Knowledge that Transforms

ABSTRACT In this study, we examine the effect of increased tax transparency on the tax planning behavior of European banks. In 2014, the European Union introduced public country‐by‐country reporting requirements to the banking industry. Treating this new requirement as an exogenous shock, we find limited evidence consistent with a decline in income shifting by the banks' financial affiliates in the post‐adoption period (starting from 2015). We do not, however, find robust evidence of a significant change in the consolidated book effective tax rates among the affected banks. Our findings suggest that increased transparency from public country‐by‐country reporting can deter tax‐motivated income shifting but that it did not appear to materially influence the banks' overall tax avoidance. Our findings have policy implications for the ongoing debate between the European Parliament, the Organisation for Economic Co‐operation and Development, and accounting standard‐setting bodies on whether to require multinationals to publish country‐by‐country reports.

ABSTRACT Auditors frequently use valuation specialists to help them evaluate fair values, but researchers and regulators know little about how auditors use these specialists. Based on interviews with 28 auditors and 14 valuation specialists, I develop a theoretical framework informed by expert systems and professional competition theories. The interviews suggest that institutional pressures in the fair value environment unevenly impact auditors and specialists, causing tension between auditors' needs for ontological security and jurisdictional claims. This tension leads to one‐sided competition between auditors and specialists and incomplete acceptance of specialists' work. Auditors' competitive behaviors coupled with this incomplete acceptance result in a tendency to make specialists' work conform to auditors' views. Collectively, these findings suggest that auditors use specialists as an institutional mechanism to create comfort, but not insight. This study links expert systems and professional competition theories, and it provides critical insight into some assumptions underlying tenets of each theory. It also informs researchers, regulators, and practitioners interested in understanding and addressing problems related to the use of specialists.

ABSTRACT Bagnoli and Watts (2005) proposed that a manager could reduce information asymmetry by choosing an income‐decreasing accounting choice that signals the firm's relatively good future prospects. A limitation in testing this theory is that most income‐decreasing accounting choices over time reverse such that aggregated earnings would be the same, regardless of the choice. One income‐decreasing accounting choice that never reverses is the choice of upward asset revaluation, where the resulting gains are recognized through other comprehensive income and reduce future earnings by increasing future depreciation expense. In the United Kingdom, prior to FRS15, firms had the option to upwardly revalue on a one‐time basis. FRS15, and subsequently International Financial Reporting Standards, however, require those firms that upwardly revalue precommit to revalue on a consistent basis. This precommitment sacrifices future reporting discretion, which, according to the aforementioned study, serves as a costly signal of a firm's relatively good future prospects that reduces information asymmetry. The choice not to upwardly revalue, therefore, serves as a signal of a firm's relatively poor future prospects and also reduces information asymmetry, but this choice does not require precommitment such that the reduction in information asymmetry would be less than the choice to precommit to upward revaluations. Using a propensity‐score matched‐pair design on a sample of United Kingdom firms to test our predictions during the period requiring precommitment, we find lower forecast dispersion, lower return volatility, and a lower cost of capital for firms that precommit to upward asset revaluations, relative to those firms that choose not to upwardly revalue their operating assets. Keywords: upward asset revaluations, income‐decreasing accounting choice, information asymmetry, precommitment

ABSTRACT We examine whether the information conveyed in a relatively new analyst research output—capital expenditure (capex) forecasts—affects corporate investment efficiency. We find that firms with analyst capex forecasts exhibit higher investment efficiency. This effect is stronger when the forecasts are issued by analysts with higher ability or greater industry knowledge. Moreover, the effect of capex forecasts on investment efficiency varies with the signals they convey about future growth opportunities—positive‐growth signals are more effective in reducing underinvestment, while negative‐growth signals are more effective in reducing overinvestment. Cross‐sectional tests suggest that these effects operate at least in part through both a financing channel and a monitoring channel. Taken together, our results suggest that analysts' capex forecasts convey useful information about firms' growth opportunities to managers and investors, which can facilitate efficient investment.

