Accounting and Finance

Permanent URI for this collectionhttps://uwspace.uwaterloo.ca/handle/10012/9868

This is the collection for the University of Waterloo's School of Accounting and Finance.

Research outputs are organized by type (eg. Master Thesis, Article, Conference Paper).

Waterloo faculty, students, and staff can contact us or visit the UWSpace guide to learn more about depositing their research.

Browse

Now showing 1 - 20 of 20

Accounting Conservatism and the Consequences of Covenant Violations
(University of Waterloo, 2011-12-20T17:14:07Z) Li, Yutao
Recent studies document that covenant violations intensify the conflicts of interest between lenders and borrowers, and lead to greater restrictions on borrowing firms’ financing and investment activities (Chava and Roberts, 2008; Roberts and Sufi, 2009b). Motivated by this literature, I investigate whether accounting conservatism, specifically conditional conservatism, mitigates the adverse consequences of debt covenant violations. I argue that conservative reporting can potentially ameliorate the conflicts of interest between lenders and borrowers. Therefore, I predict that accounting conservatism reduces the adverse impact of covenant violations on borrowers’ financing and investing activities and exhibits a positive association with operating and stock market performance after covenant violations. I obtain a sample of 312 violating and 5,327 non-violating firm-quarters observations from U.S. non-financial public firms during the period of 1998 – 2007 to test my hypotheses. Using three measures of conditional conservatism and a composite measure of the three individual measures, I find that the degree of increase in borrowing firms’ conservative reporting between loan initiation and covenant violation is associated with smaller reductions in firms’ financing and investing activities in the post-violation period. Furthermore, my analyses provide some evidence that firms that increase conservative reporting exhibit better stock market performance, implying that conservative reporting is beneficial for shareholders after covenant violations. I find no evidence that increased accounting conservatism affects operating performance after covenant violations. My results continue to hold after controlling for pre-contracting unconditional and conditional conservatism. Overall, my dissertation provides evidence that conservative accounting practices followed by borrowing firms ease the adverse consequences of debt covenant violations. My dissertation contributes to the emerging literature on the effects of accounting quality on re-contracting outcomes after covenant violations.
Can Elicitation Methods Increase the Precision of Fair Value Estimates?
(University of Waterloo, 2016-12-21) Timoshenko, Lev
This dissertation is motivated by recent changes in financial reporting regulation effected by the adoption of IFRS in Europe, Australia, and Canada, and SFAS 142 (FASB 2001) and SFAS 157 (FASB 2007 and 2011) in the U.S., that significantly increased users’ exposure to fair values. The implementation of the fair value hierarchy, as well as the switch from amortization to impairment testing of goodwill, highlighted problems with auditing highly complex, judgment-dependent and inherently uncertain fair values. There is a concern that such fair values may not always be auditable, and that requiring auditors to provide positive assurance on them may necessitate changes to the financial reporting model. The dissertation consists of two parts, the process study and the elicitation study. The process study, using the audit of goodwill/cash generating unit (CGU) impairment under IFRS as a specific example, provides quasi-experimental evidence about the fair value auditing process which can help to better understand and improve the auditing of complex fair values. The study relies on an analysis of verbal protocols to develop an understanding of how auditors and valuation specialists deal with the task. The study finds that for all of the participants who developed an auditor’s range, the width of the range is many times the audit materiality, and intervals for the experienced auditors are narrower on average than those for junior auditors. There are signs of possible issues with both interpretation and application of fair value auditing and accounting standards across all groups of the participants. At least some of the issues with application of the standards appear to be related to judgmental shortcuts (heuristics) which have not been researched in a valuation task context in prior auditing literature. Some of the experienced and junior auditors do not appear to have a complete grasp of the applicable valuation methodology. Finally, the results shed light on the division of responsibilities between assurance and valuation groups and the use of third party experts when auditing fair value impairments. The process study contributes to the literature by obtaining direct quasi-experimental evidence on auditors’ and valuation specialists’ process when they perform a fair value auditing task, and investigating the process differences among auditors with different levels of experience and experts. The objective of the elicitation study is to develop techniques that can be used by auditors and valuation specialists when auditing complex fair values, by experimentally testing elicitation methods for fair value models’ parameters. The study tests two probability distribution elicitation methods - the cumulative distribution function (CDF) method and the credible interval (CI) method. Quantitative analysis performed in this study indicates that the CDF method has a potential to improve the participants’ unaided judgment regarding fair value intervals, at least for junior auditors, while the CI method does not yield similar improvement. When the two methods are compared to each other, the CDF method proves to be more effective for experienced and junior auditors, while the opposite is true for valuation specialists. The distributions developed with the help of the CDF method are subjected to the effects of anchoring heuristic to a lesser degree than those built using the CI method. Qualitative analysis based on verbal protocols in the elicitation study indicates that the CDF distribution elicitation method surpasses the CI method for the purposes of quantification of uncertainty inherent in complex fair value estimates. The study contributes to the literature by combining auditing and elicitation research in fair value auditing settings, and has a potential to improve the practice of auditing of goodwill and possibly other complex fair values, by providing information for the development of relevant decision aids.
