Mozaffar N. Khan
James M. Collins Visiting Associate Professor of Business Administration
Mozaffar Khan is the James M. Collins Visiting Associate Professor of Business Administration. He teaches Financial Reporting and Control in the MBA Required Curriculum.
He is the Honeywell Professor of Accounting (on leave) and head of the accounting PhD program at the University of Minnesota’s Carlson School of Management where he has served since 2010, and previously served as an Assistant Professor at the MIT Sloan School of Management from 2005 to 2010.
Professor Khan’s research examines the role of accounting information in capital markets. In particular, he has examined the effect of accounting information and accounting quality on equity price formation, the interaction between equity prices and corporate equity issuance and acquisition decisions, the effect of government capital assistance programs on banks’ equity issuance and loan growth during the recent financial crisis, insider trading and short selling, the costs of corporate debt covenant violations, and measurement and effects of qualitative characteristics of accounting information such as accounting quality and conservatism. His research has been published in a variety of leading academic journals, and cited in media outlets such as The Wall Street Journal and The New York Times. His work with Leonid Kogan and George Serafeim on the stock price impact of mutual fund trading pressure has been recognized with a Whitebox Prize Runner-up award.
Professor Khan holds a PhD from the University of Toronto, and since 2009 has served as Associate Editor of the Journal of Accounting and Economics, one of the top 3 academic research journals in the area.
In his spare time Mo enjoys history, movies, and running.
Labor Unemployment Insurance and Earnings Management
There is relatively little prior evidence on the potential impact of rank and file employees on financial reporting choices outside union negotiations. We contribute to the literature by providing new evidence that firms appear to manage long-run earnings upward in order to manage employee perceptions of employment security. In particular, we exploit exogenous state-level changes in unemployment insurance benefits and test for partial unwinding of prior upward earnings management when benefits increase. An increase in unemployment benefits makes unemployment relatively less costly and reduces employees' unemployment risk, thereby reducing firms' upward earnings management incentives. Consistent with the hypothesis, we find a significant reduction in abnormal accruals, increased recognition of special items and write downs, and greater downward restatement likelihood, following an increase in state-level unemployment benefits. Cross-sectional tests suggest greater unwinding of prior upward earnings management when other upward earnings management incentives are weak, and when unemployment risk is a relatively more important determinant of firms' labor cost. Collectively the results provide new evidence of the impact of rank and file employees on firms' financial reporting choices.
Keywords: Earnings Management;
The Capital Purchase Program and Subsequent Bank SEOs
We find that in the aftermath of the recent financial crisis banks replenished only 12% of crisis-related losses through SEOs in 2009 and 2010. However, SEOs are disproportionately conducted by Capital Purchase Program (CPP) recipients, and this is not explained by CPP recipients' economic and regulatory capital needs. SEOs in 2009 and 2010 by CPP recipients alone account for 27% by number, and 52% by dollar amount, of all SEOs by U.S. banks between 1994 and 2010, indicating the CPP is an influential event in the history of U.S. bank SEOs during this period. Controlling for economic and regulatory capital determinants of SEOs, CPP recipients were more likely than non-recipients to have an SEO within four quarters subsequent to CPP receipt. SEO proceeds were used to repay CPP receipts without jeopardizing loan growth. Banks that received CPP funds prior to the passage of the American Recovery and Reinvestment Act (ARRA), and banks with greater reliance on non-traditional banking activities, were more likely to have an SEO expeditiously and repay CPP funds early. Collectively, the results provide new evidence on the realized consequences of the CPP for bank SEOs. The tests suggest the CPP's indirect costs of restrictions on corporate policies and actions as the most likely explanation for the results.
