Knowledge that Transforms

ABSTRACT This study explores whether an increase in the size of firms’ reporting networks (the number of industry peer firms reporting in comparable standards) improves the quality of analysts’ information environments. We exploit the effect of the 2005 mandatory adoption of IFRS around the world on U.S. firms, as IFRS adoption did not directly affect U.S. firms but increased the size of their reporting networks. We document that mandatory IFRS adoption is associated with a significantly larger improvement in the quality of analysts’ information environment for U.S. firms with relatively few domestic industry peers than for other U.S. firms. Further, we show that there is a larger increase in the frequency with which analysts’ research reports for U.S. firms with few domestic peers mention IFRS-adopting EU industry peer firms. Our results provide evidence that mandatory reporting regulations that increase reporting comparability can result in positive information externalities from information network effects. JEL Classifications: K22; M41; M48.

ABSTRACT This paper examines the effect of financial regulation on nonfinancial violations. Using differences in compliance requirements with Sarbanes-Oxley Act of 2002 (SOX) Section 404, we find that adoption of Section 404 increased firms’ propensity for nonfinancial violations. This effect is stronger for firms with greater external scrutiny toward their financial reporting, greater challenges in monitoring their operations, and limited resources. These results, together with an examination of changes in audit fees, conference call transcripts, and 10-K disclosures, suggest that the effects primarily stem from a shift in attention and resources toward SOX 404. Further, the effects are concentrated in employee-related violations and persist for approximately two years. Overall, our results suggest that financial reporting regulation can result in unintended consequences harming stakeholders, such as employees. JEL Classifications: M40; M41.

ABSTRACT This paper presents a model in which investors price risk and a firm makes an investment to reduce its cash flow risk. Subsequently, the firm may or may not privately receive information about the future cash flow, whose disclosure is under its discretion. We show that the equilibrium cash flow precision increases with investor risk aversion, but decreases with the likelihood that the firm has private information and the quality of that information. In addition, the equilibrium probability of disclosure increases when the firm is more likely to have higher-quality private information, but it may increase or decrease when investor risk aversion increases. Using these comparative statics, we rationalize mixed empirical findings on the relation between risk and disclosure as equilibrium outcomes. The model is extended to a setting where the firm also makes an investment to increase the mean of its future cash flow. JEL Classifications: D61; G14; M41.

ABSTRACT Although rapidly evolving, quality control (QC) systems are a poorly understood determinant of audit quality. We interview 27 QC system leaders to understand how they navigate the challenges they face in changing QC systems. We find that many challenges—including obtaining buy-in, evaluating costs and benefits, and advancing proactive over reactive changes—are caused by conflicting demands arising internally. Consistent with institutional theory, our data reveal that leaders respond to conflicting demands by seeking partial conformity (e.g., negotiating among stakeholders) or by altering the framing of the demands (e.g., using scientific logic to legitimize a QC change). Interviews of eight QC system users complement and corroborate our main results and suggest opportunities for future research. Our study sheds light on how firms update QC systems and informs practitioners, regulators, and academics of the forces that shape the evolution of QC systems. Data Availability: Our data are not publicly available to preserve participant anonymity.

ABSTRACT I examine whether mandating the disclosure of investments influences firms’ strategic interactions. I exploit an SEC regulation requiring firms to report off-balance sheet purchase obligations, such as commitments to inventory purchases, CAPEX, R&D, and advertising. Motivated by theory on strategic investments, I predict and find that firms increase investments if they have substitutive product market strategies with competitors and decrease investments if they have complementary strategies. This two-way finding is consistent with firms strategically using investments to influence competitors’ behavior. I show that changes in investments are concentrated among dominant firms (i.e., oligopolistic firms with large market shares), especially those with more irreversible investments, which have a greater ability to influence competitors’ actions. I also show that such changes in investments have real effects on firms’ sales growth, profit margins, and market share. Collectively, my results illustrate a novel channel through which financial reporting shapes firms’ investments and competition. JEL Classifications: G31; L11; L13; M40; M48.