Determinants of Undetected Unintentional Errors in Audited Financial Statements
(University of Waterloo, 2014-12-18) Hayes, Beverly Louise
This dissertation investigates the associations between financial restatements and characteristics of the parties responsible for preventing and detecting unintentional errors, i.e., boards (through their audit committees), management (through chief financial officers (CFOs)), and auditors. To conduct this investigation, I developed a theoretical model of restatement determinants that is more complete than models used in previous archival research as it includes characteristics of all three parties and the moderating effects of chief financial officers’ financial expertise and influence on the disruptive effects of organizational change. To identify restatements that correct unintentional error, I conducted automated text searches of over 10,000 restatement disclosures for language asserting or implying lack of intent. This language-based proxy is automated, direct, transparent, easily replicable, scalable, and classifies as error-correcting a smaller proportion of restatements as error-correcting than other proxies. I validated this proxy by contrasting the characteristics of the unintentional error restatements against other restatements based on theory-derived expectations. I find that annual financial statements restated to correct unintentional error(s) for years with Sarbanes Oxley Act of 2002 (SOX) Section 404 auditor’s opinions exhibit less net income smoothing, less earnings persistence, and less positive accruals than such firm-years of other restatements. Finally, I tested the theoretical model using logistic regressions and data from financial statements, proxy statements, and auditor’s SOX 404 opinions of 346 companies (i.e., 121 companies that restate to correct unintentional error; 121 companies without restatement matched by year, industry, and company size; and 104 companies with other restatements that proxy for restatements of intentional misstatement). Results show that of the three parties responsible for financial reporting quality, the CFO plays the major role with respect to unintentional error: The likelihood of restatement to correct unintentional error is decreasing in CFO financial expertise and influence, but only when companies are undergoing organizational change. Results also show that CFOs’ (audit committees’) financial expertise is more strongly associated with restatements that correct unintentional error (intentional misstatement) than intentional misstatement (unintentional error). However, I find no evidence of significant associations between auditor quality and either restatements that correct unintentional error or intentional misstatement. This research contributes to the emerging literature that examines variation in associations between type or severity of restatements and the influence of parties responsible for financial reporting quality. The new language-based proxy for restatements that correct unintentional error developed in this thesis will facilitate future research that uses type of restatement to proxy for constructs of interest.
The Effects of Audit Methodology and Audit Experience on the Development of Auditors? Knowledge of the Client?s Business
(University of Waterloo, 2005) Berberich, Gregory
This dissertation examines how differences between the strategic-systems audit approach and the traditional, transaction-based audit approach affect the content and complexity of client business knowledge in long-term memory, how these mental representations develop with experience, and how the representations affect risk assessment. Knowledge of the client?s business is essential to conducting an effective and efficient audit, but researchers have devoted little attention to how this knowledge is represented in memory and what effect it has on audit judgment. Moreover, proponents of the strategic-systems approach argue that this approach leads to the formation of a more-complex client business model and results in better audit judgments than the transaction-based approach. The study?s results contradict these claims, with the strategic-systems auditors having less-complex models than their TBA counterparts. Also, no experience-related differences were found in the client models, and risk assessments were only weakly affected by content and complexity differences between client models. After a variety of supplemental analyses, it was concluded that there is no evidence from this dissertation to suggest that the SSA methodology does not result in an auditor possessing an enhanced knowledge of the client?s business compared to that possessed by an auditor employing a traditional audit approach.
