Knowledge that Transforms

ABSTRACT During the testing stages of the audit, auditors must divide their attention simultaneously between (i) performing the planned audit procedures and (ii) remaining broadly skeptical and alert for fraud. Regulators note instances in which auditors do not take actions that effectively respond to fraud risks during these later stages, suggesting auditors may devote insufficient attention to fraud while they are busy executing the planned audit procedures. Leveraging prospective memory theory, I identify and test an intervention that can improve auditors' attention to fraud by encouraging auditors to have implementation intentions—that is, more detailed plans about when and how they will consider fraud. I find that encouraging implementation intentions interacts with auditors' perceived fraud task importance to increase auditors' attention to fraud when this attention would otherwise be lower, making auditors more likely to take effective fraud actions. Importantly, these results also indicate that, even in a high fraud risk setting, auditors may devote insufficient attention to fraud while performing the planned audit procedures, confirming concerns voiced by regulators. However, my study also highlights concerns about regulators' inspection processes prompting auditors to focus too heavily on inspection risk, as the results suggest auditors are less likely to detect fraud in high‐risk audit areas thought to have low inspection risk.

Abstract The revised Markets in Financial Instruments Directive (MiFID II) requires the unbundling of research payments from trading execution, fundamentally changing the way in which investors typically pay for analyst research in Europe. We examine the effectiveness of the regulation in changing the link between analyst research and trading, the research‐trading link, and the analyst response to this potential change in incentives. Using a difference‐in‐differences research design, we find that forecast frequency, optimism, and accuracy are less associated with the brokerage trading share after MiFID II, suggesting that MiFID II weakened the link between the brokerage share of trading and analyst research. Following MiFID II, analysts in Europe are less likely than analysts in the United States to continue high forecast frequency, optimism, and accuracy for stocks with high share importance for the analyst's brokerage house. We find similar results throughout for buy/sell recommendations. Overall, our evidence suggests that MiFID II is at least partially successful in unbundling research from execution, and impacts both the trading effects and the production of analyst research.

ABSTRACT Natural language is a key form of business communication. Textual analysis is the application of natural language processing (NLP) to textual data for automated information extraction or measurement. We survey publications in top accounting journals and describe the trend and current state of textual analysis in accounting. We organize available NLP methods in a unified framework. Accounting researchers have often used textual analysis to measure disclosure sentiment, readability, and disclosure quantity; to compare disclosures to determine similarities or differences; to identify forward‐looking information; and to detect themes. For each of these tasks, we explain the conventional approach and newer approaches, which are based on machine learning, especially deep learning. We discuss how to establish the construct validity of text‐based measures and the typical decisions researchers face in implementing NLP models. Finally, we discuss opportunities for future research. We conclude that (i) textual analysis has grown as an important research method and (ii) accounting researchers should increase their knowledge and use of machine learning, especially deep learning, for textual analysis.

Abstract In 2005, the SEC suffered a high‐profile loss in its first court case, SEC v. Siebel Systems, Inc. , in an effort to enforce Regulation Fair Disclosure (Reg FD). We examine the impact of this loss on managers' selective disclosure to sell‐side analysts. We provide evidence that the informativeness of analyst reports increased after the Siebel decision, especially for observable instances of private meetings. This finding suggests that such selective disclosure increased significantly after the court's decision. Our results also suggest that the increased selective disclosure faded as the SEC resumed enforcement actions related to Reg FD in 2009. In exploratory analyses, we survey and interview law firm partners to investigate possible mechanisms for our results; their responses suggest that the Siebel outcome reduced manager concern about liability from selective disclosure. Collectively, our results highlight how the anticipated costs of regulatory enforcement affect private information flow from managers to analysts in particular.

ABSTRACT The management control information used in decision‐making comports with one of the two generally accepted roles—to monitor and evaluate employees to conform their behavior to achieving organizational goals (decision‐influencing role), or to reduce decision uncertainty (decision‐facilitating role). However, the ways in which these two roles may combine concurrently has received limited empirical attention. Thus, in this case study, archival data and evidence from 30 interviews with space sector experts are employed to evaluate how the two roles assumed by management control contributed—both individually and jointly—to the achievements of the National Aeronautics and Space Administration's Apollo program. The analysis leads to a proposed 2×2 matrix that better characterizes the roles that could be assumed by management control in decision settings. This study extends the management control literature by presenting an additionally nuanced picture of these roles, as well as the subsequent consequences that arise from their combinations. Its findings provide insight for management control development and application.

