doing good.” 

Thousands of funds and other investment products have been created around the idea that identifying companies with rising scores on environmental, social, and governance (ESG) measures can lead to market-beating returns. 

Yet a new paper co-authored by Berkeley Haas accounting professor Panos N. Patatoukas, forthcoming in The Accounting Review, suggests that outperformance attributed to improving ESG scores—as measured by current standards—may be a mirage.

“Sorting out correlation from causation is critical in the debate over ESG investing, and we found correlation, not causation,” Patatoukas says. “Our research finds there’s no hidden information in proprietary ESG scores beyond what is already contained in easily accessible financial reports.” 

The researchers—who include Byung Hyun Ahn, PhD 21, of Dimensional Fund Advisors, and George S. Skiadopoulos of Queen Mary University of London—found that larger, more stable, and more profitable companies are the ones more likely to have their ESG scores upgraded. These are the companies with the most resources to devote to fixing any weaknesses in their ESG scores and promoting their improvements. 

But any above-market returns attributed to ESG scores disappeared when the researchers controlled for revenue, growth potential, and other factors used in traditionally used to screen stocks. 

“Trillions of dollars of value have been allocated according to the idea that you can do the right thing and beat the market,” Patatoukas says. “Our data challenge this idea.”

“Trillions of dollars of value have been allocated according to the idea that you can do the right thing and beat the market. Our data challenge this idea.” —Professor Panos Patatoukas

The research does not imply that companies should turn away from efforts to reduce their carbon footprints, become more socially responsible, and be better corporate citizens—rather, those efforts must accelerate in the face of the climate crisis, Patatoukas says. He argues it’s the ESG measurement system that needs a major overhaul to incorporate information that goes beyond what is already reflected in corporate financial statements in order to give investors the transparency to make decisions in line with their values.

Questioning ESG frameworks

As of late 2023, $2.74 trillion was invested globally in funds that track companies with better sustainability scores, according to Morningstar. Last August, Bloomberg counted 14,500 funds with ESG called out in their prospectuses, holding $7 trillion in assets. And despite a recent political backlash and some $13 billion in outflows last year, trillions remain invested in ESG funds globally.

The question of whether ESG issues have a material impact on stock prices is critical to the industry. The search for an answer has spawned an ecosystem of standard-setting organizations, rating agencies, and index providers. At the foundation of this ecosystem is a materiality framework with industry-specific disclosure standards developed by the Sustainability Accounting Standards Board (SASB). 

Prior academic research, as well as researchers at McKinsey, Charles Schwab, Morgan Stanley, and others, have found that companies with higher ESG scores can match or exceed benchmark-adjusted returns, often due to factors like lower costs, less regulatory pressure, and higher productivity. Such outperformance, known as “alpha,” is the holy grail of the investing industry.

“Index fund managers and index providers often cite evidence of ESG alpha as evidence of the value of the SASB materiality framework,” Patatoukas says, adding that some financial leaders might even cherry-pick benchmarks to show above-market returns.

Yet Patatoukas and his co-authors showed ESG alpha to be elusive. Through an analysis of the MSCI/KLD indicators of ESG strengths and weaknesses for U.S. public firms, they concluded that financially established companies—characterized by larger size, lower growth, and higher profitability relative to their sector—are associated with higher ESG scores because they are more likely to resolve material weaknesses and create strengths in their ESG scoring. But there’s no new information embedded in a rising ESG score that hasn’t already been priced into a stock’s price, he says.

“Our evidence shows that a simple benchmark portfolio based on established firms is indistinguishable—both in terms of performance and overall ESG score—from a portfolio based on firms with rising ESG scores,” he says. “Investors could target an overall ESG score by selecting portfolio stocks on fundamental firm characteristics, which is simpler and cheaper.”

“Investors could target an overall ESG score by selecting portfolio stocks on fundamental firm characteristics, which is simpler and cheaper.” 

As an external validity test, the researchers also analyzed the performance of the Bloomberg/SASB index family powered by State Street’s “Responsibility Factor” (R-Factor), which is aligned with the SASB materiality framework and draws from several alternative ESG data sources. They found that,  compared with matched benchmark indices that do not incorporate ESG considerations, the Bloomberg/SASB indices do not generate additional returns. 

