We examine a comprehensive set of investigations by the SEC’s Division of Enforcement offices to provide evidence on the consequences of these office’s busyness on the formal investigation process. We find that higher office case backlog decreases the likelihood of an investigation into a restating firm. Our results show no evidence that higher backlogs affect the SEC’s ability to pursue cases involving revenue recognition issues and high insider trading, which is consistent with the agency’s stated priorities. But our findings indicate that busy SEC offices are less likely to pursue cases with the largest shareholder losses, which is inconsistent with SEC priorities. Backlog also impacts pursued investigations, leading to more prolonged investigations, a lower Accounting and Auditing Enforcement Releases likelihood, and smaller SEC penalties. Our evidence suggests that busyness undermines the SEC’s investigation process.

We study whether recognition versus disclosure affects debt contracting using SFAS 158 as a setting. Upon recognition of previously disclosed pension liabilities, we find that debt contracts of firms that have high pension underfunding contain relatively more covenants based on the balance sheet and a lower cost of debt. Additional analysis suggests that improved reliability of recognized information is a likely mechanism for these findings. We also document that recognition did not affect the credit risk of the borrower or the use of income statement–based covenants that were unaffected by the accounting standard change. Collectively, our evidence suggests that recognition of previously disclosed accounting information can facilitate the incorporation of that information into lenders’ screening and monitoring. Data Availability: Data used in this study are available from public sources identified in the study.

We conduct an experiment in the securities-based crowdfunding setting to investigate whether some investors avoid accounting information for psychological reasons, even when they understand the information is useful in their decision-making. Results suggest investors who experience relatively more psychological discomfort when working with quantitative information are relatively less likely to acquire the financial statements of a potential crowdfunding investment. Importantly, this effect is incremental to any effect of investors' quantitative ability (i.e., their numeracy) and attenuates with an intervention designed to help investors overcome their psychological discomfort. Altogether, the results extend our understanding of the theory of information avoidance, provide a behavioral explanation for investors' documented underuse of accounting information, and can inform regulators as they revise crowdfunding regulations.

Auditor credibility is important in the banking industry due to the opacity of bank assets and the use of financial statements by external parties to facilitate monitoring. Depositors monitor and discipline bank behavior, but they can also contribute to the spread of shocks from one bank to another. We argue that depositors perceive bank failure as an audit failure, which reduces their assessment of auditor credibility. We document that exposure to failure through the audit firm is associated with lower uninsured deposit growth following the failure, consistent with depositors perceiving failures as a negative signal of auditor credibility. We further document that this association is stronger when depositors perceive connection to failure to reflect a pervasive issue within the audit firm. Collectively, our results suggest that depositors consider accounting signals at other banks in assessing financial reporting credibility.

Regulators now require auditors to provide information about how they evaluate complex estimates. Because users encounter this auditor-provided information alongside management-provided information, we jointly examine the value relevance of these disclosures. We also examine whether visual cues in audit reports influence how nonprofessional investors use these disclosures. We find that disclosures from managers and auditors provide different value-relevant information about the same underlying issue. While users struggle to weight fully narrative auditor disclosures in their valuation judgments without corresponding management disclosures, visual cues facilitate their weighting of information about the audit. Specifically, users take increased price protection when auditor disclosures also include visual cues. However, consistent with market signaling theory, corresponding voluntary disclosures from management attenuate this price protection. This suggests management can mitigate negative valuation effects that may arise from auditor disclosures, and implies that visual cues in audit reports can prompt managers to increase disclosure transparency. Data Availability: Contact the authors.

This study examines local characteristics associated with non-Big 4 local market leadership and the impact of non-Big 4 local market leadership on competition. We identify non-Big 4 local market leaders by collecting accounting firm rankings from business publications for 46 of the largest metropolitan statistical areas from 2005–2010. These rankings are based on the number of local office employees and provide a more holistic measure of office size than measures based on public company audit fees. We find local supply and demand factors are significantly associated with non-Big 4 local market leadership and that non-Big 4 leadership is associated with lower overall audit fees in the local market. We also find that non-Big 4 leaders earn a fee premium over other non-Big 4 auditors. Our results imply that non-Big 4 leaders increase local market competition. Data Availability: All data are publicly available from sources identified in the study.