ABSTRACT Valuation ratios divide stock price by accounting metrics such as earnings, earnings growth, and book value. This study adapts the general valuation framework in Ohlson and Juettner‐Nauroth (2005) and Ohlson (2005) to present a unified approach for developing valuation ratios based on fundamentals, referred to as fundamental valuation ratios. One starts with a valuation model that is driven by an accounting metric a and its abnormal growth, then divides the valuation model by a to get a fundamental valuation ratio. For any valuation ratio, one can find a corresponding fundamental valuation ratio, as long as the valuation model is based on the same metric a as the valuation ratio denominator.

ABSTRACT We investigate whether potential pension contracting benefits lead institutions that provide pension services to acquire ownership blocks in firms and the implications of such blockholdings on the firms' corporate governance. We use the 2006 Pension Protection Act, which expanded pension participation in certain states, as a quasi‐exogenous shock and find an increase in block ownership by pension‐providing institutions in firms with substantial operations in affected states. Further, we find that the acquisition of a large block increases the likelihood that the institution will provide future pension services to the firm. With regard to corporate governance, we find that the acquisition of large pension blockholdings is associated with higher CEO pay and lower CEO turnover following poor financial performance. However, contrary to the prediction of the private benefits hypothesis, we do not find consistent evidence that large pension blockholdings are associated with declining firm profitability, suggesting that pension institutions are incentivized to exert monitoring to preserve the investment value of their blockholdings. Overall, our evidence is consistent with pension service institutions acquiring ownership blocks to obtain pension contracts, but our evidence does not support the prediction that they use their influence to compromise shareholder value.

ABSTRACT In this study, we predict and provide evidence that distressed firms that rely more heavily on major customers for sales have a comparatively higher incidence of receiving going‐concern opinions (GCOs). Moreover, we find that the effect of increased reliance on major customers is driven by firms that are more distressed. We also theorize that variations in key characteristics of the relationship between a distressed firm and its largest major customer are incrementally linked to GCOs, and present evidence consistent with this. Specifically, we find that the effect of greater reliance on major customers is driven by firms that are relatively smaller than their largest major customer. Additionally, we find that greater reliance on major customers is positively (negatively) associated with GCOs when firms are in a shorter (longer) relationship with their major customer and when firms have a different auditor to (same auditor as) the largest major customer. Overall, our study indicates that supply chain relationships are relevant business risks associated with auditors' going‐concern assessments.

ABSTRACT Previous studies on accounting innovations emphasize the key role played by innovators and other core actors in theorizing and popularizing such innovations. This paper extends this literature by drawing attention to the role of actors who occupy a more peripheral position within the innovation‐based field. We regard accounting innovations as strategic action fields, in which core and peripheral actors interact to shape the trajectory of the innovation. In contrast to core actors, peripheral actors only weakly identify with the innovation‐based field and often occupy a core position in some other industry, professional, and/or geographical field. Given their embeddedness in these other fields, they are likely to try to accommodate an innovation with existing practices. Such frame blending can be problematic for core actors who envisage a more radical frame shift. Using the case of Beyond Budgeting, we show how the interplay between core and peripheral actors shapes the trajectory of an innovation, in terms of the composition of the field and the framing tactics that dominate at different stages in the development of the field. Our paper advances a perspective on accounting innovations which highlights the variable nature of the innovation space, in terms of different actors entering and exiting this space over time, as well as the importance of considering the overlaps between an innovation‐based field and other (industry, professional, geographical) fields.

ABSTRACT China's split‐share reform of 2005 (the Reform) converts the previously restricted shares held by founding shareholders to shares tradable on the open market. Against this backdrop, we study how underwriter‐affiliated analysts and firms' large shareholders interact in the event of the latter's sales of restricted shares. We document that recommendations made by affiliated analysts are significantly more optimistic when firms' large shareholders plan to sell their restricted shares. This optimism, however, is associated with negative post‐sale stock returns, suggesting large shareholders profit from share sales. Furthermore, large shareholders sell more restricted shares through the affiliated brokerages for which analysts have issued more optimistic recommendations and firms under their control are more likely to appoint such brokerages as lead underwriters when they refinance in the future. The affiliated analysts also conduct more site visits to the firms after the share sales, thereby improving their earnings‐forecast accuracy. Our analysis shows how conflicts of interest by financial intermediaries arise following the Reform and lead to large shareholders' extraction of rents from public investors.