Troubling lack of transparency

Patatoukas finds the current system troubling for a few reasons. First off, socially and environmentally responsible small and mid-sized companies may be penalized because they have fewer resources to devote to the logistics of ESG reporting. Second, the current frameworks might allow a company to get upgraded even if it becomes less environmentally efficient, and might penalize a company for being more transparent than its competitors. 

For example, a company might opt to be fully transparent and include data on all of its contractors—including carbon emissions from their activities, and even injury rates experienced by contract workers. Another company might only include its direct employees and receive higher ESG scores.

The research also takes issue with the premise that more environmentally and socially responsible portfolios need to outperform the market—the very idea of “doing well by doing good.” Though this may be possible, investment outperformance is not an indication of environmental or social progress, but rather a measure of capital transfer across investors who are buying and selling, he says. 

“Social welfare creation involves directing investments toward companies and projects that positively impact society and the environment,” he says. “The time is ripe to evaluate the real effects of corporate sustainability reporting in terms of mobilizing capital to enable the transition to a more sustainable economy.”

New measurement targets

So what should be measured to allow people to make investment choices in line with their values? That question will be a key topic of a conference on March 20 at Berkeley Haas organized by the Center for Financial Reporting and Measurement, titled “Corporate Sustainability Measurement and Reporting: From Whether to How.”

Patatoukas says we’re getting closer to measuring what matters with ESG in terms of a company’s carbon emissions. This metric comes with strong measurement incentives. California is leading the charge with the first-in-the-nation disclosure requirements about carbon emissions. For example, under the Climate Corporate Data Accountability Act coming into force in 2026, California will mandate that both public and private companies with more than $1 billion in revenue disclose details about their carbon emissions. 

The European Union has its own environmental disclosure requirements under its Corporate Sustainability Reporting Directive (CSRD), which applies to non-EU entities that meet certain thresholds. The U.S. Securities and Exchange Commission approved new rules this month on how companies should disclose climate risks, but they were almost immediately halted by a federal court.

Efforts at greater transparency could falter if firms don’t accurately measure indicators that meaningfully capture, in granular detail, each of the individual performance factors of ESG, Patatoukas says. This will require the intersection of different disciplines—finance, accounting, economics, operations, climate science, and software engineering. 

“The massive opportunity here is measurement—to go beyond measuring the companies that are good at checking all the boxes and develop a way to measure those that make significant strides towards our decarbonization path,” Patatoukas says. “Better measurement will facilitate more efficient allocation of capital and accelerate transition to a more sustainable future.”

Research in Action: The SEC looks to Haas research on SPAC rule change to protect investors

Special Purpose Acquisition Companies, known as SPACs, were a hot new investing trend over the past couple of years. 

In this short video, accounting professor Omri Even-Tov explains how Special Purpose Acquisition Companies (SPACs) work, how his concerns that they harming individual investors drove his research, and how that research influenced the U.S. Securities and Exchange Commission to tighten up rules.

Even-Tov’s recent paper,  Are SPAC Revenue Forecasts Informative?“,  is co-authored with Michael Dambra of the University at Buffalo School of Management and Berkeley Haas PhD Kimberlyn Munever (George) and forthcoming in the The Accounting Review. (See full video transcript below.)


Hi everyone, my name is Omri Even-Tov and I’m an accounting professor at the Haas School of Business. You might have heard about SPACs, which was a pretty hot trend until recently. So my colleagues and I actually wrote a paper about SPACs because we had a feeling that they might harm investors.

But before we begin I want to describe to you a bit what a SPAC is and how it works. Let me go to my slides here for some help.

So SPACs are, first, Special Purpose Acquisition Companies. Those are blank-check companies that raise money via an IPO for the sole purpose of acquiring a private company. This transaction is also known as a de-SPAC. Now those SPACs are usually managed by a sponsor. The sponsor can be a private equity firm, a venture capital firm, a hedge fund, or in some cases it can also be an individual—like in the case of Chamath from Social Capital that you all know from the “All-In” a podcast.

