Knowledge that Transforms

Regulators have expressed concerns that an emphasis on non-audit services (NAS) could distract from the audit function, even for clients with minimal NAS purchases. Motivated by this concern, we examine whether a greater emphasis on providing NAS to audit clients generally (i.e., not to a specific client) can distract from the audit function, thus reducing audit quality. We find evidence of an NAS distraction effect, where a greater emphasis on NAS at the audit office-level results in more client financial statement restatements, even after controlling for client-specific NAS. Further, the association exists among clients that purchase minimal NAS, suggesting that this association relates to distraction effects in addition to independence issues examined in prior research. This study should be of interest to audit firms, audit committees, and regulators because it provides new evidence regarding issues related to a business model that includes both audit and non-audit services.

We examine how the qualitative characteristics of a non-GAAP earnings disclosure reveal the quality of the non-GAAP performance metric itself. We measure the qualitative aspects of the non-GAAP disclosure using an index of 12 hand-coded characteristics and presentation choices that provide context to non-GAAP disclosures. We find that more transparent qualitative information in non-GAAP disclosures is associated with more transitory non-GAAP exclusions and a lower likelihood that managers will aggressively exclude expenses in calculating non-GAAP earnings to meet or beat analysts’ forecasts. We also find that the association between non-GAAP exclusions and earnings announcement period returns is less negative for firms with more transparent qualitative information accompanying their non-GAAP disclosures. Overall, these results suggest that qualitative characteristics of non-GAAP disclosures convey useful information about the quality of non-GAAP earnings metrics.

While studies have sought to explain the benefits of cross-listing, little attention has been paid to the role of communication between managers and investors during this process. In this paper, I investigate whether managers change communication policies around U.S. cross-listings. I document significant increases in communication when firms cross-list. I then test whether these investor communication practices around cross-listing are associated with capital market benefits. I find that cross-listed firms that communicate more with investors experience greater and longer lasting cross-listing benefits. Lastly, I explore two potential reasons that may lead managers to choose higher levels of communication: to support an increase in investor recognition and to facilitate monitoring. I find results consistent with communication increasing visibility and scrutiny, suggesting that communication functions as a supporting tool to achieve managers’ cross-listing goals.

We examine whether the public availability of product market incumbents' financial disclosures leads to greater capital structure mimicking of incumbents by entrants. Exploiting a change in disclosure enforcement for German private firms in the mid-2000s, we find entrant-incumbent mimicking rises substantially in concentrated markets once incumbents' financial statements are publicly available. Additional tests exploring potential mechanisms are more consistent with interfirm learning underlying the effect than alternative channels. Our findings shed light on the effects of competitor financial statement disclosure on private firms’ initial financing decisions and highlight how capital structure dependencies among peer firms arise.

This paper analyzes the effects of expanded compensation disclosures on manager pay. For identification, I use the introduction of the Compensation Discussion and Analysis (CD&A) in the 2007 proxy season, a significant expansion in required compensation disclosures, to compare manager pay at firms with and without the disclosure in a difference-in-differences analysis. These disclosures are associated with increasing pay, contrary to the conventional wisdom that pay disclosures reduce pay levels via better shareholder monitoring. I hypothesize that enhanced ex ante disclosures of incentive plans reduce boards’ flexibility to make ex post adjustments or to use subjectivity and pressure boards toward more formulaic plans. Both effects impose higher payout risk on managers, leading to increased pay levels. Consistent with this hypothesis, the CD&A introduction is associated with lower likelihood to earn variable cash pay, greater use of formula-based pay, and higher pay at firms with more volatile measures of performance.

We examine how supplier industry competition affects CEO incentive intensity in procuring firms. Using Bureau of Economic Analysis data to compute a weighted supplier industry competition measure, we predict and find that higher supplier competition is associated with stronger CEO pay-for-performance incentive intensity. This effect is incremental to that of the firm's own industry competition previously documented and is robust to alternative measures of supplier competition and to exogenous shocks to competition. Importantly, we show that performance risk and product margin act as mediating variables in the relation between supplier competition and CEO incentive intensity providing support for the theory underpinning our finding. We document that CEO compensation contracts are used as a mechanism to exploit the market dynamics of upstream industries to a firm's benefit. Our findings are economically important as suppliers provide, on average, 45 percent of the value delivered by procuring firms to the market (BEA, 2016).

Executive bonus plans often incorporate performance measures that exclude particular costs—a practice we refer to as “cost shielding.” We predict that boards use cost shielding to mitigate underinvestment and insulate new managers from the costs of prior executives’ decisions. We find evidence that boards use cost shielding to deter underinvestment in intangibles and encourage managers to take advantage of growth opportunities. We also find that cost shielding tends to be elevated for newly-hired executives, and decreases over tenure. Collectively, our results suggest that boards deliberately choose performance metrics that alleviate agency conflicts.

This study investigates whether brokerage houses appear to provide stock tips to politicians. Our results indicate that trades by politicians who are politically connected to the brokerage house where the trade is executed are more profitable. Our estimates suggest that these connected trades earn an incremental 0.3% over a five-day window relative to the politician's average profitability. Given the average number of trades our sample politicians execute in a year, the 0.3% return per trade translates to an incremental $3,411 in trading profits each year. We provide additional support by investigating the frequency and differential profitability of politicians' trades immediately before the brokerage house issues a revised recommendation, as well as during a period when Goldman, Sachs & Co. was sanctioned for providing stock tips to high priority clients. Additional tests suggest that brokerages may provide stock tips to politicians in exchange for favorable legislative outcomes or political information.

This study examines peer effects in corporate disclosure decisions. Peer effects suggest that the average behavior of a group influences the behavior of individual group members. Consistent with peer effects, I find that disclosures made by industry peers induce firm disclosure. Peer effects in disclosure are more pronounced when a firm's strategic uncertainty is higher, indicating that peer firm disclosure reduces the external uncertainty arising from the firm's interaction with its industry peers and thus increases the precision of managerial private information. I also find that peer effects are stronger when a firm's dependence on external financing is greater, suggesting that peer firm disclosure increases the costs on firm visibility and reputation in capital markets. Overall, these findings suggest that peer firm disclosure shapes a firm's information environment.

The originate-to-distribute (OTD) model, in which the originators of mortgages sell or securitize the mortgages to third parties, likely contributed to the 2008 financial crisis. Auditors were blamed for permitting clients to understate the risks of the model in their financial reports, fostering undisciplined lending. We investigate whether public audit oversight influences OTD lending by promoting more vigilant audits of the financial reports of originators. Using a difference-in-differences design prior to the financial crisis, we find reduced OTD lending by banks after the Public Company Accounting Oversight Board (PCAOB) criticizes their auditors’ audits of financial reports regarding OTD transactions. The reduction is greater for banks with poorer risk controls and stronger incentives to manage earnings. We also find a reduction in gains on loan sales and securitizations. The results suggest that PCAOB inspections can help discipline OTD lending, a real effect of public audit oversight in the United States.