Knowledge that Transforms

We examine whether the change in earnings announcement textual tone, aggregated across individual publicly traded firms, helps predict gross domestic product (GDP) growth. The literature finds that changes in aggregate accounting earnings do help predict GDP growth, but only when aggregate earnings changes are negative. Because conservative accounting rules limit managers' ability to communicate positive news promptly, we examine the tone of quarterly corporate earnings announcements as a possible source of timely positive information provided by firms. We find that the change in aggregate tone in the earnings announcements from the same quarter in the previous year predicts one‐quarter‐ahead GDP growth, but only when the change is positive. Our study contributes to the literature by investigating the relation between aggregate corporate disclosure tone and macroeconomic outcomes.

In response to the extended audit report regulations implemented in the United States and internationally, both audit firms and regulators have increased scrutiny over critical audit matters/key audit matters (collectively referred to as CAMs) through internal and external inspections. At the same time, auditors and audit committees (ACs) have altered the content and timing of CAM‐related discussions by communicating specific planned audit procedures earlier in the audit process. This study explores the effect of early communication of CAM‐related audit procedures to the AC and increased scrutiny from inspections on auditors' propensity to adjust planned audit procedures in the presence of newly identified audit risks. Based on self‐justification theory, we predict and find that early communication of planned audit procedures to the AC causes auditors to be less likely to adjust planned audit procedures even when additional risks arise that necessitate change, especially when inspection is likely. This has the potential for diminished audit quality. Interviews with audit partners provide context for how these findings relate to the current auditing environment.

In this field study, we examine tax advisors' decision‐making process when developing tax planning arrangements. Through interviews with 40 tax advisors, our analysis indicates that tax savings may come at a price in practice by unveiling adverse post‐implementation experiences shared by tax partners. Partners find themselves in a tricky position at the time they form their recommendation as they cannot be certain that their client will be able to “live with their tax structure”—that is, maintain it and cope with the inherent risks once implemented. Their main concern is that their client may “get caught out” by a structure too aggressive or complicated for them, having no control over the client's behavior once the plan is implemented. This has significant implications in the tax planning decision‐making process as these concerns shape how partners adapt their work to their client's perceived competency and possibly restrain corporate firms' tax aggressiveness. Following Feller and Schanz (2017, Contemporary Accounting Research , 34 (1), 494–524), we conceive of this as the fourth hurdle of tax planning— whether a tax structure is maintainable, as perceived by tax advisors—and unpack how it operates. Interestingly, restraining the client's tax planning aggressiveness (and the corresponding potential tax savings) is not necessarily perceived by partners as detrimental to the client relationship. Our findings contribute to a better understanding of tax planning in action, highlighting how tax partners seek to influence their client's tax planning aggressiveness.

This study examines whether using cash‐flow‐based performance metrics (CFM) in CEO compensation contracts affects the design of loan contracts. Cash‐flow‐based performance evaluation explicitly motivates the CEO to improve the firm's cash flows, which may enhance debt repayment ability and reduce credit risk. We thus hypothesize that lenders, anticipating this incentive effect, offer lower loan spreads and reduce cash‐flow‐based performance covenants when firms use CFM in CEO compensation contracts. Consistent with our expectation, the use of CFM is associated with lower loan spreads and less use of cash‐flow‐based performance covenants. These findings remain robust after we account for endogeneity. Furthermore, these results are more pronounced in firms with higher credit risk or risk of cash flow shortfalls, suggesting that lenders consider internally generated cash flows more valuable when borrowers face higher external financing costs or have greater liquidity concerns. Additionally, we find that using CFM is associated with improved cash flow performance and enhanced creditworthiness, which supports the notion that CFM is an effective incentive mechanism. Overall, our evidence suggests that lenders consider the incentive effect of cash‐flow‐based performance evaluation in the debt contracting process.

We examine whether a firm's corporate social responsibility (CSR) actions that benefit external parties can cause the firm's employees to reduce their effort. We expect employees will reduce their effort in response to their firm's external CSR actions when they perceive that they are treated poorly by the firm and that the firm's external CSR actions use resources that could have been readily transferred toward improving employee treatment. We expect that, when employees hold both of these perceptions, they will react negatively to the firm's CSR actions due to heightened feelings of unfairness. Results support our expectations and theory. We find that employees respond negatively to CSR only when they perceive that they are treated poorly by their firm and that CSR uses transferable resources. Further, we find these effects are driven by employees' perceptions of the fairness of their firm's actions toward employees. Our study suggests that firms should consider how employees perceive their treatment by the firm and the transferability of the resources used for CSR actions that benefit external parties.

