Knowledge that Transforms

In this study, we examine whether investors' actions to acquire accounting information are predictive of future firm performance because these actions partially reveal investors' private expectations of this performance. Using a database of EDGAR downloads, we find some evidence that information acquisition of accounting reports by EDGAR users is, on average, predictive of future firm performance. We then determine the identity of the EDGAR user and examine whether different users' private expectations will be relatively more predictive of subsequent performance. We find that the information acquisition activities of more sophisticated institutional users (e.g., hedge funds, investment banks) are more strongly associated with future performance than are those of less sophisticated retail users. Finally, we find that information acquisition by sophisticated institutions is a leading indicator of their equity holdings. In summary, this study provides evidence of predictive information embedded in sophisticated investors' actions to acquire accounting information.

Recent technological advances make it possible to create automated virtual interviewers, called embodied conversational agents (ECAs). We study how an ECA compares to a human interviewer in three experiments. In experiment 1, we show that two theoretically motivated factors—making the ECA facially and vocally similar to the interviewee—result in the ECA performing similarly to or better than human interviewers for six antecedents of disclosure quality. In two additional experiments, we show that employees are, on average, 21 to 32 percent more likely to disclose violating internal controls to an ECA than to a human, even if the human interviewer has significant interviewing experience. These findings contribute to the ECA design literature by showing that similarity-enhancing features of ECAs increase the antecedents of disclosure. The findings also contribute to the accounting literature by demonstrating that ECA technology can increase the scope of interviewing in accounting without reducing interview quality.

When emerging market firms disclose relationship-based transactions, they face a trade-off in which greater transparency may help lower their cost of capital at the cost of revealing proprietary information. We find that firms overcome this challenge by relying on analysts within their private networks (i.e., connected analysts) who, through repeated interaction with the firm, can better verify relationship-based transactions. Using Chinese firms, we show that firms with more connected analysts have more accurate consensus forecasts and lower forecast dispersion. When a connected analyst departs and stops covering a firm, the accuracy and informativeness of the unconnected analysts' forecasts decrease, suggesting that information spills over from the connected analyst to analysts outside the network. We find a potential mechanism for this information spillover: communication through common institutional clients, which suggests that embedded financial analysts—those sharing close connections with firms and analysts—serve as a channel for disseminating proprietary, hard-to-verify information. JEL Classifications: G14; G15; M40; N25. Data Availability: Data are available from sources identified in the text.

We examine whether the relationship between managerial tone and earnings performance depends on the performance of the firm relative to earnings expectations. Using both annual changes in earnings and the difference between realized earnings and analyst consensus forecasts, we find evidence of “tone concavity” around earnings expectations. Specifically, the covariance between managerial tone and earnings performance is positive when earnings are below expectations, but negative when earnings meet or exceed expectations. We interpret our results to suggest that managers downplay positive changes in earnings to attenuate future growth expectations. We also find that tone concavity is significantly attenuated by managers' career concerns and accounting conservatism, but unrelated to litigation risk. Our results indicate that the effect of earnings performance on disclosure tone is complex and reflects managers' incentives to manage expectations.

This study investigates whether the benefit firms can extract from team member communication to the team manager—who may use such information for rewarding individual team members—is affected by differences in the type of mutual monitoring information available to team members. We predict and find that team performance is higher when team members can observe only each other's effort than when they can observe both each other's effort and output levels; conversely, team performance is lower when team members can observe only each other's output than when they can observe both each other's effort and output levels. The intuition behind these results is that the type of observable mutual monitoring information creates different degrees of ambiguity regarding what should be considered a fair reward allocation for team members' contributions. Such ambiguity reduces the usefulness of team member communication to the manager for allocating rewards, resulting in lower team performance. Data Availability: Data are available from the authors upon request.