To facilitate managers' decision-making, firms develop strategic performance measurement systems that translate strategy into performance measures. Ideally, managers see measures for what they are—imperfect proxies for intangible strategic constructs. However, managers may fail to fully appreciate the fact that measures are merely representations of the strategic constructs, and act as though the measures are the construct of interest—a phenomenon we label surrogation. In this paper, we investigate whether and how the use of strategically linked performance measures for compensation purposes affects managers' propensity to exhibit surrogation. In accordance with the attribute substitution framework (Kahneman and Frederick 2002), we predict incentive compensation exacerbates surrogation, and that this effect is more prevalent when managers are compensated on a single measure of a strategic construct than when managers are compensated on multiple measures of a strategic construct. Via two experiments, we find support for these hypotheses. Our paper contributes to the literature on strategic performance measurement systems by highlighting the tendency of managers to use measures as surrogates for strategy. More generally, we identify a by-product of contracting on imperfect performance measures not previously considered in extant literature, and establish when consideration of costs of this by-product are likely to be critical.

Auditors often receive summary information or conclusions from management about account balances or internal controls. They must then gather evidence to assess whether this information is fairly stated. In such situations, management can be considered the “first mover” and the auditor the “second mover.” When auditors are the second mover, they are vulnerable to the curse of knowledge bias—the inability to ignore previously processed information (Fischhoff 1977). Specifically, because information from management could be incorrect or biased, auditors must arrive at an independent evaluation of the item in question (e.g., year-end book values, accounting estimates, or internal controls). This study examines the general issue of auditors being “second movers” by investigating how their awareness of management’s severity classifications of internal control problems influences auditors’ initial assessments of internal control over financial reporting (ICFR) under Auditing Standard No. 2. Our experimental design allows us to determine that management’s “first mover” influence on auditors’ judgments is an unintentional cognitive effect, rather than an intentional use of management’s classifications. We further examine whether cognitively restructuring the ICFR assessment task reduces management’s influence on auditors’ judgments by asking auditors to evaluate and explicitly document the likelihood and magnitude of the effect of an ICFR problem on the financial statements. We find that cognitively restructuring the task mitigates management’s “first mover” influence on auditors’ judgments.

Auditors are charged with the responsibility of evaluating internal control systems. Recent advances in decision support systems indicate that the speed, accuracy, and memory capacity of computers may be used to aid auditors in this task. To test this proposition, a computer-assisted method of designing, analyzing, and evaluating internal control systems, called The Internal Control Model or TICOM, was designed and implemented. The technical manual and the TICOM software are available from the authors. This paper presents the results and conclusions of that project. TICOM is a computer-based analytic tool that aids the auditor first to model the internal control system and then to query the model in order to aid the auditor in evaluating the internal control system. TICOM is based on concepts in artificial intelligence such as knowledge representation and graph simplification. It serves (1) to describe office information systems while emphasizing internal accounting controls and (2) as an aid in control evaluation. It was found that the advantages of TICOM over traditional evaluation methods are that (1) the evaluation can be more rigorous and exhaustive, (2) the documentation of the system can be more thorough because of automated completeness and consistency tests, and (3) the modeler may probe and test controls by using the query-processing portion of TICOM.

We examine methods for evaluating interventions designed to improve decision-making quality when people misunderstand the consequences of their choices. In an experiment involving financial education, conventional outcome metrics (financial literacy and directional behavioral responses) imply that two interventions are equally beneficial even though only one reduces the average severity of errors. We trace these failures to violations of the assumptions embedded in the conventional metrics. We propose a simple, intuitive, and broadly applicable outcome metric that properly differentiates between the interventions, and is robustly interpretable as a measure of welfare loss from misunderstanding consequences even when additional biases distort choices.