We examine the economic determinants and informational effects of credit rating affirmations (i.e., the reiteration of past credit ratings) for a sample of US public firms from 1995 to 2020. We find that credit rating affirmations typically follow major corporate events and changes in firm fundamentals that increase information uncertainty about a firm's creditworthiness, suggesting that affirmations reduce uncertainty. We further document that rating affirmations provide value‐relevant information to equity and debt investors. Using a short‐window event study method, we show that equity investors react positively to rating affirmations and that information uncertainty around affirmations diminishes. These findings are more pronounced for firms with non‐investment‐grade ratings. We further show that our results strengthen for firms with greater pre‐affirmation information uncertainty. Finally, consistent with our information uncertainty reduction results from the stock market, we report that bond yield spreads decrease for affirmed firms. Again, the effect is more pronounced for firms with non‐investment‐grade ratings. In summary, we highlight the significant capital markets' effects of credit rating affirmations, an area that the literature has largely ignored.

This paper presents new evidence on the economic benefits arising from common institutional ownership. We find a negative and significant effect of common institutional ownership on stock price crash risk. This effect is robust to a battery of robustness checks and is causal according to some identification tests, including difference‐in‐differences analyses on financial institution mergers. We find evidence that the negative effect is attributable to the monitoring role of common institutional owners—a role that is enabled by common owners' lower information processing cost and greater monitoring incentives owing to governance externalities. We also find that common owners negatively influence crash risk through constraining bad news hoarding and that common owners are more likely to force CEO turnover when a firm has higher crash risk. Overall, our results suggest that common institutional shareholders play a unique and effective monitoring role that fends off stock price crashes.

In empirically estimating the relation between CEO compensation and accounting‐based firm and peer performance, researchers often define the performance variables net of CEO compensation expense. We analytically show that a researcher's use of CEO compensation as a regression's dependent variable and as an expense in defining a regression's independent variables representing accounting‐based firm and peer performance will bias the researcher's pay‐for‐performance and relative performance evaluation (RPE) regression coefficients. In a panel estimation of CEO compensation, we document an attenuation bias in the coefficients on net firm and net peer performance. This evidence may partially explain inferences of weak CEO incentives and limited usage of RPE in prior work. Our results imply that in CEO compensation regressions, a researcher can remove biases in inferring CEO incentives and RPE usage by using gross rather than net accounting performance variables—that is, by adding back CEO compensation expense to net accounting measures.

We investigate whether a larger CEO employment network provides access to information that improves firms' earnings forecasts and find a significantly positive relation between CEO employment network size and management earnings forecast accuracy. Our results suggest that firms use information obtained from CEO contacts to increase the accuracy of their earnings forecasts. Our conclusion is further supported by evidence of positive associations between CEO employment network size and the likelihood, frequency, and precision of management earnings forecasts. We also find that CEO employment network size is positively related to analysts' reactions to the forecast news and the accuracy of management earnings forecasts relative to analyst forecasts. Overall, our results are consistent with a larger CEO employment network generating external information that increases the accuracy of firms' earnings forecasts.

The general anti‐avoidance rule, or GAAR, is an enforcement mechanism that gives a country's taxing authority broad power to deny a taxpayer tax benefits associated with any transaction. Although GAARs are becoming increasingly common, the presence of a GAAR is generally overlooked by researchers and thus has been left unstudied. In this paper, we provide an initial investigation by studying the effect of GAARs on firm‐level corporate tax avoidance behaviors. Using an indicator for the enactment or strengthening of a GAAR within a country in a stacked difference‐in‐differences design, we find GAAR enactment is associated with a statistically and economically significant decrease in firm‐level tax avoidance. Additional cross‐sectional analyses show that the decline in tax avoidance occurs for conventional GAARs and economic substance‐type rules, original and strengthened GAARs, and domestic and multinational firms. Results also show that the effect is strongest for firms with higher levels of pre‐GAAR‐enactment tax avoidance and for firms incorporated in countries where the burden of proof lies with the taxpayer.