Knowledge that Transforms

Abstract Fiscal‐year‐end cash holdings are an important indicator in external stakeholders' assessment of a firm's liquidity and credit risk. Do fiscal‐year‐end cash holdings reflect a firm's intra‐year liquidity conditions? We observe that firms report significantly higher cash holdings in the fourth fiscal quarter, followed by a subsequent reversal. This pattern is pervasive across industries, persistent over time, and not explained by conventional factors or calendar effects. The extent of the fourth‐quarter cash increase is more pronounced for informationally opaque firms reliant on external markets and those with financial constraints and reduced monitoring. We investigate firms' real, financing, and timing activities that could potentially account for this pattern. Our study suggests that a complete picture of intra‐year cash holdings dynamics is necessary for external stakeholders to fully assess a firm's liquidity and credit conditions.

Abstract Public accountants are in high demand by non‐accounting firms. While this demand attracts high‐quality accountants to public accounting, it can negatively impact audit quality by distracting auditors. We find that the number of metropolitan statistical area–level busy season job postings for public accountants by non‐accounting firms is positively associated with misstatements. Results are most pronounced (1) when outside job opportunities are from non–publicly traded companies, which likely provide better work‐life balance, and (2) when auditors are under a heavier workload, as captured by higher audit fee‐to‐auditor ratios and increased job postings by audit offices leading into the busy season. Results also suggest that accounting firms that provide large pay increases before the busy season can mitigate the negative audit‐quality effects of busy season job postings for public accountants. These results suggest that accounting firms are not immune to negative effects of auditor distraction from outside job opportunities despite accounting firms knowing that their auditors are highly sought after by non‐accounting firms.

Abstract The IRS administers tax laws enacted by Congress. As part of the IRS's duties, they often consider taxpayers' financial statements to help ensure accurate tax reporting and payments. We posit that enhanced financial statement disclosures of tax information under FASB Interpretation Number 48 (FIN 48) lead to more IRS scrutiny and alter the incentives for corporate innovation. Using patent applications as a measure of corporate innovation, we employ a difference‐in‐differences research design with publicly listed US firms as the treatment group and privately held US firms not subject to the disclosure requirements as the control group. We find robust evidence that, following the onset of FIN 48, the number of patent applications by publicly listed firms decreased between 15.4% and 24.3% relative to private firms. This decline in patent applications is attributable to incremental innovation, suggesting that firms lower innovation related to projects with tax benefits that are more likely to be scrutinized by the taxing authorities. These findings suggest that there are real effects of IRS scrutiny and, in particular, real effects of tax disclosures under FIN 48 on corporate innovation.

Abstract In this paper, we investigate the real effects of information transparency in crowdfunding markets. Our analysis shows that the crowdfunding market features an under‐implementation inefficiency, driven by two types of uncertainty that consumers face: fundamental uncertainty about the entrepreneur's implementation cost, and strategic uncertainty due to potential coordination failures among consumers. We find that when both fundamental and strategic uncertainties are present, eliminating the fundamental uncertainty alone by revealing the implementation cost does not necessarily improve efficiency. Surprisingly, from an ex ante perspective, greater transparency makes the coordination among crowdfunding consumers less efficient, which makes the under‐implementation problem even worse and thus impairs efficiency. Our findings send a message of caution against promoting greater transparency in the crowdfunding market.

Abstract Using data collected from 21 interviews with audit committee members (ACMs) of Canadian reporting issuers, this study examines the ways in which ACMs understand and enact the additional responsibilities placed on them by regulators in the post–Sarbanes‐Oxley Act era. Adopting a social constructivist approach to knowledge and expertise, the study shows that despite the financial literacy requirements for ACMs, financial expertise is far from being uniformly understood by ACMs. Indeed, ACMs perceive expertise in many different ways, which leads them to engage in a wide variety of practices to fulfill their responsibilities on audit committees (ACs). The analysis of the data makes it possible to identify three oversight styles— observing , inspecting , and storytelling —that illustrate the differences in how ACMs understand their role, prepare for AC meetings, invest time in this preparation, and develop lines of questioning. These findings provide empirical insights into both the substantive and symbolic roles of ACs and illustrate the role of knowledge and ignorance in shaping ACMs' understanding of their oversight role. This study also raises questions about the soundness of having ACs oversee multiple different processes. By highlighting that ACMs do not comprehend and enact their role uniformly, this study reveals the important nuances in ACMs' oversight approaches.

Abstract We examine how public enforcement and private enforcement interact to contain self‐dealing activities in emerging markets. Using data from China, we find that firms receiving comment letters concerning related party transactions (RPTs) from stock exchanges significantly reduce their RPTs in subsequent years. We further find that (1) the subsequent reduction in RPTs is more pronounced when independent directors have higher career or reputation concerns and (2) independent directors are more likely to dissent or resign if their firms do not significantly reduce RPTs after receiving RPT comment letters, especially if they have high reputation concerns. Our study sheds light on a within‐firm mechanism through which public enforcement takes effect. Our empirical findings also illustrate how “sunshine enforcement”—maintaining timely transparency of the enforcement process—can significantly enhance the effectiveness of regulatory programs.