Banks and Banking;
Khan, Mozaffar N., and Dushyantkumar Vyas. "The Capital Purchase Program and Subsequent Bank SEOs." Journal of Financial Stability
(forthcoming). View Details
Mutual Fund Trading Pressure: Firm-Level Stock Price Impact and Timing of SEOs
In tests of the equity market timing theory of external finance, the prior literature has used overvaluation identifiers such as high market-to-book and high prior returns that are likely correlated with other determinants of SEOs. We use price pressure resulting from purchases by mutual funds with large capital inflows to identify overvalued equity. This is a relatively exogenous overvaluation indicator as it is associated with who is buying—buyers with excess liquidity—rather than what is being purchased. Using this indicator we document that 1) inflow-driven buying pressure by mutual funds has a pronounced and persistent stock price impact, 2) the probability of an SEO increases by 59%, 3) insider sales increase by 7%, and 4) the probability of completing a stock-based acquisition increases by 20% in the four quarters following the buying pressure. These results provide new evidence that firm managers are able to identify and exploit overvalued equity.
Are Accruals Mispriced? Evidence from Tests of an Intertemporal Capital Asset Pricing Model
This paper proposes a risk-based explanation for the accrual anomaly. Risk is measured using a four-factor model motivated by the Intertemporal Capital Asset Pricing Model. Tests of the model suggest that a considerable portion of the cross-sectional variation in average returns to high and low accrual firms is explained by risk. The four-factor model also performs better than some other widely used models in pricing a number of different hedge portfolios.
Estimation and Empirical Properties of a Firm-Year Measure of Accounting Conservatism
We estimate a firm-year measure of accounting conservatism, examine its empirical properties as a metric, and illustrate applications by testing new hypotheses that shed further light on the nature and effects of conservatism. The results are consistent with the measure, C_Score, capturing variation in conservatism and also predicting asymmetric earnings timeliness at horizons of up to 3 years ahead. Cross-sectional hypothesis tests suggest firms with longer investment cycles, higher idiosyncratic uncertainty and higher information asymmetry have higher accounting conservatism. Event studies suggest increased conservatism is a response to increases in information asymmetry and idiosyncratic uncertainty.
A Simple Model Relating Accruals to Risk, and its Implications for the Accrual Anomaly
This paper models systematic risk as a function of mean-reverting accruals. When the true abnormal returns are zero, but the true betas are empirically unobserved, the model predicts the anomalous pattern of empirical results on the accrual anomaly: (i) CAPM abnormal returns to an accrual hedge portfolio are positive on average, (ii) are positive in almost all years, (iii) decay as the holding period is extended beyond one year, and (iv) the Mishkin (1983) test of market efficiency is rejected. Using simulations, small and plausible degrees of risk mismeasurement also reproduce the magnitudes of prior results on the accrual anomaly.
Accounting Quality, Stock Price Delay, and Future Stock Returns
In frictionless capital markets with complete information and rational investors, stock prices adjust to new information instantaneously and completely. However, a substantial body of research studies information imperfections such as asymmetric information and incomplete information. Information imperfections potentially hinder timely price discovery and are likely associated with delayed stock price adjustment to information. Our first research question therefore is whether the quality of accounting information (or "accounting quality") is one such information imperfection that is associated with cross-sectional variation in stock price delay. We define accounting quality as the precision with which financial reports convey information to equity investors about the firm's expected cash flows. Poor accounting quality is likely associated with higher expected returns through uncertainty about stock valuation parameters and incomplete information. Our second research question therefore is whether the accounting quality component of price delay is associated with higher future stock returns. Consistent with our hypotheses, the results show that poor accounting quality is associated with delayed price adjustment and higher future stock returns. Thus, accounting quality plays a role in timely stock price discovery.
Do Short Sellers Front-Run Insider Sales?
We study the behavior of short sellers as informed market participants and examine potential sources of their information. Using a newly available dataset with high-frequency short sales data, we find evidence of significant increases in short sales immediately prior to large insider sales, but not prior to small insider sales. We examine a number of explanations that the increase in short sales is driven by public information, either about the firm or about the impending insider sale. The evidence is inconsistent with these explanations, but is consistent with front-running facilitated by leaked information. The front-running appears to be concentrated in firms with poor accounting quality, suggesting that information about a large insider sale reinforces short sellers' adverse opinion about firm value when accounting quality is poor.
