Audit firms are organized as collections of geographically decentralized offices. Decentralization allows for increased proximity between offices and clients, improving the efficiency of auditors' interactions with client personnel. Yet decentralization also decreases the proximity between offices within each firm, potentially impeding auditors’ interactions with each other. We show that decreased proximity between offices reduces inter-office audit quality “spillovers” and that this effect is driven primarily by reduced monitoring and knowledge sharing. Our findings expand the “within office” view of audit production by demonstrating the importance of interactions between offices and the role of geographic proximity in facilitating them.

ABSTRACT We investigate whether audit offices respond to audit fee pressure by increasing their focus on nonaudit services (NAS), as well as the combined effect of audit fee pressure and an increased focus on NAS on audit quality. We find a positive association between audit fee pressure and changes in NAS at the audit office level. We also find increased rates of client misstatement among audit offices that increase focus on NAS in the presence of audit fee pressure compared to audit offices that do not, suggesting a joint effect on audit quality. We find that the reduction in audit quality occurs in large audit offices. Overall, we provide evidence that audit offices’ provision of additional NAS in the presence of fee pressure is an important dimension to consider when examining the effects of declining audit fees on audit quality.

ABSTRACT Two distinct lines of research have been dedicated to empirically testing how financial reporting quality (measured as the earnings response coefficient or ERC) is associated with management's choice of reporting bias and with audit quality. However, researchers have yet to consider how ERCs are affected by either the auditor's reaction to changes in the manager's reporting bias or the manager's reaction to changes in audit quality. Our study provides theoretical guidance on these interrelations and how changes in the manager's or the auditor's incentives affect both reporting bias and audit quality. Specifically, when the manager's cost (benefit) of reporting bias increases (decreases), we find that expected bias decreases, inducing the auditor to react by reducing audit quality. Because we also find that the association between expected audit quality and ERCs is always positive, changes in managerial incentives for biased reporting lead to a positive association between ERCs and expected reporting bias. When the cost of auditing decreases or the cost of auditor liability increases, we find that expected audit quality increases, inducing the manager to react by decreasing reporting bias. In this case, changes in the costs of audit quality lead to a negative association between ERCs and expected reporting bias. Finally, we demonstrate the impact of our theoretical findings by focusing on the empirical observations documented in the extant literature on managerial ownership and accounting expertise on the audit committee. In light of our framework, we provide new interpretations of these empirical observations and new predictions for future research.

Capital structure choice based on costs associated with asymmetric information is examined in order to present a new perspective on the standard pecking order and trade-off theories. In the model, both the face value of debt and the restrictiveness of the associated debt covenants are chosen as part of the financial structure, allowing a more complete characterization of this decision. Debt structure choice balances ex ante adverse selection against ex post moral hazard, providing a natural integration of the pecking order and trade-off theories and the development of interesting empirical implications.

We find that the controlling family holds both the chief executive officer and chair positions in 79% of Norwegian family firms. The family holds more governance positions when it owns large stakes in small, profitable, low-risk firms. This result suggests that the family trades off expected costs and benefits by conditioning participation intensity on observable firm characteristics. We find that the positive effect of performance on participation is twice as strong as the positive effect of participation on performance. The endogeneity of participation, therefore, should be carefully accounted for when analyzing the effect of family governance on the family firm’s behavior.

Using a sample of 1593 US firms that go public between 1990 and 2007, we find that VC-backed IPOs experience less financial distress risk post-offering than do comparable non-VC-backed IPOs. After controlling for endogeneity, we find this is related to the screening done by VC-investors, who select firms with lower risk of financial distress and by VCs reducing risks when they finance portfolio firms. We find companies backed by more reputable VCs exhibit higher levels of financial distress risk even when they show superior operating performance, due to their highly levered capital structure and investment in relatively illiquid assets.

ABSTRACT The elimination of goodwill amortization in 2001 brought about significant change in how companies are required to account for goodwill. This change in accounting also brought with it new challenges for auditors, namely evaluating the reasonableness of management's assumptions related to goodwill valuation. In addition to introducing technical challenges, this task is particularly difficult given the misalignment in incentives it creates between managers who likely prefer to avoid recording an impairment and auditors who seek to minimize the bias in management's impairment testing. This study focuses on the consequences of the misaligned incentives that auditors face under the current goodwill assessment process. We find that the decision to record a goodwill impairment is associated with an increase in the probability of auditor dismissal. Consistent with the presence of significant friction with clients, our results also indicate that the likelihood of auditor dismissals is negatively related to the favorability of the impairment decision. Furthermore, we find that companies impairing goodwill prior to dismissing auditors subsequently employ auditors that are, on average, more favorable to clients in their impairment decisions.

ABSTRACT In this paper, we investigate whether the current references to probability in standard setters' conceptual definitions of assets and liabilities cause individuals to believe that the probability of a future transfer of economic benefits must be above some meaningful threshold for an asset or a liability to exist—a belief that is contrary to standard setters' intent. Results of multiple experiments indicate that the majority of individuals do use a high probability threshold to determine asset existence, whereas for liabilities the majority use a very low threshold. Thus, even under ceteris paribus conditions, liabilities are more frequently judged to exist than assets—a phenomenon analogous to accounting conservatism, as has been discussed in terms of the performance statement. These findings are robust to variation in formal training and in type of liability, and cannot be explained by alternative approaches to judging existence. Consistent with standard setters' intentions, results also suggest that their proposed changes to the definitions of assets and liabilities—changes that attempt to clarify the intended role of probability—do cause a greater proportion of participants to indicate that the relevant financial statement element (asset or liability) exists, relative to participants with no definition. Our study provides important insights for standard setters as they continue work on their missions to update their Conceptual Frameworks and for researchers regarding the role of conservatism on the balance sheet.