Knowledge that Transforms

This study investigates whether PCAOB inspections of foreign auditors affect global financial reporting comparability. Foreign auditors may adjust audit methodologies to address PCAOB inspection findings, which could affect financial reporting of local clients. Exploiting both within‐ and cross‐country variation in PCAOB inspections, we predict and find that non‐US‐listed foreign companies' financial reporting becomes more comparable to their US and non‐US industry peers after their auditors undergo an initial inspection. However, there is a decrease in comparability compared to local peers whose auditors have not been inspected. Subsample tests suggest that the improvement in comparability is driven by (i) auditors that satisfactorily address deficiencies and (ii) auditors that do not publicly push back against deficiencies. The effects are dampened after local audit regulators begin inspection programs. Overall, our evidence suggests that the PCAOB international inspection program affects audit methodologies of inspected auditors in a consistent way, improving comparability across jurisdictions. The improved comparability implies that the PCAOB international inspection program may unintentionally help meet accounting regulators' goals of cross‐country financial reporting convergence, which potentially promotes efficient cross‐country capital allocation.

This study examines the relation between earnings management and block ownership of same‐industry peer firms by a common set of institutional investors (common institutional ownership). This relation is important given the tremendous growth of common institutional ownership and the significant influence of blockholders on financial reporting. We hypothesize that common institutional ownership mitigates earnings management by enhancing institutions' monitoring efficiency and by encouraging institutions to internalize the negative externality of a firm's earnings management on peer firms' investments. Consistent with our hypothesis, we find that higher common institutional ownership is related to less earnings management. Analyses of a quasi‐natural experiment based on financial institution mergers show that this negative relation is unlikely to be driven by the endogeneity of common institutional ownership. Cross‐sectional tests provide evidence that the negative relation is stronger among firms for which common institutional ownership is likely to generate a greater reduction in institutions' information acquisition and processing costs, and among firms whose severe financial misstatements are more likely to distort co‐owned peer firms' investments, supporting both mechanisms underlying our hypothesis. Our findings inform the ongoing debate on the costs and benefits of common institutional ownership by highlighting an important benefit: the enhanced monitoring of financial reporting.

We use a novel data set to examine the across‐time consistency and across‐firm comparability of firms' non‐GAAP earnings disclosures. Given widespread concern about non‐GAAP reporting among regulators, standard setters, the investor community, and academics, our investigation provides timely evidence on how managers' deviations from their own non‐GAAP disclosure history, or the reporting of industry peers, affects how well earnings inform on firm performance. We begin by identifying firms that change their non‐GAAP earnings definition from one year to the next. These deviations are uncommon, but when managers change the items they exclude in calculating non‐GAAP earnings, the changes generally enhance the information in earnings about firms' core performance. We also examine whether non‐GAAP earnings are more comparable than GAAP earnings and find that firms' non‐GAAP adjustments result in greater earnings comparability. Finally, we examine instances in which firms deviate from common sector‐wide definitions of non‐GAAP earnings. We find that these deviations also result in earnings metrics that better represent firms' core operations. Overall, our results suggest that when managers vary their non‐GAAP calculations, either across time or across firms, the resulting non‐GAAP metrics generally enhance the information in earnings about firms' ongoing performance. Thus, our analysis helps mitigate concerns about why managers might vary their non‐GAAP reporting calculations.

This paper reports the results of multiple studies that together provide converging evidence in support of the theory that gender stereotypes bias employee selection during group recruiting events. Specifically, we predict and find that female (male) job candidates who exhibit stereotypically male behaviors receive lower (higher) evaluations during group recruiting events, particularly among male recruiters. Prior research suggests gender stereotypes do not bias employee selection during one‐on‐one interviews. However, our results suggest that evaluating job candidates in the more social context of group events can have important unintended consequences on employee selection, a key component of the accounting control environment. Given the importance of group recruiting events to inform hiring decisions across organizations such as investment banks and public accounting firms, our results contribute to a better understanding of survey and field evidence suggesting that entry‐level male and female employees have different personalities at these organizations, which appear to influence their career trajectories.

We study manufacturing firms' asymmetric inventory investment in response to sales changes. Focusing on the costs of resource adjustment and stockout that likely differ in sales‐increasing and sales‐decreasing periods, we predict and find that inventory investment declines less during periods with sales decreases than it rises during periods with sales increases. We validate this claim by showing that managers' expectations of future demand and desire to avoid inventory stockouts are important determinants of this asymmetry. In addition, we find that asymmetric inventory investment provides useful information for predicting future sales growth, and that both managers' and analysts' sales forecasts are positively associated with the asymmetry. Lastly, we document that forecasts of future sales growth that incorporate asymmetric inventory investment are associated with lower absolute forecast errors than benchmark forecasts. Overall, we highlight the importance of inventory information in understanding managers' resource adjustment and utilization decisions that have implications for forecasting future demand. Our findings on asymmetric inventory management provide new insights to fundamental analysis based on inventory signals.

