Knowledge that Transforms

ABSTRACT In this study, we examine the benefits of membership in an accounting firm association, network, or alliance (collectively referred to as “an association”). Associations provide member accounting firms with numerous benefits, including access to the expertise of professionals from other independent member firms, joint conferences and technical trainings, assistance in dealing with staffing and geographic limitations, and the ability to use the association name in marketing materials. We expect these benefits to result in higher-quality audits and higher audit fees (or audit fee premiums). Using hand-collected data on association membership, we find that association member firms conduct higher-quality audits than nonmember firms, where audit quality is proxied for by fewer Public Company Accounting Oversight Board (PCAOB) inspection deficiencies and fewer financial statement misstatements, as well as less extreme absolute discretionary accruals and lower positive discretionary accruals. We also find that audit fees are higher for clients of member firms than for clients of nonmember firms, suggesting that clients are willing to pay an audit fee premium to engage association member audit firms. Finally, we find that member firm audits are of similar quality to a size-matched sample of Big 4 audits, but member firm clients pay lower fee premiums than do Big 4 clients. Our inferences are robust to the use of company size-matched control samples, audit firm size-matched control samples, propensity score matching, two-stage least squares regression, and to analyses that consider changes in association membership. Our findings should be of interest to regulators because they suggest that association membership assists small audit firms in overcoming barriers to auditing larger audit clients. In addition, our findings should be informative to audit committees when making auditor selection decisions, and to investors and accounting researchers interested in the relation between audit firm type and audit quality.

ABSTRACT This study examines the tax avoidance behavior of firms prior to the issuance, and following the resolution, of SEC tax comment letters. We find that firms that appear to engage in greater tax avoidance are more likely to receive a tax-related SEC comment letter. We also find that firms receiving a tax-related SEC comment letter, relative to firms receiving a non-tax comment letter, subsequently decrease their tax avoidance behavior consistent with an increase in expected tax costs. Additionally, we document evidence consistent with other firms that do not receive a comment letter reacting to multiple publicly disclosed tax-related comment letters within their industry by increasing their reported GAAP ETR, consistent with an indirect effect of regulatory scrutiny on certain types of tax avoidance.

ABSTRACT In this paper, we examine why Chinese reverse merger (RM) firms have lower financial reporting quality than U.S. IPO firms. We find that the financial reporting quality of U.S. RM firms is similar to that of matched U.S. IPO firms, but Chinese RM firms exhibit lower financial reporting quality than Chinese ADR firms. We also find that Chinese RM firms exhibit lower financial reporting quality than U.S. RM firms. These results indicate that the use of the RM process is associated with poor financial reporting quality only in firms from China, where legal enforcement and investor protection are weak. In addition, we find that compared with Chinese ADR firms, Chinese RM firms have weaker bonding incentives (as measured by CEO turnover-performance sensitivity) and poorer corporate governance. These factors, in turn, contribute to the lower financial reporting quality of Chinese RM firms. Overall, our results suggest that the less scrutinized RM process allows the Chinese firms with weak bonding incentives and poor governance to gain access to U.S. capital markets, resulting in poor financial reporting quality. JEL Classifications: G15; G24; G34; G38.

ABSTRACT We examine how accounting practices that aggregate or disaggregate the contributions of different economic agents influence the choice of organizational form. We consider a principal/multi-agent model where the principal either contracts with all parties directly or delegates part of the contracting authority to one of the agents. Delegated contracts improve risk sharing and generate implicit incentives for the agent entrusted with contracting authority. However, delegated contracts also entail a loss of control in motivating lower-level agents. In addition, when performance is aggregated, delegated contracts render agents' incentives more interdependent and create spillovers up and down the hierarchy. We demonstrate that accounting practices that aggregate the performance of multiple agents can complement organizational forms characterized by greater decentralization. In contrast, accounting practices that capture agents' performance contributions separately favor more centralized organizational forms. Our findings suggest that in settings where performance measurement systems are more aggregate, decentralization is more prevalent. JEL Classifications: L22; M12; M4.

ABSTRACT The within-year walkdown of analysts' earnings forecasts has largely been attributed to analysts' incentives to curry favor with managers. We appeal to cognitive psychology literature on motivated reasoning and propose that forecasting difficulty interacts with such incentives to yield the observed walkdown. Higher forecasting difficulty generates a wider range of outcomes from which analysts can justify optimistically biased forecasts. In regression analyses, we find that the interaction between analysts' incentives for optimism and difficulty exhibits the strongest effect on earnings walkdowns. We also examine revenue forecasts as a benchmark of lower forecasting difficulty and find that revenue walkdowns are relatively diminutive. However, when analysts forecast losses, revenue forecasts are more critical and exhibit markedly steeper walkdowns. Our results suggest that analyst forecast walkdowns are better characterized by an interactive effect between analysts' strategic incentives for optimism and forecasting difficulty. JEL Classifications: G17; M41. Data Availability: Data are available from public sources identified in the text.