The Effects of Reward Type and Relative Performance Information on Budget Slack and Performance
(University of Waterloo, 2014-01-07) Presslee, Charles Adam
To motivate effort, organizations commonly use budget-based tangible rewards (e.g., gift cards, merchandise) in lieu of or in addition to cash rewards and they can distribute tangible rewards to employees either directly (employees are given merchandise directly) or indirectly (via a redeemable points program). In conjunction with various budget-based financial rewards, employees can receive feedback about how they performed relative to other employees. However, employees can intentionally misstate their expected performance (i.e., create budget slack) when participating in the budgeting process, impairing the usefulness of budgets for planning and motivation. This dissertation investigates the effects of different types of budget-based rewards (cash, tangible, or redeemable points) on budget slack creation and performance, and whether relative performance information [RPI] moderates these effects. As predicted, results from an experiment completed by 166 undergraduate students show that participants eligible to earn redeemable points create less slack (i.e., set more difficult performance budgets) than those eligible for cash or direct tangible rewards. Further, RPI provides participants with a descriptive norm that slack creation is socially acceptable, resulting in more slack. Although I do not find support for the predicted indirect relationship between reward type or RPI on performance via their effects on budget slack, I do find that the provision of RPI has a direct positive effect on performance. Finally, supplemental analysis shows that those provided with RPI and cash rewards outperform all others. These results suggest that firms choosing to provide budget-based tangible rewards and allowing employees to participate in the budgeting process should consider using a redeemable points system rather than providing rewards directly to eligible employees. Further, before deciding whether to provide RPI to employees, firms should weigh the positive direct effects of RPI on performance against its negative effects on budget slack creation. Last, if a firm does choose to provide employees with RPI because of its positive effects on employee effort, firms may be well-advised to offer employees budget-based cash rewards instead of budget- based tangible rewards or budget-based points rewards.
The Effects of Situated Client Identity and Professional Identity Salience on Auditor Judgments
(University of Waterloo, 2011-11-29T18:34:01Z) Bauer, Tim
Recent accounting research suggests that auditor identification or familiarity with their clients may be an additional threat to auditor independence, which may be mitigated by a strong professional identity (King 2002; Bamber and Iyer 2007). However, social identity theory suggests that a strong professional identity will only be effective if it is highly salient and thus readily activated. Yet, professional identity salience is argued to have diminished in recent years (Warren and Alzola 2009). I examine if the level of professional identity salience moderates the positive association between auditor agreement with the client and client identity strength, or the negative association between auditor agreement with the client and professional identity strength. I address these research questions using two experiments completed by experienced professional auditors. In the first experiment with an ambiguous audit judgment task, I examine client identity strength and professional identity salience at two levels each and measure professional identity strength. Results show that auditors with stronger client identities agree more with the client, but only when professional identity salience is not heightened. I do not find that auditors with stronger professional identities agree less with the client, even when professional identity salience is heightened. In the second experiment with an unambiguous audit judgment task, I examine client identity strength at two levels when professional identity salience is not heightened. Results are inconclusive as to whether auditors with strong client identities differ in their agreement with the client, relative to auditors with weak client identities. My research contributes to literature on auditor identification and independence by demonstrating the importance of professional identity salience, not just professional identity strength, on auditor judgments. I also show that threats to auditor objectivity can arise from client identity that develops even without a familiar client relationship.
An Examination of the Impact of Disclosure Regulations on the Market Reaction to TSX Open Market Repurchase Program Announcements
(University of Waterloo, 2010-01-11T19:39:13Z) Moore, James
This thesis investigates open market repurchase announcements by Toronto Stock Exchange (TSX) listed firms. First, I develop a comprehensive database of normal course issuer bids (NCIB) and report descriptive data on repurchasing activity between 1994 and 2005. I find that repurchase programs peak in 2000 and then decline. I also find evidence that repurchase programs are concentrated in certain industries. Next, using Compustat data, I investigate the characteristics of firms announcing repurchase programs. I find evidence that firms who announce repurchase programs are large in size and have high operating cash flows, low leverage, low share turnover and low dividend yields. I extend the repurchases literature by demonstrating that firms with low trading volume are more likely to initiate repurchase programs, consistent with an attempt to improve sell side liquidity. Finally, I investigate the market reaction to NCIB announcements. The results indicate that TSX firms experienced a significant market reaction to repurchase announcements between 1994 and 2005 as measured by both return and volume tests. I extend the repurchases literature by showing that announcement returns are higher for firms who followed through on their previous repurchase announcements. Little evidence exists of investor response to the disclosed reasons for repurchase programs.