So let’s assume in our case there’s a SPAC and this SPAC is called “Just another SPAC.” So this SPAC goes public via an IPO and they raise money. In our case they raise $500 million. Now the SPAC has between 18 to 24 months to try and identify a suitable target to acquire. So let’s assume that they managed to find this target. This target is called, “Some Private Company.” Now once they found the target, the shareholders of the SPAC need to vote on this transaction. If they vote yes, then we have an acquisition and this process is called a de-SPAC transaction and then good luck to all of us.

In the case that the shareholders vote no, or in the case that the SPAC wasn’t able to identify a suitable target, then there is no transaction and all of the money that was initially raised by the SPAC is returned to investors.

Now why is why are SPACs so interesting? They’re very interesting because in the last few years they actually outpaced the number of traditional IPOs.  So if we look at this figure you can see that this line counts the number of SPAC IPOs and this line is actually higher than the line of the traditional IPOs—and not just in terms of numbers but also in terms of volume and proceeds raised using the SPAC process. We can see that those bars that reflect SPAC IPO proceeds are actually higher than those of the traditional IPO proceeds.

So why are SPACs so unique that we decided to explore them and examine what’s happening with them? So a main difference between traditional IPOs and SPACs is that traditional IPOs do not have any protection from liability if they provide future-looking statements. So if they provide projections that are misleading or inaccurate, they’re going to be liable for them. In the case of SPACs, those are basically mergers as you saw in the in the in the slide, so they are entitled to a protection under the Safe Harbor rule that came out in 1995. And because of that many SPAC sponsor thought, ‘we basically have a shield from liability if we provide future projections of the companies.

So in our case, what we felt is that because of this theoretical shield, sponsors are going to take advantage of that and they’re going to issue very optimistic projections in order to entice retail investors and investors in general to invest in those companies. And this is exactly what our research finds. We find that SPAC companies, on average, provide very optimistic projections, and in most cases, they underperform. And unfortunately those projections lead to the attraction of a lot of retail investors—not so much institutional investors that are likely are able to steer away from those very optimistic projections. And because retail investors are attracted to those companies, they invest and in the long term they suffer from under performance. We also find that those companies are actually more likely to be sued in a class action lawsuit because this shield doesn’t shield you from everything. If you provide misleading information that is inaccurate then you’re going to be liable for that.

And so our paper was actually very instrumental in a new rule that the SEC issued just a few days ago about amendments being made to the rule about SPACs. And the SEC sites both a common letter that we wrote and our paper by stating that some of the amendments are directly related to that. The first change is to level the playing field between SPAC IPOs and traditional IPOs, and remove this protection from SPAC IPOs from providing future projections. The second thing is basically adding much more disclosure to the projections. How are they being made, who’s making those assumptions, what assumption are being made.

And this is in the hope of helping investors have better information about the companies they invest in. So hopefully this really helps protect retail investors.  We believe it does. Thank you for listening.

Trading Up

Absent fees, retail traders do better

Illustration of woman breaking through a cinder block wall to reach a large dollar sign.The advent of no-fee trading on platforms such as Robinhood has helped fuel an explosion in retail investing—and raised concerns that novices would be tempted to trade too often and lose more money.

But new research co-authored by Assistant Professor Omri Even-Tov shows this fear may be exaggerated: While average investors trade more when fees are removed, they also earn more.

“We show that portfolios don’t underperform just because of greater activity,” Even-Tov says. “In fact, net performance improves by about 11% annually, and this improvement is driven by savings from the removal of fees rather than changes in the returns of trades.”

In a new working paper, co-authored by doctoral student Kimberlyn Munevar, PhD 24, and professors from the University of Pennsylvania and MIT, the researchers analyzed a natural experiment by international trading platform eToro, which dropped fees on certain trades in different countries at different times over the past several years.

