Knowledge that Transforms

Theory posits that mandatory disclosure influences peer firms' learning from stock prices in two non‐mutually exclusive ways: intra‐industry information transfers and the reallocation of information acquisition efforts. Using mandatory segment disclosure as our setting, we document a decrease in investment‐ q sensitivity for peers of disclosing firms. This effect is stronger among peers with greater economic links to disclosing firms and peers with the greatest incentives to glean information from prices. Our findings provide novel evidence that mandatory disclosure can have significant negative externalities on peer firms' investment efficiency via a managerial learning from the stock price channel. These insights inform regulators assessing the economic consequences of mandatory disclosure, while also assisting managers who rely on information from stock prices to guide investment decisions.

Companies have widely adopted a system of work‐product reviews whereby the work of one individual is subsequently reviewed by another to ensure its quality. We examine how managers can effectively implement a review of employee work to improve performance. Organizations review employees' work to identify mistakes and improve work quality. However, reviews may also reduce employees' effort and initiative if they expect reviewers to identify and correct their errors for them. We use an experiment to examine how employee performance depends on who conducts the review and how feedback is provided. Specifically, participants' work was reviewed by either a superior or a peer, and the reviewer provided either general, high‐level guidance (autonomy‐oriented) or specific corrective information about errors (dependency‐oriented). Employees performed best when superiors provided high‐level guidance or when peers provided specific corrective feedback, with these benefits emerging over time. Guidance from a superior increased employees' sense of responsibility, whereas corrective help from a peer strengthened feelings of teamwork and cohesion. Review approaches that did not fit these combinations offered no clear performance benefit relative to having no review. The findings show that review effectiveness depends on matching the feedback approach to the reviewer's organizational rank. These results have important implications for managers, accountants responsible for internal controls, and audit professionals involved in designing and implementing the review process.

We examine whether PCAOB inspection deficiencies related to management review controls (MRCs) affect financial reporting decisions. Using the goodwill impairment setting, we find that firms are more likely to record goodwill impairments when their auditors have received more PCAOB inspection deficiencies related to goodwill MRCs. The association is stronger when inspection deficiencies are more likely to lead to changes to the design or implementation of an internal control (repeat deficiencies and deficiencies related to MRC precision). We observe some evidence that MRC inspection deficiencies increase the likelihood of goodwill impairment even when unrelated to goodwill, indicating that improving the audit of MRCs can broadly affect financial reporting. Our findings provide evidence that PCAOB inspections affect not only auditor behavior but also the financial reporting behavior of audit clients. Specifically, inspection feedback appears to influence reporting outcomes through changes in the audit and evaluation of MRCs, identifying a channel through which regulatory oversight affects issuers. The results have implications for audit firms seeking to remediate inspection deficiencies, for management and audit committees responsible for overseeing significant estimates and impairment analyses, and for regulators evaluating the broader effectiveness of the PCAOB inspection process.

This paper studies how the accuracy of a short‐term performance measure affects its value when a principal decides whether to retain or fire an agent, who can manipulate that measure. Compared with ignoring performance and never firing the agent, the performance measure is valuable when the savings in the expected cost of the retention error is more than the expected cost of the firing error. A more accurate performance measure can have a non‐monotonic effect on its value: Greater accuracy improves the principal's ability to correctly identify the agent, which increases efficient firing, but it causes the incompetent agent to increase manipulation to avoid being fired, which increases inefficient retention. With a less accurate performance measure, the incompetent agent has weaker incentives for manipulation, and an increase in accuracy increases its value due to the identification effect. With a more accurate performance measure, the manipulation effect dominates, and an increase in accuracy decreases its value. The results imply that the principal prefers an imperfect performance measure when the agent can choose the level of manipulation.

Using online job postings data, we explore whether auditors adjust their human capital in response to clients' cyber breach incidents. We find that audit offices increase their demand for cybersecurity specialists after their clients' cyber breaches, implying that cyber breaches change not only client risk but also their auditor's production function. Consistent with expectations, we document that this impact is larger when breaches involve their own clients (rather than those of peer offices within the same audit firm) and when breaches directly involve financial information. Our evidence holds for both cyber‐focused and non‐cyber‐focused offices, highlighting the broad impact of cybersecurity risks on audit practices. Additionally, we find that audit offices with relatively high investment in cybersecurity human capital are better able to preserve their market share among clients in high‐cyber‐risk industries after a client's cyber breach.