We investigate the audit fee response to CEO behavioral integrity (BI). BI refers to the perceived congruence between an individual's words and deeds (Simons 2002). Because low word-deed congruence should result in more explanations when communicating, we use variation in explanations beyond firm fundamentals and CEO-specific characteristics in more than 30,000 shareholder letters to serve as a linguistic-based proxy for CEO BI. We find that audit fees increase as BI decreases, but BI is not associated with financial misstatement or litigation. These findings are potentially consistent with auditors undertaking additional work in response to low BI, which, in turn, mitigates the risk of restatements and lawsuits. The likelihood of option backdating increases as BI decreases, consistent with the contention that auditors lacked incentives to prevent backdating. Finally, BI is increasing in future performance, which suggests that CEOs partially underpin the returns to high-integrity corporate cultures. JEL Classifications: J24; L25; M14; M41; M42. Data Availability: Proprietary data from KRW International cannot be shared because of the terms of a confidentiality agreement. All other data are available from the public sources cited in the text.

We examine the costs and benefits of proactive financial reporting enforcement by the U.K. Financial Reporting Review Panel. Enforcement scrutiny is selective and varies by sector and over time, yet can be anticipated by auditors and companies. We find evidence that increased enforcement intensity leads to temporary increases in audit fees and more conservative accruals. However, cross-sectional analysis across market segments reveals that audit fees increase primarily in the less-regulated AIM segment, and especially those AIM companies with a higher likelihood of financial distress and less stringent governance. On the contrary, less reliable operating asset-related accruals are more conservative in the Main segment and, in particular, those Main companies with stronger incentives for higher financial reporting quality. Overall, our study indicates that financial reporting enforcement generates costs and benefits, but not always for the same companies. JEL Classifications: K42; M41; M42; M48. Data Availability: Data are available from the public sources cited in the text.

Research documents that firms shift operating expenses into income-decreasing, but not income-increasing, discontinued operations. We argue that valuation considerations explain this asymmetric result, as acquirers are likely to value the earnings of income-increasing discontinued operations more highly than the earnings of income-decreasing discontinued operations. Using a large sample of hand-collected data, we show that pre-tax earnings and operating expenses are significantly more value-relevant for income-increasing discontinued operations, supporting our economic explanation for why firms do not shift operating expenses into income-increasing discontinued operations. Additional analysis shows that in situations where managers are constrained from shifting operating expenses due to valuation concerns, they shift tax expense (an expense that is less value-relevant) from continuing operations into income-increasing discontinued operations. Overall, we conclude that valuation considerations constrain firms from shifting operating expenses into income-increasing discontinued operations, but do not constrain firms shifting tax expenses.

This study analyzes whether fair value estimates of fund net asset values (NAVs) produced by private equity managers are accurate and unbiased predictors of future discounted cash flows (DCFs). We exploit the fact that private equity funds have finite lives to compare reported NAVs to DCFs based on realized cash flows for 384 Venture Capital (VC) funds and 195 Buyout funds spanning 1988–2016. Findings reveal that Buyout funds' NAVs display little systematic bias, but VC funds' NAVs are relatively aggressively biased compared to Buyout funds, especially since 2000. Accuracy is worse in the first half of the sample period even though NAV estimates generally are more conservative. Overall, the results reveal significant differences in the association between NAVs and DCFs for Buyout versus VC funds, which is particularly important for private equity fund investors in their consideration of the relevance and reliability of NAV estimates provided by fund managers.

Brand name audit firms are global networks of local audit firms. These networks claim to enforce consistent audit methodologies across their member firms, which, if true, should systematically affect client financial reporting. We find that clients from different countries have more (less) comparable accruals when they are audited by local audit firms from the same global network (different global networks). Furthermore, inferences are similar when we examine client accrual comparability around audit firm switches induced by the failure of Andersen, which serves as a shock that helps improve identification. In falsification tests, having auditors from the same global network is not associated with differences in operating cash flows. Results also suggest that the role of global network methodologies in global financial reporting comparability is more pronounced across stronger investor protection jurisdictions and across jurisdictions that have adopted International Standards on Auditing.