Knowledge that Transforms

ABSTRACT We exploit the technological closeness among clients of the same auditor to examine whether auditors accumulate knowledge from their clients’ technological proximity. We find that a client firm’s technological proximity to other clients of its audit office improves audit quality and results in an audit fee discount, even after controlling for the product similarity effect, auditors’ overall technological expertise, and industry specialization. Both an increase in audit quality and a decrease in audit fees occur if a client firm exhibits greater technological similarity to clients of other audit offices within the same audit firm. Our findings suggest that the auditors’ technological proximity knowledge enhances the effectiveness and efficiency of audit work at both the audit firm and audit office levels. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; M49; O30.

ABSTRACT Utilizing the Trade Reporting and Compliance Engine (TRACE) setting as an exogenous shock to bond market transparency, we find that improved bond market transparency leads to lower crash risk in the stock market, consistent with increased information spillover from the bond market into the stock market. Results from the Path analysis suggest that bond market transparency affects stock price crash risk not only directly, but also indirectly through its effects on management guidance, analyst forecasts, and media reports. We also find that the mitigation effect of bond market transparency on stock price crash risk is more pronounced for firms with higher default risk bonds, lower institutional stock ownership, and more opaque financial reporting. Overall, our findings suggest that increased bond market transparency following TRACE generates a positive externality in reducing crash risk in the stock market. JEL Classifications: D83; G14; G24.

ABSTRACT Fair value estimates from external third-party sources are generally considered more reliable than internal estimates based on managerial inputs. However, even externally sourced estimates are subject to managerial opportunism, because firms can switch from one external source to another. In the context of life insurance companies that mostly rely on external sources, we posit that such source switches could be driven by managerial incentive either to faithfully report fair values (objective valuation) or to inflate estimates to avoid OTTI (opinion shopping). Our results support both motives. In instances in which the two incentives yield conflicting predictions for source switching, we find the opinion-shopping motive dominates. We also find that switches that increase fair value estimates are associated with a reduced OTTI likelihood and magnitude, especially for high-impairment-risk securities. On balance, our evidence suggests that opportunism with respect to source switching can compromise the reliability of externally sourced fair value estimates. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G22; M41.

ABSTRACT In this study, we examine whether firms respond to internal control weaknesses (ICWs) by requiring accounting-specific skills when hiring rank-and-file employees. Using unique data containing an extensive collection of job postings, we document significant increases in firms’ job postings that list accounting skills after the disclosure of an ICW. This effect is more pronounced for firms with better financial resources and when ICWs are more severe or personnel-related. In addition, our results extend to employees that are not specifically designated as accountants, suggesting a broader role for rank-and-file employees in influencing internal control quality. Finally, we find that increases in job postings with accounting skill requirements are associated with improvements in internal controls and a higher likelihood of ICW remediation. Overall, our findings shed new light on how firms respond to ineffective internal controls by increasing their emphasis on accounting skills in their workforce. Data Availability: Data are publicly available from the sources identified in the text. JEL Classifications: G30; J23; M41; M42.

ABSTRACT I study whether there are peer effects in disclosure timing decisions. Using plausibly exogenous variation in the timing of peers’ earnings announcements based on a threshold in Securities and Exchange Commission (SEC) reporting deadline rules, I find that a focal firm responds to a peer’s early announcement by announcing its own earnings early. Consistent with attention competition, early-announcing peers attract market attention away from the focal firm, incentivizing it to also accelerate its own announcement. Moreover, peer effects impose significant negative spillover effects in the form of increased accounting-related costs on firms facing peer pressure to report early. My findings highlight a novel externality of peer effects in disclosure that has important implications for policymakers concerned with the timing of information releases. JEL Classifications: M41; M42; M48.

ABSTRACT Using a comprehensive database of U.S. internal auditor job postings, we find that firms are about 10 percent more likely to post an internal auditor job after the revelation of accounting and operational failures. Also, the demand for internal auditors is stronger when a failure is more severe. Among firms posting internal auditor jobs, firms demand higher-quality internal auditors in response to a failure compared with when there has not been a recent failure. We find evidence of internal audit demand spillovers through connected directors, which helps mitigate concerns that the primary results are due to replacing internal auditors that recently left or due to endogenous links between hiring internal auditors and failure revelations. Overall, our evidence suggests that firms demand internal auditors to help ensure high-quality financial reporting and effective operations. JEL Classifications: G34, J23, M41, M42.

ABSTRACT We explore whether income tax accounting (ITA) for pensions provides measurement benefits incremental to U.S. GAAP. We use publicly reported Form 5500 defined-benefit pension expense and funding measures, which are calculated using ITA rules, and contrast them with parallel GAAP amounts. We document that ITA measures are more strongly associated with market value, future cash contributions, the cost of equity capital, and credit ratings than comparable GAAP measures, particularly when ITA better maps to economic fundamentals and when GAAP offers greater managerial discretion. Using intraday returns and disclosure times obtained through a Freedom of Information Act request, we also find that markets quickly react to the release of ITA measures in Form 5500. Our study provides novel empirical tests of theory about the benefits of ITA using actual, not imputed, ITA measures and provides evidence that investors can and do use the unique information in a publicly disclosed tax form. JEL Classifications: H25; J32; M41; M48.

ABSTRACT The limitation of executive compensation has been a matter of public and policy debate for at least 20 years. We examine a regulatory action in Austria in 2014 where the tax deductibility of the total value of executive compensation is unavoidably limited. We find no average effects on the growth or composition of executives’ pay. However, the deductibility limit affects the managers of firms with low bargaining power and of firms with strong corporate governance, indicating that they are affected by the deductibility limit. Additionally, the contract durations for executives decrease after renegotiation. We further find that affected firms experience cuts in investment and research and development, suggesting that shareholders bear part of the economic burden. Our results indicate that the effectiveness of other reforms, such as the Tax Cuts and Jobs Act of 2017, in restricting executive pay is rather limited. JEL Classifications: H21; H22; M41.

ABSTRACT I examine whether book-tax differences (BTDs) are mispriced. I predict that BTD mispricing is the operating cash flows-to-price (CFO/P) anomaly in disguise. Using both time-series asset pricing tests and cross-sectional returns tests, I provide consistent evidence that returns to trading on BTDs are explained by CFO/P. Rather than being an independent anomaly, the findings indicate that any evidence of BTD mispricing is subsumed by the broader CFO/P anomaly. These findings stand in contrast to many studies that infer BTDs possess unique information for future earnings reflected in stock prices with a delay. JEL Classifications: G12; G14; M41

ABSTRACT This study examines managers’ strategic use of concurrent disclosures around the announcement of negative material events. We predict and find that managers disclosing negative 8-K news are more likely to issue a concurrent press release about an unrelated event relative to a press release providing additional context for the 8-K–triggering event in order to increase investor information processing costs. This strategy appears distinct from the bundling of news to deter litigation. We find that managers more commonly issue concurrent unrelated press releases when they have stronger incentives to impede the pricing of negative information and that doing so is associated with a reduction in the speed with which prices reflect the news. Our findings shed light on a previously unexplored tool managers use to exploit investors’ processing capacity constraints to “hide” negative news. JEL Classifications: G12; G14; M41; M48.