Hedge Funds and Financial Misreporting

The growth of the hedge fund industry can be ascribed to its performance-based incentive compensation system as well as a lighter regulatory environment. These features, however, could also potentially create more opportunities for financial misreporting and even fraud. In response, recent research has attempted to detect misreporting by using due diligence information or by examining patterns in hedge fund returns. Empirical evidence suggests that hedge fund fraud can be usefully predicted from due diligence information, especially evidence of previous misrepresentation. Predicting misreporting from hedge fund returns, however, is much more difficult. This is because returns may reflect patterns in underlying assets instead of manager manipulation. For hedge fund investors, the good news is that the accumulated body of experience about detecting misreporting should help improve the quality of hedge fund investments. In addition, newly-imposed registration requirements for hedge fund advisors should also lower occurrences of misreporting.

Executive Network Centrality and Corporate Reporting

This paper investigates the association of corporate reporting and executive network centrality, which measures an executive’s relative position in a massive network consisting of outside corporate leaders. I find that high-centrality chief executive officers (CEOs) and chief financial officers (CFOs) are generally more likely to engage in financial misreporting than low-centrality CEOs and CFOs. I also find that the influence of CFO network centrality is greater than that of CEOs in financial misreporting. Further analyses show that the monitoring effect of internal governance mechanisms on high-centrality executives is very limited and that the discipline of the managerial labor market is weaker for high-centrality CFOs as well. My results hold for a subsample subject to exogenous shocks to CFO connectedness and are robust to a series of alternative specifications including using CFO fixed effects. Taken together, my findings suggest that corporate reporting can be influenced by executives’ social network position, with high-centrality CFOs using their social power to make adverse corporate reporting decisions to gain personal benefits. This paper was accepted by Brian Bushee, accounting.

The Economic Consequences of Financial Misreporting: Evidence from Employee Perspective

This study investigates the economic consequences of financial misreporting from the employee perspective. Specifically, we examine two employee reactions: (1) exiting from misreporting firms and (2) reducing holding of employer stock, in both the misreporting period and the post-restatement period. We find an increase in employee turnover and a decrease in employee holding of employer stock in the post-restatement period (restatement effect) and some evidence that employees start to react in the period of misreporting (misreporting effect). We also find some evidence that the misreporting effect varies with employee tenure in the misreporting period and the restatement effect varies with the severity of misreporting in the post-restatement period. We further show that our results are not driven by labor demand, increased likelihood of executive turnover, declining stock prices, internal control weakness disclosure, and poor firm performance.