Knowledge that Transforms

We examine the adoption of expanded audit reports that include key audit matters (KAMs) in Hong Kong (2016) and mainland China (2017). These jurisdictions are highly integrated and together constitute one of the largest economies to adopt the IAASB's reporting standards in a staggered fashion, while also differing in investor protection and legal enforcement. Using matched samples, pre‐post tests, and staggered difference‐in‐differences analyses with company fixed effects, we do not find compelling evidence that expanded audit reports affect market reactions or audit quality. These findings suggest a substantial gap between regulatory intent and implementation—on average, in these markets, KAMs do not appear to meet investors' demand for incremental information or to improve audit quality substantially. At the same time, our cross‐sectional evidence on KAM characteristics is more nuanced. A higher number of KAMs and the presence of novel or transaction‐specific KAMs are associated with stronger pricing of fundamentals, consistent with investors perceiving the related financial statements as better vetted. Yet a higher number of KAMs and novel KAMs are also associated with lower profitability persistence, consistent with these disclosures reflecting company risk and volatility. In contrast, industry‐common KAMs appear less relevant for valuation, consistent with investors discounting routine disclosures, even though they are associated with more persistent performance likely reflecting more stable industry conditions. Overall, our evidence suggests that mandating expanded audit reports alone may be of limited value, whereas better tailored KAM disclosures may still serve as signals of firm fundamentals and future performance.

Operating cash flows are a critical input to valuation activities. Research and practice indicate that the most common method of presenting operating cash flows, the indirect method, is viewed as overly complex. We experimentally examine whether two theoretically motivated factors represent shortcomings of the indirect method: (1) inadequate linking of related components of net income and changes in working capital accounts, and (2) inconsistent income statement labeling between components of net income and their corresponding working capital changes. Drawing on causal reasoning theory, we predict and find that these factors hinder the decision usefulness of the operating section of the statement of cash flows. The results of our study are informative to the academic literature and standard setters, as we examine underlying reasons why the indirect method may be viewed unfavorably.

We examine the welfare-based opportunity cost of foreign exchange (FX) intervention when both covered interest rate parity (CIP) and uncovered interest rate parity (UIP) deviations are present. We consider a small open economy that receives international capital flows through constrained international financial intermediaries. Deviations from CIP come from limited arbitrage or through a convenience yield, while UIP deviations are also affected by global risk. We show that the sign of CIP and UIP deviations may differ for safe haven countries. We find that FX reserves may provide a net benefit, rather than a cost, when international intermediaries value the safe-haven properties of a currency more than domestic households. We show that this has been the case for the Swiss franc and the Japanese Yen. We examine the optimal policy of a constrained central bank planner in this context.

We examine the association between permissible non-audit services provided by auditors and the timeliness of earnings announcements. Although earnings announcements are unaudited, audit progress influences management’s ability to release earnings while maintaining confidence in reported results. We posit that non-audit services generate earnings announcement timeliness benefits by improving the efficiency and timing of audits through knowledge transfer. We find that tax non-audit services are associated with timelier earnings announcements while nontax non-audit services are not. These benefits are concentrated in the pre-regulatory period before changes in the mid-2000s. Following these changes, the association persists for firms with weaker information environments, poorer performance, and greater audit-related challenges. Overall, our findings show that auditor-provided tax services are associated with enhanced timeliness of unaudited disclosures and that these benefits vary across firms and over time, highlighting previously undocumented spillovers from non-audit services with implications for academic research and regulation.

We examine whether prominent behavioural theories – prospect theory, salience theory, and regret theory – help explain investors’ stock choices in the real world. Whereas prior studies rely on indirect tests based on the cross-section of stock returns, we study investor behaviour directly using approximately five years of comprehensive limit order book data from the Taiwan Stock Exchange. We find that aggregate investor demand, proxied by buy-sell order imbalance, is most consistent with regret theory. At the investor-type level, however, the evidence points to substantial heterogeneity: domestic individual investors’ trading is most consistent with regret theory, prospect theory has greater explanatory power for non-individual investors, and salience theory has predictive power primarily for foreign investors. Overall, our findings highlight the importance of investor heterogeneity and of accounting for investor composition when evaluating behavioural theories in financial markets.

We explore the dynamics of venture capital (VC)‐backed startup boards using novel data on director entry, exit, and characteristics. At formation, a typical board is entrepreneur‐controlled. Independent directors join the median board after the second financing and hold a tie‐breaking vote. Their presence is particularly likely when potential VC‐entrepreneur conflicts are larger. At later stages, control switches to VCs and independent director characteristics change. These patterns align with key financial contracting theories, but also highlight unique roles of independent directors over the life cycle: mediation followed by advising. Independent directors thus represent another potential source of value‐add to startup performance.