Knowledge that Transforms

Creativity drives profit in an idea economy, and many companies organize teams to facilitate creativity. This paper investigates the strategic deployment of individuals to boost a team’s creativity. More individualistic team members tend to generate highly original ideas yet are less likely to share these ideas. We theorize that adding a connector—an individual strongly predisposed to form and foster relationships—to a team will enable more idea sharing among individualistic team members, thus increasing the likelihood that the team’s creative potential will be realized. We leverage a new conceptualization of the “connector” construct to identify connectors and then use an experiment to study the impact of their presence or absence on team creative performance. Our results support these predictions and suggest that connectors improve team creativity by enabling others to share in the creative process and not because connectors themselves exhibit greater creative performance than their average peer. Data Availability: The data reported in the paper are available from the authors.

I evaluate the effect of financial statement audits on the governance practices of nonprofit organizations. Using a regression discontinuity design that exploits revenue-based exemption thresholds, I find that financial audits cause organizations to implement governance mechanisms, such as conflict of interest policies, whistleblower policies, and formal approval of the CEO’s compensation by a committee. Consistent with these governance practices curtailing managers’ private benefits, I document reductions in nepotism and CEO-to-employee pay ratio. The results are more pronounced for organizations (1) whose audit is overseen by an audit committee, (2) that already have an independent board, and (3) that face high charity-level demand for oversight. Collectively, these findings shed light on how financial audits shape the governance practices of small, less sophisticated organizations like nonprofits in ways that go beyond financial statements’ direct use in decision-making and contracting.

We use a simple k-nearest neighbors algorithm (hereafter, k-NN*) to forecast earnings. k-NN* forecasts of one-, two-, and three-year-ahead earnings are more accurate than those generated by popular extant forecasting approaches. k-NN* forecasts of two- and three-year (one-year)-ahead EPS and aggregate three-year EPS are more (less) accurate than those generated by analysts. The association between the unexpected earnings implied by k-NN* and the contemporaneous market-adjusted return (i.e., the earnings association coefficient (EAC)) is positive and exceeds the EAC on unexpected earnings implied by alternate approaches. A trading strategy that is long (short) firms for which k-NN* predicts positive (negative) earnings growth earns positive risk-adjusted returns that exceed those earned by similar trading strategies that are based on alternate forecasts. The k-NN* algorithm generates an empirically reliable ex ante indicator of forecast accuracy that identifies situations when the k-NN* EAC is larger and the k-NN* trading strategy is more profitable. Data Availability: Data are available from the public sources described in the text.

This study investigates the economic consequences of the IFRS 3 (2008) requirement for fair valuing earnouts. Using a hand-collected sample of earnout fair value estimates in acquisitions completed by Australian firms, we find that a significant portion of acquirers overstate initial earnout liabilities and strategically reverse them as operating gains to boost post-M&A earnings. These overstatements are more pronounced when acquirers face investment- and performance-related pressure but attenuated in the presence of high-quality auditors and debt-financed deals. Acquirers also obfuscate earnout-related disclosures, inhibiting investors’ assessment of earnout values. By doing so, managers extend their tenure. Further analysis reveals that IFRS 3 (2008) leads to a significant increase in both the frequency and magnitude of earnouts in public acquirers’ transactions. Overall, we highlight the accounting benefit of earnouts for acquirers under IFRS 3 (2008), with implications for investors, analysts, auditors, and standard setters. Data Availability: Data are available from the public sources cited in the text.

We study how vertical integration shapes firms’ public disclosures. Theory suggests that firms can use public disclosure to coordinate with supply chain partners and predicts a substitution between vertical integration and public disclosure of future strategic plans, since the internalization of production reduces the need to publicly coordinate. Using data on the extent of vertical integration, we find that firms that become more vertically integrated reduce their public disclosures about their product strategies and that the reduction is most pronounced for vertically integrated firms with greater internalization of production and those with the largest informational and strategic frictions along the supply chain.

