Knowledge that Transforms

ABSTRACT We examine the consequences of the 2020 amendment to Exchange Act Rule 12b-2, which exempted low-revenue issuers from the ICFR audit requirement and reignited the debate among regulators, issuers, auditors, and academics about the costs and benefits of ICFR audits. We find that exempt issuers rarely obtain ICFR audits voluntarily, indicating they generally do not view such audits as cost beneficial. We also find that exempt issuers report fewer MWs than nonexempt issuers, although this effect is driven by a recent increase in MWs for nonexempt issuers rather than a decline in MW for exempt issuers. We find no evidence that exempt issuers misstate more frequently or that they have less informative control effectiveness disclosures. Overall, our findings suggest that the exemption was welcomed by affected issuers and did not materially impair reporting quality, informing the literature and ongoing policy discussions regarding the appropriate scope of ICFR audit requirements. Data Availability: Data are publicly available from the sources identified in the text. JEL Classifications: M42; M48.

ABSTRACT Financial reporting standard-setting bodies are expected to include academic research in their decision-making processes. However, little is known about whether, why, and how they engage with research. We interview staff from two major accounting standard-setting bodies and, using the information seeking and communication model as a theoretical lens, identify factors shaping their research engagement. These factors include perceptions of academic research, search difficulties, and challenges with assessing the credibility and utility of academic research. Our findings reveal an unstructured, idiosyncratic approach to information seeking, a reliance on academic papers over direct researcher interaction, a significant lack of two-way communication, and concerns relating to incentive differences between academics and standard setters. These structural issues limit the extent to which academic research can inform standard setting. We provide insights on improving the inclusion of academic research in the standard-setting decision-making process and contribute to broader discussions on research relevance. JEL Classifications: M41; M48.

ABSTRACT Facing pressure to meet short-term earnings expectations, corporate managers often take actions that are perceived as value-destroying. Our study provides empirical evidence supporting an alternative view: earnings pressure can discipline managers to undertake value-enhancing actions by refocusing on the firm’s core products. Consistent with this product refocus hypothesis, we find that firms under earnings pressure reduce investment in non-core products, leading to the subsequent underperformance of these non-core products, whereas the performance of core products remains unaffected. As predicted, product refocus is stronger when managers exhibit ex ante high-level agency problems. To strengthen identification, we exploit shocks arising from analyst brokerage mergers and closures. Our study suggests a bright side of earnings pressure—it helps reduce agency-motivated product diversification. JEL Classifications: G10; M11; M41.

ABSTRACT We conduct two experiments to investigate the effects of giving subordinates the possibility to return budget surplus on capital budgeting processes. We predict and find that when subordinates face low uncertainty when submitting their budget request, the possibility to return budget surplus increases budget requests compared to not having this possibility but that this effect is mitigated under high uncertainty. We also predict and find that subordinates return more budget surplus under high than low uncertainty. Together, these results imply that the possibility to return budget surplus can be particularly beneficial for firms operating under high uncertainty. We contribute to the literature by integrating an important feature of budgeting practice into research, i.e., subordinates’ possibility to return budget surplus and by showing that the effects of implementing such an option may strongly depend on the level of uncertainty a subordinate faces. Data Availability: The data and research instrument are available from the authors upon request. JEL Classifications: D91; M10; M40.

ABSTRACT This paper examines whether U.S. domestic firms’ investment decisions are affected by their expectations of market leaders’ tax-motivated income shifting. Market leaders’ financial reports can help peers evaluate industry conditions and potential investment payoffs, but income shifting obscures the geographic source of profits and reduces the informativeness of these disclosures. Thus, when peers expect that leaders shift income, they face greater uncertainty about the outcomes of their own investments. Consistent with the theory of investment under uncertainty, we find that U.S. domestic firms are less responsive to investment opportunities as expectations of leaders’ shifting increase. This reduced responsiveness is concentrated among firms facing higher investment irreversibility and those whose market leaders provide less transparent geographic disclosures. Our findings identify a novel spillover cost of income shifting and suggest that policies enhancing the transparency of multinational firms’ geographic reporting or constraining income shifting could help improve domestic firms’ investment decisions.

