Knowledge that Transforms

We examine how the presence of multiple supervisory agencies affects firm‐level compliance in form and substance with disclosure regulations. This analysis is important because coordination problems among regulators are frequently present in practice but often overlooked in academic research. We exploit that banks are subject to equivalent risk disclosure rules under securities laws (IFRS 7) and banking regulation (Pillar 3 of the Basel II Accord) but that different regulators start enforcing the rules at different points in time. We find that banks substantially increase their formal risk disclosures upon the adoption of Pillar 3 even if they already had to comply with the same requirements under IFRS 7. The effects are stronger if the central bank is responsible for bank supervision and bank regulators are equipped with more supervisory resources, but are less pronounced if the securities market regulator is an independent entity. In turn, banks facing more market pressures are more compliant with the rules. We further find persistent liquidity benefits of the increased risk disclosures but only after Pillar 3 became effective and its compliance was enforced by the banking regulator. Our results suggest that formal and material compliance with risk disclosure regulation are a function of both the resources of the supervisory agency and its incentive alignment with the regulated firms. In our setting, the banking regulator seems more effective in fulfilling this role.

We show that managers have a propensity to disproportionately report total revenues just above base‐ten thresholds (e.g., 10 million, 30 million, 1 billion) and examine motives for and consequences of this behavior. Focusing on base‐ten thresholds in revenues is important because, despite being unusually prevalent in revenue targets set in executive compensation contracts, analyst forecasts, and management forecasts, they have not been previously explored. We also show that pressure to beat these targets provides one explanation for the base‐ten bias in reported revenues. However, these incentive effects do not offer a complete explanation because base‐ten threshold‐beating is observed even in the absence of these explicit targets. We further find that when firms beat a base‐ten threshold for the first time, they experience increases in news coverage, institutional ownership, liquidity, and analyst following, even after controlling for whether they have beaten other common benchmarks. These results suggest that managers also beat base‐ten thresholds in order to increase their firms' overall visibility. Overall, we show that a preference for base‐ten numbers, which have no inherent economic meaning, has a measurable effect on the actions of market participants. These results open the door to a new range of managerial targets previously unexplored.

Motivated by ongoing worldwide efforts to improve the comparability of accounting information, I examine the temporal trend in global financial reporting comparability. Regulators have made serious efforts to improve comparability, but numerous frictions may have limited their effectiveness. Accordingly, I examine the time‐series properties of comparability measures for a sample of the 36 largest economies and provide two key empirical insights consistent with expectations. First, I confirm comparability is increasing over 2002–2018. Second, I document that this increase primarily occurs in firms applying local accounting standards, as opposed to those applying global standards (defined as either US GAAP or IFRS). Additional analyses reveal that: (i) firms applying local standards are becoming more comparable to firms applying IFRS but not to those applying US GAAP, and (ii) comparability within global‐standards firms is not changing. I also document that certain market liquidity benefits of comparability are sustained in the long term, as firms increasing comparability over the sample period experience greater reductions in bid‐ask spread and zero‐return trading days relative to those decreasing comparability. Overall, the results reveal that comparability has increased—consistent with systematic regulatory efforts—but that this increase arises heterogeneously across firms, with the primary effects in recent years occurring among those applying local standards.

We examine how the extent and distribution of industry knowledge within an audit team affect audit outcomes. While prior research examining the role of auditors' industry knowledge focuses mainly on audit firms, audit offices, and audit partners, audits are conducted by audit teams. Using an audit framework and proprietary data from a Big 4 firm that includes audit hours for each team member, we find that Big 4 audit teams with higher average industry knowledge are associated with more audit effort. In contrast, we find mixed evidence on the relation between the average hourly internal cost rate and team knowledge. Furthermore, we find that balanced teams, which have at least one team member who qualifies as an industry specialist at both the senior rank and junior rank, produce higher‐quality audits than teams that have no specialists. In contrast, the audit quality of unbalanced teams, which have a specialist at the senior rank but not the junior rank or vice versa, is not statistically different than teams with no specialists. Overall, our evidence suggests that both the extent and distribution of industry knowledge within a team matter for audit production and that industry knowledge is utilized more effectively when it is spread throughout the team. The findings have useful implications for audit firms and regulators regarding how team composition and industry knowledge affect audit outcomes.

This study examines corporate integrity culture—that is, a firm's shared values and behaviors related to compliance, trustworthiness, and ethics. Different from prior research that associates culture measures with general firm‐level outcomes, we evaluate the pervasiveness of the integrity culture within an organization across two disparate business functions: operations and financial reporting. We first develop a measure of corporate integrity culture based on firms' internal control environments and show that, as predicted, weak integrity culture contributes to both operational and financial non‐compliance. We next document the predicted positive contemporaneous association between operational and financial non‐compliance, controlling for the integrity culture reflected in the internal control environment. Given the organizational and physical distances and lack of day‐to‐day interactions between the two business functions, we infer that management's “tone at the top” likely affects non‐compliance in both functions. Finally, for firms with existing operational non‐compliance, we find more negative market reactions to accounting restatements and higher CEO turnover propensities following restatements. These results indicate that top management must consistently reinforce a culture of compliance and integrity, lest it decay throughout the organization. Our results also imply that regulators evaluating compliance in specific functions could benefit from reviewing compliance in other functions within the firm.

