Houston research on asset valuation reveals importance of 'opinion shopping'

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New research reveals that companies often “opinion shop” to shape their financial reality. Photo via rice.edu

Firms often have to estimate the “fair value” of their investments, meaning they have to declare what an asset is worth on the market. To avoid the potential for bias and manipulation, companies will use third-party services to provide an objective estimate of their assets’ fair value.

But nothing prevents a company from seeking multiple third-party estimates and choosing whichever one suits their purpose.

In a recent study, Shiva Sivaramakrishnan (Rice Business) and co-authors Minjae Koo (The Chinese University of Hong Kong) and Yuping Zhao (University of Houston) examine two motives for switching third-party evaluators: “opinion shopping” and “objective valuation.”

Firms that opinion shop are looking for a third-party source to make their investments look better on paper. For example, if Service A says an asset is worth $80 — and that means the company would have to take an accounting loss — the company might switch to Service B, which says the asset is worth $90. By using the higher estimate from Service B, the company avoids a loss.

Opinion shopping can be a dangerous practice, both on a macro level and for the specific firms that engage in it. Not only does it reduce the quality of fair value estimates for everyone, it means some company assets are potentially overvalued. And if those assets ever decline in value for real, the company will eventually take a loss.

Moreover, opinion shopping opens the door to managerial opportunism. If assets are valued more highly, managers are likely to receive credit and potentially use that perceived accomplishment to advance their careers.

There are reasons for companies to go the other way. In the hypothetical scenario above, our company might switch from Service B ($90) to Service A ($80) to receive a more accurate and objective estimate. The “objective valuation” motive helps companies meet regulatory requirements and ensure estimates reflect true market value. What’s more, the objective valuation motive helps curb managerial buccaneering.

The study looks at when and why life insurance companies will switch their third-party review service. The team finds that both motives — opinion shopping and objective valuation — are common. Sometimes companies want to better align their fair value estimates with what similar assets are trading for in the market. Other times, they want assets to look better on paper.

Of the two motives, opinion shopping is the more dominant, particularly when they are in conflict with each other. On the whole, evidence suggests that companies switch price sources strategically to inflate estimates and avoid losses, rather than to get more accurate estimates.

The study has implications for investors, regulators and researchers. “Opinion shopping” could be prevalent in non-financial industries, as well — especially public firms with capital market incentives. More disclosure around price sources could improve estimate reliability.

Future research could examine asset valuation practices and motives in other sectors such as banking, real estate and equity investments. Are some industries more prone to opinion shopping than others? What factors make opinion shopping or objective valuation more likely? Are there certain signals or patterns that indicate when a company is opinion shopping versus seeking objectivity?

Answers to these questions could help discern acceptable from unacceptable third-party source switching. And understanding if certain types of companies are more at risk could help regulators and auditors focus their efforts.

The bottom line:

Accurate accounting matters. While external sources are better for measuring the fair value of any given asset, companies can distort the very concept of fair value estimates by changing their source. More rigor, transparency and auditing around price sources could curb manipulation and improve estimate reliability.

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This article originally ran on Rice Business Wisdom and was based on research from Shiva Sivaramakrishnan, the Henry Gardiner Symonds Professor of Accounting at Rice Business.

Research shows that some corporate executives skew earnings to influence the market and inflate share price. Photo via Pexels

Rice University research finds market outliers at risk of misreporting

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Say a company called CoolConsumerGoodsCo has just released its quarterly earnings report, revealing significantly higher profits than its consumer goods industry counterparts.

That result might spur analysts to slap a buy rating on the stock and investors to snap up shares. In an ideal world, the market wouldn't have to consider the possibility that the numbers aren't legit — but then again, it's not an ideal world. (Enron, anyone?)

Rice Business professors Brian R. Rountree and Shiva Sivaramakrishnan, along with Andrew B. Jackson at UNSW in Australia, studied what makes business leaders more likely to engage in fraudulent earnings reporting. Specifically, they focused on the relationship between this kind of misrepresentation and the degree to which a company's earnings are in line with the rest of its industry — a variable the researchers term "co-movements."

Many people are familiar with a similar variable, calculated using stock returns often referred to as a company's beta. The authors adapted the stock return beta to corporate earnings to see how a company's earnings move with earnings at the industry level.

The researchers hypothesized that the less in sync a company's earnings are with its industry, the higher the chance a company's leaders will manipulate earnings reports. They started with the well-accepted premise that corporations try to skew earnings reports to influence the market. The primary motive is typically to raise the company's stock price, as when an executive tries to "choose a level of bias" that balances potential fallout of getting caught against the benefits of a higher stock price.

