Knowledge that Transforms

We examine whether peer audit choices influence a bank's decision to obtain an audit voluntarily. We find that the likelihood of a bank voluntarily obtaining an audit is significantly associated with the audit decisions of peers. The relation is stronger when the peers are more salient due to closer geographic proximity, similarity in loan portfolio, and similarity in size. In addition, we find that peer influence on a bank's audit decision is moderated by the bank's existing level of assurance. Specifically, banks already obtaining a lower level of assurance are less likely to begin an audit in response to peer influence. We also find no evidence that peer influence extends to banks' decisions to cease obtaining an audit. Overall, our findings are consistent with peer influence significantly influencing banks' decisions to begin obtaining an audit.

IPOs and direct listings (DLs) offer two different mechanisms for firms to go public. In contrast to IPOs, DLs do not employ an underwriter or raise new capital. Using a sample of IPOs and DLs on major stock markets in the European Union, we document that firms that choose to go public via DLs are larger, more profitable, and less levered, on average, than IPO firms. These pre‐listing differences suggest that DL firms should be less risky than IPO firms; however, controlling for this selection effect, we find that DLs have higher aftermarket price volatility than IPOs. This is consistent with some policy‐makers' concerns that, because they lack an underwriter, DLs expose investors to higher risk than IPOs in the immediate post‐listing period. We show that this heightened price volatility persists, on average, for the first 20 trading days after listings, and is larger in industries where listed peer firms provide relatively low‐quality disclosures. Our results provide new evidence regarding the types of firms that choose to list via DLs versus IPOs and the riskiness of IPOs versus DLs in the immediate post‐listing period; additionally, our results are consistent with underwriters improving the quality of information available to investors for IPO firms in the pre‐listing period.

Prior research shows that contingent liabilities do not accurately predict future cash payments due to the managerial discretion afforded by accounting standards. We examine the extent to which current accounting guidance for a material contingent liability—the reserve for unrecognized tax benefits (UTBs) under Financial Interpretation No. 48 (FIN 48)—generates accruals that are predictive of future income tax cash outflows. We document that UTBs fully unwind as cash tax payments over the subsequent 5 years, suggesting that managers, on average, accurately incorporate their expectations of future tax liabilities. This result persists for firms that are (1) most affected by the implementation of FIN 48, (2) unable to impound detection risk into their reserves, (3) engaged in relatively more ex ante tax avoidance, (4) suspected to have engaged in earnings management through the tax accounts, and (5) subject to plausibly exogenous shocks to tax reporting. Overall, our results suggest that current accounting guidance under FIN 48 for contingent tax liabilities enables managers to accurately report, and financial statement users to reliably predict, future cash obligations.

We examine the costs associated with public disclosure, as opposed to confidential reporting, of tax country‐by‐country reporting (CbCR) information. Our study addresses a critical knowledge gap, considering the growing adoption of public tax transparency measures. We aim to illuminate this matter by examining the expected costs for firms of making previously confidential CbCR information publicly available. The fact that the information was previously confidentially reported to the tax authorities allows us to assess the cost of publication in isolation. Employing an event study methodology, we provide early evidence on the capital market reaction to this new requirement on a sample of European firms falling within its scope. We document a significantly negative cumulative average abnormal return of EUR 47 billion to 64 billion for up to 3 days following the announcement. Additional cross‐sectional results suggest that concerns about the reputational costs arising from public scrutiny and the proprietary costs from disclosing sensitive business information outweigh the potential benefits of an extended information environment from an investor perspective. Our findings highlight that the public disclosure of tax information imposes significant—and likely unintended—costs from a firm perspective. This aspect should be carefully considered when developing tax transparency measures.

This study examines the relationship between government subsidies and income smoothing using a sample of US‐listed firms. We find that subsidized firms smooth their earnings more aggressively than their unsubsidized peers. This finding is consistent with the reasoning that subsidized firms bear higher political costs and have more incentives to smooth earnings to avoid public attention. In addition, smoothing by subsidized firms is more pronounced when the subsidies are granted through non‐tax‐related channels than through tax‐based channels, and the positive association between government subsidies and income smoothing is stronger for firms under higher public scrutiny and with less transparent information environments. Further analysis shows that smoothing by subsidized firms serves mainly to obfuscate earnings and that subsidized firms that smooth earnings tend to continue receiving subsidies in the future. Overall, our results help explain the role of government subsidies in shaping firms' accounting and disclosure choices.

