I propose an explanation for the positive relation between R&D, future earnings, and future stock returns based on the fixed‐cost qualities of R&D. If R&D is relatively fixed over short horizons, demand shocks realized by some R&D firms will push these firms into R&D intensity levels that are suboptimal as common scale proxies—market equity, assets, and sales—respond more quickly to demand shocks than R&D. In response, R&D firms realizing negative demand shocks reduce future expenses and capital expenditures, producing higher future profitability on lower sales growth. Consistent with the fixed‐cost hypothesis, I find the higher future profits of high R&D firms are explained by cost cutting, not revenue growth. Collectively, the restructuring of cost and capital structures of the subset of high R&D firms realizing demand shocks explains the future profit and investment patterns of R&D firms, while the fixed‐cost qualities of R&D seem to explain patterns in future stock returns. My results have implications for literatures that examine how decisions on R&D investment levels affect future firm performance, growth, and stock returns.

Prior research finds that signals of remediation of internal control weaknesses do not guarantee that all weaknesses are fully resolved. However, why certain remediation strategies fail is unclear. This study examines how remediation timing and actions affect the likelihood of a failed remediation. I predict and find that the likelihood of a failed remediation is decreasing in both the time a company takes to remediate and in the extent of remediation actions employed. Importantly, this study documents that disclosures of material changes in internal control provide information useful in assessing the likelihood of a failed remediation, as well as evidence that prompt remediation does not necessarily result in a successful remediation. Moreover, I find that there are consequences to remediation failures in the form of a higher likelihood of management and board turnover. Finally, I find evidence that economic benefits of remediation found in prior research may be understated. This study can provide stakeholders with insights into how the nature, extent, and timing of a remediation strategy can reduce the likelihood of a failed remediation.

Literature to date reveals relatively little about the role of expertise in auditor selection beyond basic preferences for Big 4 and industry specialist auditors. We hypothesize that audit committees whose members have no Big 4 auditing experience are likely to struggle when interviewing prospective Big 4 partners, leading such committees to draw on superficial, heuristic cues in lieu of conducting more substantive evaluations. To test this prediction, we obtain independent ratings of the facial attractiveness of audit partners identified from Form AP filings recently mandated by the US PCAOB. Our primary finding is that audit committees with no Big 4–experienced members are more likely to favor partners whose photographs raters view to be highly attractive. We characterize attractiveness as a superficial attribute for auditor selection because we detect no relation between attractiveness and accruals‐ or restatement‐based measures of financial reporting quality for audit committees with one or more Big 4–experienced members. We do find an inverse association between attractiveness and financial reporting quality for committees without this experience, likely reflecting the statistical implication of a selection bias. We conclude that auditing expertise mitigates the influence of superficial considerations in auditor selection, enabling audit committees to fulfill their stewardship role more effectively.

As part of its goal to monitor and enhance the quality of information available to investors, the SEC reviews companies' filings to ensure compliance with applicable financial reporting and disclosure requirements. Increased public interest and the substantial costs for both the SEC in reviewing and the companies in responding have led to a rapidly growing body of accounting literature that examines the filing review process. We survey and comment on 80 published and unpublished academic research papers in this literature and identify significant gaps that future research should address. We also summarize the institutional features of the filing review process, aiming to inform future academic studies. Our survey should be of interest to both academics and market participants evaluating the effectiveness and efficiency of the filing review process.

Prior research suggests that even for the same decision task there will be variation in decision outcomes across decision makers due to idiosyncrasies in their styles. This variation brings up a fundamental challenge in the realm of regulations, where consistency of application is of great importance. This study examines whether the idiosyncrasies of individual employees of the SEC contribute to inconsistent regulatory outcomes. Using a sample of SEC comment letters, we show that SEC reviewers' idiosyncratic style plays a significant role in explaining the cross‐sectional variation in filing review outcomes, even after holding firm and disclosure attributes constant. In addition, the likelihood of restatement during the review process varies systemically with the reviewers' review style. These findings suggest that reviewer style influences shareholders and other stakeholders via its impact on the costs in resolving comment letter issues and the quality of corporate disclosure. They also have public policy implications for the way financial reporting rules and regulations are applied.

This study examines the effect of regulatory approval on a firm's voluntary product‐level disclosures. We focus on the US biotechnology industry, a setting that allows direct observation of whether firms disclose more information as products proceed through well‐defined—though successively more complex and costly—regulatory hurdles. Consistent with predictions motivated by biotech firms' need to repeatedly raise capital, we find that firms disclose more as their products move to later stages in the development process, both when the products receive regulatory approvals as well as when they receive regulatory denials. In addition, these findings are consistent across phases of development as well as product disclosure categories and are accentuated for firms without internal sources of capital (i.e., lacking product revenue). Collectively, these findings reveal that biotechnology firms respond to the considerable incentives to provide enhanced product disclosure and thus facilitate their ongoing need for capital to proceed through subsequent stages of product development.

