Knowledge that Transforms

ABSTRACT We examine the “black box” of corporate tax risk management by providing unique insights into practitioners' tax risk perceptions, tax risk management practices, and influences leading to variation in tax risk management practices across firms. Opening this black box is important as tax risk has become an increasingly relevant aspect in corporate tax practice—little is yet known about how firms define and manage tax‐related risks. We perform our analysis based on 33 expert interviews, which we conducted with 42 tax risk experts. The first important finding from our interviews is that tax risk is a multifaceted and context‐dependent construct, consisting of six tax risk components: financial, reputational, compliance, political, tax process, and personal liability risk. Furthermore, we find that perceived tax risk varies substantially between corporate insiders and corporate outsiders. Our interview insights further reveal that firms' most frequently used tax risk management practices relate to some form of tax communication. The tax departments' rationale for using tax communication as a key tax risk management practice is to protect the firm—in particular, the CFO—from three types of pressure: public pressure, peer pressure, and regulatory pressure. Our analysis has important implications for future studies. First, our insights reveal that several tax risk components are not sufficiently covered by common tax risk measures used by the archival literature. Second, we find that communication has a key role in managing tax risk. This deviates from the purely supportive role that extant risk management frameworks have assigned to communication.

ABSTRACT Sovereign wealth funds (SWFs) are government‐owned institutional investors pursuing political and financial investment objectives. With $8 trillion in assets, SWFs are geopolitical powerbrokers actively participating in global capital markets, yet we know little about the financial reporting consequences of SWF investment. I document evidence supporting the hypothesis that the simultaneous pursuit of political and financial investment objectives renders SWFs weak monitors. Using a staggered difference‐in‐differences research design, I document economically significant increases in discretionary accruals for SWF target firms after SWF investment, relative to an entropy‐balanced control group of non‐SWF target firms. Corroborating tests document that the effect of SWF investment on discretionary accruals strengthens with SWFs' equity stake and SWF target firms' earnings management incentives and weakens when regulators curb SWFs' pursuit of political objectives. I highlight SWFs' distinct monitoring effect by replicating my analyses after replacing SWF investment with conventional institutional investment, and document that conventional institutional investment instead reduces discretionary accruals. I further corroborate SWFs' distinct monitoring role among conventional institutional investors using a wide variety of robustness tests employing alternate specifications, samples, and financial reporting proxies. Overall, this study introduces an economically important and fundamentally distinct but little‐studied institutional investor to the accounting literature.

ABSTRACT This paper examines the pricing efficiency of 8‐K filings for events other than earnings announcements. Since these filings provide timely information that is material to investors and explain variations in quarterly returns to a degree similar to other disclosures, understanding how the stock price absorbs their information is important for investors, regulators, and academics. By testing the statistical correlation between the immediate stock returns in response to these filings and subsequent stock returns before, during, and after the forthcoming earnings announcement, we find evidence of investor overreaction to good news but underreaction to bad news in the immediate window. Essentially, the price increases too much for good news but fails to decrease enough for bad news, resulting in overpricing for both. Most of the correction for this overpricing occurs in the period leading up to the forthcoming earnings announcement, while the rest happens during the announcement. Drawing on Miller (1977), we further illustrate that, in the presence of short‐sale constraints, increase in investor disagreement spurred by interpretation difficulty is the most likely mechanism for the observed overpricing. We fail to find sufficient evidence in support of alternative mechanisms, including managerial disclosure strategies, analyst optimistic bias, and retail investor participation. This asymmetric mispricing for non‐earnings 8‐Ks contrasts with the symmetric mispricing commonly found for other types of disclosures, where investors either systematically underreact or overreact to public information. Our results could broadly speak to the pricing of other public information that is inherently difficult to interpret.

ABSTRACT The ability to develop bots to automate tasks and processes using robotic process automation (RPA) is receiving significant attention in accounting. Auditors often struggle to know what tasks to automate and how to prioritize bot development. Drawing upon socio‐technical systems (STS) theory and using a design science methodology, we develop and validate a three‐step evaluation framework to assist auditors as they decide what activities to automate. We validate this framework using interviews, surveys of experienced internal and external auditors, and two case studies. By developing and validating our framework through the lens of STS theory, we also provide several insights that help explain the mixed findings in prior research regarding the effectiveness and adoption of emerging technologies in audit. The implications of our study yield many opportunities for future research in the areas of RPA and emerging technologies in audit.

ABSTRACT We examine whether audit firm alma mater ties between the auditor and the audit committee (AC) are associated with significantly greater nonaudit services (NAS) provided by the auditor. We further examine whether greater NAS in the presence of such alma mater ties are associated with audit quality. Since the AC is responsible for approving and monitoring the services provided by the auditor, the presence of AC and auditor alma mater ties underscores the controversies surrounding such ties' undermining audit quality. Predicating our hypotheses on social ties theory, we find a positive association between the presence of an audit firm alumnus on the AC and NAS acquired from the alma mater auditor. We further find that this association becomes stronger as the tenure of the alumnus increases. Next, using multiple measures of audit quality, we find that, when the alumnus on the AC is associated with significantly more NAS provided by the alma mater audit firm, the quality of the audit suffers. Collectively, our results suggest that audit firm alma mater ties between the AC and auditor engender economic ties that adversely affect audit quality. Our study provides new evidence on the channels through which the quality of the audit is affected and raises important implications for the composition of the AC, auditor‐provided NAS, and client assignment to engagement partners.

