(585) Earnings Management and Cost Behavior, Debt Contracting, Corporate Governance and Political Connection

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1 SHUNLAN FANG (585) EDUCATION, Fox School of Business, Philadelphia, PA PhD August 2013 University of Rochester, Simon School of Business, Rochester, NY MS Business Administration May 2008 Renmin University of China, School of Finance, Beijing, China MS Finance (Valedictorian) June 2005 BS Economics (Summa Cum Laude) June 2003 RESEARCH AREAS Earnings Management and Cost Behavior, Debt Contracting, Corporate Governance and Political Connection WORKING PAPERS Loan Financing and Real Cost Management (with R.Banker, presented in AAA Management Accounting Section Meeting, New Orleans, LA, 2013, AAA Annual Accounting Meeting, Anaheim, CA, 2013, Cost and Earnings Behavior Conference at, finalizing the submission to Journal of Accounting Research) The World Economic Crisis and Asymmetric Cost Behavior (with R. Banker and M. Mehta, finalizing the submission to The Accounting Review) Creditors Dynamic Monitoring---Financial Covenants with Time Varying Requirements (presented in Financial Accounting and Reporting Section Midyear Meeting, Chicago, IL, 2012,Accounting Research Consortium, Sydney, 2012, PhD Research Workshop, Univ. of Toronto, ON, Canada, 2011, AAA Annual Accounting Meeting, Anaheim, CA, 2013, finalizing the submission to Review of Financial Studies) Do Corporate Political Contributions Enhance Equity Value? (with S. Prabhat, under review of Journal of Finance) RESEARCH-IN-PROGRESS Accounting Quality and Creditor Restrictions over Firm Investment (presented in AAA Northeast Region Meeting, White Plains, NY, 2011)

2 The Impact of Asymmetric Cost Behavior on the Relation between Expenses and Revenue (with R. Banker, S. Basu and D. Byzalov) Why Do Information Technology Firms Hold Large Cash Balances? (with R. Banker and D. Zhang) PUBLICATIONS A Quantitative Model on Credit and Liquidity Risk of Commercial banks. Operations Research and Management Science, 2004, 13, No. 6, Several Key Issues on Seasoned Equity Offering Reform in China. Research on Financial and Economic Issues, 2002, 220, No. 3, Some Statistical Properties of a Measure of Information Discrepancy. Journal of Systems Sciences and Systems Engineering, 2002, 111, No. 4, A Decision Support System of Multi-Expert Judgments Based on a New Approach of Information Theory. Chinese Journal of Management Science, 2001, 9, Special Issue, SELECTED CONFERENCE PARTICIPATION 2013 AAA Annual Meeting, Anaheim, CA 2013 AAA Management Accounting Section Meeting, New Orleans, LA 2012 AAA Financial Accounting Midyear Meeting, Chicago, IL 2012 Accounting Research Consortium, Sydney, Australia 2012 AAA Annual Meeting, Washington, DC 2011 AAA Northeast Regional Meeting, White Plains, NY 2009 AAA Financial Accounting Midyear Meeting, New Orleans, LA 2008 Journal of Accounting & Economics Conference, Rochester, NY 2008 AAA Deloitte J. Michael Cook Doctoral Consortium, Phoenix, AZ 2004 Global Finance Conference, Las Vegas, NV REVIEW EXPERIENCE Journal of Accounting and Economics, Journal of Accounting Research, Review of Accounting Studies, Financial Management, Financial Accounting Reporting Section Midyear Meetings, Management Accounting Section Meetings TEACHING EXPERIENCE Undergraduate Lecturer: Managerial Accounting University of Rochester MBA Lecturer: Designed and taught the course Mathematics for Management (rating 4.2/5) MBA Lab Instructor & Tutor: Financial Accounting, Accounting for Decision and Control

