Audit committees evaluate financial reporting quality as part of their corporate oversight responsibilities. Given this responsibility, the national stock exchanges now require all audit committee members to be financially literate and at least one member to have financial expertise. In light of recent debates over this requirement, we provide evidence on how experts and literates differ in their evaluations of financial reporting quality. Results suggest that experts' evaluations of financial reporting quality are more strongly associated with their assessments of characteristics underlying reporting quality (e.g., relevance) espoused in Statement of Financial Accounting Concepts No. 2's framework than literates' evaluations. Additionally, literates are more likely than experts to identify concerns about reporting treatments for business activities that are prominent in the business press or are distinguished by their nonrecurring nature, while experts are more likely to raise concerns about reporting treatments for less prominent, recurring activities. This same pattern occurs in the ratings of the quality of the reporting treatments for specific financial statement items with respect to elements underlying reporting quality (e.g., neutrality); literates (experts) assess the quality elements for the reporting treatments of prominent and nonrecurring items (less prominent and recurring items) comparatively lower than experts (literates). These results suggest that including financial experts on audit committees is likely to change the structure and focus of audit committee discussions about financial reporting quality, and may affect the committee's overall assessment of the quality of a company's financial reports.

This paper investigates whether insider trading is informative about earnings quality and the valuation implications of accruals. We show that (1) the one-year-ahead persistence of income-increasing accruals is significantly lower when accompanied by abnormal insider selling and greater when accompanied by abnormal insider buying; (2) the accrual mispricing phenomenon observed in previous work (e.g., Sloan 1996) is due to the mispricing of income-increasing accruals; (3) one-year-ahead hedge returns to trading strategies based on the direction of accruals and insider trading significantly exceed those based on accruals alone; and (4) the lower persistence of income-increasing accruals accompanied by abnormal insider selling appears to be at least partly attributable to opportunistic earnings management. Our evidence suggests that market participants and researchers can use managers' contemporaneous trading in ex ante assessing the likelihood that the firms' accruals are of high or low quality, and in assessing the likelihood of earnings management. Our evidence suggesting that insiders trade on their knowledge of factors associated with accrual persistence is also relevant to policymakers charged with regulating insider trading.

This paper suggests a new measure of one aspect of the quality of working capital accruals and earnings. One role of accruals is to shift or adjust the recognition of cash flows over time so that the adjusted numbers (earnings) better measure firm performance. However, accruals require assumptions and estimates of future cash flows. We argue that the quality of accruals and earnings is decreasing in the magnitude of estimation error in accruals. We derive an empirical measure of accrual quality as the residuals from firm-specific regressions of changes in working capital on past, present, and future operating cash flows. We document that observable firm characteristics can be used as instruments for accrual quality (e.g., volatility of accruals and volatility of earnings). Finally, we show that our measure of accrual quality is positively related to earnings persistence.

Citing fear of legal liability as a partial explanation, prior research documents (1) managers' reluctance to voluntarily disclose management earnings forecasts, and (2) greater forecast disclosure frequencies in periods of bad news. We provide evidence on how management earnings forecast disclosure differs between the United States (U.S.) and Canada, two otherwise similar business environments with different legal regimes. Canadian securities laws and judicial interpretations create a far less litigious environment than exists in the U.S. We find a greater frequency of management earnings forecast disclosure in Canada relative to the U.S. Further, although U.S. managers are relatively more likely to issue forecasts during interim periods in which earnings decrease, Canadian managers do not exhibit that tendency. Instead, Canadian managers issue more forecasts when earnings are increasing, and their forecasts are of annual rather than interim earnings. Also consistent with a less litigious environment, Canadian managers issue more precise and longer-term forecasts. These findings hold after controlling for other determinants of management earnings forecast disclosure that might differ between the two countries—firm size, earnings volatility, information asymmetry, growth, capitalization rates, and membership in high-technology and regulated industries.

This study provides evidence on how auditors' use of decision aids affects jurors' evaluation of auditor legal liability, based on an experiment in which actual jurors responded to a hypothetical audit lawsuit. The results suggest that decision aids can have positive, negative, or neutral effects on auditors' legal liability, depending on how auditors use the decision aid and the reliability of the decision aid. For high-reliability aids, jurors attributed more responsibility for an audit failure to the auditor when the auditor overrode the recommendation of a decision aid than when the auditor did not use the decision aid. However, jurors attributed lower responsibility to an auditor who relied on the recommendation of a highly reliable decision aid, even though the aid turned out to be incorrect. In contrast to the high-reliability conditions, auditors' use of the decision aid had virtually no impact on jurors' liability judgments when the reliability of the decision aid was low.