To test their prediction, the professors analyzed a sample of enforcement actions taken by the U.S. Securities and Exchange Commission against companies for problematic financial reporting from 1970 to 2011 — although they noted that given the SEC's limited resources, the number of enforcement actions probably underestimates the actual amount of earnings manipulation in the market.

Their analysis revealed that firms with low earnings co-movements (meaning their earnings were out of sync with industry peers) were more likely to be accused by the SEC of reporting misdeeds. They concluded that the degree of earnings co-movement determines the probability of earnings manipulation. Put another way, earnings co-movements are a "causal factor" in the chances of earnings manipulations — and to a significant degree. The researchers found that firms who don't co-move with the market are more than 50 percent more likely to face an SEC enforcement action, compared with firms who are perfectly aligned with the market.

The researchers drilled deeper into the data to study whether the odds changed depending on the industry, since past research has indicated that the amount of competition in an industry works to constrain misreporting. That premise seems to hold true, the researchers concluded. In industries with more competitive markets, the impact of low co-movement on earnings manipulation is moderated.

They also studied whether the age of a firm played a part in the likelihood of earnings manipulation. Newer firms often rely more on stock compensation, which could be a motive for manipulating earnings reporting to drive up share price. Indeed, younger firms were more susceptible to misreporting when their earnings were out of whack with the rest of the marketplace.

Every firm faces some risk of misreporting, however. Even for public companies under analyst scrutiny, low co-movement proved to be a driver of earnings manipulation. But companies known for conservative reporting tend to be less likely to exaggerate their earnings, in general; these firms typically recognize losses in a more timely manner, the professors found.

These findings suggest a number of future lines of research. For example: When do executives underreport earnings? And can analyzing patterns related to cash flow reporting help better isolate earnings manipulation?

In the meantime, if you come across a company like CoolConsumerGoodsCo with an earnings report that's widely out of sync with the rest of its industry, you might think twice before rushing to buy in.

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This article originally ran on Rice Business Wisdom and is based on research from Brian R. Rountree, an associate professor of accounting at the Jones Graduate School of Business at Rice University, and Shiva Sivaramakrishnan is the Henry Gardiner Symonds Professor of Accounting at Rice Business.

In a recent study, a Rice Business professor found that board members actually need incentives — both short- and long-term — to act in stakeholders' best interests. Getty Images

Rice University research finds executive board members are driven by incentives

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If you're a stockholder, you may envision your investment helmed by a benevolent, all-knowing board of directors, sitting around a long finely-grained wooden table, drinking coffee, their heads buried in PowerPoint charts as they labor to plot the best course for the company. Too often, however, you can't take for granted that a company's board will steer it wisely.

Companies choose directors because they offer rich and varied experience in the business world. Many who serve on boards, moreover, are CEOs of other corporations, or have headed big companies in the past. As of October 2018, for example, six of the 11 directors on Walmart's board and eight of 13 on AT&T's board hold CEO or CFO positions in other firms. So it's easy to assume that board members will act in the best interests of stockholders.

But in a recent study, Rice Business professor Shiva Sivaramakrishnan found that board members actually need incentives — both short- and long-term — to act in stakeholders' best interests.

Corporations usually compensate board members with stock options, grants, equity stakes, meeting fees, and cash retainers. How important is such compensation, and what sort of incentives do board members need to perform in the very best interests of a company? Sivaramakrishnan joined co-author George Drymiotes to trace how compensation impacts various aspects of board performance.

Recent literature in corporate governance has already stressed the need to give boards of directors explicit incentives in order to safeguard shareholder welfare. Some observers have even proposed requiring outside board members to hold substantial equity interests. The National Association of Corporate Directors, for example, recommended that boards pay their directors solely with cash or stock, with equity representing a substantial portion of the total, up to 100 percent.

To the extent that directors hold stock in a company, their actions are likely influenced by a variety of long-and short-term incentives. And while the literature has focused mainly on the useful long-term impact of equity awards, the consequences of short-term incentives haven't been as clear. Moreover, according to surveys, most directors view advising as their primary role. But this role also has received little attention.

To scrutinize these issues, the scholars used a simple model, which assumes the board of directors perform three roles: contracting, monitoring and consulting. The board contracts with management to provide productive input that improves a firm's performance. By monitoring management, the board improves the quality of the information conveyed to managers. By serving in a consulting role, the board makes managers more productive, which, in turn, means higher expected firm output.