The staggered removal of trading fees allowed the researchers to compare investors’ behavior before and after fees were gone. Even-Tov and his co-authors looked at these patterns for over 40,000 investors between 2018 and 2019. They found that the removal of fees increased trading frequency by an average of about 30%. Having no fees also drew people to the eToro platform: New users grew by 172% in countries without fees and only 18% in countries where fees remained in place. The removal of fees also led people to hold significantly more diverse portfolios.

Though this study investigated non-U.S. markets, the researchers ran an analysis to demonstrate that the kind of retail trading conducted by their subjects corresponds with trading on American platforms.

These results come at a time when the U.S. Securities and Exchange Commission is considering whether to regulate one of the main ways that retail brokerage firms make revenue outside of commission, a process called payment for order flow. “Now regulators are looking at whether or not these new methods need to be reined in,” says Even-Tov. But regulatory bodies should be wary of pushing online trading platforms back toward a commission model when putting new policies in place, he says.

Shake On It

Personal relationships matter in lending

A man and woman shaking hands while sitting on a rocket fashioned out of a 100-dollar bill. The rocket is pointed upwards.

Numbers are important when it comes to loans. Lenders look at companies’ financial statements and loan history when determining interest rates or loan terms.

But in the competitive landscape of loan acquisition, it’s not just about crunching numbers. Loan officers and borrowing managers are people, after all, and those who do repeat business build relationships. New research co-authored by Asst. Prof. Omri Even-Tov shows that the soft information accumulated in these relationships can reduce the costs of screening and monitoring and thus reduce the cost of debt.

“These relationships foster trust and reduce information gaps, allowing lenders to gain valuable information about a borrower’s sense of responsibility and overall creditworthiness,” says Even-Tov.

In fact, established relationships between loan officers and borrowing managers not only increase the likelihood of a loan but tend to improve loan conditions for the borrower without increasing risk for the lender.

Using a sample of loans from 1996 to 2016, Even-Tov and his colleagues compared one-off interactions with loans conducted by the same parties. In established relationships, the borrowers saw better interest rates and the lenders got better screening and monitoring as evidenced by fewer rating downgrades.

They also found that when a borrowing manager and loan officer left their jobs, the two firms were roughly 70% less likely to engage in business together.

Professor Yaniv Konchitchki: Is a soft landing still possible?

In this live interview on Wharton Business Daily, Associate Professor Yaniv Konchitchki discusses whether a soft landing is still possible and provides insights about the current state of the capital markets and the macroeconomy. Konchitchki argues, based on his research, that the Federal Reserve has made systematic and predictable errors, waiting too long to raise interest rates and letting inflation get out of control. He comments on whether further interest rates hikes are necessary, whether the Fed’s 2% inflation target is the right one, and discusses whether inflation can get under control without further hurting consumers, businesses, households, and the economy.

Konchitchki also refers to his new working paper, “Predictable Errors in Monetary Policy Communications and Decisions,” coauthored with Berkeley Haas professors Don Moore and Biwen Zhang.

Listen to the full interview:

Absent fees, retail traders do better

A new study is the first to document how removing commission fees on trading platforms improves returns for the average trader.

Photo of a professional woman looking at two monitors showing stock prices
Photo: iStock

The advent of no-fee trading on platforms such as Robinhood has helped fuel an explosion in retail investing—and raised concerns that novices would be tempted to trade too often and would lose more money.

New research co-authored by Berkeley Haas assistant professor Omri Even-Tov shows this fear may be exaggerated: While average investors trade more when fees are removed, they also earn more.

“There is a lot of debate about whether more activity among retail traders will harm their performance, and we show that portfolios don’t underperform just because of greater activity,” Even-Tov says. “In fact, net performance improves by about 11% annually, and this improvement is driven by savings from the removal of fees rather than changes in the returns of trades.”

In a new working paper, co-authored by Berkeley Haas doctoral student Kimberlyn George and professors Shimon Kogan from the University of Pennsylvania and Eric So from MIT, the researchers took advantage of a natural experiment by international trading platform eToro, which dropped fees on certain trades in different countries at different times over the past several years. The research also concluded that individuals craft more diverse portfolios when trading is free.

