Knowledge that Transforms

Successfully producing relevant research requires investment throughout one's career to acquire fresh institutional knowledge, theories, and methods. In my case, almost a decade in public accounting launched multiple papers examining the tension between financial reporting and tax planning. Some of these papers directly generated new requirements for tax compliance (Schedule M-3) and indirectly influenced new financial reporting disclosures (FIN 48). As tax accounting researchers, we have the best competitive advantage in helping tax policymakers and tax authorities distinguish real effects from reporting effects. We can use that knowledge when analyzing the 2017 tax reform, especially with the help of the American Accounting Association (AAA) to build our professional networks.

We find that firms that grant performance-contingent (p-c) equity awards with accounting-based vesting conditions to their CEOs have lower cost of debt and less restrictive loan terms. The benefits of p-c accounting-based awards on debt financing are greater when the moral hazard problem faced by debtholders is potentially more significant—for example, for firms with poorer credit ratings and lower asset tangibility. We find some evidence that certain types of p-c equity awards with stock price-based conditions increase the cost of debt financing. The adoption of p-c accounting-based awards increases firm value, as indicated by stock and bond event studies. Overall, our findings suggest that the incentive compatibility of accounting-based p-c awards mitigates the potential agency conflict between shareholders and debtholders.

We examine the strategic effects of auditor tenure on the auditor's testing strategy and the manager's inclination to commit fraud. Most empirical studies conclude that longer tenure improves audit quality. Proponents of restricting tenure argue that longer tenure impairs auditor independence and a “fresh look” from a new auditor results in higher audit quality. Validating this argument requires testing whether the observed difference in audit quality between a continuing auditor and a change in auditors is less than the theoretically expected difference in audit quality without impairment. Our findings provide the guidance necessary for developing such tests. Our results show that audit risk (the probability that fraud exists and goes undetected) is lower in both periods for the continuing auditor than with a change in auditors. More importantly, we show that across both periods, expected undetected fraud is lower for the continuing auditor than with a change in auditors.

We document time-varying investor sentiment for corporate social responsibility (CSR) performance. We show that announcements of CSR activities generate positive abnormal returns during periods when investors place a valuation premium on CSR performance. In addition, we find that firms boost CSR performance in response to investor sentiment, and that this response is more pronounced for those firms that are more inclined to respond to investor sentiment due to valuation uncertainty and investor horizon. Our results suggest that investor sentiment plays a role in firms' commitment to CSR. JEL Classifications: M41; D82; G14; G30; G31; G32; G34. Data Availability: Data are available from the public sources cited in the text.

We investigate the impact of recurring fair value versus amortized cost measurement for accounting recognition purposes on the timeliness of insurers' other-than-temporary (OTT) impairments of non-agency residential mortgage-backed securities (NAMBS) around the 2007–2009 financial crisis. Unlike largely predetermined amortized cost measurement, recurring fair value measurement requires firms to invest in information and control systems to assess relevant economic conditions and estimate fair values quarterly. We expect these systems discipline insurers' OTT impairments. Exploiting statutory requirements that PC (life) insurers measure securities with NAIC designations from 3 to 5 at fair value (amortized cost) and disclose security-level accounting information, we predict and find that PC insurers record timelier OTT impairments of the same NAMBS with NAIC designations of 3 to 5 than life insurers. We predict and find weaker evidence of spillover effects to the timeliness of OTT impairments of the same NAMBS with NAIC designations of 1 or 2. JEL Classifications: G22; M41. Data Availability: Data are available from public sources cited in the text.

We develop an agency model in which managerial information manipulation creates pooling and entails ex post costs internal and/or external to the firm. We examine the implications of the strategic interactions between shareholders (who set internal governance and managerial incentive compensation), the manager (who exerts effort and reports on its outcome), and an external regulatory authority or RA (who investigates for fraud and levies penalties ex post). When the RA cannot pre-commit to an ex post investigation strategy, a fraudulent equilibrium obtains if the firm's internal governance costs are sufficiently high. Consistent with (so far fairly scant) post-SOX empirical evidence, but the opposite of the implications of signal-jamming models and equilibria with pre-commitment, the model implies an increase in minimum internal governance standards or ex post fraud penalties (as with SOX) results in decreased equilibrium pay-for-performance sensitivity and firm performance.

We examine how managers' ethnic cultural background affects their communication with investors. Using earnings conference calls with executives from 42 countries, we find that managers from ethnic groups that have a more individualistic culture use a more optimistic tone and exhibit greater self-reference. Managers' ethnic culture has a lasting effect and persists for executives whose work experience later exposes them to different ethnic cultures. The effect of ethnic heritage is observed in dialogues that reflect real-time interactions (i.e., Q&A ) and is less pronounced in the scripted, less spontaneous portion of the calls (i.e., management discussion). Analysts respond positively to optimistic tone, but only those who share the manager's ethnic background adjust their earnings forecasts for the cultural component of managerial tone. The findings suggest that managers' ethnic background has a significant effect on how they communicate with the capital market and how the market responds to the disclosure.

This field study investigates an empirical setting where the introduction of new formal results controls—stretch targets for productivity that are seemingly unachievable with current process efficiencies—is associated with high productivity gains over extended periods of time. Contrary to findings from the prior management accounting research, employees meet the targets by being creative and risk-taking in continuously innovating processes, despite the pressure induced by high target-level difficulty. Mobilizing self-determination theory, we argue that a specific interrelation of personnel and cultural control with results control supports internalization of the latter by employees. In this situation, employees perceive the high performance required by the results control assimilated into their own values, which facilitates the autonomous motivation necessary for their creativity. Our findings contribute to the literature by identifying the conditions, and discovering the mechanisms, that enhance the efficacy of stretch targets.

Analysts are selective about which forecasts they update and, thus, convey information about current quarter earnings even when not revising the current quarter earnings (CQE) forecast. We find that (1) textual statements, (2) share price target revisions, and (3) future quarter earnings forecast revisions all predict error in the CQE forecast. We document several reasons analysts sometimes omit information from the CQE forecast: to facilitate beatable forecasts by suppressing positive news from the CQE forecast, to herd toward the consensus, and to avoid small forecast revisions. We also show that omitting information from CQE forecasts leads to lower forecast dispersion and predictable returns at the earnings announcement.

We examine economic consequences of U.S. bank regulators' phased removal of the prudential filter for accumulated other comprehensive income for advanced approaches banks beginning on January 1, 2014. The primary effect of the AOCI filter is to exclude unrealized gains and losses on available-for-sale securities from banks' regulatory capital. We predict and find that, to mitigate regulatory capital volatility resulting from the filter removal, advanced approaches banks increased the proportion of investment securities classified as held-to-maturity, thereby limiting their financing and interest rate risk management options, and they decreased securities risk, thereby reducing their interest rate spread. We further predict and find that these banks borrow more under securities repurchase agreements potentially collateralized by held-to-maturity securities and reduce loan supply owing to their reduced financing options, and that they increase loan risk to mitigate the decrease in their interest rate spread. JEL Classifications: G21; G28; M41; M48. Data Availability: Data are available from the public sources cited in the text.