Recent literature finds that firms led by female CEOs are more likely to be targeted by activist shareholders and that female CEOs are more likely to cooperate with activist shareholders' requests. Our study complements this literature by using two controlled experiments and a series of semi‐structured interviews with CEOs and CFOs to investigate how a CEO's response to shareholder activism influences investors' reactions and whether these reactions differ depending on the gender of the CEO or on how their response is explained. In the first experiment, we find that investors evaluate a firm as less attractive when a female CEO uses an uncooperative response rather than a cooperative response to shareholder activism, absent any explanation for the CEO's response. Conversely, investors evaluate a firm as less attractive when a male CEO uses a cooperative response rather than an uncooperative response. In the second experiment, where there is an added explanation for the CEO response, we find that investors react more positively to a female CEO's uncooperative response when the explanation is more communal (vs. agentic). Our interviews with CEOs and CFOs provide insights into how the gender of firms' leadership may play a role when activist shareholders target firms. Our results collectively suggest that investors rely on gender stereotypes when evaluating the responses of male and female executives to shareholder activism and that these evaluations affect their investment judgments. Our results also suggest a potential alternative explanation for the finding that female CEOs are more likely to cooperate with activist shareholders than are male CEOs. Rather than inherent differences in the management styles of male and female CEOs, responses to activist shareholders may be driven, at least in part, by managers anticipating that they will be penalized by investors for deviating from gender‐stereotypical behavior.

Regulators and practitioners have concerns that the lack of standardization in non‐GAAP disclosure can make it challenging for users to process non‐GAAP earnings and use it in decision‐making. We examine whether auditor style extends beyond mandatory disclosures to induce similarity in non‐GAAP earnings disclosures. Specifically, we find that clients audited by the same auditor are more likely to disclose non‐GAAP earnings in a similar manner. We assess disclosure similarity using (1) the decision to disclose non‐GAAP earnings, (2) the disclosure prominence of non‐GAAP earnings in the earnings press release, (3) the discussion of non‐GAAP earnings in the management discussion and analysis of the annual report, (4) the choice to exclude recurring items, and (5) the receipt of SEC comment letters related to non‐GAAP earnings. We find that the association between auditor style and non‐GAAP disclosure is determined by Big 4 accounting firms and clients audited by the same audit office. The results are stronger for larger audit offices and smaller clients. We provide evidence that auditors facilitate non‐GAAP disclosure, which can improve compliance with SEC requirements and increase the standardization of non‐GAAP earnings disclosures. Our results are relevant to current policy discussions regarding auditor involvement in unaudited non‐GAAP earnings reporting.

This study examines the effect of shareholder scrutiny of corporate tax avoidance behavior and its related financial reporting. Specifically, we explore the factors associated with shareholder tax litigation and its effect on the future tax behavior of the sued firm and its peers. We find that sued firms have lower cash and GAAP effective tax rates (ETRs) and engage in extreme tax avoidance before litigation. After litigation, they decrease tax avoidance activities, relative to matched control firms. Peer firms in the same industry as sued firms similarly reduce their level of tax avoidance and the likelihood of extreme tax avoidance after the litigation, relative to control firms. Additional analyses suggest that sued firms change their tax avoidance behavior, rather than merely their tax financial reporting. Finally, the spillover results are strongest for peer firms with the most tax avoidance (i.e., the lowest cash ETRs) when the sued firm's alleged misconduct is revealed.

Firms are required to provide financial information via the financial statements and the management discussion and analysis (MD&A), a narrative explanation of the financial statements. Our study examines how firms use the MD&A channel when their financial statement channel is inadequate. We focus on two textual attributes of the MD&A: non‐GAAP disclosure and forward‐looking statements. We find that firms with less adequate financial statements discuss non‐GAAP measures more and provide a larger number of forward‐looking statements. We then identify the topics, and therefore the context, in which non‐GAAP and forward‐looking disclosures are provided. Our study provides evidence on how managers use the MD&A, a relatively more flexible channel, to provide information when their financial statement channel is less adequate.

Building on Banker, Byzalov, and Plehn‐Dujowich's (2014, The Accounting Review , 89 (3), 839–865) congestion cost theory, we model firms' trade‐off between a rigid cost structure and a high inventory level to reduce the congestion costs caused by uncertain demand. We demonstrate that firms with a higher inventory level adopt a less rigid cost structure, but the effect of cost structure on inventory is theoretically ambiguous. Using a large sample of manufacturing firms in the United States, we empirically investigate the dynamic interdependence between cost structure and inventory choices. Our results reveal that cost structure rigidity and inventory are negatively associated with each other over time, suggesting that they serve as substitutes in tackling demand uncertainty. Further analysis demonstrates that firms favor higher inventory levels over more rigid costs when inventory‐carrying costs decrease, fixed input costs increase, or downside risk escalates.