3 HONORS & AWARDS Academy of Business Research Conference, LA 2013 a. Silver Wheaton Best Paper Award Fox School of Business,, PA, 2012 a. Young Scholar Award for Interdisciplinary Studies b. 2 nd Runner-up, School Wide Research Competition Accounting Research Consortium, Sydney, Australia, 2012 a. Travel Grant, awarded to only 3 students from the U.S. University of Rochester, Rochester, NY, 2008 a. Teaching Excellence Awards b. Academic Excellence Awards c. Graduate Fellowship Renmin University of China, Beijing, 2005 a. Academic Achievement Award, Xin Shan Foundation, Hong Kong b. Letter of appreciation from, Michael Spence, Nobel Laureate in Economics, commending creativity, intelligence and professionalism c. Silver Medal, National College Mathematical Olympiad, China INTERNAL SERVICE Teaching Fellow of joint MACC program of and Beijing National Accounting Institute PROFESSIONAL AFFILIATIONS American Accounting Association, American Finance Association INDUSTRY EXPERIENCE Negotiation Representative, Civil Aviation Administration of China, Beijing, China Equity Research Analyst, Huaji Investment Co. Ltd., Nanjing, China Risk Analyst, Pingan Insurance Co. of China Ltd., Beijing, China

4 REFERENCES Rajiv D. Banker Merves Chair in Accounting and Information Technology Phone: Sudipta Basu Professor in Accounting Phone: Lalitha Naveen Associate Professor in Finance Phone: (215) Mihir Mehta Assistant Professor in Accounting Phone: RESEARCH PAPER ABSTRACTS Loan Financing and Real Cost Management (with Rajiv Banker) This paper examines whether managers engage in real cost management around loan financing. Compared with equity financing, loan financing is more frequent, larger in size and subject to creditor monitoring. Both the potential economic benefits and costs of performance management could be substantial. We propose a new model controlling for the features of loan financing to examine firms operating activities. We find that managers significantly cut back operating expenses prior to loan financing. However, cost reduction is asymmetric with respect to the direction of sales changes. Compared with firms experiencing sales increases, firms experiencing sales declines reduce costs to a greater extent prior to financing and also exhibit a reversion in the cost level after financing. The reversion in cost level is negatively related to the intensity of covenants that are based on earnings. We do not find consistent evidence suggesting that managers engage in accrual management, overproduction or abnormal asset sales. The World Economic Crisis and Asymmetric Cost Behavior (with R. Banker and M. Mehta) The world economic crisis beginning during 2008 caused many firms to experience sales declines and created pessimism about prospects of sales rebounding in the future. We posit that firms exhibit anti-sticky cost behavior during this period; that is, costs are cut back more steeply as sales fall than the increase in costs as sales rise. Such a behavior during the economic crisis is exactly the opposite of the on-average sticky cost behavior during normal economic periods documented in prior accounting research. This, in turn, implies that net income and cash flows from operations (as percentage of sales) may increase, rather than decrease during an economic downturn. We further posit that firms in industries with high fixed assets intensity will be

5 limited in their ability to manage costs downward during the economic crisis. Evidence from about 42,000 firm-year observations on U.S. companies over the period from 2005 to 2011 supports our hypotheses regarding cost behavior and explains the apparently anomalous behavior of net margin ratio. Time Varying Requirements of Financial Covenants Financial covenant requirements in 42% of loan contracts are automatically adjusted to prespecified levels following a predetermined schedule during the life of contracts. About 96% of cases, covenants include an increasing trend in requirements. However, prior literature has paid little attention to this feature of financial covenants. This is the first study investigating the pervasive use of such a covenant design in loan contracts. I find that the presence of financial covenants with increasing requirements is positively associated with expected changes in firm risk instead of the risk level at loan initiation. Firms facing increasing covenant requirements have a greater increase in investment expenditure and also exhibit a greater investment cut after covenant violation than firms facing constant covenant requirements. Overall, results suggest that the presence of financial covenants with increasing requirements reflects lenders incentives to actively monitor firm investment at each stage. Do Corporate Political Contributions Enhance Equity Value? (with S. Prabhat) This paper investigates whether firms corporate political contributions increase their equity value and how the valuation effects of these contributions vary with firm characteristics. We address the questions by exploiting the McConnell v. FEC Supreme Court decision of 2003 and other related events that impose greater restrictions on firms abilities to make political contributions. We find that restrictions on firms abilities to contribute to national political parties reduce equity value by up to $ million (1.06%). The negative impact of such restrictions on equity value is greater for firms that make larger contributions or lobbying expenditures. Overall, the evidence suggests that political contributions have a causal effect on equity value. Accounting Quality and Creditor Restrictions over Firm Investment This paper provides direct evidence on whether accounting quality affects capital market investors evaluation on firm investment risk by examining restrictions on acquisitions in loan contracts for acquisition and takeover related financing. The setting allows researchers to observe creditors monitoring incentives over specific firm investment activities that significantly increase the uncertainty about firm future prospects. I find that accounting quality is negatively associated with restrictions on acquisition activities, after controlling for firms' investment opportunities and corporate governance. Moreover, accounting quality and corporate governance (measured by shareholder protection provisions) have opposite effects on lenders' incentives to restrict firm investment. The results suggest that a high degree of accounting quality mitigates the agency conflicts between shareholders and debt holders over firm investment.

