Knowledge that Transforms

The PCAOB posits that audit partner and manager involvement, primarily through greater supervision and review (“oversight”) of audit engagements, is an important determinant and indicator of audit quality. We test this notion by empirically examining the link between staffing leverage, as measured by an office's ratio of audit partners and managers to audit employees, and audit outcomes from 2008 to 2022. We find staffing leverage is associated with lower rates of client misstatements, comment letters, and PCAOB inspection deficiencies, suggesting higher audit quality. When disaggregated, the association pertains to both partners and nonpartner managers. This relation is stronger for more complex clients and for offices with better management. We also find that staffing leverage measured at the firm level predicts audit quality, and that both office‐ and firm‐level staffing leverage are incrementally informative of audit quality, suggesting disclosing audit oversight metrics at multiple levels could be beneficial. However, the association between firm‐level staffing leverage and audit quality is statistically detected only within Big 4 audits. These findings suggest that audit committees, investors, and regulators can use audit‐office partner‐staffing and manager‐staffing leverage as an informative indicator of audit quality, particularly for complex engagements.

We find that banking relationships built through institutional cross‐ownership influence the granting of loans as well as loan contract terms. Firms that are newly added to institutional cross‐owners' portfolios are more likely to borrow from banks that previously issued loans to other firms within the same portfolio. These related banks charge lower loan interest spreads and offer greater loan amounts than other banks issuing loans to the same borrower. However, such loans also are more likely to include capital covenants in the presence of high shareholder–debtholder conflicts. Thus, lenders appear to value the benefits of common institutional ownership while still protecting themselves against potential risk shifting. The interest spread effect is stronger for borrowers with high information asymmetry, low accounting quality, more financial distress risk, and dedicated institutional common owners. These results are consistent with either direct information flows or indirect signaling effects and are robust to different fixed effects specifications as well as to an identification strategy that exploits common ownership stemming from financial institution mergers. Overall, our study provides evidence that investor networks play a beneficial role in the production and dissemination of contracting‐relevant information and highlights cross‐ownership as a favorable determinant for contracting efficiency beyond traditional accounting measures.

Whereas prior studies primarily examine how environmental shocks affect manufacturing, distribution, and supply chains, we examine a distinct and understudied channel: the effect of wildfire smoke on human capital operating from firm headquarters. Using satellite‐based smoke plume measures, we show that wildfire smoke exposure in a firm's headquarters county is associated with lower operating income, with effects strengthening as smoke becomes more frequent and severe. Exposure is associated with increased employee health concerns, higher employee turnover, and shorter tenure. The negative association is stronger for firms that rely more heavily on skilled employees, and it is concentrated in higher operating costs. Collectively, these findings are consistent with wildfire smoke impairing workforce stability and productivity. Our study points to the need for enhanced climate‐risk and human‐capital disclosures. It also informs HR managers' planning for absenteeism and employee well‐being, and helps investors, audit committees, and auditors better assess smoke‐related operating risks.

We examine the adoption of expanded audit reports that include key audit matters (KAMs) in Hong Kong (2016) and mainland China (2017). These jurisdictions are highly integrated and together constitute one of the largest economies to adopt the IAASB's reporting standards in a staggered fashion, while also differing in investor protection and legal enforcement. Using matched samples, pre‐post tests, and staggered difference‐in‐differences analyses with company fixed effects, we do not find compelling evidence that expanded audit reports affect market reactions or audit quality. These findings suggest a substantial gap between regulatory intent and implementation—on average, in these markets, KAMs do not appear to meet investors' demand for incremental information or to improve audit quality substantially. At the same time, our cross‐sectional evidence on KAM characteristics is more nuanced. A higher number of KAMs and the presence of novel or transaction‐specific KAMs are associated with stronger pricing of fundamentals, consistent with investors perceiving the related financial statements as better vetted. Yet a higher number of KAMs and novel KAMs are also associated with lower profitability persistence, consistent with these disclosures reflecting company risk and volatility. In contrast, industry‐common KAMs appear less relevant for valuation, consistent with investors discounting routine disclosures, even though they are associated with more persistent performance likely reflecting more stable industry conditions. Overall, our evidence suggests that mandating expanded audit reports alone may be of limited value, whereas better tailored KAM disclosures may still serve as signals of firm fundamentals and future performance.

