Knowledge that Transforms

ABSTRACT This study examines whether the ideological orientation of the audit partner and audit committee members—defined as their personal belief systems and inclinations, including their attitude toward risk, ambiguity, and novelty—has an impact on engagement partner selection and the effectiveness of oversight in the financial reporting process. Drawing on prior evidence that the two main US political parties reflect different ideologies, we hand‐collect political donation data to construct ideological scores for audit partners and audit committee members. Our findings highlight several intriguing relationships. First, audit committees are more likely to select an ideologically dissimilar partner. Second, greater ideological dissimilarity between these two key monitors is associated with higher financial reporting quality. The effects of financial reporting quality are most pronounced among more effective audit committees and when audit partners have longer tenure with the client. These effects are incremental to both social connections between the audit partner and audit committee and to ideological differences between these parties and the CEO and CFO. Overall, the results support the notion that ideological dissimilarity between audit partners and audit committees can foster effective oversight of the financial reporting process. Moreover, ideological dissimilarity appears to be a useful and rational cue in audit partner selection decisions.

ABSTRACT Corporate tax avoidance is a recurring focus of policy‐makers, the media, activist groups, and researchers. This focus often centers on multinational enterprises' (MNEs) use of tax havens, with a wide body of research utilizing MNEs' tax haven use as evidence of corporate tax avoidance activities. However, the common assumption that MNEs operate in tax havens only for tax avoidance purposes overlooks the role tax havens play as homes for captive insurance entities, which allow firms to secure “self” insurance coverage but do not provide obvious differential federal tax benefits. When we remove the effect of captives on tax haven–based measures, we observe a roughly threefold increase in the magnitude of tax savings specifically associated with haven noncaptive activity. We document that nonfinancial firms' use of captive insurance occurs in approximately 11% of firm‐years and spans nearly all Fama–French 49 industries. We construct a haven captive use determinants model, with strong discriminatory power and compelling out‐of‐sample corroboration tests, that future research can employ to account for firms' use of haven captives. Our findings underscore the importance of separating captive and noncaptive‐related haven activities.

ABSTRACT We examine the effects of the 2017 Tax Cuts and Jobs Act's (TCJA) interest deduction limitation on suppliers. Using a difference‐in‐differences design, we find that suppliers with customers subject to the limitation (“affected suppliers”) report increased accounts receivable of between 11.2% and 14.9% relative to their pre‐TCJA average accounts receivable. Using a triple differences design, we provide more granular evidence by documenting that the limitation's effects on affected suppliers' accounts receivable are driven by suppliers with customers that report increased trade credit use (i.e., higher accounts payable). In cross‐sectional analyses, we find that the effects are stronger when suppliers are smaller, have higher peer product similarity, operate in industries with low entry barriers, or are in the early stage of their life cycle, consistent with suppliers with weaker bargaining power providing more trade credit to customers compared to other suppliers. Turning to supplier consequences of increased accounts receivable, we find that affected suppliers' days sales outstanding and operating cycles increase. Next, we use path analyses to find that affected suppliers experience lower cash flows and higher risks due to their increased accounts receivable. Overall, our study provides evidence that the interest deduction limitation yielded externalities on affected firms' supply chains.

ABSTRACT We examine the impact of a 2020 “comply‐or‐explain” disclosure mandate implemented in Canada. This regulation imposed the first disclosure mandate extending beyond gender diversity to include racial diversity. Using federally registered public firms as a treatment group and provincially registered public firms as a control group, we establish two main findings. First, racial diversity increased among directors of firms subject to the disclosure mandate. Gender diversity also increased, but only for firms not subject to an earlier rule pertaining only to gender diversity. Second, the impact of the disclosure mandate is plausibly driven by shareholder monitoring, notably through director elections. Overall, our findings contribute to the policy debate on the effects of disclosure mandates on social dimensions.

Abstract Although the community of tax professionals is a key actor in the tax realm, its nature continues to remain elusive in many countries. Using a qualitatively driven mixed‐methods approach that integrates the insights obtained from in‐depth interviews and the results of a survey of practitioners, we examine the Canadian tax field. Although tax work has traditionally been dominated by lawyers and accountants, our study finds that a distinct expert occupation has taken shape, as evidenced by the collective identification of those working full‐time in the area. Theoretically, we show how individuals can effectively generate an occupational community through their collective identification with it and how professions that do not fit the ideal type or that are in the process of emerging may be understood. The concepts of boundary erasure and boundary emergence are introduced as variants of boundary blurring and boundary making to explain how boundaries in a professional field may be reconfigured, allowing for the emergence and informal closure of occupations. Advancing the understanding of occupational groups that have not yet embraced the professional project, our study offers insight into why some forms of expertise might not professionalize in the traditional way. Overall, the findings have implications for research on tax professionals as well as for efforts to govern their work.