ABSTRACT We examine the implications of GAAP earnings forecast quality for accounting research. Using a tax law change with an estimable and material GAAP earnings impact, we find that analysts’ GAAP forecasts generally fail to incorporate this impact, whereas investors respond promptly, suggesting that GAAP forecasts omit earnings information deemed relevant by investors and are of low quality. Analyzing quarterly GAAP forecasts from 2004–2019 and classifying GAAP forecasts that equal their street counterparts when GAAP and street actuals differ as low quality, we again find widespread low GAAP forecast quality. Low quality GAAP forecasts affect research inferences: they dampen GAAP earnings response coefficient (ERC) estimates, reduce the explanatory power of GAAP surprises for returns, affect inferences regarding market rewards for meeting-or-beating via exclusions, and understate the extent that GAAP forecasts incorporate exclusion components. We propose two strategies to mitigate the adverse effects of low quality GAAP forecasts on research inferences. Data Availability: Data are from publicly available sources as identified within the manuscript. JEL Classifications: G14; M40; M41.

ABSTRACT We examine whether and how a widely established finding—employees respond negatively to managerial monitoring—generalizes to different performance-evaluation systems. We predict that relative performance evaluations (RPEs), a common evaluation feature in multiagent settings, attenuate employees’ negative responses to managerial monitoring. The results of our experiment support our theory. Consistent with prior literature, we find that without RPE, employees respond significantly more negatively to managerial monitoring compared to no monitoring. However, we find that the effect of managerial monitoring on employee responses is moderated in the presence of RPE—employees respond similarly regardless of whether their manager implements a monitoring control. We provide robust analyses to support our theory-derived mechanisms, demonstrating that our results are driven by employees’ fairness perceptions of managers’ monitoring decisions. Collectively, this study aids in the understanding of how and under what circumstances managerial monitoring may be more or less beneficial. Data Availability: Available upon request. JEL Classifications: C90; D91; J31; M40.

ABSTRACT Seasonal fluctuations in a firm’s business activities can affect its balance sheet and give rise to seasonally predictable accruals. We find that seasonal patterns in accruals are associated with future stock returns. Specifically, we find that firms with historically lower (higher) accruals in a given fiscal quarter have higher (lower) stock returns in the months when those accruals are expected to be announced. Our results suggest that investors do not fully understand and price historical information on accruals seasonality. Additional analyses suggest that the emergence of this accruals seasonality anomaly is concentrated in the post-2001 period and driven by the effects of unsophisticated arbitrage against the accruals anomaly. JEL Classifications: G10; G12; G14.

ABSTRACT We examine year-to-year adjustments of performance measure weights in managers’ incentive contracts. Using survey panel data on financial middle managers over four years, we document that higher target achievement on a given measure is associated with an increase in the measure’s relative weight for the subsequent year. We explore three potential explanations for this pattern: retention considerations, managerial influence, and gradual strategic shifts. Consistent with retention considerations, we find that shifts toward better performing measures are stronger for managers who outperform their peers and in firms facing greater labor market competition. Consistent with managerial influence, we find that shifts are also stronger for managers with greater influence on their incentives and in firms with lower incentive design transparency. We find, however, no support for the gradual strategy change explanation, as results do not show that shifts vary with managers’ involvement in strategic decision-making or subsequently observed strategy changes. Data Availability: The survey data used in this project are protected by a nondisclosure agreement. JEL Classifications: J33; M12; M40; M46.

ABSTRACT We develop an empirical proxy for companies’ differential communication to local and foreign investors using translation differences in public disclosure. We validate our proxy using a field experiment and then use this proxy to document that differential communication is associated with increases in information asymmetry between local and foreign investors. It is also linked to decreases in the relative information quality of foreign analysts, even when foreign demand for information is high and communication costs are low. These and a variety of supporting tests, including those using an alternative artificial intelligence (AI)-based measure of translation differences, suggest that firms engage in differential communication because of a preference for local investors and when responding to incentives to maximize stock price. This study highlights the role of differential communication as one driver of local information advantage in our setting. Data Availability: Most data are available from publicly available sources, as described in the paper. The field experiment data are available upon request. JEL Classifications: G15; G14; M40; M41; G30.