Knowledge that Transforms

We study whether the availability of public audited financial statements influences the probability of private firms receiving private firm equity financing. Using a setting in the EU with plausibly exogenous variability in the extent to which private firms issue public financial reports, we find that private firms subject to public reporting requirements have a higher probability of obtaining private equity (PE) financing. In addition, we show that the increase in PE financing occurs in industries in which PE funds have prior experience. Last, we show that our findings also extend to other forms of private firm financing such as private firm acquisitions and venture capital. Our evidence highlights the importance of public financial statements in the decision-making of PE investors, an important and understudied segment of the private firm financing market. Data Availability: Data are available from the public sources cited in the text.

Companies are offering managers compensation incentives to increase promotions of under-represented employees to higher level organizational positions (hereafter, “diversity incentives”). This study uses an experiment to examine how diversity incentives affect managers’ promotion decisions and employees’ effort choices before and after those decisions. The results suggest that managers’ diversity incentives do not affect employees’ pre-promotion effort choices. Additional analyses indicate that both over- and under-represented employees expect managers to promote them based on effort instead of group membership. Consistent with predictions, diversity incentives increase the likelihood that managers promote under-represented employees whose pre-promotion efforts are comparable to their over-represented colleagues’ efforts. After the promotion decision, nonpromoted employees whose managers receive diversity incentives choose the lowest effort, regardless of group membership. Collectively, these results inform companies about the potential costs and benefits of using diversity incentives by demonstrating that diversity incentives can increase diversity in promotions but reduce nonpromoted employees’ efforts. Data Availability: Data are available from the author upon request.

We document that firms in more politically corrupt regions of China adopt more conservative accounting. The relation between local political corruption and accounting conservatism weakens after China’s anticorruption campaign launched in 2012 and in firms with a lower risk of expropriation by corrupt officials, stronger incentives to report earnings aggressively, or greater gains from corruption. Further analysis shows that accounting conservatism and alternative corporate strategies complement each other in shielding firms against corrupt officials’ expropriation of corporate resources. Our study provides novel evidence about an accounting approach used by firms in response to perceived political costs.

We use audit firm data breaches as time-varying, reputation-harming events to examine the value of auditor reputation—independent of actual audit quality—in the IPO process. We find that auditor data breaches are negatively associated with IPO offer price revisions. We demonstrate that this effect is due to an increase in institutional investors’ perception of information risk. Specifically, the effect is mitigated when other parties involved in the IPO reduce information risk themselves and when institutional investors are less likely to rely on audited financial information. In additional tests, we find that the impact of breaches on IPO offer price revisions is concentrated in breaches with greater severity, saliency, and frequency, consistent with institutional investors reacting to the announcement of the data breach rather than some other confounding factor. Collectively, our evidence suggests that IPO investors perceive time-varying reputational value of the external auditor, independent of changes in audit quality.

We study voluntary cost disclosure by duopoly firms when they can invest in a cost-reduction technology, i.e., when their private cost is endogenously determined. We find that, contrary to most of the literature, firms disclose their endogenous cost information regardless of the type of competition. The underlying mechanisms and welfare implications, however, are different. Under Bertrand competition, cost disclosure helps a firm avoid aggressive investment in cost reduction to coordinate actions to the mutual advantage of the duopoly firms. Under Cournot competition, disclosing cost information enables a firm to show a hardened stance toward the competing firm. Although firms gain from their disclosure decisions under Bertrand competition, their disclosure decisions under Cournot competition place them in a prisoner’s dilemma, as both firms would be better off if they chose not to disclose their information. Consequently, consumers may lose under Bertrand competition but gain under Cournot competition.

We examine whether auditor scrutiny over the allowance for loan losses (ALL) is associated with bank lending decisions. Using PCAOB inspection findings over the ALL to capture increases in auditor scrutiny, we find that auditor scrutiny is associated with a larger ALL for homogeneous loans (i.e., residential mortgages and consumer loans) but not for heterogeneous loans (i.e., commercial real estate; commercial and industrial loans). We next find that auditor scrutiny is associated with a shift in lending away from homogeneous loans, consistent with auditor scrutiny reducing the relative attractiveness of homogeneous loans. These findings suggest that policymakers and audit regulators can indirectly affect bank lending by exercising their authority in ways that affect auditor scrutiny. Data Availability: All data are publicly available from the sources discussed in the paper.

Creativity-dependent companies often implement failure disclosure programs to encourage employees to publicly disclose failures encountered in exploration activities with a focus on learning. We examine the effects of failure disclosure on employees’ exploration performance using an experiment in which participants perform a letter-search task by counting the search letters in each question (i.e., exploitation) or identifying an embedded shortcut that applies to all questions (i.e., exploration). We manipulate two factors: (1) whether participants are encouraged to disclose their failed attempts at finding the shortcut to future participants and (2) whether they are evaluated for their task-related skills. We predict and find failure disclosure increases the likelihood of shortcut identification in the presence of evaluation, and this effect is mitigated in the absence of evaluation. Because evaluation is typically present in natural work settings, our theory and results suggest failure disclosure is an effective mechanism to increase employees’ exploration performance.

This paper provides an accounting-based valuation model that predicts that cross-sectional variation in firm-level returns to investments in both stock and stock return volatility are related to cross-sectional variation in firm-level fundamentals. The model predicts that expected stock returns have a positive quadratic relation with stock return variance and a negative quadratic relation with gains to trading in stock return variance. Consistent with these predictions, firms with high model-implied expected stock returns have high future stock return variance, and the relation is roughly quadratic. In contrast, firms with high expected stock returns have low future returns to trading in stock return variance through option contracts because these firms have high option-implied variance relative to future realized variance, i.e., low variance risk premia (VRP). The study provides a framework for using fundamentals for trading in individual stocks and options.

We show that financial reporting influences consumer behavior by drawing consumer attention to announcing firms. Analyzing global positioning system (GPS) data, we document upticks in foot traffic to firms’ commercial locations immediately following their earnings announcements. This increase is more pronounced for announcements with substantial media attention, fewer concurrent announcements, heightened internet search volume, and extreme stock price jumps and earnings surprises—indicating that announcement coverage impacts consumer behavior by capturing attention. Furthermore, foot traffic increases with positive earnings for firms offering durable goods, suggesting consumers respond to news about firms’ financial prospects. Consumer attention patterns increase revenues and advertising effectiveness, ultimately suggesting that financial reporting serves a marketing function. Data Availability: All other data are available from the public sources cited in the text.

We use large, detailed data on individual auditor employment to examine the antecedents of turnover decisions and subsequent career paths of diverse individuals in public accounting—namely women and racial/ethnic minority groups (Asian, Black, and Hispanic). Despite investments in diversity, equity, and inclusion (DEI) recruiting by firms, we observe a higher likelihood of turnover among diverse auditors. Consistent with the principle of homophily, we find that same-group representation is crucial in retaining diverse auditors. These individuals are less likely to leave when surrounded by peers and leaders of the same group and are more likely to join an organization with greater same-group representation. We also find that most individuals leave the audit profession, but those who stay longer have higher seniority later in their careers—suggesting that extended tenure could mutually benefit firms and individuals. Our findings offer valuable insight for firms seeking to promote DEI while improving retention rates.