Knowledge that Transforms

ABSTRACT The SEC Advisory Committee on Smaller Public Companies recommends paid-for research to fill the void created by declining sell-side coverage. Potential conflicts of interest inherent in paid-for research challenge this recommendation. We evaluate whether paid-for research provides value to investors or merely reflects hype. Analyses of one- and two-year-ahead paid-for earnings forecasts fail to identify significant bias. Using a portfolio approach, favorable (unfavorable) paid-for recommendations yield positive (negative) stock returns at release, with upward (downward) drift over the following year. Regressing future stock returns on recommendations and valuation estimates using paid-for analysts' forecasts yields similar results. Further, results fail to indicate significant differences in paid-for and matched sell-side research. Overall, our evidence suggests that paid-for research provides relevant information for the buy-and-hold investor that is comparable to that of matched sell-side research, providing empirical support for the SEC Advisory Committee recommendation. JEL Classifications: G11; G14; G24. Data Availability: Data are publicly available from the sources identified in the text.

ABSTRACT The term “audit style” is used to characterize the unique set of internal working rules of each Big 4 audit firm for the implementation of auditing standards and the enforcement of GAAP within their clienteles. Audit style implies that two companies audited by the same Big 4 auditor, subject to the same audit style, are more likely to have comparable earnings than two firms audited by two different Big 4 firms with different styles. By comparable we mean that two firms in the same industry and year will have a more similar accruals and earnings structure. For a sample of U.S. companies for the period 1987 to 2011, we find evidence consistent with audit style increasing the comparability of reported earnings within a Big 4 auditor's clientele. Data Availability: All data are publicly available from the sources identified in the text.

ABSTRACT Calls from practice suggest that audit committee members with industry expertise can improve audit committee effectiveness. Nevertheless, regulators and the extant literature have focused on the financial expertise of the audit committee. We posit that audit committee industry knowledge is valuable because accounting guidance, estimates, and oversight of the external auditor are often linked to a company's operations within a particular industry. Taking a holistic view, we examine two measures of financial reporting quality (financial restatements and discretionary accruals) and two measures of external auditor oversight (audit and nonaudit fees). As predicted, we find that audit committee members who are both accounting and industry experts perform better than those with only accounting expertise. We also find that in certain instances, supervisory experts who are also industry experts perform better than supervisory experts alone. Overall, these results suggest that industry expertise, when combined with accounting expertise, can improve the effectiveness of the audit committee in monitoring the financial reporting process. Data Availability: All data are gathered from publicly available sources.

ABSTRACT Standard-setters and many investors argue that loan fair values provide more useful information about credit losses than historical cost information, while bankers and others generally disagree. We examine the ability of reported loan fair values to predict credit losses relative to the ability of net historical costs currently recognized under U.S. GAAP. Our analysis is important because credit losses in the banking sector can have severe and widespread economic effects, as the recent financial crisis demonstrates. Overall, we find that net historical loan costs are a better predictor of credit losses than reported loan fair values. Specifically, we find that historical cost information is more useful in predicting future net chargeoffs, non-performing loans, and bank failures over both short and long time horizons. Further tests indicate that the relative predictive ability of reported loan fair values improves in higher scrutiny environments, suggesting that a lack of scrutiny over reported loan fair values may contribute to our findings. Data Availability: Data are available from sources identified in the text.

ABSTRACT This paper studies the optimal design of long-term executive pay plans when boards of directors use accounting information for investment decision-making and executives can take costly actions to manipulate this information. The model predicts that a shift to more convex executive pay plans, such as equity plans that rely more on options and less on stock, is associated with higher levels of manipulation, lower reporting quality, and less efficient investment. When designing the optimal contract, the board trades off these effects with the cost of inducing executive effort. The paper also analyzes how the optimal pay convexity and the equilibrium level of manipulation change when the CEO's opportunistic reporting discretion changes. The model predicts that an increase in the CEO's marginal cost of manipulation increases the optimal level of pay convexity and first increases and then decreases the magnitude of manipulation. JEL Classifications: M12; M41; G31.

