Knowledge that Transforms

ABSTRACT Performance evaluations are typically based on a formula that specifies in advance all performance measures, their relative incentive weights, and targets to be met. However, beginning‐of‐year performance targets can become outdated due to unforeseen events that call for ex post adjustments to formula‐based incentive plans to restore incentives. We discuss three types of ex post incentive plan adjustments—end‐of‐year subjective performance evaluation, changes in next‐year relative incentive weights, and changes in next‐year performance targets—and empirically examine the extent to which they are used to discourage failure to meet a target by a wide margin. Specifically, we use 2004–2015 data on formula‐based bonus plans, subjective performance evaluations, and performance in Korean state‐owned enterprises. Consistent with our predictions, we find that very low performance relative to target is associated with (i) low subjective evaluations and (ii) an increase in next‐year incentive weights, conditions that render areas with poor performance more important in future evaluations. These findings are more pronounced on performance dimensions of high importance and less pronounced when very low performance is due to an adverse uncontrollable shock. Finally, we find evidence that ex post incentive plan adjustments are associated with future performance improvements. Combined, our findings suggest that ex post incentive plan adjustments can be used to strengthen incentives when performance targets get outdated.

ABSTRACT Governments regularly offer non‐income tax relief to attract business investment. However, it is unclear whether or how markets impound information about the relief into security prices. We use novel data from retrospective public records to examine the information content of non‐income tax relief. We predict and find that the receipt and magnitude of this relief are both strongly associated with recipients' future accounting performance and future abnormal returns. We further find that abnormal returns associated with the relief cluster around future earnings information events. In combination, this evidence suggests that non‐income tax relief is value‐relevant but is incorporated into prices over time.

ABSTRACT How employees mentally break up or segment time likely influences key performance behaviors. Thus, it is important to understand how features of the work environment influence the mental time segments employees create. Consistent with my predictions, I provide evidence across four experiments that feedback systems can alter the way employees segment their work time—a process that I refer to as feedback‐driven time segmenting. Consistent with the theory of feedback‐driven time segmenting, the experiments demonstrate that more (less) frequent feedback leads employees to create smaller (larger) mental time segments. Furthermore, the results indicate that employees who create smaller mental time segments are less likely to find efficiencies at work, suggesting an unintended cost of increasing feedback frequency. However, I also find that employees with smaller mental time segments work with higher levels of effort intensity. Together, these experiments provide evidence that the economically meaningless time segments employees create can significantly influence their behavior. Consequently, firms and future researchers should carefully consider how features of the work environment influence the mental time segments employees create.

ABSTRACT Asymmetric information is a fundamental friction that results in mismatches and efficiency losses in the labor market. In this study, we posit that more disaggregated financial disclosure by a CEO candidate's prior employer can help the hiring firm better assess the possible fit between its operational needs and the candidate's skill set. Using a mandatory segment reporting reform in the United States (SFAS 131) as an exogenous shock to disclosure disaggregation, we find a significant increase in the firm‐CEO match quality when the hiring firm has access to more disaggregated segment information about the external candidate's past employment. Furthermore, the improvement in firm‐CEO matching is greater when segment information is incrementally more useful for evaluation of candidate skills. These findings reveal a novel labor market benefit of disaggregated financial disclosure: alleviating pre‐hiring information deficiencies and facilitating efficient allocation of CEO talent across firms.

ABSTRACT While prior accounting research documents normalizing strategies within the accounting profession and in instances of accounting adoption, the potential of accounting itself as a strategic tool toward normalizing that which is considered socially abnormal (i.e., dirty) remains an important and unexamined area of inquiry. In this study, we conduct in‐depth interviews to examine the role accounting plays in the development of the US cannabis industry (CI) as it transitions from the illicit market in which formal accounting was systematically avoided to a state‐legal market in which participants are subject to conventional business processes. Facing impediments to traditional operating practices and pressures to increase normative conformity for industry survival, cannabis operators (COs) incorporated the use of accounting in three normalizing strategies (creative concession, collaborative facilitation, and experimentation), seemingly influenced by the incongruencies between prior illicit‐market culture and experiences and the state‐legal operating environment. In response to what operators perceived to be coercive regulation, they employed creative concession strategies, including influencing, bargaining, challenging, escaping, and cessation tactics. However, in response to pressures to adopt more commonly accepted forms of accounting, COs instead deployed two different strategies, one focused on acquiescence to normalizing pressures when doing so facilitated essential relationship building (i.e., collaborative facilitation strategies), and one deployed as strategic experimentation, working to normalize industry activities in areas of perceived threats to industry acceptance and continuity. Given CO accounting naiveté, its usefulness was often introduced by peripheral industry parties attempting to normalize their own participation with the CI. Notably, we also find that normalizing pressures occasionally resulted in unintended consequences, including reversion to the illicit market and forgoing normalizing strategies in favor of retaining some level of dirtiness to fend off pending competition, both of which threaten to reemphasize the industry's dirtiness. Our study, therefore, points to accounting itself as a central mechanism in the complex, multidirectional strategy to normalize transitional dirtiness.