ABSTRACT This paper draws on the social control and sensemaking literatures to study how a Big 4 audit firm in the Netherlands sought to contest the national oversight body's inspection findings on one of its audit engagements. Our case study leads us to develop the concept of professional ambiguity to capture the multiple, coexisting meanings and interpretations of audit evidence and professional judgment inherent in audit work. We show how professional ambiguity creates a space for discursive struggles between auditors and inspectors, enabling audit firms to engage in strategic sensemaking aimed at contesting looming inspection findings. In our case, this process entailed the mobilization of senior firm actors who reinterpreted the focal engagement as broadly acceptable—or “good enough.” Yet, when enacting this pragmatic reframing, the firm ultimately failed to overturn the oversight body's findings. Despite this outcome, we argue that audit firms seek to mobilize professional ambiguity and engage in strategic sensemaking to reshape oversight bodies' interpretations of audit engagements in inspection processes.

Abstract Firms with multiple pieces of information can disclose the information concurrently (bundled disclosure) or sequentially (unbundled disclosure). This paper examines the pricing implications of (un)bundled disclosure in a rational expectations equilibrium model. The model considers a firm whose liquidating cash flow consists of two components. Some investors possess private information about one component (e.g., earnings) and all investors are uninformed about the other component (e.g., unexpected events). We analyze three disclosure policies. In bundled disclosure, both cash flow components are disclosed concurrently; in unbundled disclosure, the informed cash flow component is disclosed early, and the uninformed component is disclosed later; and in alternative unbundled disclosure, the uninformed component is disclosed early, and the informed component later. We find that the disclosure policy influences the cost of capital prior to any disclosure through a risk allocation effect and a price informativeness effect. Unbundled disclosure results in a lower cost of capital compared to bundled disclosure, as it improves risk allocation and enhances the informativeness of the stock price prior to any disclosure. However, for alternative unbundled disclosure, the cost of capital can be higher or lower than that of the other disclosure policies. This is because late disclosure of the informed cash flow component alters investors' risk exposure to the noisy supply of shares, thereby influencing the risk allocation and price informativeness effects.

Abstract Sell‐side equity analysts serve as external monitors, yet evidence on how they fulfill this monitoring role remains limited. We examine whether analysts utilize earnings conference calls to monitor firms suspected of real earnings management and assess the implications of such monitoring. Our findings reveal that analysts are more likely to ask about discretionary expenses during conference calls of firms suspected of lowering these expenses to meet or narrowly beat analysts' expectations. These questions are associated with lower subsequent EPS forecast revisions, indicating a potential cost to managers. Moreover, analysts' questions on discretionary expenses to suspect firms are linked to subsequent increases in discretionary expenses and a lower likelihood of meeting or narrowly beating analysts' earnings expectations in the following 2 years. Overall, our results suggest that analysts' active participation in earnings conference calls potentially discourages managers from engaging in real earnings management.

Abstract Downside risks are ubiquitous and can profoundly impact firm operations and valuation. Failure to adequately assess and manage target firms' downside risks hinders acquirers' ability to integrate and manage these businesses. This article introduces a novel measure of firms' downside risk similarity (DRS) based on risk factor descriptions and examines its implications for mergers and acquisitions (M&A) outcomes. We first validate that the measure is distinct from existing similarity measures and that it captures similarity in firms' potential significant downside. Using the new measure, we find that the market reacts more positively to deals in which acquirers and targets share more downside risks. Additional analyses show that this beneficial effect of DRS is driven primarily by risks that are idiosyncratic or firm‐specific, consistent with these risks requiring acquirers' relevant expertise to manage. Last, we document that in deals with more similar downside risks, the acquirers experience fewer risk profile changes and are less likely to suffer from adverse outcomes, such as deal‐specific goodwill impairment, divestitures, and significant profitability declines. Overall, we conclude that DRS plays a significant role in the M&A process.

ABSTRACT Accounting firms have traditionally operated as both elite and reinventive institutions that offer a structured and prestigious career path and enforce a deeply transformative socialization process for auditors. However, recent labor market shifts and evolving work preferences are challenging this regime of power, with significant implications for firms and their employees. Drawing on 31 semistructured interviews with auditors in Canada, our study examines how these changes are reshaping power dynamics within accounting firms. First, we find that firms are increasingly struggling to define and produce the ideal auditor. Instead, as we highlight, they are experiencing the emergence of the default auditor , a professional shaped more by labor market constraints and transactional engagement than by traditional firm‐driven selection and disciplinary mechanisms. Second, we analyze the erosion of pastoral power (i.e., power rooted in guidance and care) within firms, as staff auditors prioritize the care of the self, while partners and managers (P&Ms) increasingly struggle to establish and sustain pastoral relationships with their subordinates. As a result of this erosion, P&Ms fluctuate between self‐sacrifice (i.e., taking on additional responsibilities to compensate for auditors' disengagement) and a growing sense of inequity (i.e., feeling they are giving too much while receiving too little in return). To capture this growing impasse, we develop the concept of disciplinary and pastoral paralysis , a state in which P&Ms can no longer rely on traditional mechanisms of discipline and punishment to enforce norms of professional conduct but also struggle to reinvent new forms of pastoral power. We examine the implications of this loss of control, questioning whether it represents a temporary shift or a more permanent transformation. Finally, we discuss the broader consequences of accounting firms becoming less like normalizing institutions and more like “ normal ” organizations.