Abstract We examine the consequences of real earnings management from an innovation perspective and investigate the patent output of firms likely to be managing earnings through altering their R&D expenditures. We find that R&D cuts related to earnings management lead to fewer patents, less influential patent output, and lower innovative efficiency compared to other R&D cuts. Our results thus suggest that real earnings management may obstruct firms’ technological progress and highlight the potential costs of managerial manipulation of R&D expenditures to alter reported earnings.
ABSTRACT Prior research documents that, in the presence of investor disagreement, short‐sales constraints can lead to equity overvaluation. We examine whether conservative accounting practices reduce the susceptibility to such overpricing, as predicted by Miller (1980). Consistent with Miller's prediction, we find that when shorting constraints and disagreement are high, the degree of overvaluation decreases systematically with accounting conservatism. These findings suggest that financial reporting conservatism helps improve market efficiency by counteracting the tendency to overvaluation that typically occurs in the presence of short‐selling constraints and divergence of opinion.
ABSTRACT Mashruwala and Mashruwala (2011) argue that inconsistent earlier findings regarding whether accruals quality (AQ) is priced in equity markets (Core, Guay, and Verdi 2008; Kim and Qi 2010) may be explained by seasonality in returns deriving from tax‐loss selling. Finding no evidence of annual AQ premia for U.S. firms, Mashruwala and Mashruwala report that significant monthly premia concentrate in January, with the remainder of the year demonstrating negative or insignificant returns to AQ and attribute this strong seasonality to tax‐loss selling by investors, rather than information risk. However, the end of the tax year for U.S. investors coincides with the calendar year and the financial year for the majority of firms, which may suggest alternative explanations for seasonal variation in returns. We extend Mashruwala and Mashruwala's study, using an international sample including countries where incentives for tax‐loss selling exist, but in which the standard tax and financial years differ (Japan and the United Kingdom), and where the tax and financial years conclude in a month other than December (Australia), as well as employing a longer U.S. sample. We find some evidence of an AQ premium in the United States, which although dominated by January returns, remains significant annually. However, these findings are sensitive to the inclusion of low price stocks and the choice of asset pricing test. In Japan, the United Kingdom, and Australia we document consistent evidence that an AQ premium exists on average throughout the year, and in samples excluding the first month of the tax year. The sensitivity of our U.S. results to the January period may reflect the conflation of numerous seasonal influences on returns, not all of which necessarily reflect mispricing.
Abstract Our study evaluates the role of coordination, at both the government and the firm level, on the transfer prices set by U.S. multinational corporations ( MNC s) when income taxes and duties cannot be jointly minimized with a single transfer price. We find that either the presence of a coordinated income tax and customs enforcement regime or coordination between the income tax and customs functions alters transfer prices for these firms. Our analyses have implications for both firms and taxing authorities. Specifically, our findings suggest that MNC s might decrease their aggregate tax burdens by increasing coordination within the firm or that governments might increase their aggregate revenues by improving coordinating enforcement across taxing authorities. Our study is novel in that we document, in a specific setting, how coordination influences MNC s’ tax reporting behavior.
Abstract This paper examines how disclosures regarding internal controls, required by sections 302 and 404 of the Sarbanes‐Oxley Act of 2002 ( SOX ), affect the market for corporate control. We hypothesize that acquirers with internal control weaknesses ( ICW s) make suboptimal acquisition decisions based on poor‐quality information generated by their ineffective controls over financial reporting. We expect that such acquirers will be more likely to misestimate the value of their targets or the potential synergies from mergers, thereby overpaying for completed deals. Using a treatment sample of acquisitions made by acquirers that have disclosed ICW s and two matched control samples without ICW disclosures, we document that ICW acquirers experience a substantially more negative market response to acquisition announcements and have lower future performance than the two matched control samples without ICW disclosures. Overall, our results suggest that ineffective internal controls hinder decision making related to mergers and acquisitions (M&A).
