Treasury Regulations typically require a firm to use its manufacturing cost as one input in calculating the transfer price to be used for tax purposes. Because the characteristics of the firm's capital assets determine the realized manufacturing cost, the firm has an incentive to distort its investment choices in order to receive a more favorable tax transfer price. This represents an ex ante form of shifting income across divisions. Practical difficulties in enforcing the regulations provide the firm with another way to shift income. In particular, regulators often can identify only a range of acceptable transfer prices. As a result, the firm will not use the true “arm's length” transfer price, but will instead choose a transfer price that is more favorable for tax purposes. I find that the opportunity to shift income ex post in this manner may reduce the value of investment-based ex ante income shifting. That is, if the firm has more discretion over the ex post transfer price, then it may invest more efficiently ex ante. Although it is commonly perceived that ex post income shifting is purely deleterious, the analysis shows that it may have benefits.

We study the role of individual CEOs in explaining corporate social responsibility (CSR) scores. We find that CEO fixed effects explain 59 percent of the variation in CSR scores, whereas firm fixed effects explain 23 percent of the variation in CSR scores. Specifically, firms led by materialistic CEOs have lower CSR scores, fewer strengths, and more weaknesses. Finally, we document that CSR scores in firms with non-materialistic CEOs are positively associated with accounting and stock price performance. In contrast, CSR scores in firms with materialistic CEOs are unrelated to profitability.

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.

We provide a theoretical investigation of the effects of the Sarbanes-Oxley Act of 2002 on auditing intensity and internal control strength. We propose a model of strategic auditing in which the auditor can use resources for both internal control tests and substantive tests, while the manager can choose the strength of internal controls and the amount of fraud. We find that control tests are a valuable tool for the auditor when control strength is informative about the likelihood of fraud. We find that Sarbanes-Oxley has the desired effect of inducing stronger internal control systems and less fraud, but does not necessarily induce higher levels of control testing. Our model suggests that audit risk increases as a result of the Sarbanes-Oxley Act.

In this study we examine the long-run effects of unexpected firm performance on CEO compensation. We find that unexpectedly good accounting performance is initially associated with increases in CEO pay. However, this initial effect soon reverses, and is followed by lower CEO pay in later years. Overall, the CEO's long-run cumulative financial gain from unexpectedly good accounting performance is not significantly different from zero. In contrast, unexpectedly good stock price performance is associated with increases in CEO pay for several years. Thus, the CEO's long-run cumulative financial gain from unexpectedly good stock price performance is positive and significant.

Protection of outside investors depends on the detection and punishment of resource diversion by corporate insiders, including managers and controlling shareholders. We focus on the role played in investor protection by self-interested auditors operating in a competitive audit market. In our setting, auditors represent the mechanism whereby detection of diversion occurs. We show that markets with relatively greater auditor penalties for audit failures and greater insider penalties for detected resource diversion have larger total investment levels, a higher proportion of the firm held by outsiders, higher audit resource investment, higher audit fees, and higher expected investment returns.

We examine the strategic effects of auditor tenure on the auditor's testing strategy and the manager's inclination to commit fraud. Most empirical studies conclude that longer tenure improves audit quality. Proponents of restricting tenure argue that longer tenure impairs auditor independence and a “fresh look” from a new auditor results in higher audit quality. Validating this argument requires testing whether the observed difference in audit quality between a continuing auditor and a change in auditors is less than the theoretically expected difference in audit quality without impairment. Our findings provide the guidance necessary for developing such tests. Our results show that audit risk (the probability that fraud exists and goes undetected) is lower in both periods for the continuing auditor than with a change in auditors. More importantly, we show that across both periods, expected undetected fraud is lower for the continuing auditor than with a change in auditors.