We examine how audit partners' geographic proximity to clients affects audit quality. We use hand‐collected data to show that approximately half of audit partners are assigned to clients headquartered more than 100 km away from the partners' home locations. Few of these partners relocate after receiving their assignments and, as a result, more than one‐third of clients are audited by partners who must commute long distances to visit the client in person. We explore this phenomenon by first modeling how distance affects partner‐client matching. We find that partners' geographic proximity to a prospective client is an important matching criterion, but also that trade‐offs are made when other partner characteristics such as industry specialization are more likely to be important. Next, consistent with our prediction, we show that audit quality is lower when partners reside farther from their clients. We corroborate our primary findings by showing that the association between partner distance and audit quality is mitigated when partners have access to direct flights to their clients' headquarters and when clients are geographically dispersed. Our paper should be informative for regulators, practicing auditors, and academics interested in how partner‐client matching affects audit outcomes.

We conduct two experiments to investigate the joint effect of two justification factors of earnings management—namely, attribution for the firm's underperformance and benefits accruing to other employees from inflating reported earnings. This investigation is important because prior research examines the effects of individual justification factors, whereas real‐world settings entail more complexity involving multiple justification factors. In Experiment 1, we predict and find that managers are more likely to manage earnings when the firm's underperformance is caused by an external event and misreported earnings benefit other employees besides the reporting manager. Furthermore, we show that the extent to which participants use moral justifications mediates the effect of benefits sharing on earnings management, but only when causal attribution is external, and that it mediates the effect of causal attribution on earnings management, but only when benefits are shared. In Experiment 2, we use a neutral control condition that makes no mention of inconsistent incentives to demonstrate that it is the combination of causal attribution and benefits sharing that triggers earnings management. We contribute to the accounting and psychology literature by proposing and testing a theory that explains how multiple justification factors interact to cause opportunistic behavior. Our results suggest that policy‐makers and governing parties should consider developing a holistic view of possible justification factors, focusing on situational opportunities created by combinations of factors rather than individual factors alone.

Trading volume is increasingly shifting to dark venues, and the causes of this move are not well understood. We examine whether a firm's reporting opacity affects its dark pool trading and provide robust evidence that (partly) explains this volume migration. Exploiting the exogenous variation in home‐country reporting opacity in a sample of American Depositary Receipts (ADRs) and using multiple metrics for reporting opacity, we find that greater opacity associates with increased dark pool trading. This relation holds after controlling for firms' information environments, country‐specific governance issues, observable differences between ADRs and other securities that trade in dark pools (matched sample analysis), volume migration to dark pools during earnings announcements, informed trading in lit versus dark venues, ADR levels, IFRS reporting requirements, and the possible endogenous determination of home‐country reporting opacity and dark pool volume. The positive relation is stronger for ADRs held by (quasi‐indexing) institutions with low turnover and diversified holdings and weaker for ADRs favored by (transient) institutions that trade frequently and (dedicated) institutions that hold concentrated portfolios. Bid‐ask spreads are greater for higher opacity ADRs that trade in dark pools, indicating that reporting opacity is associated with the negative effect of dark pool trading on market quality. Our findings help inform the current debate on off‐exchange trading by showing how reporting regimes affect the trading venue choice.

In this study, we provide theoretical guidance for both analytical research and empirical research by considering how changing expectations of earnings affect a dishonest manager's strategy to overstate earnings and an auditor's strategy to exert effort in a two‐period setting. We expect our study's insights on changing economic conditions to help shape future research. We model the manager type as either honest or dishonest, which allows us to differentiate audit risk from audit effort. The key takeaways for future research are the insights on how changes in payoffs and expected earnings affect the associations that involve earnings overstatements and audit effort with audit risk and market price. For instance, researchers typically assume audit effort and audit risk are negatively associated, but we find the association can be positive when, for example, the auditor chooses a period 2 strategy based on the changes in period 1 game parameters. The results of our study provide two additional key insights on the design of future empirical tests. First, by dichotomizing, we show the importance of estimating the intercept in the market pricing equation when studying earnings quality, because market price also adjusts for expected bias through changes in the intercept. Second, our multiperiod setting demonstrates that the effects from a change in the manager's or auditor's incentives in period 1 may reverse in period 2. Empirical studies typically examine the contemporaneous effects of these changes on market price and/or audit risk but fail to identify the cross‐temporal effects we document in our study.