Abstract This study investigates whether an individual's status as a current or a prospective investor affects the investor's susceptibility to earnings fixation and proposes a mechanism to reduce earnings fixation. Our experimental results suggest that current investors are more susceptible to earnings fixation than prospective investors, and that current investors can reduce earnings fixation by explicitly forecasting future earnings as part of their evaluation process. We provide theory‐consistent evidence that current investors' prevention focus makes them elevate the importance of summary earnings in their evaluation of a company. However, after forecasting future earnings, current investors view summary earnings as only one of several similarly important evaluation inputs rather than as one substantially more important input (relative to its components). Our study contributes to research on earnings fixation and investor status. We also contribute to practice by documenting the moderating effect of investor status on earnings fixation and by identifying a simple mechanism that current investors can use to reduce their susceptibility to earnings fixation.

Abstract This study provides evidence on how local office growth affects audit quality. We predict that significant recent growth will temporarily stress office resources, leading to a negative relation between office‐level growth and audit quality. To test this prediction, we examine a sample of 17,062 firm‐year observations from 2005 to 2010. Results indicate a consistent negative relation between changes in volume of audit work and audit quality. Specifically, clients of offices that experience increases in workload over the prior year have greater absolute discretionary accruals as well as an increased likelihood of restatement. Our tests also indicate that the effect of office growth is transient and vanishes after one year. We find limited evidence that the size of the auditor's national network of offices partially mitigates the negative effects of office growth on audit quality. We further show that proxies for audit quality are negatively related to office‐level growth from new and existing clients. These findings are robust to controls for client and auditor characteristics as well as alternative specifications of growth. Taken together, evidence indicates that while larger offices provide higher audit quality, the benefits of office size are not realized immediately and rapid growth temporarily impairs audit quality. These results are informative to regulators concerned with audit quality and to practitioners charged with adjusting to office growth.

Abstract Academic and anecdotal evidence indicates that incentive systems often provide short‐term payouts without regard for long‐term consequences. New detailed disclosures mandated by FIN No. 48, Accounting for Uncertainty in Income Taxes, enable us to use a tax setting to investigate whether boards adjust performance‐based pay for uncertainty. We find managers’ bonus payouts are positively associated with tax performance; however, bonus payouts are lower when measures of ex ante tax uncertainty are higher. Our results are robust to tests of alternative explanations including financial reporting aggressiveness, overall firm risk, and other forms of compensation. Further, we document that the relation between bonus compensation and tax performance has changed in the post‐ FIN No. 48 period. Specifically, we identify a significant association between bonus payout and GAAP ETR only in the pre‐ FIN No. 48 period and a significant association between bonus payout and cash ETR only in the post‐ FIN No. 48 period, suggesting that the relation between compensation and tax avoidance should be examined carefully with particular attention to the post‐ FIN No. 48 period.

Abstract In this study we examine whether the reported performance of one firm affects the discretionary reporting behavior of another firm. We do this by identifying the leader within each industry, defined as the first large announcing firm. We find that the discretionary performance of followers (those firms announcing after the leader) relates positively to the leader's reported performance. Specifically, when the leader misses analysts’ expectations, followers report lower discretionary accruals, have fewer income‐decreasing special items, and are less likely to meet analysts’ expectations. In contrast, when leaders report good news, followers report higher discretionary accruals and are more likely to meet expectations (although we do not find evidence of a positive association between leaders’ good news and followers’ income‐decreasing special items). Overall, the results are consistent with managers of followers perceiving that earnings news of the leader will affect investors’ and others’ performance expectations for their firms.

Abstract This study examines the implicit incentive effects of horizontal monitoring and team member dependence for individuals working in teams but facing explicit incentives based solely on measures of individual performance. We combine proprietary performance data with survey data for 133 internal auditors. We show that the social influences of relatively high levels of both horizontal monitoring and team member dependence provide implicit incentives that motivate individual performance, making the provision of team rewards unnecessary to ensure individual and team productivity. We conclude that horizontal monitoring and team member dependence are complementary control mechanisms whose effectiveness helps explain the observed practice of organizing work into teams without explicit team‐based rewards.

Abstract During the past decade, new regulations have been adopted to improve audit committee effectiveness. Prior research has generally provided evidence in support of these regulations and suggests that a more independent and expert audit committee is more effective. We posit that CEO power reduces or even eliminates the improvements in audit committee effectiveness resulting from independent and financially expert committee members. Thus, CEO power may result in an audit committee that appears effective in form but is not in substance. We construct a composite index for CEO power by combining ten CEO characteristics and employ the incidence of internal control weaknesses as a proxy for audit committee monitoring quality. Since all the firms in our sample have completely independent audit committees, we use financial expertise to examine the impact of CEO power on audit committee effectiveness. We find that, when CEO power is low, audit committee financial expertise is negatively associated with the incidence of internal control weaknesses. However, as CEO power increases, this association monotonically weakens. When CEO power reaches a sufficiently high level, this association is no longer negative. The moderating effect of CEO power on audit committee effectiveness is more prominent when the CEO extracts more rents from the firm through insider trading. Our results are not driven by the CEO 's involvement in director selection. Our paper suggests that more expert audit committees in form do not automatically translate into more effective monitoring. Rather, the substantive monitoring effectiveness of audit committees is contingent on CEO power.

Abstract This study examines the relation between performance covenants in private debt contracting and conservative accounting under adverse selection. We find that under severe adverse selection (i.e., high information asymmetry), accounting conservatism and performance covenants act as complements to signal that the borrower is unlikely to appropriate wealth from the lender. No such relation obtains in a low information asymmetry regime. We further show that in the high information asymmetry regime, borrowers with high levels of conservatism and tight performance covenants generally enjoy lower interest rate spreads than borrowers with low levels of conservatism and loose performance covenants. Consistent with our signaling theory, in the high information asymmetry regime, borrowers with high levels of conservatism and tight performance covenants are less likely to make abnormal payouts to shareholders. Our empirical results are robust to alternative measures of conservatism and covenant restrictiveness.