This model allowed the scholars to better understand the relationship between the board of directors and the company's managers, as well as with shareholders. The former was particularly important to take into account, because conflict between a board and managers is typically unobservable and can be costly.

The results were surprising. Without short-term incentives, the researchers found, boards did not effectively fulfill their multiple roles. Long-term inducements could make a difference, they found, but only in some aspects of board performance.

While board members were better advisors when given long-term motivations, short-term incentives were better motivators for performing well in their other corporate governance roles, according to the research, which tied specific aspects of board compensation to particular board functions.

Restricted equity awards provided the necessary long-term incentives to improve the efficacy of the board's advisory role, the scholars found, but only the short-term incentives, awarding an unrestricted share or a bonus based on short-term performance, motivated conscientious monitoring.

The scholars also examined managerial misconduct. Board monitoring, they concluded, lowered the cost of preventing such wrongdoing — but only if the board had strong short-term incentives in place.

Even at the highest rungs of the corporate ladder, in other words, short-term self-interest is the greatest motivator. Maybe it's not surprising. In the corporate world, acting for one's own benefit is a given — so stockholders need to look more closely at those at the very top. Like everyone else, board directors need occasional brass rings within easy reach to do their best.

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This story originally ran on Rice Business Wisdom.

Shiva Sivaramakrishnan is the Henry Gardiner Symonds Professor in Accounting at the Jesse H. Jones Graduate School of Business at Rice University.

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Houston healthtech leader launches clinical trial for innovative anxiety-treating device

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Houston-based Nexalin Technology’s proprietary neurostimulation device will move forward with a new clinical trial evaluating its treatment of anxiety disorders and chronic insomnia in Brazil.

The first of Nexalin’s Gen-2 15-milliamp neurostimulation devices have been shipped to São Paulo, Brazil, and the study will be conducted at the Instituto de Psiquiatria university hospital (IPq-HCFMUSP). The shipments aim to support the launch of a Phase II clinical trial in adult patients suffering from anxiety and insomnia, according to a news release.

“Brazil is an important emerging market for mental health innovation, and this collaboration marks our first IRB-approved study in the region,” Mike White, CEO of Nexalin, said in the release.

The study will be led by Dr. Andre Russowsky Brunoni, who specializes in neuromodulation and interventional psychiatry. He currently serves as director of the interventional psychiatry division at IPq-HCFMUSP and this summer will join UT Southwestern in Dallas and its Peter O’Donnell Jr. Brain Institute as a professor of psychiatry.

The Phase II study plans to enroll 30 adults in São Paulo and assess the efficacy of Nexalin’s non-invasive deep intracranial frequency stimulation (DIFS™) of the brain in reducing anxiety symptoms and improving sleep quality, according to the company. Using the Hamilton Anxiety Rating Scale (HAM-A), the trial’s goal is a reduction in anxiety symptoms, and assessments of sleep onset latency, total sleep time, overall sleep quality, depressive symptoms and clinical impression of improvement. The company plans to share results in a peer-reviewed scientific journal.

“Anxiety and insomnia are very common conditions that often occur together and cause significant distress,” Brunoni added in the news release. “In this study, we are testing a new, non-invasive brain stimulation technology that has shown promising results in recent research. Our goal is to offer a safe, painless, and accessible alternative to improve people’s well being and sleep quality.”

The Nexalin Gen-2 15-milliamp neurostimulation device has been approved in China, Brazil, and Oman.

The company also enrolled the first patients in its clinical trial at the University of California, San Diego, in collaboration with the VA San Diego Healthcare System for its Nexalin HALO, which looks to treat mild traumatic brain injury and post-traumatic stress disorder in military personnel and the civilian population. It also recently raised $5 million through a public stock offering. Read more here.

Texas university to lead new FAA tech center focused on drones

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The Texas A&M University System will run the Federal Aviation Administration’s new Center for Advanced Aviation Technologies, which will focus on innovations like commercial drones.

“Texas is the perfect place for our new Center for Advanced Aviation Technologies,” U.S. Transportation Secretary Sean Duffy said in a release. “From drones delivering your packages to powered lift technologies like air taxis, we are at the cusp of an aviation revolution. The [center] will ensure we make that dream a reality and unleash American innovation safely.”

U.S. Sen. Ted Cruz, a Texas Republican, included creation of the center in the FAA Reauthorization Act of 2024. The center will consist of an airspace laboratory, flight demonstration zones, and testing corridors.

Texas A&M University-Corpus Christi will lead the initiative, testing unstaffed aircraft systems and other advanced technologies. The Corpus Christi campus houses the Autonomy Research Institute, an FAA-designated test site. The new center will be at Texas A&M University-Fort Worth.

