Knowledge that Transforms

Using Public Company Accounting Oversight Board (PCAOB) inspection data from 2006 to 2018, we examine the use of auditor‐employed specialists in audit engagements. First, we find that the use of specialists is increasingly prevalent and related to clients’ size and complex accounting estimates. Second, the use of specialists is positively associated with the incidence of audit process deficiencies (identified by PCAOB inspections) but is not associated with output‐based audit‐quality proxies (restatements or absolute discretionary accruals). Hence, although process deficiencies are more likely to occur in engagements with higher use of specialists, financial reporting quality is not negatively impacted. Third, the use of specialists is positively associated with the likelihood of goodwill impairments and negatively associated with engagement profitability. Finally, cross‐sectional tests suggest that board accounting expertise is a salient condition for more effective use of specialists. Collectively, our findings align with concerns noted by the PCAOB and prior experimental and survey studies. Although specialists assist auditors with the audit of complex estimates, engagements with comparatively high specialist use entail an incremental risk of audit process deficiencies.

Managers often face the choice between promoting an internal employee and hiring an external candidate. Using an interactive experiment, we examine the drivers of managers’ promote/hire decisions and internal employees’ behavior before and after those decisions. Consistent with gift exchange theory, we find that employees exert costly effort to increase the chance of being promoted, and they raise their effort level as the promote/hire decision becomes imminent. Managers respond by promoting those who exert high effort, despite employees’ inferior ability compared to external candidates. Results suggest that managers view employees’ past effort as both a gift to reciprocate and a signal of their future effort. Moreover, we find that managers are more likely to promote internally rather than hire externally under a less precise performance measurement system, and this result is driven by managers who observe low employee output. Finally, we find that total effort is significantly higher when managers promote internally versus hire externally.

This study examines an initiative by a large multinational garment retailer (H&M Group) to increase wages at its supplier factories by intervening in their wage‐related management practices. Difference‐in‐differences estimates based on eight years of data from over 1,800 factories show that the interventions were associated with an average real wage increase of approximately 5% by the third year of implementation. Our estimates suggest that the intervention‐associated wage increase was many times greater than if the retailer's cost for the program was instead paid directly to affected workers. We find that the wage effects were driven by factories with relatively poorer supplier ratings and do not find significantly different wage effects depending on the presence of trade unions. We also examine several nonwage outcomes such as factory orders, supplier price competitiveness, overtime pay, and total employment to probe the mechanisms underlying the wage increases. These findings offer new evidence on corporate social impact in global supply chains.

George Floyd's murder caused many firms to reveal how exposed they are to racial diversity issues. We examine investor and firm behaviors after this socially significant event to provide evidence on the valuation effects of the exposure and ensuing corporate responses. We develop a text‐based measure of a firm's exposure to racial diversity issues from conference call transcripts and find that, after the murder of George Floyd, firms with diversity exposure experience a stock price decrease of approximately 0.7% around the date of the conference call. We provide evidence that this effect is attributable to race‐related exposure and not gender‐related exposure. Initiatives taken by firms mitigate the negative market reaction. We document that firms with racial diversity exposure respond by appointing Black directors. The stock market views appointments of Black directors more favorably after George Floyd's murder, except when they are perceived as symbolic. We also find that firms with greater exposure to racial diversity are more likely to establish diversity, equity, and inclusion (DEI) departments, appoint DEI leaders, specify diversity goals, increase supply chain diversity, and donate to racial justice causes. Our paper provides evidence that exposure to racial diversity issues adversely affects firm value, and companies address the exposure by taking actions.

We study the role of a relatively new type of external firm monitor, an on‐site government‐appointed Corporate Monitor, and assess whether such appointments reduce firms' propensity to violate laws. Using a sample of deferred and nonprosecution agreements, we first document the determinants of Monitor appointment. We find firms that voluntarily disclose wrongdoing and have more independent directors are less likely to have Corporate Monitors, whereas those with more severe infractions, mandated board changes, and increased cooperation requirements are more likely to have Monitors. We find such appointments are associated with an 18%–25% reduction in violations while the Monitor is on site, however, the effect does not persist after the Monitorship ends. Using a semisupervised machine learning method to measure changes in firms' ethics and compliance norms, we find that the reduction in violations is associated with changes in ethics and compliance that also do not persist. Finally, we document that firms under Monitorship experience a persistent reduction in innovation, highlighting a previously unexplored cost of these interventions. Overall, our results suggest that, although Corporate Monitors on site are associated with fewer violations, firms revert to previous levels of violations following Monitors' departure.