ABSTRACT Prior earnings management research often focuses on specific accounts or on estimations of discretionary accruals but provides only limited insight into the methods firms actually use to manage earnings. In order to begin exploration of some of the operational details regarding how earnings are managed, we investigate whether firms time their decisions to make changes in accounting estimates (CAEs) in consideration of their earnings benchmarks. Using CAE data across all accounts from 2006 to 2018, we find that 28.1% of income‐increasing CAEs are implemented in quarters where pre‐CAE earnings are below a forecasted earnings benchmark but inclusion of the CAE effectively allows the firm to meet the benchmark. We find that income‐increasing CAEs are more likely implemented when a firm's pre‐CAE earnings are further below the benchmark. We also find that firms are more likely to implement income‐decreasing CAEs under two scenarios: (i) when pre‐CAE earnings are relatively high, as a way either to smooth earnings or to “bury bad news,” and (ii) when pre‐CAE earnings are already low, as a way to take a financial “big bath” and position the firm for positive future earnings. In addition, we present evidence that firms using CAEs to achieve an earnings benchmark face financial consequences in terms of poorer immediate stock price performance and subsequent return on assets. Our conclusions hold after performing several additional analyses, including consideration of other discretionary options, addressing endogeneity concerns, and conducting falsification tests. In sum, we contribute to the earnings management literature by presenting consistent evidence that firms appear to time CAEs to meet earnings benchmarks or achieve other reporting objectives.

ABSTRACT This study examines how organized labor affects selling, general, and administrative (SG&A) cost behavior. Human capital is emerging as firms' most valuable asset, and we further the understanding of the interaction between employees and SG&A cost behavior. We predict and find that labor cost stickiness is higher for firms facing stronger unions, but the stickiness of SG&A costs is lower. This is consistent with our arguments that in firms with stronger unions, managers' discretionary decision to retain SG&A resources is negatively affected by higher labor adjustment costs that result in the retention of slack labor resources during periods of decreased demand. To assess the robustness of our main findings, we conduct an event analysis of labor union elections and find that SG&A cost stickiness decreases after firms experience new union certification. Cross‐sectional tests also show that the effect of labor union strength on SG&A cost stickiness is more pronounced for firms that are in better financial condition, have higher analyst coverage, and have higher net operating assets. We find a similar effect of union strength on discretionary spending when examining R&D costs. Overall, we contribute to the literature by showing that organized labor has a significant effect on cost behavior, which has implications for financial statement users and financial forecasting.

ABSTRACT We examine the effects of corporate networks involving common directors and auditors (i.e., connections creating single or double ties between companies) on two important monitoring roles: financial reporting quality and auditor dismissal decisions. We also investigate how shocks to the networks, in the form of the audit failing to detect misstatements, affect these networks' structure. The investigations are important because these networks can have significant effects on firm governance and may have different effects when they overlap. We have three primary findings about double‐tie networks: (i) there is no evidence that they improve overall financial reporting quality beyond the effect of single‐tie networks; (ii) they lower directors' willingness to dismiss the auditor, even when there is a signal of an audit failure within the network; and (iii) they allow audit‐quality problems to spread between companies. Our results demonstrate the importance of investigating multiple types of networks and how shocks travel through them. Our findings also lend credence to concerns that “cozy” relationships between directors and auditors diminish the link between poor audit quality and market‐imposed reputation penalties—specifically, auditor dismissals.

ABSTRACT This paper develops a unified framework to synthesize the growing stream of positive research on the role of individual decision makers in shaping observed accounting phenomena. This line of research recognizes two central ideas in behavioral economics. First, individual behavior depends not only on economic incentives and accessible information but also on individual preferences, abilities, experiences, and other characteristics. Second, the constraints that structure human interactions encompass both formal institutions (e.g., rules, laws, constitutions) and informal institutions (e.g., norms, conventions, rituals). Our review covers a broad set of individuals who are of interest in accounting research: managers, directors, audit partners, analysts, standard setters, politicians, judges, journalists, loan officers, financial advisors, and investors. We aim to understand the systematic effects of individual characteristics on a wide spectrum of accounting phenomena, including financial reporting, disclosure, tax planning, auditing, and corporate social responsibility. We highlight the importance of personal characteristics not only for an individual's own behavior but also for others' perceptions. Our review mainly focuses on archival research in accounting and provides some thoughts about opportunities for archival empiricists going forward. We also, when feasible, highlight opportunities for future field, survey, and experimental research. A central takeaway from our review is that individual‐level factors significantly improve our ability to explain and predict accounting phenomena beyond firm‐, industry‐, and market‐level factors.

ABSTRACT We investigate variation in information production by sell‐side analysts and its potential role in hedge fund activist intervention, an important external corporate governance mechanism that creates shareholder value. Using textual analysis to derive an activism dictionary from intervention objectives and tactics, we find substantially more activism content in pre‐intervention analyst reports of target firms than propensity score matched control firms. Activism content is associated with more detailed reports containing more quantitative information. Target firm intervention‐date stock returns are significantly higher when activist intention (13D) filings are supported by reports with more general and objective‐specific activism content. Of activists' public letters to stakeholders, 31.9% directly mention sell‐side analysis, amplifying the association between target returns and analyst report information. The relationship between analyst information and activism returns is robust to using brokerage closures as an exogenous shock and is consistent with analyst incentives. Activist funds with no prior disclosed position in target firms and more experienced funds capture higher returns from sell‐side information. Overall, our results suggest sell‐side analysts play a significant informational role in supporting hedge fund activism.