Institutional cross-owners, specifically institutional investors with significant stakes in multiple firms in the same industry, are becoming increasingly common in the United States. In this paper, we investigate and find that the presence of institutional cross-owners facilitates a firm's financing of its investment opportunities, consistent with institutional cross-owners reducing the adverse selection concerns of those who provide capital for the investment opportunities. We then examine the conditions under which the presence of institutional cross-owners is likely to more significantly reduce adverse selection and thereby have even more of a positive effect on the financing of investment opportunities. We document that relative to transient institutional cross-owners, dedicated institutional cross-owners facilitate more financing of investment opportunities. We also find that institutional cross-owners facilitate the financing of investment opportunities even more for firms with greater dependence on external financing, those with an opaque financial reporting environment, and those with more product market competition. Our paper offers novel insight into how a firm can benefit from the presence of institutional cross-owners.

Regulators and researchers tend to focus primarily on the risk‐shifting benefits of audit liability insurance. We obtain field data from the US audit insurance industry (16 interviews and 83 survey responses) to examine whether insurers also possess characteristics favorable to transferring their private risk management knowledge to the audit firms they insure. Possessing such characteristics would enable insurers to use their relative knowledge advantage to provide a benefit to audit firms beyond risk shifting. Thus, examining this issue helps broaden our understanding of insurers' role in auditing. We examine our data through the lens of the knowledge transfer theory and find evidence that audit liability insurers have the motivation and capacity to accumulate and transfer risk management knowledge to the audit firms they insure. We find that audit firms, particularly the small resource‐constrained firms (i.e., non–Big 4 and non‐second‐tier), rely on and benefit from their insurers' risk management knowledge. We also find that insurers transfer such knowledge through multiple mechanisms, including free consultative services, policy premium incentives, and continuing professional education classes. Our results highlight the important role of audit insurers as transferors of risk management knowledge to audit firms. Broadly, our results extend knowledge transfer theory and suggest areas for future research in US and international contexts.

We test the association between CFO effort and the quality of public firms' financial information environments. We evaluate this relation using a measure of CFO leisure consumption—specifically, the amount of golf played—as an inverse proxy for effort. We find a negative relation between CFOs' compensation incentives and golf play, suggesting they exert more effort when they have greater incentives to increase firm value. High CFO leisure consumption is associated with lower earnings quality, less accurate earnings guidance, and reduced CFO conference call participation. Additionally, CFO leisure appears to affect external monitors, as it is associated with greater analyst forecast dispersion and increased audit fees. We do not find similar relations when evaluating the amount of golf played by CEOs, suggesting the unique importance of CFO effort in the financial reporting process.

We reexamine the positive association between stock option vega and earnings management previously documented by Armstrong, Larcker, Ormazabal, and Taylor (2013; henceforth, ALOT). In contrast to ALOT, prior empirical research and practitioner literature emphasizes earnings management's goals of increasing stock price and reducing volatility. Specifically, we assess whether the association is robust to (i) employing discretionary accruals that are less prone to misspecification, (ii) focusing on a more recent time period, and (iii) including additional controls for period‐specific factors. Our main findings are as follows. First, we fail to find a positive association between vega and earnings management after controlling for performance‐related misspecification in discretionary accruals. Second, we find no association between vega and earnings management in a more recent time period, suggesting the results of ALOT may be sensitive to period‐specific factors. Last, the positive association vanishes when we control for year fixed effects, growth opportunities, or monitoring, suggesting the original results of ALOT's research may be sensitive to correlated, omitted variables. Overall, our results question the extent to which vega incentivizes earnings management. Our results may be of interest to boards of directors in designing executive compensation contracts, to regulators in crafting policies that maintain high levels of financial reporting quality, and to researchers seeking to identify settings where earnings management incentives are most salient.

Recent amendments to Auditing Standard (AS) 3101 require disclosure of the initial year of the auditor‐client relationship in the audit report. As the standard was being discussed, auditors, clients, and some PCAOB members expressed reservations about the necessity of tenure disclosures and were particularly concerned about disclosing tenure in the audit report. Our purpose is to investigate whether the tenure disclosures mandated by AS 3101 are associated with changes in stakeholder behavior. We predict and find that after the implementation date, ratification votes against the auditor and the probability of subsequent auditor dismissal increase for long‐tenured versus short‐tenured auditors. Results from a path analysis further suggest that the relative increase in dismissal for long‐tenured auditors appears to be influenced directly through tenure disclosures and indirectly through ratification voting. We also predict and find that negotiating power decreases for long‐tenured auditors as evidenced by lower audit fees. Our results are comparable for companies that voluntarily disclosed and companies that did not disclose auditor tenure in their proxy statements prior to the AS 3101 amendment. Overall, our study suggests that mandatory disclosure of auditor tenure in the audit report significantly affects stakeholder behavior. The PCAOB should consider our findings carefully as they evaluate whether AS 3101 is achieving its intended purpose.