Boom in retail trading

The popularity of retail investor trading has skyrocketed in recent years. In 2020, more than 10 million Americans opened a new brokerage account. In the month of January 2021, six million more downloaded a financial trading app. There is, according to Deloitte, “an emerging class of individual retail investors” that now accounts for approximately 20% of all trading volume in U.S. stock and options.

A confluence of factors is behind these numbers, from accessibility through smartphones to stay-at-home orders during the pandemic. But central to this growth is the introduction of zero-commission trades, in which startups like Robinhood have done away with the longstanding convention of charging a fee for each trade.

“They’ve found other ways to support their operations, and now regulators are looking at whether or not these new methods need to be reined in,” says Berkeley Haas assistant professor Omri Even-Tov. “But what happens if we reintroduce commission fees? Nobody has an answer to that question.”

No fees means more trading and better performance

The trading platform eToro’s staggered removal of trading fees in different countries allowed the researchers to compare investors’ behavior before and after fees were gone. Even-Tov and his co-authors looked at these patterns for over 40,000 investors between October 2018 and November 2019.

The research design proved particularly powerful as it cut across three different dimensions of trading behavior. First, the researchers could look at how individuals changed their own behavior (if at all) when trading fees were removed. Second, they could compare trading behavior between individuals in countries with and without fees. And third, they could compare how individuals traded stocks that had no commission (non-leveraged trades) as opposed to those that continued to have a commission (leveraged and short sale trades).

Even-Tov and his colleagues found, first and most intuitively, that the removal of fees increased trading frequency by an average of about 30%. Having no fees also drew more people to the eToro platform: New users grew by 172% in countries without fees and only 18% in countries where fees remained in place. Interestingly, the removal of fees also led people to hold significantly more diverse portfolios. Most important, taking away fees improved net performance among traders.

The regulatory question

These results come at time when the U.S. Securities and Exchange Commission is considering whether to regulate one of the main ways that retail brokerage firms make revenue outside of commission, a process called payment for order flow. Though the new study looked at markets outside the U.S., Even-Tov and his colleagues ran an analysis to demonstrate that the kind of retail trading conducted by the subjects of their research maps neatly onto the kind of trading taking place on American platforms.

As a result, one of the implications from this work is that while stricter scrutiny of payment for order flow may be important for several reasons, regulatory bodies should be wary of pushing online trading platforms back toward a commission model when putting new policies in place.

“There is a common belief in this idea that if people trade more they will lose more, and that getting rid of fees encourages all kinds of irresponsible trading behavior,” Even-Tov says. “In fact, we found that a reduction in fees resulted in net savings, among other positive outcomes. So the SEC should tread carefully when it looks to monitor how retail trading platforms charge their users.”

Read the paper:

Fee the People: Retail Investor Behavior and Trading Commission Fees
By Omri Even-Tov, Kimberlyn George, Shimon Kogan, and Eric C. So
June 2023

In the data-driven world of lending, a personal relationship can still mean a better deal

Closeup shot of two two men shaking hands in an office
Credit: Peopleimages for iStock

In getting a good deal on a loan, numbers matter: Lenders look at companies’ financial statements and payback on past loans. Strong financial statements could mean a lower interest rate or better terms for the borrower.

But in the competitive landscape of loan acquisition, it’s not just about crunching numbers. Loan officers and borrowing managers are people, after all, and those who do repeat business build relationships and trust over time. The soft information accumulated in these relationships can reduce the costs of screening and monitoring, and thus reduce the cost of debt, according to new Berkeley Haas research.

“While two companies with the same credit score may appear similar on paper, our research shows that individual lending relationships can reveal important differences between them,” said Omri Even-Tov, assistant professor of accounting at the Haas School of Business. “These relationships foster trust and reduce information gaps, allowing lenders to gain valuable soft information about a borrower’s sense of responsibility and overall creditworthiness.”

Even-Tov’s forthcoming paper in the Review of Accounting Studies—coauthored by Xinlei Li of the Hong Kong University of Science and Technology, Hui Wang of the Renmin University of China, and Christopher Williams of the University of Michigan—shows that established relationships between a loan officer and a borrowing manager not only increase the likelihood of a loan, but tend to make the conditions of that loan better for the borrower without increasing risk for the lender.

