Knowledge that Transforms

ABSTRACT This study examines the impact of cross‐firm financial statement comparability on regulatory oversight of accounting quality. Required to review each firm's periodic filings at least once every three years, the SEC learns about the degree to which a firm's accounting system is comparable to those of its peers. We posit that the SEC's ex ante knowledge about financial statement comparability, gleaned from prior‐year filing reviews, facilitates its evaluation of firms' accounting quality during the current‐year filing review. Consistent with the notion that comparable accounting systems enhance regulators' ability to identify discretionary accounting deviations, we find that the likelihood of the SEC issuing a comment letter for higher abnormal accruals increases with financial statement comparability. Further analysis reveals that the regulatory benefits from higher financial statement comparability are more salient when the SEC faces higher monitoring constraints in filing reviews. Moreover, our finding shows that comparable accounting numbers across firms help the SEC detect severe accounting violations that necessitate restatements. Overall, we provide novel evidence suggesting that higher financial statement comparability improves the efficacy of the SEC's oversight of accounting quality by reducing the information costs associated with cross‐firm comparisons.

Abstract This study examines how principals adjust their control over agents based on their prior controlling experience. According to standard economic theory, principals should be equally willing to decrease their control as they are to increase it. However, I use psychological theory to predict that prior experience with exercising tight control reinforces a principal's belief that agents are self‐interested and that they should be controlled. In contrast, I predict that the reinforcement of the belief that agents are socially interested and should not be controlled is weaker for principals who have prior experience with exercising loose control. I test my prediction using an experiment that exposes principals to either an increase or a decrease in the economic costs of control. The results support the predictions by exhibiting an asymmetric adjustment pattern. The data also show theory‐consistent conditions under which the asymmetry in principals' control adjustments diminishes. Overall, my study suggests that prolonged experience with exercising high levels of control over agents may cause principals to hold on to their control disproportionally.

Abstract Prior literature has studied firm uniqueness and its implications for capital market participants by investigating earnings uniqueness. We recognize that cost and revenue uniqueness provide separate insights about firm uniqueness because different forces drive firm‐specific revenues and costs. Cost uniqueness is of special interest because costs are opaque to investors and more complex than revenues. Therefore, we examine how cost uniqueness affects information uncertainty from the perspective of external participants. We find that idiosyncratic stock return volatility increases with cost uniqueness independently and incrementally from revenue uniqueness. We validate these results with several cross‐sectional tests that provide insights into the forces that drive the association between information uncertainty and cost uniqueness. In addition, we find that higher cost uniqueness is associated with finer cost disclosure. Overall, we show that cost uniqueness is an important dimension of cost behavior that is linked to strategic decision‐making and affects uncertainty surrounding firm valuation.

ABSTRACT This study examines whether auditors' evaluation and reporting of firms' internal control over financial reporting (ICFR) affects firm operational efficiency. Prior research indicates that the strength of internal controls is positively associated with economic benefits. However, notwithstanding the underlying strength of controls, whether the mere presence of an ICFR audit provides similar economic benefits is unclear. We predict and find that small firms with ICFR audits have significantly higher overall operational efficiency than small firms with only management ICFR reports, even after controlling for underlying internal control strength. We find this effect manifests through improvements in inventory turnover and innovation, and through increased relative product market share. Separately, we find ICFR audits are associated with lower efficiency in SG&A expenses. Cross‐sectional analyses indicate that the mechanism by which ICFR audits affect overall operational efficiency is through auditor detection of internal control problems and through knowledge spillover from auditing other highly efficient firms in the audit office's metropolitan statistical area. These results provide additional evidence on the ongoing cost and benefit debate of ICFR audits for small firms.

Abstract Human capital is a major impetus for technological innovation. We examine the relation between the technological dimension of product market competition and the disclosure of skill requirements in job postings. On the one hand, technological competition may raise the urgency of recruiting tech talent and make firms provide more specific skill requirements. On the other hand, technological competition can increase the proprietary costs of skill requirement disclosure. Using technological peer pressure as a measure of technological competition, we find that firms facing intense technological competition provide more specific skill requirements for tech positions, suggesting that the disclosure benefits outweigh the proprietary costs when firms face pressure to innovate. The effect of technological peer pressure is more pronounced among firms that make only incremental innovations and less pronounced among firms that rely on trade secrets or have greater industry peer presence in close geographical proximity. Our study documents a distinct relationship between technological competition and voluntary disclosure targeted to labor market participants.