The College Station-based Texas A&M system says the center will “bring together” its 19 institutions, along with partners such as the University of North Texas in Denton and Southern Methodist University in University Park.

According to a Department of Transportation news release, the center will play “a pivotal role” in ensuring the safe operation of advanced aviation technologies in public airspace.

The Department of Transportation says it chose the Texas A&M system to manage the new center because of its:

  • Proximity to major international airports and the FAA’s regional headquarters in Fort Worth
  • Existing infrastructure for testing of advanced aviation technologies
  • Strong academic programs and industry partnerships

“I’m confident this new research and testing center will help the private sector create thousands of high-paying jobs and grow the Texas economy through billions in new investments,” Cruz said.

“This is a significant win for Texas that will impact communities across our state,” the senator added, “and I will continue to pursue policies that create new jobs, and ensure the Lone Star State continues to lead the way in innovation and the manufacturing of emerging aviation technologies.”

Texas Republicans are pushing to move NASA headquarters to Houston

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Two federal lawmakers from Texas are spearheading a campaign to relocate NASA’s headquarters from Washington, D.C., to the Johnson Space Center in Houston’s Clear Lake area. Houston faces competition on this front, though, as lawmakers from two other states are also vying for this NASA prize.

With NASA’s headquarters lease in D.C. set to end in 2028, U.S. Sen. Ted Cruz, a Texas Republican, and U.S. Rep. Brian Babin, a Republican whose congressional district includes the Johnson Space Center, recently wrote a letter to President Trump touting the Houston area as a prime location for NASA’s headquarters.

“A central location among NASA’s centers and the geographical center of the United States, Houston offers the ideal location for NASA to return to its core mission of space exploration and to do so at a substantially lower operating cost than in Washington, D.C.,” the letter states.

Cruz is chairman of the Senate Committee on Commerce, Science, and Transportation; and Babin is chairman of the House Committee on Science, Space, and Technology. Both committees deal with NASA matters. Twenty-five other federal lawmakers from Texas, all Republicans, signed the letter.

In the letter, legislators maintain that shifting NASA’s headquarters to the Houston area makes sense because “a seismic disconnect between NASA’s headquarters and its missions has opened the door to bureaucratic micromanagement and an erosion of [NASA] centers’ interdependence.”

Founded in 1961, the $1.5 billion, 1,620-acre Johnson Space Center hosts NASA’s mission control and astronaut training operations. More than 12,000 employees work at the 100-building complex.

According to the state comptroller, the center generates an annual economic impact of $4.7 billion for Texas, and directly and indirectly supports more than 52,000 public and private jobs.

In pitching the Johnson Space Center for NASA’s HQ, the letter points out that Texas is home to more than 2,000 aerospace, aviation, and defense-related companies. Among them are Elon Musk’s SpaceX, based in the newly established South Texas town of Starbase; Axiom Space and Intuitive Machines, both based in Houston; and Firefly Aerospace, based in the Austin suburb of Cedar Park.

The letter also notes the recent creation of the Texas Space Commission, which promotes innovation in the space and commercial aerospace sectors.

Furthermore, the letter cites Houston-area assets for NASA such as:

  • A strong business environment.
  • A low level of state government regulation.
  • A cost of living that’s half of what it is in the D.C. area.

“Moving the NASA headquarters to Texas will create more jobs, save taxpayer dollars, and reinvigorate America’s space agency,” the letter says.

Last November, NASA said it was hunting for about 375,000 to 525,000 square feet of office space in the D.C. area to house the agency’s headquarters workforce. About 2,500 people work at the agency’s main offices. NASA’s announcement set off a scramble among three states to lure the agency’s headquarters.

Aside from officials in Texas, politicians in Florida and Ohio are pressing NASA to move its headquarters to their states. Florida and Ohio both host major NASA facilities.

NASA might take a different approach, however. “NASA is weighing closing its headquarters and scattering responsibilities among the states, a move that has the potential to dilute its coordination and influence in Washington,” Politico reported in March.

Meanwhile, Congressional Delegate Eleanor Holmes Norton, a Democrat who represents D.C., introduced legislation in March that would prohibit relocating a federal agency’s headquarters (including NASA’s) away from the D.C. area without permission from Congress.

“Moving federal agencies is not about saving taxpayer money and will degrade the vital services provided to all Americans across the country,” Norton said in a news release. “In the 1990s, the Bureau of Land Management moved its wildfire staff out West, only to move them back when Congress demanded briefings on new wildfires.”

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