ABSTRACT To ensure that audit committees provide sufficient oversight over the auditing process and quality of financial reporting, legislators have imposed stricter requirements on the independence of audit committee members. Although many audit committees appear to be “fully” independent, anecdotal evidence suggests that CEOs often appoint directors from their social networks. Based on a 2004 to 2008 sample of U.S.-listed companies after the Sarbanes-Oxley Act, we find that these social ties have a negative effect on variables that proxy for oversight quality. In particular, we find that firms whose audit committees have “friendship” ties to the CEO purchase fewer audit services and engage more in earnings management. Auditors are also less likely to issue going-concern opinions or to report internal control weaknesses when friendship ties are present. On the other hand, social ties formed through “advice networks” do not seem to hamper the quality of audit committee oversight. Data Availability: All data are publicly available from sources identified in the text.

ABSTRACT: This paper investigates the effect of investments in internal investor relations (IR) departments on firm outcomes. We find that companies initiating internal professional IR experience increases in disclosure, analyst following, institutional investor ownership, liquidity, and market valuation relative to a matched sample of control firms. We also examine the differential impact the exogenous shock of Regulation Fair Disclosure (Reg FD) had on firms with an established professional IR department. We find these IR firms more than doubled their level of public disclosure post-Reg FD. Despite IR firms losing a potential communications channel following Reg FD adoption, we find they did not suffer adversely and instead show a post-Reg FD increase in analyst following, institutional investors, and liquidity relative to a control sample of similar non-IR firms. This implies that the effectiveness of professionalized internal IR increased post-Reg FD consistent with IR firms being relatively better positioned to navigate the more complicated regulatory environment. JEL Classifications: D82; M41; G11; G12; G14; G24 Data Availability: Data are publicly available from the sources identified in the paper with the exception of the membership data from the National Investor Relations Institute, which is a proprietary dataset.

ABSTRACT Although recent academic studies on nonprofits have documented aggressive accounting behavior, these studies have primarily examined the sector in isolation and have not reached definitive conclusions regarding the relative aggressiveness of the nonprofit and for-profit sectors. Using actuarial assumptions for defined benefit (DB) pension plans as a proxy for discretionary accounting choices, we examine whether nonprofit managers respond through their actuarial choices to incentives to manage DB pension assumptions, and whether differences exist in the aggressiveness of these assumptions for nonprofits and for-profits. We find evidence consistent with nonprofits managing pension assumptions when incentives and less monitoring exist. Comparing our nonprofits to a sample of for-profits, we find evidence consistent with nonprofits utilizing more aggressive pension assumptions and making stronger responses to incentives to manage these assumptions. Our findings are consistent with the premise that nonprofits are more aggressive than for-profits when using actuarial estimates that deflate pension obligations and inflate performance.

ABSTRACT This paper examines how the external information environment in which foreign subsidiaries operate affects the investment decisions of multinational corporations (MNCs). We hypothesize and find that the investment decisions of foreign subsidiaries in country-industries with more transparent information environments are more responsive to local growth opportunities than are those of foreign subsidiaries in country-industries with less transparent information environments. Further, this effect is larger when (1) there are greater cross-border frictions between the parent and subsidiary, and (2) the parents are relatively more involved in their subsidiaries' investment decision-making process. Our results suggest that the external information environment helps mitigate the agency problems that arise when firms expand their operations across borders. This paper contributes to the literature by showing that the external information environment helps MNCs mitigate information frictions within the firm. JEL Classifications: D83; G31; M41. Data Availability: Data are available from public sources identified in the paper.

Views Icon Views Article contents Figures & tables Video Audio Supplementary Data Peer Review Share Icon Share Facebook Twitter LinkedIn Email Tools Icon Tools Get Permissions Search Site Cite View This Citation Add to Citation Manager Citation Gregory B. Waymire; Neuroscience and Ultimate Causation in Accounting Research. The Accounting Review 1 November 2014; 89 (6): 2011–2019. https://doi.org/10.2308/accr-50881 Download citation file: Ris (Zotero) Reference Manager EasyBib Bookends Mendeley Papers EndNote RefWorks BibTex toolbar search Search Dropdown Menu toolbar search search input Search input auto suggest filter your search All ContentThe Accounting Review Search Advanced Search