ABSTRACT This study examines whether the volatility of interim estimates of the annual effective tax rate (ETR) provides ex ante information about the quality of firms' internal control environments. Recent research suggests that some firms selectively disclose internal control weaknesses (ICWs). Given the negative consequences associated with ICWs, it is important for capital market participants to be able to identify firms with ineffective internal controls in a timely manner. We find that firms with more volatile annual ETR estimates are more likely to report both tax‐ and nontax‐related ICWs in the current year. Our results also indicate that the volatility of annual ETR estimates declines following the remediation of tax‐related ICWs, but not following the remediation of nontax‐related ICWs. In addition, we find that ETR volatility in the current year is associated with the likelihood that a firm will report an ICW in the following year. Finally, we provide evidence that the volatility of annual ETR estimates is associated with the likelihood that a firm has an undisclosed ICW. In combination, our results suggest that the volatility of interim estimates of the annual ETR provides an ex ante signal of the likelihood that a firm's internal controls are ineffective.

ABSTRACT We select a small set of recommendations that lie in the upper and lower tail of the empirical distribution of divergences between a recommendation, and the consensus over the window (−30, −1) days prior to that recommendation. We classify these extremely divergent recommendations as bold, and then subdivide them into informative bold recommendations that lead other analysts (leading‐bold) and those that are ignored by other analysts (contra‐bold) based on the consensus change in the 30 days after the announcement. We focus on the information conveyed to the market by these bold, leading‐bold, and contra‐bold recommendations through their effects on cumulative abnormal returns (CAR). We find that bold recommendations are not anticipated by market participants (CARs are negative before a bold buy and positive before a bold sell). The next finding is that the market responds strongly to both leading and contra‐bold recommendations over the (0, +4)‐day window and that these reactions are stronger than that to nonbold recommendations. In contrast, over the longer (0, +30)‐day window, leading‐bold recommendations earn additional returns whereas contra‐bold ones reverse significantly due to lack of confirmation. The overall pattern is one of rational market reaction both in the short and long windows. We support the rationality of the market reaction by showing that the percentage of leading‐bold recommendations exceeds that of contra‐bold recommendations, and that these two types of recommendations cannot be separated using observable analyst characteristics such as experience or brokerage size.

ABSTRACT This study uses insights from tax practitioners and tax authorities to define and develop an estimate of ex ante tax risk that is independent of common tax outcomes studied in prior literature. Validation tests confirm that our tax risk measure (i) represents the predictable and unpredictable uncertainty inherent in the three sources of tax risk (i.e., economic risk, tax law uncertainty, and inaccurate information processing) and (ii) is a construct different from tax avoidance, tax uncertainty, and general business risk. Using our tax risk measure, we address two research questions of interest to academics and practitioners. First, we examine the association between tax risk and long‐run tax avoidance and find a negative association between tax risk and future long‐run cash effective tax rates (ETRs). Second, we consider the extent to which unrecognized tax benefits (UTBs) reflect tax risk, tax avoidance, or financial reporting incentives and demonstrate that our tax risk measure explains a substantial portion of UTBs, incremental and relative to measures of information risk, conditional conservatism, unconditional conservatism, and tax avoidance. Our study offers a measure of tax risk that, consistent with the Scholes‐Wolfson paradigm, reflects the tax risk inherent in all business activities, not just tax avoidance activities; has unique industry effects; and contributes to our understanding of the factors that affect tax planning decisions and result in variation in firms' ETRs. Our findings will help managers and tax practitioners focus on industry‐specific tax risk components, assess risk during tax planning initiatives, exercise caution when engaging in additional risk if ETRs are low, and adapt tax risk strategies to fit specific company needs. We enhance future tax research by improving the definition and measurement of tax risk.

ABSTRACT This study examines the effect on investors' judgments of corporate social responsibility (CSR) measures when integrated with financial information in a single report versus when presented in a separate CSR report. Advocates for integrated reports argue that CSR information will be perceived as more relevant and have a greater impact on users when observed in an integrated report. However, we provide experimental evidence that CSR measures have greater influence on investors' judgments when investors observe the CSR information and financial information depicted in separate reports. We also provide evidence that this greater influence of CSR measures is caused by investors' evaluations taking on a “multidimensional perspective” that includes both a social responsibility and a financial dimension, which is triggered by observing the separate CSR report. Activating a social responsibility dimension elevates the perceived relevance of CSR measures, increasing their influence on investors' judgments. Our study contributes to practice by highlighting a potential unintended consequence of issuing integrated versus separate CSR reports: that investors incorporate CSR information less when it is integrated with financial information versus separately reported.

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.

ABSTRACT Inadequate testing of fair value accounting estimates, including goodwill, is often cited as an audit deficiency in PCAOB inspection reports, and, in some cases, these deficiencies have led to enforcement actions against the auditor. As a result of these issues, the PCAOB recently proposed a new auditing standard for fair value accounting. While these regulatory actions suggest that auditors are challenged by the fair value regime of accounting for goodwill, they also highlight an area where the auditor could be influenced by their financial ties to a client. In this study, we test whether nonaudit fees are associated with goodwill impairment decision outcomes. Our results indicate that the nonaudit fees a client pays are inversely related to the likelihood of impairment in settings where goodwill is likely to be impaired. Additional examinations suggest that the negative relation between nonaudit fees and auditor independence is driven by clients who are most incentivized to exert their influence over the auditor.

ABSTRACT Prior research indicates that most audit legal disputes settle. There is, however, little evidence of the factors that drive the settlement norm and its exceptions in audit legal disputes. To better understand these factors, we rely on theory related to how professionals manage risks and, as a result, how professions defend jurisdictional claims. We use this theoretical lens to help motivate four research questions that we probe by interviewing 27 prominent attorneys experienced in audit litigation. Consistent with our lens, our interview data indicate that attorneys manage their risks, including the risk of reputational loss, by settling based on their expectations of trial verdicts. Unlike trials, settlements simultaneously enable attorneys on both sides to limit costs and avoid catastrophic jury verdicts and, by doing so, claim “wins” for their clients. Attorneys also stress that they settle many audit disputes without any legal filings. Thus, a large subset of disputes is invisible to the public and researchers. Attorneys characterize trials as exceptions to the settlement norm that emerge due to abnormal conditions sometimes present in disputes. However, trial verdicts in these abnormal conditions help attorneys justify the use of settlements to clients, as attorneys stress that by settling they can avoid the dreaded possibility of extreme unfavorable verdicts. We conclude that as individual attorneys manage their risks, especially the risk of reputational loss, their profession maintains its public image and thereby defends its jurisdictional claims. Among the many questions we pose for future research is whether the settlement norm reduces society's ability to monitor the audit profession and, more generally, whether this norm's benefits outweigh its drawbacks.