Litigation risk is an important source of motivation for auditors to conduct high‐quality audits, but theory suggests that certain lawsuits will have a more salient disciplining effect on auditor behavior. To this end, we identify lawsuits naming an individual partner as a co‐defendant along with the audit firm. We then examine how these lawsuits affect subsequent behavior of other auditors in the office of the sued partner. Relative to lawsuits naming only the firm, our results indicate that lawsuits naming individual partners as co‐defendants are significant office‐level events that motivate a meaningful response from non‐sued audit partners in the form of higher quality and fees on existing clients and more careful client portfolio management. These results have practical implications about how auditor litigation incentivizes individual auditors to fulfill their professional duties. For regulators and audit firms seeking to promote audit quality, these findings highlight the disciplining effect of auditors' concern for their personal reputation and litigation exposure. Furthermore, audit committees, clients, and investors may observe elevated audit quality, effort, and fees following partner‐level litigation in the local office.

Prior research criticizes PCAOB inspection reports for focusing solely on audit deficiencies, arguing that this encourages auditors to pursue traditional procedures to demonstrate compliance with standards rather than procedures that maximize audit quality. We contribute to this debate by examining whether the PCAOB's approach discourages auditors from considering innovative audit procedures (that are potentially more effective), since they are, by definition, less standard. We compare the PCAOB's current inspection approach (which focuses on reporting audit deficiencies) to a balanced inspection approach that discloses examples of audit strengths as well as deficiencies discovered during inspections. We predict and find that when the risk of material misstatement (RMM) is moderate, a balanced inspection approach leads auditors to consider the potential effectiveness of innovative audit procedures to a greater extent, ultimately prioritizing more of them in audit plans. Our findings contribute to both research and practice by enhancing our understanding of ways to encourage audit innovation and ultimately improve overall audit quality.

When managers revise earnings guidance between earnings announcements, they choose not only what to disclose but also where to disclose—in a standalone release, a guidance call, an investor conference, or an analyst/investor (A/I) day. These venues differ in audience, format, and visibility, raising the question of whether venue choice is a strategic communication decision. In a large sample of unbundled revisions, we find that managers use calls for relatively large negative revisions and when litigation risk is higher and that they use conferences and A/I days for smaller revisions and when analyst disagreement is greater. Textual analysis reveals that calls feature cautious, litigious language for both upward and downward revisions, whereas conference and A/I day communications remain optimistic. In line with these framing differences, calls are associated with amplified reaction to negative news and are followed by more favorable earnings surprises, suggestive of effective expectation management, whereas conferences and A/I days are associated with muted reactions and reduced analyst dispersion and are followed by less favorable surprises. Our findings suggest that venue choice is a dimension of disclosure strategy for managers and an informative signal for investors.

Audits of complex fair value estimates involve evaluating and challenging key client assumptions. Auditors generally lack the necessary expertise to perform this work, and thus, they often engage valuation specialists to perform this audit work. However, valuation specialists primarily perform advisory work and may not put enough care into their audit work. We examine whether valuation specialists' psychological ownership of audit work and auditors' infringement on that work affect specialists' judgment quality. Using a survey and an experiment with practicing valuation specialists, we find that higher psychological ownership improves specialists' evidence evaluation and judgments, but only when auditors do not behave intrusively by infringing on their work. When auditors behave intrusively, the benefits of specialists' higher psychological ownership disappear. Our findings show that audit quality depends not only on specialist behavior but also on auditor interactions with specialists. Our study offers practical guidance to audit firms on how to organize audit work and manage internal working relationships between auditors and valuation specialists.

As firms increasingly rely on collaborative innovation to develop new technologies, they face a growing tension between signaling their technological capabilities and protecting sensitive information. This tension is especially important in co‐patenting settings, where firms jointly develop innovations and operate in a more interconnected information environment. We examine how firms' narrative R&D disclosures are associated with collaborative innovation, measured by firm‐level co‐patents (i.e., patents jointly owned by multiple entities). Using data for US public firms from 1996 to 2017, we find that firms with more co‐patents tend to disclose less R&D information in 10‐K filings, consistent with heightened proprietary cost and negative externality concerns. This negative relationship is stronger with greater competition, weaker intellectual property protection, a greater number of partners, or repeated collaborations with the same partners. However, the relation between co‐patenting and R&D disclosures becomes positive when firms collaborate with universities, consistent with signaling incentives. We also find that firms are more likely to highlight collaborations in their 10‐Ks when forming new partnerships, working with universities or public firms, or leveraging partners' complementary assets. Overall, our results suggest that firms' R&D disclosure choices are influenced not only by their own proprietary concerns but also by partner‐related disclosure externalities and signaling incentives. Our findings highlight the importance of considering collaborative innovation arrangements when interpreting firms' R&D disclosures. They also suggest that managers should tailor R&D disclosure strategies to the characteristics of their collaborations.