ABSTRACT We study the desirability of transparent accounting information for banks depending on their liability structure. In our model, a bank finances a long-term project with both uninsured and insured deposits. Although uninsured deposits increase rollover risk, they may also generate efficient liquidations. Importantly, a transparent regime provides timelier information about the project’s payoff than an opaque regime. We show that the transparent regime is surplus-enhancing when the amount of insured deposits is small, as the bank issues the optimal amount of uninsured deposits and transparency leads to efficient liquidations. Otherwise, when the amount of insured deposits is large, the cost of inefficient liquidations dominates, making the opaque regime optimal. In addition, the bank may favor transparency to reduce its funding cost even when it is surplus-decreasing. Overall, our results show that transparent accounting is not a panacea and provide some support for the “mark-to-funding” accounting rule. JEL Classifications: G20; G28; M41; M48

ABSTRACT Results from multiple experiments demonstrate that evaluators more favorably evaluate creative output produced by designers with higher expertise, even when the underlying creativity of the output is held constant (hereafter, expertise bias). We find, however, that this bias is mitigated when evaluators know that Artificial Intelligence (AI) can augment creative design processes, because AI’s capabilities reduce the perceived exclusivity of designers’ domain expertise. We also show that designers can restore the perceived exclusivity of their expertise, reestablishing the expertise bias, by choosing not to use available AI tools. Although prior research focuses on AI’s ability to enhance or inhibit the creativity of output, we highlight that it can enhance the creative process by mitigating a prevalent human bias in the subjective evaluation of this output. We also contribute to a better understanding of why some experienced designers refuse to utilize AI. Data Availability: Data are available upon request. JEL Classifications: L29; M41; M55.

ABSTRACT In April 2016, the European Union adopted the General Data Protection Regulation (GDPR), significantly expanding privacy protections for personal data handled by firms. I examine the regulation’s impact on U.S. firms’ internal information quality (IIQ) and operational efficiency. Although privacy regulations target one subset of firms’ information assets (i.e., personal data), they may spur broad improvements in firms’ information governance practices and systems, resulting in higher quality information available for decision-making and, by extension, more efficient operations. Using a difference-in-differences design, I find that U.S. firms with European operations (i.e., treated firms) exhibit improvements in IIQ around the adoption of the GDPR. Furthermore, although the GDPR’s regulatory burden is overall costly to firms, GDPR-induced improvements in IIQ contribute positively to operational efficiency. These findings highlight that privacy regulation can act as a catalyst for firms to improve IIQ, yielding operational benefits that may partially offset the regulation’s costs. Data Availability: All data are available from public sources discussed in the text. JEL Classifications: L51; M40; M41; K24.

ABSTRACT We examine the impact of the SEC’s Office of Minority and Women Inclusion (OMWI) on the role of employee gender in the Division of Corporation Finance’s filing review process. Gender bias theory suggests that women may work harder to compensate for perceived bias and discrimination. Consistent with this theory, we find that women reviewers issue longer comment letters, raise more issues, ask more accounting-specific questions, reference more authoritative guidance, request more filing amendments, follow up on more issues from prior rounds, and take longer to close the comment letter process. We also find that women are less prevalent in higher paygrades and leadership positions. These gender differences attenuate after the establishment of OMWI in 2011, but significant differences remain. Analyses of SEC employee survey data corroborate our comment letter results. Data Availability: All data are publicly available. JEL Classifications: G18; J16; M48.

ABSTRACT We examine whether accrual accounting loses relevance with the rise of knowledge firms. Investigating a large sample of U.S. firms from 1990 to 2022, we compare magnitudes, components, quality, and pricing of accruals across knowledge- and physical-asset firms. Knowledge firms report lower accruals and poorer accrual quality, but the gap is concentrated in small knowledge firms. Their low-quality accruals reflect largely innate, volatile, uncertain, early-stage operations, not discretionary reporting. As these firms scale, their accrual magnitudes and quality converge to those of similarly sized physical firms. These life-cycle dynamics reconcile the 1990s decline and post-2000 improvement in aggregate accrual quality through offsetting “new-list” and “maturation” effects. Accrual accounting remains decision-useful in a knowledge economy, as the market prices, and thus seems to recognize, the information risk emanating from poor accrual quality, especially for knowledge firms. JEL Classifications: M13; M41.