How do tax and accounting policies affect cross-border mergers and acquisitions?
(University of Waterloo, 2007-09-21T20:00:28Z) Mescall, Devan
Using a large sample of mergers and acquisitions from 27 countries over a 16-year period, I investigate how differences in tax and financial reporting policies affect the premium and structure of cross-border mergers and acquisitions. I find evidence that firms pay a premium to reduce the tax risk associated with strict transfer pricing rules. Further analysis segments acquisitions into those that are strictly financial versus those that are more strategic. Financial acquisitions are those where the acquirer is making the purchase for investment purposes rather than strategic reasons. These financial transactions generally lead to less integration between the two companies and therefore less inter-company transactions involving transfer pricing. Evidence based on this segmentation suggests that only differences in transfer pricing risk for non-financial acquisitions are priced. The results suggest that while on average non-financial acquirers will pay a higher premium to reduce transfer pricing risk regardless of industry, only those in highly scrutinized industries with high levels of intangibles, such as pharmaceuticals, will demand a discount for transactions which increase transfer pricing risk. In tests of acquisition structure, I find that shareholder-level capital gain taxes influence the structure of an acquisition. The influence of shareholder-level taxes is reduced by the presence of information asymmetry concerning the acquirer’s stock value. However, higher quality financial reporting reduces information asymmetry and improves the tax efficiency of acquisition structure providing tangible economic benefit to shareholders.
How incentive contracts and task complexity influence and facilitate long-term performance
(University of Waterloo, 2009-08-07T19:26:19Z) Berger, Leslie
The purpose of this study is to investigate how different incentive contracts that include forward-looking and contemporaneous goals motivate managers to make decisions consistent with the organization’s long-term objectives, in tasks of varying complexity. Two research questions are addressed. First, in a long-term horizon setting, how do incentive contracts based on various combinations of forward-looking and contemporaneous measures influence decisions? Second, how does task complexity influence the expected effect of various incentive contracts on management decisions? I address my research questions using a multi-period experiment where I compare the effects of three different incentive structure types and two different levels of task complexity. Results show that in a low complexity task, individuals perform better when only contemporaneous goal attainment is rewarded in the incentive contract than when both forward-looking and contemporaneous goal attainment is rewarded. In a high complexity task, individuals perform better when both contemporaneous and forward-looking goal attainment is rewarded, but only when the contemporaneous goal attainment is weighted more heavily in the incentive contract. My research contributes to the existing literature in two ways. First, this is the first study of which I am aware that compares the performance effects of long-term incentive contracts that reward forward-looking and contemporaneous goal attainment. Second, this study is the first of which I am aware to experimentally test incentive contracts, for employees with a long-term horizon, that incorporate various weightings of forward-looking measures in the contract. In addition, this study will be amongst the first to examine the impact of task complexity on incentive contract effectiveness.
THE IMPACT OF EARNINGS MANAGEMENT AND EXPECTATIONS MANAGEMENT ON THE USEFULNESS OF EARNINGS AND ANALYST FORECASTS IN FIRM VALUATION
(University of Waterloo, 2008-01-16T16:08:26Z) Tian, Yao
In this dissertation, I examine the impact of earnings management and expectations management on the usefulness of earnings and analyst forecasts in firm valuation. Earnings and analyst forecasts are important inputs into accounting valuation models. Their ability to reflect current and predict future firm performance can help valuation models predict intrinsic value. However, increasing earnings management and expectations management activities in recent years may have adversely affected the usefulness of these information items in firm valuation. This study shows that intrinsic value metrics estimated using manipulated earnings or forecasts have less ability to track stock prices and predict future returns through V/P ratios, providing evidence for the joint hypothesis of (i) long-term market efficiency and (ii) the negative impact of earnings management and expectations management on the usefulness of earnings and analyst forecasts in firm valuation. It contributes to the accounting literature in several ways. First, it challenges the conventional view that more accurate and less biased forecasts are necessarily of better quality and proposes to assess the quality of analyst forecasts directly by examining their usefulness. It also introduces an improved measure for expectations management and presents new evidence on (i) the usefulness of earnings and analyst forecasts in firm valuation; (ii) the negative impacts of earnings management and expectations management on this usefulness; and (iii) the overall performance of accounting valuation models in firm valuation.