These results, the researchers suggest, are increasingly important as technological innovation means fewer personal relationships in banking—and beyond.

Unique dataset

Even-Tov and his colleagues examined a sample of loans from between 1996 and 2016. They manually collected the signatures on these loans to determine the names of two key actors who are typically engaged in contracting negotiations and interact extensively. This laborious process allowed them to create a dataset comprising nearly 4,000 loans with 2,800 unique borrowing managers and 2,100 unique loan offices. The vast majority of these loans were one-off interactions, but some of them were conducted by the same loan officer and borrowing manager two or more times.

Comparing these groups, the researchers found that established relationships between lenders and borrowers proved favorable for both parties. For the borrowers, they led to better interest rates. For the lenders, they allowed for better screening and monitoring as evidenced by fewer rating downgrades.

The cost of turnover

They also found that when a borrowing manager and loan officer left their jobs, the two firms were roughly 70% less likely to engage in business together. These results were especially pronounced among smaller institutions, and with loan officers who manage fewer transactions, as these two groups rely more heavily on soft information accumulated in their relationships.

“This really quantifies a lot of anecdotal evidence about the importance of relationships, and it also sheds light on an underappreciated cost of turnover,” Even-Tov said. When an employee leaves a company, it’s a loss not only of their knowledge and skills, but their relationships, too. If a company loses its CFO, it has not only lost that distinct set of talents, but possibly the chance of getter better deals on loans. “Companies need to factor in these less-tangible assets of their employees.”

Decline in professional relationships

Even-Tov highlighted two related implications raised by this paper: New technological tools are driving a decline in professional relationships, and this is happening in industries beyond banking. He gave the auditing industry as an example. Auditors in previous years would be embedded in clients’ offices. They got to know the companies they were auditing, and the people who worked there. Today, a great deal of auditing is done remotely, or even automatically. The same is true for consulting, real estate, venture capital, and private equity. 

“We need to think about what we lose when technologies allow us to bypass the need for interaction between individuals,” Even-Tov said. “There are advantages to doing this work more quickly or from a distance, of course. But these changes also introduce costs, and this work makes some of those costs clear.”


Read the paper:

The Importance of Individual-Pair Lending Relationships
By Omri Even-Tov, Xinlei Li, Hui Wang, and Christopher Williams
Review of Accounting Studies (forthcoming)


Executives ignore SEC legal requirements to warn investors about inflation risk, new research finds

Illustration of a stock market graph next to a dollar bill
iStock/Getty Images

New research published in the Journal of Monetary Economics

BERKELEY, Calif.—Inflation is back with a vengeance. Prices of goods and services have risen at rates not seen since the 1980s, slamming households, small businesses, corporations, and governments at all levels.

But new research by Berkeley Haas Associate Professor Yaniv Konchitchki finds that most corporations that face significant risk from inflation have failed to disclose it. Inflation has caused trillions of dollars in shareholder stock price loss damages thus far and is threatening major additional losses for shareholders.

In a paper published in the Journal of Monetary Economics and coauthored with Jin Xie of Peking University’s HSBC Business School, the authors show that when it comes to inflation, companies widely ignore U.S. Securities and Exchange Commission (SEC) legal rules requiring them to disclose important risks to their business. The authors developed a novel approach to extracting the attitudes and beliefs of corporate managers toward inflation risk from SEC reports, by examining over 65,000 10-K annual reports filed by major corporations with the SEC from January 2005 to April 2021. They discovered that, despite SEC legal requirements to disclose risk factors, more than 61% of the companies at high risk when prices rise never mentioned inflation or used inflation-related words in the risk disclosure section of those reports.

The failure of exposed companies to disclose inflation risk is not a trivial matter. Securities laws require public companies to disclose risks to their business in order to protect investors. “Corporate executives do not follow the legal requirement to warn shareholders about inflation risk,” said Konchitchki, an expert on the interface between capital markets, corporate financial reporting, and macroeconomics. “Several trillions of dollars in shareholders’ wealth have been damaged, and more are at stake.”