Financial Services Industry;
Corporate Sustainability: First Evidence on Materiality
An increasing number of companies make sustainability investments, and an increasing number of investors integrate sustainability performance data in their capital allocation decisions. To date however, the prior academic literature has not distinguished between investments in material versus immaterial sustainability issues. We develop a novel dataset by hand-mapping data on sustainability investments classified as material for each industry into firm-specific performance data on a variety of sustainability investments. This allows us to present new evidence on the value implications of sustainability investments. Using calendar-time portfolio stock return regressions we find that firms with good performance on material sustainability issues significantly outperform firms with poor performance on these issues, suggesting that investments in sustainability issues are shareholder-value enhancing. Further, firms with good performance on sustainability issues not classified as material do not underperform firms with poor performance on these same issues, suggesting investments in sustainability issues are at a minimum not value-destroying. Finally, firms with good performance on material issues and concurrently poor performance on immaterial issues perform the best. These results speak to the efficiency of firms' sustainability investments, and also have implications for asset managers who have committed to the integration of sustainability factors in their capital allocation decisions.
corporate social responsibility;
Corporate Social Responsibility and Impact;
Accounting Quality and the Speed of Price Adjustment: New Evidence
We examine the role of accounting quality (AQ), defined as the reliability with which accounting earnings map into cash flows, in stock price formation. We expect that poor AQ is more conducive to fostering differences in higher-order beliefs among investors, and such settings have been shown in prior theoretical work to generate slow price adjustment. Consistent with this, we document significant one-month-ahead positive return predictability from good AQ firms to industry- and size- matched poor AQ firms, but no reverse predictability. In exploring the delayed-information-processing mechanism behind the return cross-predictability, we find that analyst earnings forecast revisions (FR) mimic the return patterns: FR of good AQ firms significantly positively predict one-month-ahead FR of matched poor AQ firms, but there is no reverse predictability. Further, return cross-predictability is concentrated in months with substantial news arrival, but not in no-news months, and is stronger when the good AQ predictor firms have a richer information environment than poor AQ firms as proxied by analyst following and institutional ownership. Finally, using a measure of the linguistic complexity of qualitative information in financial statements to alternatively index accounting quality, we document return predictability from good to poor accounting quality firms, but no reverse predictability. Collectively the results provide direct evidence that complicated accounting affects the speed with which information flows into stock prices.
Chen, Wen, Mozaffar N. Khan, Leonid Kogan, and George Serafeim. "Accounting Quality and the Speed of Price Adjustment: New Evidence." Working Paper, September 2015. View Details
Third-party Costs of Debt Covenant Violations
Using both quasi- and Precise-Regression Discontinuity designs we provide new evidence on third-party costs of technical defaults that have not been examined previously in the literature. In particular, we show that even where the violation has relatively low lender-imposed costs, firms incur significant third-party costs in the form of higher audit fees, stock return volatility and bid-ask spreads resulting from heightened uncertainty and information asymmetry. The presence of third-party costs highlights costs to the firm of having bright lines in contracts, suggests the importance of endogenizing third-party behavior in theoretical models of debt contract design, and the importance of a more comprehensive view of covenant violation costs.
Accor: Designing an Asset-Right Business and Disclosure Strategy
Sebastien Bazin was now in charge of Accor, the world's largest French hotelier, a CAC 40 company with 3,600 hotels in 92 countries and a market cap of €10 billion. Previously as the European head of Colony Capital, one of the largest private equity groups and the largest shareholder of Accor, Bazin had since 2005 relentlessly pushed an asset-lite strategy from his perch on the Accor Board in the face of vigorous opposition from employees, senior management, and some Board members. Accor's stock price underperformance and the continuous fight over the strategic direction of the company had created turmoil and turnover in the C-suite and on the Board. After multiple CEO exits, and a failure by the Board to identify the next CEO in 2013, Bazin's offer to resign from Colony and assume the CEO position at Accor was met with incredulity from friends, alarm from Accor employees, and applause from the stock market. But would Bazin be able to deliver on his promises to investors and employees to pursue an asset-right strategy? Was an asset-heavy hotelier viable in today's economic environment? Could the market understand and appropriately value such a firm and what could be its disclosure strategy to ensure a fair valuation of the stock? How long would it be before he could deliver on his promises and show fruit from the restructuring?