Governmental Accounting Standards Board Statement No. 34 (GASB 34, 1999) standardized financial reporting and disclosure requirements for U.S. state and local governments. We interpret debt issuing patterns surrounding GASB 34 implementation as evidence of strategic behavior by governments in anticipation of GASB 34 consequences. Specifically, governments that expected more favorable post-GASB 34 evaluations by municipal bond investors delayed new uninsured debt issues until after, whereas governments that expected less favorable evaluations accelerated debt issues to before, GASB 34 information became publicly available. Governments expecting favorable consequences were more likely than governments expecting adverse consequences to substitute away from insured debt and toward uninsured debt, and to choose new debt financing rather than alternative financing sources following GASB 34. These findings are consistent with the notion that expectations about GASB 34 consequences were realized, and that standardization created through GASB 34 facilitated separation in the municipal debt market. Data Availability: Data are from publicly available sources identified in the manuscript.

Despite the increase in and diversity of disclosure channels available, our understanding of how managers incorporate channel features into their disclosure decisions remains incomplete. I provide evidence that managers choose relatively rich channels that offer multiple cues, opportunities for interaction, and linguistic diversity (i.e., the earnings call, as compared to the press release) to communicate complex information. The positive relation between disclosure channel richness and subject matter complexity persists in both a document-level analysis and a small sample test examining disclosure channel choice from all possible disclosure channels. I provide some evidence that deviating from the complexity/richness matching strategy is associated with a muted market response to firms’ quarterly disclosures. The results are consistent with managers choosing disclosure channels to reduce investors’ information processing costs. Data Availability: Data are available from the public sources cited in the text.

As remote auditing remains widespread, the profession is concerned that decreased auditor-client interactions and remote supervision challenges can reduce audit quality. In response, some firms have increased supervisor monitoring of remote auditors. We experimentally examine how two key remote audit factors, the spatial distance between auditors and clients and the frequency of supervisor monitoring, influence auditors’ judgments in creative tasks. We predict and find that working remotely facilitates auditors’ higher-level cognition that enhances creative hypothesis generation and improves decision quality when uncovering a seeded error if monitored less frequently than more frequently. More frequent monitoring constrains auditors, which squashes effort and creativity, diminishing the benefits of working remotely. Working onsite at the client location reduces the sense of psychological distance, thereby diminishing the difference between monitoring frequencies. These findings have implications for audit practice as working remotely can enhance performance on creative problem-solving tasks, but only when monitored less frequently.

There are instances where CEO turnover occurs, even if the company has not made any significant strategy changes, and the new CEO possesses similar abilities as the predecessor. This paper aims to provide a rational explanation for this seemingly irrational phenomenon. One possible reason for this “aggressive” CEO turnover is the board’s desire to reduce the information rents earned by the privately informed CEO. Specifically, the incumbent CEO has a temptation to “sandbag” the board about profitability prospects to secure more generous incentive pay for future implementation, and a (seemingly aggressive) replacement policy helps discourage this kind of gaming. That is, instead of “information-based entrenchment” as suggested by the literature (Laux 2008; Inderst and Mueller 2010), this paper shows a countervailing effect that the CEO’s private information (combined with the later-stage moral hazard problem) may lead to her dismissal more often than the ex post efficient benchmark.

Using the staggered adoption of takeover laws, this study examines implications of takeover threats on earnings management around the world. I find that the enactment of takeover legislation leads to increased earnings management (abnormally high accruals, target beating, and poor accruals quality). Results are driven by underperforming managers with higher turnover risk in countries with high increases in turnover sensitivity to performance, indicating job security concerns as the channel through which takeover laws increase earnings management. Furthermore, results are strongest in countries with weak investor protection, where existing governance mechanisms are weaker and earnings management is more prevalent. Moreover, regulation provisions that most directly increase takeover threats experience greater earnings management responses. Additionally, I show that accounting restatements and fraud scandals become more frequent following takeover legislation. Overall, I provide evidence that takeover reforms, although enhancing discipline of underperforming managers, inadvertently incentivize accounting manipulation due to heightened job security concerns.