Knowledge that Transforms

Securities regulators frequently punish firms for their managers’ misreporting. They argue that this would enhance firms’ long-term value by mitigating underinvestment in compliance mechanisms, such as internal controls over financial reporting. Opponents of corporate penalties argue that the penalties would harm the very same investors already harmed by misreporting. We evaluate these arguments in a model with a capital market-oriented misreporting manager and a board of directors that invests in internal control quality. We identify governance transparency and board dependence as key factors that moderate the firm-value effects of corporate penalties. Internal control underinvestment occurs only if the board is severely dependent and if its choice of internal controls is opaque. Then corporate penalties curb internal control underinvestment, but they only improve long-term firm value if, additionally, internal control costs are sufficiently small (e.g., in small and less complex firms). Overall, our differentiated results have implications for regulatory enforcement policies and empirical studies on the firm-value effects of public enforcement.

Abstract We explore the capabilities and dangers of artificial intelligence (AI) usage in accounting research. We focus on mining U.S. securities regulations as an economic shock, testing the causal effect of these shocks on U.S. firms’ voluntary disclosure, and writing a complete academic paper, conditional upon finding statistically significant results. Overall, this research experiment demonstrates the capacity for AI to provide efficiencies in research. AI-generated papers are not ready to be submitted to top accounting journals, but they constitute a useful starting point for accounting researchers and using AI saves valuable time in identifying exogenous shocks that significantly affect an outcome of interest. When we repeat the same experiment to explore the causal effect of non-U.S. securities regulations on U.S. firms’ voluntary disclosure practices, AI writes many professional looking papers with spurious results and unsubstantiated economic arguments, highlighting the potential dangers of AI for accounting scholarship.

Abstract We examine the relation between the gender composition of audit teams and two important audit outcomes—audit quality and audit fees. We identify gender composition across auditor ranks with novel audit-office level data for 20 large U.S. public accounting firms from 2010 to 2018. We find engagements of audit offices with more female auditors are associated with higher audit quality and lower audit fees. We find the association between gender composition and audit outcomes is strongest at the staff level, and among audit seniors in particular. The results also strengthen in offices with more supportive workplace environments. Overall, our large-scale evidence provides important insights on the role of gender composition of audit teams.

Abstract Analyzing a panel of earnings announcers from 1998–2022, we document that the aggregate market return on quarterly earnings announcement dates is positively associated with the announcing firm’s subsequent three-day abnormal returns. This phenomenon is strongest for firms with extreme earnings surprises and dissipates by day seven, indicating a short-lived delay in incorporating the aggregate news. We also document a sluggish return response to same-day macro news disclosures, especially when earnings surprises are extreme. Effects strengthen when investors exert more effort in acquiring announcing firm information, measured by SEC EDGAR filing downloads, when macronews has a larger impact on a firm’s stock returns, when firms are smaller, and when investors’ attention and processing capacity are more constrained, proxied by retail trading. Overall, the findings support the notion that investors have finite information processing capacity and that intensive efforts to acquire firm earnings news delay the incorporation of macroeconomic news into prices.

Abstract This paper examines earnings management in response to changes in tax planning and financial reporting incentives around the corporate income tax rate decrease from 35% to 21% enacted by Tax Cuts and Jobs Act (TCJA) of 2017. Given the higher level of book-tax conformity of real activities manipulation (RAM) relative to accrual-based earnings management (AEM), we hypothesize that firms concertedly use these techniques for different purposes. Specifically, we predict and find that firms use RAM to reduce taxable income prior to the TCJA with firms in our sample saving between $9.1 billion and $11.0 billion in taxes by shifting taxable income from the high-tax to the low-tax period. We also predict and find that firms use AEM, which has lower book-tax conformity than RAM, to simultaneously increase book income in the high-tax period. These results inform policymakers, regulators, and researchers on the economic effects of corporate tax reform.

Abstract We examine whether private firm disclosure affects the price that public firms pay for their bank loans. Using global data on syndicated loans, we find that private firm disclosure significantly reduces public firms’ loan spreads. This finding supports a positive information externalities view whereby private firm disclosure helps banks evaluate public borrowers’ credit risk within the industry context and reduces information asymmetry between banks and borrowers. Consistent with this mechanism, we find larger reductions in public firms’ loan spreads when banks have less information about the borrower or lower expected monitoring intensity, when public-firm borrowers are more informationally opaque, when private firms have greater economic importance in the industry, when private and public firms are more economically similar, or when a larger share of private firms in an industry have audited financial statements. We show that private firm disclosure generates positive externalities for the loan market by reducing information asymmetry.

Abstract This study implements topical analysis to identify the extent to which managers shift their responses from analysts’ questions in earnings conference calls. We refer to this behavior as managerial topic-shifting. Using a sample of conference calls from 2002 to 2017, we find that managers in firms with better performance, more powerful CEOs, and a weaker information environment shift more from the topics of analysts’ inquiries. Managers are also more likely to shift topics when analysts’ questions display a more positive tone or lower specificity. Moreover, we find that managerial topic-shifting provides incremental information to capital markets by facilitating the incorporation of earnings information into stock prices. Our study documents a previously unexplored dimension of managerial disclosure strategy.