The Impact of the Transfer of Intangible Assets on the Valuation Effects of High-Tech Cross-Border Mergers and Acquisitions
(University of Waterloo, 2009-09-04T15:17:16Z) Sinclair, Andrew John
The technology industry is characterized by a greater than usual reliance on intangible assets. During the tech bubble many firms were valued entirely on intangible assets and growth prospects. In the aftermath of the bubble, intangible assets still play an important role as the innovative performance of a firm’s human capital and the value of its patents creates much of the value of high-tech firms. The problem of transferring human capital and knowledge may be further exacerbated when the firms belong to separate national cultures. Investor perception of acquisition announcements may be more favourable if the target workforce is much smaller relative to the bidder, and thus easier to integrate. Also, perceptions may be favourable when the target has a high ratio of intangible assets to total assets, as this may be a proxy for the relative value of the extractible intangible assets. This study uses a sample of 61 acquisition announcements between 1991 and 2004, where both acquirer and target are high-tech firms and accounting and trading data is available from three years prior to three years after the acquisition announcement. There is weak evidence to support the employee ratio hypothesis for bidder returns, and no evidence to support the intangible assets to total assets hypothesis for either bidder or target returns. Additionally, it is found that average bidder abnormal returns during the announcement period (as measured from one day prior to the announcement acquisitions to one day afterwards) are negative but not significantly different from zero, and that average target abnormal returns are positive and significant. Average wealth gains to bidders are negative and to targets are positive over the window from five days prior to the acquisition announcement to five days afterwards. Furthermore, combined wealth gains are negative, indicating the synergistic gains from high-tech cross-border acquisitions are offset by high premiums paid by the bidders for the targets. Relatedness, a lack of tender offers, and non-US acquirer status are demonstrated to be related to negative returns to bidders, whereas tender offers, US-acquirer status, and termination provisions are shown to be related to increased returns to target shareholders. In the long-run, it is found that acquirers experience superior operating cash flow returns when compared to their industry peers, however, the acquirer experiences diminished performance when compared to the combined performance of the pre-acquisition acquirer and target firms.
Internal Control Quality as an Explanatory Factor of Tax Avoidance
(University of Waterloo, 2011-10-11T17:53:09Z) Bauer, Andrew M
Internal control disclosures mandated by section 404 of the Sarbanes-Oxley Act (SOX) are designed to provide information about a firm’s financial reporting quality and in doing so may offer information on firm-specific tax planning activities. Internal control weaknesses disclosed under SOX are frequently related to a firm’s tax function (Ge and McVay, 2005; Gleason, Pincus and Rego, 2010) and thus raise the question of whether or not these frequent problems affect corporate tax avoidance. In this thesis, I test hypotheses that tax-related disclosures, particularly those that contain company-level internal control weaknesses (ICWs), provide information with respect to long-run tax avoidance. Furthermore, I test hypotheses that the combination of internal control quality and aggressive tax avoidance aid in assessing shareholder returns. To conduct these tests, I collect and construct firm-level SOX disclosure data from 2004 to 2006 across 1,286 publicly-owned corporations. I begin with an empirical analysis of the association between tax avoidance and firm-level ICWs and generally find that the presence of tax ICWs and company-level tax ICWs constrain long-run tax avoidance. For firms with low cash constraints however, company-level tax ICWs appear to lead to an increase in tax avoidance. Nevertheless, subsequent analysis of monthly abnormal returns implies that the stock market reacts negatively to the disclosure of company-level tax ICWs, regardless of whether or not tax aggressiveness is also present. This thesis contributes to the literature by documenting the first evidence that internal control disclosures provide information regarding firm-level tax planning. Although the number of internal control weakness disclosures is decreasing over time, the availability of these SOX disclosures represents a previously unavailable opportunity to examine and further understand internal governance mechanisms within the firm and their influence on tax planning. In addition, this thesis further corroborates prior literature that argues for the importance of the pervasiveness of internal control weaknesses by showing that the pervasive, company-level tax internal control weaknesses are associated with tax avoidance and lower shareholder returns. Finally, my dissertation implies that the presence of tax internal control weaknesses constrains tax avoidance and thus a focus on improving internal controls could help improve the tax planning function. However, my firm-level analysis also implies that effective tax planning is a sustainable process and thus a firm and its stakeholders may require several periods before the full benefits of these improvements are realized.