Abstract Extant management accounting research has conceptualized the interplay between trust, distrust, and open‐book accounting (OBA) as a relationship‐level phenomenon, largely ignoring that inter‐organizational relationships are often complex entities that comprise multiple arenas of exchange where (dis)trust and OBA can interact in different—and potentially contradictory—ways. To address this theoretical oversight, we draw on relational exchange theory to propose that (dis)trust largely forms within OBA domains where different forms of data are exchanged for different purposes. Trust and distrust may thereby coexist within a relationship. We also propose that (dis)trust spills over to influence the conditions for OBA in other domains. Consequently, trust and distrust not only take shape in cumulative processes within OBA domains but also diffuse between domains in a relationship. Empirical observations from a longitudinal case study of a retail buyer's attempts to introduce OBA in three vendor relationships lead us to suggest that competence‐trust spillover is determined largely by domain similarity, while goodwill‐trust spillover relies to a greater extent on staff mobility between OBA domains. Overall, the negative effects of distrust spillover on the implementation of OBA appear greater than the positive effects of trust spillover. Our study shows that, by analyzing the domain‐specific nature of trust and distrust, future research can increase our understanding of the relationship between data characteristics and (dis)trust, as well as explain how trust and distrust interact to determine conditions for data exchange between organizations.

Abstract In 2017, the PCAOB began requiring audit firm tenure disclosure within the audit report for SEC registrant clients. Many commenters raised the concern that prominent disclosure of firm tenure would lead investors to inappropriately infer a negative relation between audit quality and long tenure. This is particularly troubling given that empirical evidence generally does not support this concern. In our first experiment, we predict and find that disclosing an audit firm's long tenure within the audit report increases investors' perceptions that the audit firm's independence was impaired while conducting the audit. However, we also identify an intervention that mitigates the effects of disclosing long tenure—an accompanying disclosure in the audit report of the firm's adherence to the SEC's mandatory partner rotation requirement. We find that such a disclosure moderates the effect of long tenure disclosure such that in the absence (presence) of a partner rotation disclosure, investors do (do not) perceive increased independence impairment when long firm tenure is disclosed. In a second experiment, we predict and find that long firm tenure disclosure reduces investors' preference to invest in an otherwise quantitatively optimal investment and that this relation is driven, in part, by perceptions of independence impairment. Again, this result is attenuated by partner rotation disclosure. Our results should be useful to regulators in understanding the effects of their disclosure mandate and to audit firms in understanding a practical way in which they might mitigate the implications of such effects.

Abstract The objective of this research is to better understand experts' contributions to the prospective evaluation of a new audit standard—in this case, key audit matter (KAM) reporting. To this end, we assisted the Canadian Auditing and Assurance Standards Board by leading its consultation of 22 expert financial statement users. The methodology employed to observe our participants' opinions and cognitive processes involves thought protocol and interviews. By analyzing the rhetorical base of experts' prospective analysis, we show that our participants' arguments are often laden with postulates and lack data points, leading to generalizations. Sounder arguments entail more nuanced views but lead to uncertainties. We therefore highlight a tension between the rhetorical content of experts' insights and the calculative rationality of a cost‐benefit analysis. We also find that experts with less cognitive flexibility are less likely to be supportive of the adoption of a standard implying a change of habits in the way they process information. This tension and cognitive bias generate a significant interpretive challenge to determine a clear and dominant stance in the consultation. We discuss the implications of these findings for the legitimacy of prospective evaluations and the conduct of cost‐benefit consultations with experts. We also contribute to the literature on KAMs by substantiating concerns about the value of extended auditor reports to users.

Abstract Since the passage of the Sarbanes‐Oxley Act of 2002, many notable frauds have been tied to ineffective audit committee (AC) oversight. As a result, AC oversight is of continuing interest, and regulators continue to debate this issue, garnering a growing body of research focused on the role played by the AC. But little theoretical research exists to guide analytical and empirical researchers investigating AC oversight. The purpose of this study is to provide theoretical guidance by examining AC oversight in a strategic setting. We focus on the AC's role in overseeing internal controls (ICs) and the impact of whether the AC relies on management in designing the controls. We characterize how the nature of control risk changes and how IC strength is associated with the amount of managerial fraud, expected probability of fraud detection (which, on average, equates to audit effort), and audit quality (assessed as 1 − audit risk) across two settings defined by the degree of AC oversight. As one example that highlights the need for theoretical guidance, we consider the literature's presumption that IC strength is negatively associated with audit effort. We find that this association may be positive or negative as IC changes, where the association varies with the degree of direct AC oversight and the change in payoff parameters.