6 The Impact of Asymmetric Cost Behavior on the Relationbetween Expenses and Revenues (with R. Banker, S. Basu and D. Byzalov) The time series variation in the relation between expenses and revenues reflects changes in both managerial operational decisions and financial reporting policy. The magnitude of expenses relative to revenues determines profit margins and reflects business conditions. The recognition of expenses with respect to revenues indicates and reflects how financial reporting captures the underlying economics of firm business. Remarkably, the year 1983 represents a striking structural change in the composition of total expenses, while net profit margin has remained as 6.1% on average both before and after Operating margin increased from 12.4% to 13.4% after 1983, offset by an increase in non-operating expenses from 6.3% to 7.3%. Based on a sample spanning from 1967 to 2011, we find that there are striking structural changes in the composition of expenses since 1983 and such changes are particularly more prominent for firms with sales decreases. The percentage of operating expenses relative to revenues decreases by 0.8% and that of non-operating expenses relative to revenues increases by 0.6% for firms with sales increases. In contrast, the percentage of operating expenses relative to revenues decreases by 3.5% and that of non-operating expenses relative to revenues increases by 3.0% for firms with sales decreases since Moreover, the difference in the recognition of operating expenses between firms with sales increases and those with sale decreases has significantly reduced over time. The difference in the recognition of non-operating expenses between firms with sales increases and those with sales decreases almost disappear since Our empirical results suggest that the operating expenses recognized after 1983 are higher than before 1983, given that sales are at the same level and do not decrease from previous year. However, operating expenses recognized are lower if sales decline, given the same sales level. In other words, the degree of cost stickiness is declining over time. There is no significant change in the relation between operating expenses and conservatism. Why Do Information Technology Firms Hold Large Cash Balances? (with R. Banker and D. Zhang) This paper examines why information technology (IT) firms carry much larger cash balances than low-tech firms, about 14% more in Finance theory recognizes that firms hold cash despite the low return on this form of investing resources because cash-in-hand provides timely funding to exercise growth options and avoid financial distress that may disrupt R&D efforts. These reasons explain only a small portion of the large cash balances held by IT firms. We posit that being an IT firm itself is a moderating variable. The need for liquid funds and flexibility in implementing real options is much greater for IT firms because the speed of innovation required to maintain competitiveness is much greater. The frequent creation and acquisition of growth options result in much higher information asymmetry regarding the uncertain future prospects of these options. Consequently, raising capital externally at short notice is very costly or even impossible for IT firms in most cases. Moreover, the costs of delays or inability in funding growth options are particularly high for knowledge-based firms. Therefore, the value of maintaining cash holdings is much greater for IT firms. Using Compustat data from 1979 to 2011, we document that IT firms carry larger cash balances than low-tech firms do. As predicted, the coefficients on variables related to growth options and financial distress that increase

7 demand for liquidity are significantly greater for IT firms. Consistent with this higher demand, we find that investors' valuation of cash holdings is also higher for IT firms. These findings are important for senior executives leading IT firms because they highlight the value of maintaining large cash holdings.