Is there a relation between the cost of debt and environmental performance? An empirical investigation of the U.S. Pulp and Paper Industry, 1994-2005.
(University of Waterloo, 2008-09-10T14:19:22Z) Schneider, Thomas Ervin
This study shows an economically significant relation between a firm’s environmental performance and its cost of debt. Firms that have poor environmental performance will face future environmental liabilities related to compliance and clean-up costs due to increasingly strict environmental laws and regulations. Under current U.S. law, environmental liabilities can impair the value of fixed assets, as environmental claims often take precedence over the claims of creditors. Thus, future environmental liabilities are of particular concern to creditors. Previous accounting research has shown that a firm’s market value of equity is significantly affected by its environmental performance. However, the same has yet to be shown for a firm’s cost of debt capital. This study focuses on a sample of U.S. pulp and paper firms. The results imply that the market applies an ‘environmental risk’ premium of thirty-eight basis points to the cost of debt capital for the average public firm in the U.S. pulp and paper industry, based on its environmental performance. Environmental performance is measured using the annual toxic release inventory of the United States Environmental Protection Agency. It is a measure of the amount of toxic chemicals released to land, air and water by a firm’s operating facilities. This paper adds to the literature, providing evidence that environmental performance is a value relevant measure with regards to creditors. Thus, recent calls in the United States for greater cooperation between the Securities and Exchange Commission and the Environmental Protection Agency should be addressed. These calls are for the reporting, on a firm-wide basis, of quantifiable data that is already required by the Environmental Protection Agency but is not typically available in detail in firms’ reports to investors.
Multi-Jurisdictional Tax Incentives and the Location of Innovative Activities
(University of Waterloo, 2009-08-25T15:41:42Z) MacDonald, Christy
In this dissertation, I explore the effect of tax incentives on where U.S. multinationals decide to locate their innovative activities worldwide. Research and development (R&D) tax incentives offered by foreign countries and differences between U.S. and foreign tax rates provide opportunities that may influence where multinationals decide to locate their innovative activities. Using firm-level patenting data that identifies the country-specific location of innovations from 1986 to 2000, I examine the relation between innovative activities performed in a foreign country and these tax incentives using the Heckman (1979) two step estimation approach. I find evidence that the foreign percentage of innovative activities is associated with the attractiveness of foreign R&D tax incentives and with an increase in the effect of U.S. R&D allocation rules. In addition, the results suggest that firms in excess foreign tax credit positions decrease the amount of R&D activities in a foreign location with increased foreign tax rates, consistent with income shifting incentives. In contrast, I find that the firms in deficit foreign tax credit positions increase their foreign R&D activities with increasing foreign tax rates. This study is the first to examine and provide evidence of the influence of foreign R&D tax incentives and income shifting incentives on a U.S. multinational’s decision on where to locate R&D activities.
Politicians’ Equity Holdings and Accounting Conservatism
(University of Waterloo, 2014-11-14) Baloria, Vishal
In this thesis, I examine the association between politician ownership and accounting conservatism for a sample of S&P 1500 firms between 2005 and 2011. The contracting explanation predicts that politician owned firms adopt less conservative accounting because lenders are less concerned with downside default risk for these politically favored firms. The political costs explanation predicts that politician owned firms adopt more conservative financial reporting to shield allied politicians from voter scrutiny. I find that equity ownership by members of the U.S. House and Senate is associated with lower levels of conditional conservatism. This negative association is more pronounced among: (1) firms owned by local politicians, where there is a greater alignment between the interests of the politician and the firm, and (2) firms with long-term issuer credit ratings, for which debt market participants particularly value conservatism as a mechanism for conveying information on downside default risk. I also examine the relationship between politician ownership and unconditional conservatism and fail to document a statistical relationship between the two constructs. Collectively, the results of my thesis provide consistent evidence of a lower contracting demand for conditional conservatism among politician owned firms.
