Knowledge that Transforms

Organizations with a mission that extends “beyond profit” to achieve broader objectives are becoming increasingly common. This paper studies such hybrid entities—firms that value the profits they generate, as well as the utility they provide to customers—and details their implications for industry disclosure practices. The findings demonstrate that disclosure incentives are perturbed not just from being a hybrid entity, but also from competing with such entities. Accounting for both competitive and disclosure effects, the paper then assesses the circumstances under which a hybrid firm is economically viable and derives the ensuing equilibrium industry composition. As such, we show that the presence of firms with objectives beyond profit can be an endogenous characteristic of many industries.

We examine how personal lending relationships between lenders and managers are affected by information and accounting environments of borrowing firms. We address this question by exploring whether, following managerial turnover, lenders migrate with the manager from the firm where a relationship developed (origin firm) to the manager's new firm (destination firm). We find that the opacity of the external information environment of the destination firm significantly increases the probability of lenders' co-migration, while accounting irregularities at both the destination and origin firms decrease it. We also show that co-migration is affected by a lender's monitoring efficiency. A lender's monitoring efficiency increases its co-migration probability when a manager moves to an opaque firm, but not when she moves to a transparent one. When the destination or origin firm experiences accounting irregularities, even lenders with strong monitoring capabilities are mostly reluctant to continue their relationship with a migrating manager.

The Securities and Exchange Commission (SEC) recommends that firms provide MD&A disclosures quantifying the earnings effect of reasonably likely changes in critical accounting estimates (quantitative CAE). This paper examines the determinants and consequences of quantitative CAE. We find that quantitative CAE are negatively associated with management's incentives to misreport (proxied by portfolio vega) and positively associated with audit committee accounting expertise and with audit offices with multiple quantitative CAE clients. These findings hold for the presence, initiation, number, and magnitude of quantitative CAE, and for both pension and non-pension quantitative CAE. We also find that incidences of AAERs, misstatements, and small positive earnings surprises decrease after initiation of quantitative CAE. Collectively, our findings provide insight into the use of quantitative disclosure to inform users about accounting estimation uncertainty in financial reports. JEL Classifications: M41; M42; M48. Data Availability: Data are available from the public sources cited in the text.

We examine determinants of audit engagement profitability using proprietary data from the national office of a Big 4 public accounting firm in Canada. We verify through interviews with senior audit partners that the audit realization rate is the primary measure used to assess engagement-level profitability, and use the former to proxy for engagement profitability in our archival analysis. We find that engagement profitability is positively associated with the firm's assignment of lead senior audit managers, as identified by the national office, and its delivery of intangible client service dimensions, such as communication, customization, and responsiveness (obtained from satisfaction surveys of client management and audit committee chairs). We find no evidence that audit quality, measured by discretionary accruals and audit adjustments, is sacrificed to attain higher engagement profitability. We discuss implications for regulation and competition in audit markets.

We argue that the association between auditor industry specialization and audit quality depends on how long the auditor has been a specialist. We measure audit quality using absolute discretionary accruals, income-increasing discretionary accruals, and book-tax differences. Our results, based on a sample of Big 4 audit clients from 2003–2015, indicate that auditors who have only recently gained the specialist designation produce a level of audit quality that does not surpass that produced by non-specialist auditors, and is generally lower than the audit quality produced by seasoned specialists. We estimate that the seasoning process takes two to three years. In contrast to prior research that finds no effect of specialization after propensity score matching, we find that seasoned specialists generally produce higher-quality audits than other auditors even after matching. This suggests that the audit quality effect associated with seasoned industry specialist auditors is not due to differences in client characteristics. JEL Classifications: M42. Data Availability: Data used in this study are available from public sources identified in the text.

We experimentally investigate how managers' decisions to invest discretionary resources in the company's corporate social responsibility (CSR) initiatives are affected by whether the investment decision is denominated in financial or nonfinancial measures (i.e., the measurement basis used for decision making). We posit that nonfinancial measures bring attention to the society-serving nature of CSR investments, thus activating the pro-CSR social norms of the company and managers' personal CSR norms. Norm activation, in turn, influences managers' investment decisions to the extent that social norms are congruent with personal norms. As predicted, we find that the level of CSR investment is higher under a nonfinancial measurement basis than under a financial measurement basis, but only when the manager is personally supportive of CSR. Supplemental analysis indicates that CSR-supportive managers continue to invest more under a combined financial/nonfinancial measurement basis than under a financial measurement basis only. Theoretical and practical implications are discussed.

This paper examines the demand- and supply-side factors associated with audit partner selection and assignment in the United States. First, we examine whether audit partner gender and experience are associated with board and management gender and experience. Second, we investigate whether engagement audit quality varies with audit partner gender and experience, controlling for selection effects. The results indicate that companies with more gender-diverse boards of directors and top management teams are more likely to have a female lead audit partner. In addition, the experience of the client's board is positively associated with the experience of the lead audit partner. In terms of audit quality, we find that higher audit fees are positively associated with female and more experienced audit partners. Our results shed light on the important role that partner characteristics play in the demand and supply sides of audit quality.

This study finds that the association between future stock returns and information quality depends on how option-like is the firm's equity. Firms that have more growth options are more option-like. The association between future stock returns and information quality is negative (positive) for those firms with equity that is least (most) option-like. These results are consistent with traditional asset pricing theory and are robust to numerous empirical specifications. Collectively, these findings offer a theoretically based and empirically supported explanation for why prior studies that do not condition on the option-like nature of equity have documented either a positive or no association between information quality and future average stock returns.

Equity analysts are often hired by firms they cover. I document the extent to which this revolving door phenomenon impairs analysts' independence. I do this by examining the presence of biased research reports issued during the year before analysts are employed by a firm they cover. I find that during their final year, revolving door analysts bias their EPS forecasts, their target prices, and their recommendations in a direction that suggests that they are attempting to gain favor from their prospective employers. Specifically, relative to other analysts, revolving door analysts issue more optimistic reports on the firms that hire them, and they issue more pessimistic reports on firms that do not hire them. These results suggest the presence of strategic bias, although more innocuous interpretations cannot be completely ruled out. JEL Classifications: G14; G17; G24; G28; M41. Data Availability: Data are available from public sources identified in the text.

Whether Big N auditors provide higher audit quality than non-Big N auditors remains a debate. We add new evidence to this debate by utilizing the setting of Big N auditors' acquisitions of non-Big N auditors. We identify 331 treatment firms that switched to Big N auditors due to the exogenous shocks imposed by Big N acquisitions. Our difference-in-differences analyses show that treatment firms' audit quality improves after switching to Big N auditors. In comparison, mergers or acquisitions among non-Big Ns have little impact on audit quality. Our cross-sectional analyses suggest the audit quality improvement among treatment firms is more likely due to Big N auditors' general competence rather than their industry-specific expertise. Finally, we find that treatment firms experience no significant market reactions around the announcements of Big N acquisitions, indicating that the capital markets may not attach any premium to the improved audit quality associated with Big N auditors.