We provide evidence that regulatory guidance aimed at improving audit efficiency and effectiveness—allowing auditor reliance on a multi‐location client's competent and objective internal audit function (IAF)—can unintentionally increase auditors' litigation risk. Our research is important in demonstrating how client characteristics and juror cognitive processing, such as the number of client locations and jurors' susceptibility to the numerosity heuristic, factors beyond auditors' control, can exacerbate their litigation exposure. Consistent with theoretical predictions, we find that susceptibility to the numerosity heuristic contributes to jurors assessing an increased likelihood of misstatement on multi‐location compared to single‐location audits. Furthermore, these assessments of higher misstatement risk on multi‐location audits lead jurors to perceive that auditor reliance on the client's IAF in multi‐location audits is less appropriate (i.e., not normal). Accordingly, jurors judge that auditors are more negligent when they rely on the IAF during multi‐location audits than when they do not, but IAF reliance does not impact auditor negligence on single‐location audits. Our results suggest auditor reluctance to use a qualified IAF, despite client pressure and regulatory allowance, can provide potential benefits to firms in terms of reduced litigation exposure. Thus, we demonstrate the legal regime can undermine the objectives of regulators' guidance to enhance audit efficiency and corporate governance.

Many companies regularly disclose non‐GAAP performance measures to communicate firm‐specific information that does not fit within the mold of GAAP reporting. However, these non‐GAAP measures may have low information content or even be misleading to investors. Thus, the question arises of whether auditors should play a larger role in the reporting of non‐GAAP measures, which currently are not audited. We run an experiment to provide ex ante evidence on the effect of auditing non‐GAAP measures. Specifically, we present investor‐participants with a non‐GAAP measure that should be used when making investment judgments (more informative) or should not be used when making investment judgments (less informative) and is either audited or is not audited. As predicted, we find that, when participants view a non‐GAAP measure that is more informative, they appropriately use the non‐GAAP measure in their investment‐related judgments, regardless of whether the measure is audited. However, also as predicted, we find that, while participants appropriately do not use a less informative non‐GAAP measure when it is not audited, participants inappropriately do use the less informative non‐GAAP measure in their investment‐related judgments when it is audited. Mediation results provide evidence consistent with audits affecting investors' reliance on non‐GAAP measures. Specifically, our results are consistent with audits of non‐GAAP measures signaling more than is intended, evidenced by investors perceiving an audited non‐GAAP measure as being useful in their investment decisions when the measure is less informative to them. Our findings suggest that regulators should exercise caution when it comes to prescribing assurance over non‐GAAP measures.

As part of the Tax Cuts and Jobs Act (TCJA), the US Congress repealed a long‐standing exception that allowed companies to deduct executives' qualified performance‐based compensation in excess of $1 million. The purpose of this study is to examine whether Congress achieved its stated objective of reversing a shift in executive compensation away from cash compensation and toward performance pay, which Congress believed led executives to focus on short‐term results rather than the long‐term success of the company. Across a battery of tests, including a difference‐in‐differences design that exploits the staggered time‐series implementation of the deduction limit, we find evidence compatible with the new deduction limit having no effect on executives' salary, performance pay or total compensation, inconsistent with Congressional intent. Our results suggest that taxes are not a first‐order effect of executive pay and that tax regulation could be relatively ineffective at curbing executive compensation.

This study investigates whether and how organizations change their use of management accounting during crisis. The study is important because organizations regularly face significant challenges such as crisis during which the role of management accounting is not well understood. Based on interviews and observation in five private sector organizations and one in the public sector, I find that executives in organizations facing crisis due to a discontinuous and unpredictable environmental change leverage management accounting during the crisis. In contrast, executives in organizations facing crisis due to a continuous and predictable environmental change question the truth and value of their management accounting practices and, as a result, do not change their use of management accounting to manage the crisis. For those organizations that do leverage management accounting, I rely on conceptual and empirical insights from the literature examining the decision‐facilitating role of informal management accounting to examine how they adapt or develop new management accounting tools and practices to manage crisis. I find that executives first engage in a comprehensive review of their management accounting systems and reports to convince themselves that they can be relied on. Following this process, they leverage accounting to understand the past, develop metrics intended to reach all employees, and institute various forms of accountability to support the management of crisis. The use of these informal management accounting tools and practices enables organizations to develop a new language for understanding and managing crisis. The primary contribution of my study is that it conceptualizes and theorizes informal management accounting tools and practices as a mechanism that facilitates response to crisis. These tools and practices are low‐cost and easy to implement, which are favorable given the challenges associated with crisis.

This study examines the impact of control systems on corporate innovation. Innovation is key to firm performance and growth, allowing corporations to stay competitive in their industry. We expect control systems to improve information flows within the firm by allowing managers to better identify and patent their most valuable intellectual property. Despite our prediction that control systems positively impact innovation, a priori, this relation is unclear as these same control systems may create an overly restrictive bureaucratic environment that may mitigate the benefits of effective controls for innovation. Using various measures of control system quality, we find evidence that effective control systems are associated with more innovation. Overall, the results of our study suggest effective control systems are associated with the ability of a firm to leverage its innovative projects. Our results suggest that corporations with effective control systems are more likely to be able to react to market and technology changes by ensuring their best ideas are patented.