Short Rate Models with Nonlinear Drift and Jumps
(University of Waterloo, 2009-08-27T18:33:37Z) Memartoluie, Amir
Many financial contracts can be regarded as derivative securities where the underlying state variable is one or more rates of interest. A partial list of such contracts would include zero-coupon bonds, coupon paying bonds, callable bonds, convertible bonds, retractable/extendable bonds, etc., along with a number of popular interest rate derivatives such as swaps, swaptions, caps, and floors. A commonly used strategy for valuing these contracts is to base a continuous time model for the stochastic behaviour of the short term rate of interest. Three key features of most of the models currently in use are (i) the drift, or expected change over a short time period in the level of the short term interest rate, is a linear function; (ii) the conditional variance of changes in short term interest rates is not strongly related to the level of interest rates; and (iii) the short term interest rate is assumed to follow a diffusion process, which effectively means that it cannot change too rapidly over short periods of time. Each of these assumptions appears to be made primarily for modeling convenience, as they make it possible in some cases to derive analytical expressions for the values of bonds and European-style bond options. If such solutions are not available, then numerical techniques such as Monte Carlo simulation or the numerical solution of partial differential equations are needed. However, available econometric evidence indicates that all of the assumptions noted above are questionable: changes in short term interest rates may be characterized by drift which is nonlinear and by conditional variance that depends more heavily on the level of interest rates than is assumed in models with analytic solutions. Moreover, they may be better approximated by a jump-diffusion process which allows for sudden discontinuous changes. Consequently, it is of interest to develop numerical techniques to value interest rate derivative securities for cases where the short term interest rate follows a jump-diffusion process featuring non-linear drift. This thesis describes and illustrates the use of such techniques.
Tax Aggressiveness and Shareholder Wealth: Evidence from Mergers and Acquisitions
(University of Waterloo, 2013-06-21T18:13:17Z) Chow, Ka Chung
In this dissertation, I examine two related questions on whether and how tax aggressiveness of firms is associated with shareholder wealth in a new context – mergers and acquisitions (M&A). The first study investigates whether and how the tax aggressiveness of the acquirers and targets affects shareholder wealth. I present the idea of tax aggressiveness transfer whereby the acquirer’s propensity for tax planning applies to its target’s tax function after the change in ownership. I measure the degree of tax aggressiveness transfer using the relative tax aggressiveness of the acquirer and target (i.e., the difference in tax aggressiveness between the two firms). I find that acquisitions of more tax aggressive targets by less tax aggressive acquirers generate significantly lower acquisition gains. I also document weaker evidence that acquisitions of less tax aggressive targets by more tax aggressive acquirers generate higher acquisition gains. That is, the results suggest that the shareholder wealth effects of tax aggressiveness transfer are driven by the value-destroying effect of decreases in tax aggressiveness. Cross-sectional analyses reveal that the acquirer’s governance is a significant determinant of the shareholder wealth effects of tax aggressiveness transfer. Specifically, the results indicate that, when acquirers are well-governed, acquisitions of targets with lower tax aggressiveness by acquirers with higher tax aggressiveness are value-enhancing. Similarly, acquisitions of targets with higher tax aggressiveness by acquirers with lower tax aggressiveness are value-destroying. These findings are robust to various measures of tax aggressiveness. In sum, I find that tax aggressiveness transfer is a significant determinant of value creation or destruction in M&A. The second study is devoted to studying whether and how the target’s participation of tax shelters – an extreme form of tax aggressiveness – matters in acquirer’s valuation of the target firm. Using a novel dataset that identifies targets’ non-participation in tax shelters, I find that the target’s non-sheltering status is associated with a higher takeover premium, indicating that acquirers reward targets for not engaging in tax sheltering. This positive association is stronger for targets that are more opaque and for acquirers that are less tax aggressive. In addition, I find that the target’s non-sheltering status is positively associated with acquirer returns for acquirers that are weakly governed and for targets that are more opaque. Overall, my findings suggest that the target’s non-sheltering status is relevant in acquirers’ valuation of the target, and that the valuation benefits of the target’s non-participation in tax shelters are mainly accrued to the target’s own shareholders rather than to those of the acquiring firm.