Consider the losses on stocks over the past one-to-two years of rising inflation. Any individual or institutional investor who holds shares in companies, directly or indirectly—such as through retirement accounts—has suffered losses, Konchitchki said.

“Our textual analysis of corporate reports filed with the SEC reveal that executives in many of these companies never mentioned—even once over the past several years of our sample period—the word inflation, inflation-related phrases, or that the companies are highly exposed to inflation risk,” he added. “Diligent investors, plaintiff attorneys, and regulators should ask, and will probably be asking, ‘Why didn’t you tell us?’”

The paper’s findings and framework enable the identification and evaluation of shareholder damages—especially for firms with inadequate risk disclosures—and could transform corporate disclosure practices, inflation expectations, and monetary policy, Konchitchki said.

The risks of inflation

Inflation can hurt companies in a variety of ways. For example, companies currently hold in total hundreds of billions of dollars in cash on their balance sheets. “Inflation erodes the purchasing power of these cash amounts, generating massive losses that are not shown in their financial statements because the U.S. financial reporting regime is nominal—i.e., it ignores inflation effects,” Konchitchki said.

Furthermore, the authors show that inflation risk exposure is common across almost all industries. Restaurant chains that can’t raise menu prices as fast as the soaring costs of food see their profit margins squeezed—imagine a burrito and the avocados that go into it. Utility companies that need a regulator’s approval to raise prices when costs rise are also highly exposed to inflation shocks. Silicon Valley Bank collapsed recently because it was holding billions of dollars in long-term government bonds that plunged in value as the Federal Reserve raised interest rates to combat inflation.

Given inflation’s increasing prevalence, there are emerging examples across many industries that Konchitchki said he is monitoring to study the macroeconomic effects of inflation.

Damages to shareholders

Konchitchki and Xie identified companies highly vulnerable to inflation by looking for those that had seen their share prices drop following inflation shocks, that is, when inflation data was released showing prices had risen more than had been forecasted. “We developed a measure to determine the extent to which shareholder value was damaged by unexpected inflation,” Konchitchki explained. The authors found that 14-18% of the companies in their sample, calculated across all industries, are exposed to rising prices.

The failure to be warned about inflation risk could be devastating for shareholders. Konchitchki and Xie created a model to simulate stock price losses if inflation shocks occurred in a 2-6% range over three years. The model projected total shareholder damages of $0.9 trillion to $2.8 trillion for shareholders of inflation-exposed companies.

One thing did seem to change the practices of corporate executives: getting sued. Companies exposed to inflation that had been targets of shareholders’ securities class action lawsuits were more likely to begin disclosing inflation risk, the authors discovered. In contrast, companies that were not exposed to inflation risk did not change their reporting practices following such class action lawsuits.

‘Rational inattention’

Why would companies not discuss inflation dangers in their annual reports? Konchitchki doesn’t believe that executives are trying to pull the wool over investors’ eyes. After all, a failure to provide adequate disclosure puts executives and their companies in jeopardy of legal action and regulatory sanctions.

The most probable explanation, Konchitchki said, is “rational inattention”—the economic theory that decisionmakers can’t process all available information but can rationally choose which pieces of information to pay attention to. The potential damage from rising prices just isn’t on the corporate radar screen—perhaps especially among Gen X and Millennial managers who have never experienced periods of runaway prices. “Because inflation has been relatively low over the past decades and/or identifying the damages from inflation might have been too costly, executives haven’t been attuned to it,” he suggests. He predicts that in coming years executives will be more liable, and thus will pay more attention to inflation if they wish to reduce their legal liability and excel in their jobs.

This lack of attention is also a problem for Federal Reserve policymakers who have been loudly warning about inflation and its risks in a bid to manage expectations of corporations and other players in the economy. Konchitchki’s and Xie’s research shows that many executives aren’t getting the message.

Larger lesson

As a founder of a new research area that he termed macro-accounting, Konchitchki pioneered the examination of linkages between accounting data, capital markets, and the macroeconomy. He believes there’s a larger lesson in the failure to recognize the threat of rising prices in financial reports.