We show that information exposure through international business networks enables firms to take proactive measures that benefit employees and potentially the local community. Specifically, in the early days of COVID‐19, firms that have business networks with China and Italy are more likely to be aware of the severity of the disease, and proactively implement work‐from‐home (“WFH”) policies that can protect their employees. Using Safegraph foot traffic data, we find a higher stay‐at‐home ratio before local governments impose lockdowns in zip codes where firms have a larger information exposure. These areas are also associated with a lower spread of COVID‐19. Our main findings are more pronounced when local governments face constraints in quickly responding to COVID‐19 and when firms have a higher WFH capability or have more investors with socially responsible preferences. Collectively, we present evidence on the role of private corporations in mitigating the negative effects of a public health crisis before government intervention.

Prior research on auditor industry specialization documents fee premiums for local audit offices that are industry specialists. This research assumes that the effects of specialization are uniform across markets. We examine industry specialization based on the economic theory of industry agglomeration (geographic areas with high industry concentration). Agglomeration economies can facilitate access to knowledge for auditors serving a specific industry in those locations. We find that industry specialists in agglomerations earn a fee premium in excess of specialists in other markets. We find that nonspecialist offices in agglomerations also earn fee premiums in that industry when compared to nonspecialists in other markets even when controlling for these groups’ absolute share of the national market. We also address whether or not this expertise can be shared among offices in an agglomeration specialist's firm. We find that audit offices that have easy connections to a within‐firm office in an agglomerated market can earn a fee premium relative to more distant offices, suggesting a benefit from knowledge transfer. This fee premium accrues to offices that would not be considered a specialist using traditional market share measures in a given industry. These findings indicate that the benefit of industry specialization depends on more than local market share.

We conjecture that board renewal mechanisms—those substantive enough to renew the thinking of the board—are required before investors can address the mismatch between their preferences regarding environmental sustainability and what insiders at firms are actually doing. We identify the adoption of majority voting for directors and the introduction of a female director as two corporate governance mechanisms potentially strong enough to renew a board's thinking on sustainability. Using a sample of 3,293 firms from 41 countries, along with quasi‐exogenous shocks to board renewal mechanisms in Canada and France, we find that both board renewal mechanisms are associated with significantly higher future environmental performance. Further tests provide suggestive evidence that board renewal is more strongly associated with environmental performance in settings with better institutions and more motivated institutional investors. These results suggest the importance of board renewal for alignment of firm policies with investor preferences around the world.

We study the real effects of certification to demonstrate the value of mandatory certification over and above mandatory disclosure in enhancing investment efficiency. In our model, a firm's manager selects a project to maximize the firm's short‐term stock price, which is a function of her certification and disclosure decisions about the outcome of the project. Although the manager might be either forthcoming or strategic with regard to the disclosure of her private information, she can strategically choose whether to incur a cost or not to certify her disclosure, unless mandated. The manager always selects the first‐best project when both certification and disclosure are mandatory. However, when certification is voluntary, project selection is inefficient. In addition, mandating disclosure without mandating certification can lead to lower investment efficiency than mandating neither. In justifying why mandatory certification is beneficial for public firms, our results offer a note of caution regarding the contemplated regulatory moves for increased disclosures by public firms without corresponding certification requirements, for example, the recent SEC proposal requiring extensive climate‐related disclosure.

Running a contest can help managers elicit creative ideas from employees by providing employees with incentives to develop and share ideas that will help the firm. Little is known, however, about how contest design affects the outcomes of subjectively evaluated creativity‐based contests. We conduct an experiment to investigate the impact of two contest design choices, the job role of the contest's evaluator, and the number of prizes that participants compete for, on employee participation behavior. We also examine how these contest design choices impact the creativity of the submitted ideas. We find that using a peer of the employees as an evaluator increases the number of ideas shared, but it does not impact the number of unique participants who enter the contest. In addition, we find that using peer evaluators leads to an increase in the creativity of the ideas. We find that awarding more prizes to participants does not increase overall participation, but it does increase the number of ideas shared by employees from underrepresented demographics. Awarding more prizes, however, reduces the creativity of the ideas. Together, these results show that contest design choices have an important impact on employee creative idea‐sharing and that managers should carefully consider how to tailor contests to fit their firms' needs.