Abstract Auditors must frequently multitask in order to complete their work efficiently. However, the potential impact of multitasking on auditors’ judgment quality is poorly understood. Using Ego Depletion Theory and a laboratory experiment, we predict and find that auditors become less able to identify seeded errors after multitasking, and that this effect is most prominent in the identification of conceptual, rather than mechanical, errors. These negative consequences of multitasking are mitigated when auditors are exposed to an intervention based on a theoretical countermeasure of replenishing depleted self‐control resources, in that multitasking auditors identify more seeded errors with the intervention than without. Given that multitasking is a pervasive feature of the current audit environment, these findings have direct implications for audit practice. Beyond identifying multitasking as a cause of impaired performance in auditing, this study's results provide initial evidence that such negative effects can be mitigated, resulting in improved audit quality and, by extension, improved financial statement quality.
Abstract This study examines the effects of audit partner tenure and audit partner changes on internal control reporting quality for large U.S. not‐for‐profit ( NFP ) organizations. Regulators contend that audit partners lose their objectivity over successive audits, reducing audit quality. A large body of research has examined this issue, primarily in non‐U.S. jurisdictions, with mixed results. We examine the associations between audit partner tenure and audit partner changes and the incidence of reported internal control deficiencies ( ICD s), the quality of internal control reports (following PCAOB audit quality indicators), and the severity of reported ICD s. We find negative associations between audit partner tenure and the incidence of reported ICD s, the quality of internal control reports, and the severity of reported ICD s. Together, these findings indicate that internal control reporting quality deteriorates with audit partner tenure. However, we find no association between audit partner changes and internal control reporting, which is consistent with partners lacking client specific knowledge in their first year with a client. Finally, we find no association between either audit partner tenure or changes and the likelihood of remediation. Our findings contribute large‐sample U.S. evidence on the association between audit partner tenure and internal control reporting quality and provide useful information to government regulators, NFP boards charged with the oversight of the external auditor and internal controls, and NFP stakeholders.
Abstract Recent research finds that analysts' cash flow forecasts have meaningful financial reporting ramifications, but, to date, the identified effects are unlikely to yield meaningful cash flow benefits. This study examines whether analysts' cash flow forecasts encourage managers to enhance the firm's cash flow position through tax avoidance activities. We evaluate the change in cash tax avoidance after analysts begin issuing cash flow forecasts relative to a propensity score matched control sample of firms without cash flow forecasts. Consistent with analysts' cash flow forecasts encouraging tax avoidance that enhances the firm's cash flow health, we find a negative association between cash tax payments and analysts' cash flow coverage. Additional analysis suggests this association is driven primarily by strategies to permanently avoid rather than to temporarily defer tax payments and that increased cash tax avoidance activity represents a nontrivial component of the overall increase in reported operating cash flows after the initiation of analysts' cash flow coverage.
ABSTRACT This article explores commitment to knowledge templates, in this case competing measurement models, in global standard‐setting processes. In particular, I examine the positions of board members of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) on a proposal to use fair value accounting in the measurement of revenue. The proposal to measure revenue at fair value was deliberated between 2002 and 2008 as part of the joint revenue project of the FASB and the IASB. I analyze narratives of the board proceedings on the revenue project, which reveal the positions of board members over the life of the proposal. To make sense of these positions, I use Durocher and Gendron's (2014) framework on epistemic commitment, which speaks to one's allegiance to knowledge templates. The analysis shows that individual board member commitment to different knowledge templates is fairly static despite dynamic and contentious debate on this particular proposal. While stable, board member reactions to the proposed shift toward fair value fall into recognizable patterns showing how commitment to different templates entails prioritizing of different core principles and appeals to higher authorities. Finally, the analysis shows how commitment to knowledge templates varies depending on the professional affiliations of board members. For instance, the analysis shows relatively greater consistency of commitment between board members affiliated with academia and corporate preparers than between auditors. Overall, the study indicates the importance of micro‐level features in explaining the development of macro‐level accounting policy. These features are crucial to enhancing our broader understanding of the way in which accounting standards and rules ultimately develop.
ABSTRACT We examine the improvements in forecast accuracy that result from analysts' visits to listed companies. We find that company visits significantly enhance the accuracy of the analysts' earnings forecasts for those companies. The benefit from company visits is more pronounced for companies that are more neglected or less accessible and for brokerage firms that face less pressure for optimistic forecasts from buy‐side clients. Our results are robust and remain significant after controlling for endogeneity and selection bias. Overall, our findings show that private interactions with company management provide analysts with an informational advantage and suggest that company visits facilitate the mosaic approach to information acquisition.