With the widespread use of narrative feedback in companies, understanding how such feedback can be valuable for employee performance improvement is important. Drawing on proprietary data from an e‐commerce company, we investigate the role of specificity and causality—two key language characteristics for self‐regulation and learning. Our findings suggest that neither specificity nor causality is always beneficial; instead, their effects depend on whether the feedback refers to strengths or weaknesses. Specifically, employees are more likely to improve when they receive more specific narrative feedback on their strengths, consistent with employees engaging in more systematic exploration when feedback provides concrete references to desirable behaviors. In contrast, we find that increases in the specificity of narrative feedback on weaknesses can have negative performance consequences, as employees who are confronted with many specific examples of undesirable behaviors may attempt too many behavioral changes at once, undermining learning and improvement. Furthermore, employees are more likely to improve when feedback on their weaknesses uses more causal language, suggesting that explanations of why certain behaviors were ineffective help employees understand and correct those behaviors. Our study informs HR leaders, supervisors, and experts responsible for designing management control systems by showing that narrative feedback should be specific when describing strengths, but more selective and richer in causal explanations when addressing weaknesses.

Accounting standards require firms to distinguish recurring revenues and expenses from nonrecurring gains and losses, which are often referred to as special items. However, not all special items are genuinely nonrecurring. Exploiting the setting of earnings conference calls, we explore whether analysts can identify opportunistic special items, as evidenced by asking for more information about them. We find evidence that managers' discussions of special items more often relate to predicted special items, whereas analysts have more questions about potentially opportunistic special items. Managers adopt a relatively more negative tone and use more words when answering questions about potentially opportunistic special items. Finally, we find that analysts who question potentially opportunistic special items have fewer opportunities to speak in the subsequent call, consistent with managerial retaliation.

We identify sustainability‐focused analysts using recent advances in machine learning combined with conference call transcripts. Sustainability‐focused analysts issue more accurate earnings forecasts, and the stock market reacts more strongly to their revisions. The forecasting advantage of sustainability‐focused analysts is amplified for material sustainability issues, small firms, and growth firms. Consistent with a learning curve in understanding how sustainability issues relate to future performance, we find that less experienced analysts are less likely to focus on sustainability and that they reap fewer benefits in forecast accuracy when they do so. Our results suggest that far from being an inefficient use of time and resources, focusing on sustainability provides a competitive advantage in one of the most pivotal steps in valuation: forecasting earnings.

The digital evolution in auditing has triggered a rapid shift in auditors' required skill sets, with audit firms heavily investing in and extolling advanced data analytics and artificial intelligence (AI) capabilities. However, this strong emphasis on newly required digital skills can lead many experienced auditors, who perceive these competencies as their weaker areas, to feel disaffirmed in their abilities. We predict and find, across two experiments, that auditors who feel disaffirmed in their digital skills more defensively discount specialist advice that places higher versus lower reliance on AI, but that an intervention in which auditors affirm their traditional audit skills mitigates this defensive reaction. Absent self‐affirmation, higher specialist reliance on AI results in auditors denigrating the competence and quality of advice that specialists provide. These findings suggest that disaffirmation escalates AI aversion, offering important insights into how audit firms can foster less defensive decision‐making in the rapidly evolving audit environment.

We study the implications of inflation heterogeneity for individuals and firms through the lens of accounting research, applying measurement frameworks to the national accounting measurement of inflation. We first examine the systematic exposure of individuals in low‐income households to higher inflation relative to those in high‐income households. We show that this “inflation gap” is linked with future rising inequality in the form of widening gaps in healthcare insurance, education, homeownership, and credit card debt, as well as in a higher frequency of property crimes. We also provide an economic mechanism connecting the inflation gap with rising inequality, empirically demonstrating the role of basic goods in reducing the ability of individuals in the low‐income group to attain the social and economic implications that we study. In addition, we show a channel that connects the inflation gap to firms' profitability. Indeed, consistent with the inflation gap disadvantaging low‐income households mainly through basic goods, the inflation gap fluctuations are especially strongly connected to the profitability of firms operating in the energy and consumer staples sectors. Finally, we find that market power plays a role in this connection, where this link is even stronger for firms with high market power. Taking its findings together, the paper shows that differential inflation pressures have major implications for household well‐being and corporate profitability.

Regulators are increasingly considering and mandating additional public tax disclosures to enhance transparency and promote scrutiny of corporate tax avoidance. We conducted three experiments to examine how such disclosures influence retail investors' perceptions of firms with identical effective tax rates but different tax avoidance methods. In the first experiment, participants evaluated whether firms were paying their fair share of taxes. We find that additional public tax disclosures reduce retail investors' tendency to differentiate between tax avoidance methods, subsequently affecting their willingness to invest. Specifically, participants use easy‐to‐process summary tax information in the additional public tax disclosure as a heuristic shortcut. The second and third experiments demonstrate that modifying the disclosure format and prompting participants to assess tax aggressiveness rather than fairness can mitigate these adverse effects. However, none of the cases significantly alters participants' perceptions compared to the baseline condition of no public tax disclosure. Overall, our findings provide insights into the design of, and the debate surrounding, additional public tax disclosures.