Tax Incentives in Corporate Acquisitions
(University of Waterloo, 2021-09-30) Warraich, Hamza
In this dissertation, I examine tax incentives in corporate acquisitions. Reported tax losses or net operating losses (NOLs) under the United States (U.S.) income tax law have grown considerably in recent years. Yet, there is limited empirical evidence on whether target firms’ NOL carry-forward (NOLC), which is a potential tax asset, affects merger and acquisition (M&A) activity. I re-examine two open empirical questions in the literature for which there is limited or no empirical evidence. First, does the acquirer compensate the target’s shareholders for the target’s NOLC? I predict and find that the association between the target’s NOLC and acquisition premium is increasing in the acquirer’s marginal tax rate. Second, does the target’s NOLC affect how the acquisition is financed? Consistent with capital structure theory on the substitutability of debt and non-debt tax shields, I find that the probability of debt financing is relatively lower in deals in which the target has an NOLC. In accordance with the Scholes-Wolfson framework, of “all taxes, all parties, and all costs”, a key insight in this dissertation is that the tax and non-tax attributes of the target and acquirer firm interact to determine the available tax incentive and thus the optimal level of tax-planning. This dissertation also provides new insight into the distortionary effect of tax policy. NOLC-related tax incentives in corporate acquisitions are governed by Section 382 of the Internal Revenue Code. §382 imposes a loss limitation on firms’ tax attributes following an ownership change, effectively reducing the net present value (NPV) of the tax assets. Empirically, I document that the uncertainty inherent in the applicability of §382 rules increases the likelihood that a deal is cancelled. In addition, I find that §382 is an important determinant in the medium of exchange and that the applicability of loss limitation rules is a plausible explanation for the well-documented aggregate trend in the decline in the propensity of all-stock deals. My findings suggest that §382 creates serious and unintended distortions in the merger decision, the effects of which are economically large.
An Understanding of the Differences between Internal and External Auditors in Obtaining and Assessing Information about Internal Control Weaknesses
(University of Waterloo, 2014-08-08) Burt, Ian
A critical role of the internal auditor is to design and monitor their organization's system of internal controls (COSO, 2004). In addition, they may be expected to objectively assess the quality of internal controls as professional auditors (Gray, 2004). External auditors have expressed concern that an internal auditor’s strong identity with their organization will bias any internal control assessments he or she makes of that organization (Schneider, 1984). Even so, accounting regulators believe internal auditors’ internal control assessments can be objective, and also maintain that having external auditors rely on these assessments should help to lower audit fees without jeopardizing audit quality (AICPA, 1990 - AS 5). Through two separate experiments, relying on social identity theory, social norms and the organizational silence literature in psychology, I examine whether the “employee” identity the internal auditor assumes as a member of the organization encourages other employees to share more information about internal control weaknesses with the internal auditor than the external auditor. In addition, I explore conditions under which the external auditor may be willing to rely on the internal auditor’s internal control assessment even if the internal auditor’s organizational identity is strong. Overall, this research will help external auditors, managers and regulators understand conditions under which the internal auditor can maintain their objectivity when performing an internal control assessment. Specifically, this research examines the potential importance of cueing internal auditors through the use of a strong code of ethics, such as the code of ethics enacted by the Institute of Internal Auditors, to the maintenance of the objectivity of all internal auditors. If the internal audit work is objective enough to be relied upon by the external auditor, the client can benefit from an audit of high quality while at the same time potentially lowering overall audit fees.
The Use of Fair Values to Assess Management's Stewardship: An Empirical Examination of UK Real Estate Firms
(University of Waterloo, 2010-09-29T22:25:39Z) Henderson, Darren M.
The Financial Accounting Standards Board (FASB)/ International Accounting Standards Board (IASB) proposed Conceptual Framework solidifies stewardship as a primary financial reporting objective. Concurrently, fair value (FV) continues to be emphasized in FASB and IASB standards. In this study, using data from real estate firms in the UK, I test whether FVs provide stewardship-relevant information incremental to information provided by historical costs. Measuring stewardship by changes in CEO cash compensation and FVs through revaluations of investment properties, I find FVs provide stewardship information beyond historical costs; however, FVs must be supported by external appraisals to be useful. Further, FVs help to explain the traditional association between stock returns and compensation. The actual realization of FV changes through sale continues to be rewarded through compensation, meaning the full compensation value of FV changes is not given until realized. FV changes provide more useful stewardship information when FV estimates are of higher quality or when the CEO is more strongly governed. I also find that higher sensitivity to management effort, proxied by firm growth opportunities, makes FV changes more stewardship-relevant. Overall, I conclude that for UK real estate firms, FVs are useful for assessing management's stewardship with improvements in estimate quality and sensitivity to management effort increasing stewardship-usefulness; however, historical costs continue to be relevant for stewardship. My thesis provides insight into what information best captures management stewardship.

Browse

Browsing Accounting and Finance by Subject "Accounting"