“There is a disconnect between executives and an understanding of the macroeconomy,” he said. “We’ve seen shortcomings in appreciation of how inflation can be disruptive. It’s important that corporate managers become more familiar with macroeconomic and accounting research and take a more holistic approach, considering how economic turbulence will affect the financial performance of their businesses.”

Going forward, given the increase in the level and fluctuations of inflation, the effects analyzed in the paper will be even more critical for executives, shareholders, attorneys, and the macroeconomy, he said. And the methodology developed in the paper can be generalized to other macroeconomic risks. “Executives can improve their companies’ performance and risk management by adopting a macro-accounting, research-based approach, which focuses on assessing the effects of current and forecasted macroeconomic fluctuations—such as inflation, recessions, wars, and other economic uncertainties—on their accounting performance metrics.”

Read the full paper:

Undisclosed Material Inflation Risk
By Yaniv Konchitchki (University of California, Berkeley) and Jin Xie (Peking University)
Journal of Monetary Economics­, March 2023

Counties cut public welfare spending when forced to disclose pension costs, study finds

Business man and woman working at office with laptop and documents showing high costs
Photo: Natee Meepian for iStock/Getty

When local governments were required to disclose their long-term pension liabilities, they responded by diverting funds away from public welfare, salaries, and hiring, a new study has shown.

The study, in press at the Journal of Accounting and Economics, examined the economic impacts of a 2015 rule known as GASB 68 issued by the Governmental Accounting Standards Board (GASB). While the rule did not directly affect pension plans themselves, it aimed to make governments more accountable by requiring them to disclose their full defined-benefit pension obligations, which are among the most significant liabilities for local governments.

“The disclosure requirements increased awareness and clarity about future funding requirements of pension obligations,” said co-author Omri Even-Tov, an assistant professor of accounting at the Haas School of Business, UC Berkeley. “In other words, the new requirement changed the information set of county managers who did not previously understand the future cash flow requirements of their pension plan.”

Even-Tov collaborated on the paper with Michael Dambra, an associate professor of accounting at the University at Buffalo School of Management and James Naughton, an assistant professor of accounting at the University of Virginia Darden School of Business.

Chronic pension underfunding

About 83% of full-time public sector employees—or more than 25 million people—participated in a defined benefit pension plan as of 2018, with annual payments costing governments more than $300 billion. However, long-term unfunded obligations far exceed these yearly payments: According to a recent study, the national public pension funding shortfall reached $6.5 trillion as of 2021.

Despite those obligations, municipalities tend to rely more heavily on their cash budgets in managing their annual financial cycle, the researchers wrote.

Even-Tov, an authority on the impact of accounting rule changes who has also studied how conflict minerals disclosure requirements reduced violence in Central Africa and how relaxed disclosures enacted to stimulate the IPO market harmed investors, wanted to know whether governments would change their budgeting when required to make their full pension liabilities public.

Public welfare reductions

The researchers analyzed data from census bureau reports and hand-collected GASB financial statements for 432 counties across 45 states from 2013 to 2016. About half of the counties in the sample had already been reporting their pension liabilities, but the other half had been exempt from disclosure rules because their pension liabilities were only reported as part of their states’ pension plans. GASB 68 removed this exemption, requiring them to report their share.

The analysis found that when counties disclosed underfunded pension costs for the first time, they reduced public welfare expenses by 6%, payroll by 2.5%, and employee headcounts by 2%. They generally accomplished this by freezing their budgets relative to the counties that had already been disclosing their pension obligations, rather than by raising taxes or finding other ways to increase revenues.

The findings are important because they demonstrate the real impact of financial regulation on governments.

“Despite the economic importance of the government sector, we know relatively little about how GASB financial statements influence the provision of resources,” Dambra said in a press release from the University at Buffalo. “Our study shows that mandatory disclosure in the public sector can influence local-level managerial decisions.”


Read the full study:

The economic consequences of GASB financial statement disclosure
By Michael Dambra, Omri Even-Tov, and James P. Naughton
Journal of Accounting and Economics (forthcoming)