ABSTRACT This study examines whether credit default swap (CDS) trading initiation can serve as a disciplining mechanism for leading credit rating agencies. Specifically, we investigate whether rating agencies improve their rating quality when an alternative source of credit risk information from CDS threatens to expose inaccuracies in their ratings. Understanding potential drivers of credit rating quality is important given the prominence of credit rating agencies as debt market gatekeepers and perceptions that the agencies have underperformed in providing high‐quality credit risk assessments in recent decades. We hypothesize and find that the initiation of CDS trading improves the accuracy of issuer‐paid credit ratings. This evidence is robust to a number of sensitivity tests including alternative ways of measuring rating accuracy and correction for selection bias. We also find that the timeliness of credit ratings, watch list, and outlook placements improves post‐initiation—particularly for negative shocks to credit risk. This study contributes to the credit rating literature by documenting that CDS trading can help discipline rating agencies. It also contributes to the literature studying the implications of the CDS market.

ABSTRACT Conventional agency theory suggests that firms should benchmark CEO compensation to absorb systemic risk and to more efficiently incentivize executives to work hard. Yet empirical research has found only a modest use of benchmarking in CEO compensation contracts. In this paper, I highlight one weakness of relative performance evaluation (RPE). When earnings management is possible, benchmarking creates stronger incentives for misreporting performance measures compared to benchmark‐independent pay. The optimal contract will depend less on a correlated benchmark (e.g., a stock market index) if it is easier for the manager to misreport performance. Thus, the model predicts that firms with weak internal controls and bad auditors are less likely to use RPE, offering a theoretical explanation for the empirically observed lack of RPE use.

ABSTRACT Accounting rules require that certain R&D expenditures be capitalized, but academic research often states that all R&D expenditures must be immediately expensed. An accurate understanding of actual R&D accounting practices is critical because that understanding influences research questions and design choices. To examine the competing R&D accounting perspectives, we survey 184 experienced financial officers. Our survey reveals that R&D capitalization is common and extensive in practice. Over 90% of respondents indicate that their firm capitalizes at least some R&D expenditures, and our evidence shows that about 22% of annual R&D expenditures are capitalized. When facing an earnings shortfall, respondents indicate that firms are often willing to cut R&D expense. However, respondents also indicate an unwillingness to cut types of R&D expenses that cause long‐term harm—for example, laying off scientists or delaying the execution of trials—and they often redirect the freed‐up R&D resources to R&D expenditures that are capitalized. Using archival data, we also corroborate our survey finding about the pervasiveness of capitalized R&D, and we demonstrate its empirical implications. Our study helps to align the characterization of R&D accounting rules in the academic literature with the authoritative professional literature and provides a more nuanced understanding of firms’ R&D response to an earnings shortfall.

ABSTRACT We investigate what happens when accounting professionals come under external pressure to change established practices. We focus on corporate tax transparency, which has become an important battleground as stakeholders increasingly demand more information on corporate tax practices. While the Big 4 global accounting firms have traditionally played a dominant role in shaping what is perceived as acceptable corporate tax behavior, activists and critical politicians have recently mobilized public attention, challenging how accounting professionals legitimate their practices. We provide evidence of these challenges from 33 interviews and participation in 13 professional events from 2013 to 2019. We conceive of the confrontation between dominant professionals and challengers as taking place in a transnational “field,” where a range of actors struggle over how a common object—corporate tax transparency—is defined and treated. This approach helps us understand how the Big 4 navigate new challenges while seeking to maintain control over professional practices. Our interviews and observations show that Big 4 professionals are sensitive to political challenges, requiring that they engage in what we characterize as “scanning work”—ongoing activity to search for, identify, and assess challenges—to fend off outside interventions. Our analysis has important implications for further research. First, the need for scanning work when facing transnational political pressure implies a different way of seeing interactions between accounting professionals and (global) society at large. Second, viewing global accounting from a transnational field lens helps us identify complex sources of change external to already‐powerful actors.

In this study, we examine whether a country's implementation of major corporate governance reforms affects firms' cross-listing activities. Cross-listing is important in overcoming international investment barriers and thus it is worth investigating whether enhanced corporate governance at the country level contributes to the integration of international capital markets. Using a difference-in-differences (DiD) research design, we predict and find that following the implementation of corporate governance reforms in their home countries, firms are more likely to engage in cross-listing activities and tend to cross-list in host countries with stronger investor protection and more developed markets than those in countries with no reforms in the same period. The results from country-level cross-sectional tests indicate that this effect is greater for firms in home countries with weaker investor protection and less developed stock markets in the prereform period. The reforms also have a stronger effect on firms subject to less analyst following and greater external finance dependence. Finally, we find a stronger association between cross-listing activities and institutional ownership after the reforms. Taken together, this study increases understanding of the trade-off between cross-border capital supply and demand. Our finding suggests that country-level corporate governance plays an important role in facilitating the supply of cross-border capital, which in turn incentivizes firms to cross-list. Our study also offers policy implications for national stock exchanges and securities regulators by suggesting that countries without well-developed capital markets should strengthen their corporate governance to improve firms' ability to raise external financing and attract cross-border capital flows.