ABSTRACT In this study I examine how the degree and duration of overvaluation affect management's use of alternative within-GAAP earnings management, restrictions on further exploitation of within-GAAP accruals management, and subsequent non-GAAP earnings management. Further, I examine how one type of earnings management segues into another type as overvaluation persists. I present evidence that the longer the firm is overvalued, the greater is the amount of total earnings management. I also find that managers engage in accruals management in the early stages of overvaluation before moving to real transactions management, in order to sustain their overvalued equity. Finally, I find that the longer a firm is overvalued, the more likely it is to engage in one of the most egregious forms of earnings management, non-GAAP earnings management. Collectively, the results suggest that the duration of firm overvaluation is an important determinant of managements' choice of alternative earnings management mechanisms. JEL Classifications: M41, M43, M44. Data Availability: Data are available from sources identified in the text.

ABSTRACT As an alternative way to shed light on the debate over whether accruals quality is a priced risk factor, we examine the effect of seasonality on the pricing of the modified Dechow and Dichev (2002) accruals quality measure (AQ). We find that (1) high AQ stocks outperform low AQ stocks only in January; (2) during the rest of the calendar year, high AQ firms underperform low AQ firms such that there is no AQ premium on an annual basis; (3) about half of the January AQ premium occurs during the first five trading days of January; (4) a January AQ premium is observed in almost every year of our sample period; and (5) the January AQ premium reflects, at least partly, the stock price effects of tax loss selling around the turn of the year. Taken together, these findings are difficult to reconcile with a risk interpretation of accruals quality.

ABSTRACT This study examines how using the internal audit function (IAF) as a management training ground (MTG) affects external audit fees and the external auditors' perceptions of the IAF. Over half of all companies that have an IAF specifically hire internal auditors with the purpose of rotating them into management positions (or cycle current employees into the IAF for a short stint before promoting them into management positions). Using archival data, we find that external auditors charge higher fees to companies that use the IAF as a MTG. Using an experiment, we provide evidence as to why fees are higher. Specifically, we find that external auditors perceive internal auditors employed in an IAF used as a MTG to be less objective but not less competent than internal auditors employed in an IAF not used as a MTG. These results have important implications for the many companies that use their IAF as a MTG. Data Availability: Contact the authors. Data provided by the Institute of Internal Auditors Research Foundation are subject to restrictions.

ABSTRACT: This study examines the influence of organizational controls related to knowledge management and resource development on assimilation (i.e., strategic integration and use) of business intelligence (BI) systems. BI systems use analytics and performance management concepts to leverage enterprise system databases and provide core management control system (MCS) capability. Our results indicate that organizational absorptive capacity (i.e., the ability to gather, absorb, and strategically leverage new external information) is critical to establishing appropriate technology infrastructure and to assimilating BI systems for organizational benefit. Further, findings show that while top management plays a significant role in effective deployment of BI systems, their impact is indirect and a function of operational managers’ absorptive capacity. In particular, this indirect effect suggests that leveraging BI systems is driven from the bottom up as opposed to the top down. This differentiates BI from other isolated strategic MCS innovations that have traditionally been viewed as top-management driven.

ABSTRACT We examine how informed trading activities affect the market reaction to accounting restatements. We find significantly less negative reactions to accounting restatements when managers are net purchasers of stock before the restatement, and significantly more negative market reactions when managers are net sellers. Similar patterns characterize corporate trading, where prior stock repurchases dampen negative reactions and prior equity issuances increase negative reactions to the restatement. We address the possibility of reverse causality in which informed trades are undertaken because of the expected market reaction by examining the difference between disclosed and non-disclosed trades, finding that the market reaction is concentrated in the disclosed trades. Our results are incremental to general return patterns associated with insider trading and corporate equity transactions, and hold after controlling for other determinants of the market reaction to restatements. Taken together, these findings suggest that investors use informed trading activities to help interpret and price accounting restatements. JEL Classifications: M41, M42. Data Availability: Data are publicly available from the sources identified in the study.