ABSTRACT This study investigates the real effects of management communication, specifically of forecasts or earnings guidance , on investment. Managers can signal the strength of their projects through accuracy in their earnings guidance. This leads less accurate managers to distort their investments; the equilibrium investment strategy involves over‐investment when earnings exceed the forecast and under‐investment when earnings fall short. Moreover, we find that managers are pessimistic in their forecasts, which helps to explain the corresponding well‐documented empirical regularity. This downward bias increases the likelihood of investment manipulation but decreases the real loss from distortion. Interestingly, the over‐investment induced by earnings guidance helps to mitigate the classic under‐investment problem for a myopic manager with unobservable investment. Earnings guidance can therefore be value‐increasing when managerial myopia is severe.

ABSTRACT We present evidence on the effects of target firms' accounting conservatism in a merger and acquisition transaction. Conservatism is distinct from other accounting or accrual quality constructs examined in prior work. Its unique features can lead to potential benefits for both the targets and the acquirers. The use of conservatism by targets reduces acquirers' risks of acquiring underperforming assets or overpaying for well‐performing assets. In addition, targets' conservatism results in greater production of verifiable information that can help the acquirers better estimate and realize synergies of the combined firm. Consistent with these arguments, we find that firms with greater accounting conservatism are more likely to receive a bid. We also find that targets' conservatism increases the deal premium and the announcement returns of both the targets and the acquirers, respectively. Overall, these results indicate that conservatism provides benefits to both sellers and buyers of equity in an acquisition transaction.

ABSTRACT This study examines the role of information transparency in facilitating peer firms' investment in follow‐on innovation. We capture information transparency with both textual and numerical information disclosed in 10‐Ks. Using patent citations to proxy for investment in follow‐on innovation, we predict and find a positive association between transparency at the knowledge source and follow‐on innovation. We further show that the effect of information transparency varies with the degree of uncertainty around technological innovation. Thus, the evidence suggests that information transparency facilitates investment in follow‐on innovation by resolving uncertainty associated with investment in technological innovation. An analysis using the cited firms' going‐private decision as a negative shock to information transparency confirms the significant effect of a cited firm's disclosure on its decision to invest in follow‐on innovation. Our study contributes to the literature on the positive externalities of peer‐firm disclosures and highlights the important role of information transparency in shaping innovation investment decisions.

ABSTRACT Stock exchanges are important intermediaries in how firm information enters price. Trading halts are a key tool, often exercised at the exchanges' discretion, to prevent extraordinary price volatility when new information arrives. We investigate how exchanges use discretion and whether the discretion alters the effectiveness of the halts. We provide evidence consistent with halts reflecting the preferences of listed firms rather than the stated exchange objectives (i.e., minimizing excess volatility and off‐equilibrium trades). Furthermore, when exchanges exercise more discretion (unexplained by firm and information characteristics), the halts are less effective. Specifically, halts with more discretion are less likely to resume trading with efficient prices and are more likely to have been called unnecessarily (i.e., little to no price movement during the halt). These findings are consistent with exchanges using halts to cater to listed firms rather than to meet exchange objectives such as minimizing excess volatility or avoiding trades at off‐equilibrium prices.

Abstract Conventional wisdom suggests that audit engagement partner name disclosure benefits investors by informing them about the partners' performance. However, such public disclosure of the identity of the audit partners may also intensify competition for audit talent in the labor market. To examine the economic consequences of audit partner identification, we build a two‐period model in which an audit firm matches partners to clients. The audit partner identification broadens a partner's outside options in the labor market, making talent retention more costly. If the talent‐retention cost is substantial, audit partner identification may cause an audit firm to adjust its partners' compensation packages and mismatch the partners and clients, which may lead to lower audit quality. Overall, we identify unintended consequences of audit partner identification by examining its impact on the audit labor market, and we provide economic reasons for the mixed empirical findings.