Abstract A rich literature suggests that investor relations officers (IROs) fulfill a one‐way information intermediary role by transmitting firm information to investors. We advance this literature with empirical evidence suggesting IROs are two‐way information intermediaries who also return investment efficiency‐increasing investor feedback to firm insiders. Exploiting granular investor relations activity data for 1,375 global firms, we document that firm investment efficiency is higher when IROs spend more time with existing institutional investors, conduct more institutional investor outreach, and meet more often with investment professionals (market intelligence collection), and when IROs transmit investment community feedback to board directors (market intelligence circulation). We mitigate endogeneity concerns stemming from our association tests by employing an expansive suite of control variables, a high‐dimensional fixed‐effects structure, an entropy‐balanced estimation sample, and an instrumental variables analysis. Our evidence supports theory predicting that managers learn about investment opportunities and their costs and benefits from investors and informs a literature predominantly characterizing IROs as one‐way information intermediaries.

ABSTRACT We investigate how owners of small‐ and medium‐sized enterprises (SMEs) perceive, make sense of, and practice risk management. Drawing on Schatzki's practice theory, we theorize on how and why risk management happens in SMEs. Thus, we fill a gap in the extant literature, which focuses almost exclusively on risk management within large organizations. We interview entrepreneurs and conduct site observations to gain insight into their risk management activities, the drivers that lead to the adoption of said activities, their attitudes toward risk management, and how their accountants may shape and contribute to risk management in SMEs. We find that rather than a specific set of formal processes, entrepreneurs view risk management as a mindset that emphasizes the preservation of key assets, creation of competitive advantages, and development of local talent and expertise. We observe practices that are mainly informal yet planned, deliberate, and fully integrated within the fabric of organizations that align with ideal forms of risk management. We also find that full‐time, in‐house accountants do help entrepreneurs with risk management, while external accountants, whose main activities relate to financial statement preparation and tax filings, do not systematically help entrepreneurs manage risk. We contribute to both the theory and practice of risk management by sharing empirical insights into how SME owners perceive, make sense of, and manage risk.

Abstract We study the relative efficiency of centralized versus decentralized organizational forms given optimized managerial performance evaluation within an incomplete contracting framework with risk‐averse agents under moral hazard. Decentralization and performance evaluation are complementary control choices and the efficiency of an organizational form depends on the design of performance evaluation. Divisions can make relationship‐specific investments that not only improve firm performance, but also increase compensation risk. We find that pure divisional performance evaluation is optimal under centralization, whereas under decentralization, optimal compensation contracts include a combination of divisional and firm‐wide performance evaluation. When comparing both organizational forms, we find that the optimal form depends on managers’ degree of risk‐aversion and the uncertainty of the business environment. Contrary to previous literature, we find that centralization dominates in many situations, particularly at high degrees of risk‐aversion and high uncertainty.

ABSTRACT We examine how regulatory restrictions on capital market activity affect the compensation contracting environment within firms. This study aims to expand our understanding of how financial market development affects firm risk‐taking via management compensation designs. Specifically, taking advantage of the staggered implementation of the Interstate Banking and Branching Efficiency Act (IBBEA), which increases bank competition and loan geographical diversification, this study examines how borrowing firms' compensation structures change when banks increase risk tolerance in their loan portfolios. Using hand‐collected compensation data of firms with market capitalization less than $75 million, we hypothesize and find that borrowing firms are likely to increase risk incentives after IBBEA and that this increase is more pronounced for firms located in states with less banking competition in the pre‐IBBEA period. We also show the findings to be more significant for borrowers whose lenders acquire more diversification benefits after IBBEA. These findings suggest that following deregulation, when banks face increased competition as well as an enhanced ability to diversify their credit risk geographically, these same banks tend to increase their tolerance for borrowers' risk‐taking. That is, their clients—nonfinancial firms borrowing from them—adjust their compensation contracts that are previously constrained by bank distaste for risk. We also document that firms that increase their risk incentives the most invest more in R&D, suggesting that management compensation is a complementary channel through which IBBEA affects firm innovation.

ABSTRACT As audit technology becomes more widespread, practice and academia are raising concerns about the costs and benefits of these technologies. We examine how internal auditors use technology‐based audit techniques (TBATs) and how TBATs impact the efficiency and effectiveness of their audits. We use two surveys and interviews of individual auditors and chief audit executives (CAE) to examine their perceptions of TBATs. Auditors perceive TBATs as beneficial. Specifically, an increase in the use of TBATs is associated with completing more audits, finding more risk factors, providing more recommendations, and decreasing audit days. However, CAEs also perceive TBATs to be costly. An increase in the use of TBATs is associated with an increase in the size of the internal audit function. Finally, interviews with CAEs suggest that TBATs are not used more often because of difficulties in quantifying their benefits, observing their benefits in a timely manner, and hiring auditors with appropriate skills. Overall, TBATs stand to increase the efficiency and effectiveness of audit tasks, but auditors struggle to quantify their net cost‐benefit tradeoff. Our findings validate the issues raised by both proponents and opponents of audit technologies and help provide empirical data to inform their decision‐making process regarding the future of these tools. Additionally, our study prompts several avenues for future research that can help inform regulators, practitioners, and researchers on how these technologies are impacting the auditing profession.