ABSTRACT: We use confidential, U.S. Census Bureau, plant-level data to investigate aggregation in external reporting. We compare firms’ plant-level data to their published segment reports by grouping a firm’s plants that share the same four-digit SIC code into a “pseudo-segment.” We then determine whether each pseudo-segment is disclosed as an external segment, or whether it is subsumed into a different business unit for external reporting purposes. We show that a pseudo-segment is more likely to be aggregated when the agency and proprietary costs of separately reporting the pseudo-segment are higher and when firm and pseudo-segment characteristics allow for more discretion in the application of segment reporting rules. For firms reporting multiple external segments, aggregation of pseudo-segments is driven by both agency and proprietary costs. For firms reporting a single external segment, we find no evidence of an agency cost motive for aggregation.

ABSTRACT Exploiting a natural experiment in which voluntary audits replace mandatory audits for U.K. private companies, we analyze whether imposing audits suppresses valuable information about the types of companies that would voluntarily choose to be audited. We control for the assurance benefits of auditing to isolate the role signaling plays by focusing on companies that are audited under both regimes. These companies experience no change in audit assurance, although they can now reveal for the first time their desire to be audited. We find that these companies attract upgrades to their credit ratings because they send a positive signal by submitting to an audit when this is no longer legally required. In contrast, companies that dispense with being audited suffer downgrades to their ratings because avoiding an audit sends a negative signal and removes its assurance value. Data Availability: All data are available from public sources.

ABSTRACT Gains and losses reported as other comprehensive income (OCI) and as special items (SI) are often viewed as similar in nature: transitory items with little ability to predict future cash flows and minimal implications for company value. However, current accounting standards require SI gains and losses to be recognized in net income, while OCI gains and losses are deferred until realized. This study empirically compares OCI and SI gains and losses using a model that jointly estimates value relevance, predictive value, and persistence. Results show that both SI and OCI gains and losses are value-relevant, but SI gains and losses exhibit zero persistence (i.e., are transitory), while OCI gains and losses exhibit negative persistence (i.e., partially reverse over time). Further, we find that SI gains and losses have strong predictive value for forecasting both future net income and future cash flows, while OCI gains and losses have weaker predictive value. Data Availability: All data are publicly available from sources indicated in the text.

ABSTRACT This study explores decisions related to formal empirical tests of business models and interpretations and uses of those tests. Business models describe managers' rationales as to how their organizations will achieve success. This study documents a test of one company's business model under seemingly favorable conditions for such a test—a successful single-product firm following a consistent strategy over a long period of time with stable management and publicly traded stock. Although the findings provide only weak support for the hypothesized business model, the confidence of the company's top managers in their business model remained high. Further analyses reveal that the managers' response to the test results is consistent with that expected of Bayesian-rational agents. Our analyses provide the basis for development of a framework for understanding the expected value of testing business models in various circumstances. This framework might explain apparent contradictions between previous studies containing normative statements regarding the value of testing business models. Data Availability: The data used in this study are derived from a proprietary dataset and public sources.

ABSTRACT: This study jointly evaluates firm-level changes in investor composition and shareholder distributions following a 2003 reduction in the dividend and capital gains tax rates for individuals. We find that directors and officers, but not other individual investors, rebalanced their portfolios to maximize after-tax returns in light of the new tax rules. We also find that firms adjusted their distribution policy (specifically, dividends versus share repurchases) in a manner consistent with the altered tax incentives for individual investors. To our knowledge, this is the first study to employ simultaneous equations to estimate both shareholder and managerial responses to the 2003 rate reductions. We find that the generalized method of moments (GMM) estimates are substantially stronger than OLS estimates, consistent with our expectation that investor and manager responses are simultaneously determined. Failure to estimate systems of equations may account for some of the weak and conflicting results from prior studies of the 2003 rate reductions.