In this study, we examine the benefits of membership in an accounting firm association, network, or alliance (collectively referred to as “an association”). Associations provide member accounting firms with numerous benefits, including access to the expertise of professionals from other independent member firms, joint conferences and technical trainings, assistance in dealing with staffing and geographic limitations, and the ability to use the association name in marketing materials. We expect these benefits to result in higher-quality audits and higher audit fees (or audit fee premiums). Using hand-collected data on association membership, we find that association member firms conduct higher-quality audits than nonmember firms, where audit quality is proxied for by fewer Public Company Accounting Oversight Board (PCAOB) inspection deficiencies and fewer financial statement misstatements, as well as less extreme absolute discretionary accruals and lower positive discretionary accruals. We also find that audit fees are higher for clients of member firms than for clients of nonmember firms, suggesting that clients are willing to pay an audit fee premium to engage association member audit firms. Finally, we find that member firm audits are of similar quality to a size-matched sample of Big 4 audits, but member firm clients pay lower fee premiums than do Big 4 clients. Our inferences are robust to the use of company size-matched control samples, audit firm size-matched control samples, propensity score matching, two-stage least squares regression, and to analyses that consider changes in association membership. Our findings should be of interest to regulators because they suggest that association membership assists small audit firms in overcoming barriers to auditing larger audit clients. In addition, our findings should be informative to audit committees when making auditor selection decisions, and to investors and accounting researchers interested in the relation between audit firm type and audit quality.

We examine whether the effect of mandatory auditor rotation on audit quality depends on the mental frame auditors adopt in evaluating management representations. In practice, auditors can alternately frame their assessments of management representations in terms of their potential dishonesty (what we term skepticism) or potential honesty. Using psychology theory and a laboratory experiment, we predict and find that mandatory rotation improves audit quality when an auditor takes an honesty frame, but that this effect reverses when an auditor takes a skeptical frame. Thus, the benefit of using a skeptical frame occurs when auditors do not rotate, but requiring rotation can reduce audit effort for auditors using a skeptical frame. An implication of our study is that focusing auditors on a skeptical assessment frame rather than mandating auditor rotation may be a less costly way to reduce low-effort audits and aggressive reporting.

We investigate the role of accounting and audit quality in the allocation of international development aid loans provided by the World Bank. This aid is crucial to improve governance functions, infrastructure, and capital markets, and the accounting and audit environments in a country can provide the World Bank with confidence that aid is being used as intended rather than being diverted for personal or political gain. We find that development aid loans are higher for countries with stronger accounting quality, where IFRS use is mandated, and where the audit environment is stronger. However, we also find that United States geo-political interests influence these results. Specifically, the World Bank appears to “overlook” accounting and audit quality in countries where geo-political interests are relatively aligned with those of the U.S. Finally, we find that accounting and auditing matter only in countries with relatively high corruption levels, indicating that the World Bank has greater trust that accounting and auditing are of relatively high quality in low-corruption countries. Data Availability: All data are publicly available.

The SEC Advisory Committee on Smaller Public Companies recommends paid-for research to fill the void created by declining sell-side coverage. Potential conflicts of interest inherent in paid-for research challenge this recommendation. We evaluate whether paid-for research provides value to investors or merely reflects hype. Analyses of one- and two-year-ahead paid-for earnings forecasts fail to identify significant bias. Using a portfolio approach, favorable (unfavorable) paid-for recommendations yield positive (negative) stock returns at release, with upward (downward) drift over the following year. Regressing future stock returns on recommendations and valuation estimates using paid-for analysts' forecasts yields similar results. Further, results fail to indicate significant differences in paid-for and matched sell-side research. Overall, our evidence suggests that paid-for research provides relevant information for the buy-and-hold investor that is comparable to that of matched sell-side research, providing empirical support for the SEC Advisory Committee recommendation. JEL Classifications: G11; G14; G24. Data Availability: Data are publicly available from the sources identified in the text.

This study finds evidence that public-company reporting by U.S. multinational corporations (MNCs) creates disincentives to repatriate foreign earnings to the U.S. and contributes to the accumulation of cash abroad. MNCs operate under U.S. international tax laws and financial reporting rules and face two potential consequences when they repatriate foreign earnings: a cash payment for repatriation taxes and a reduction in reported accounting earnings. Using a confidential dataset of financial and operating characteristics of foreign affiliates of MNCs combined with public-company data, we examine how repatriation amounts vary across firms that face relatively strong reporting incentives to defer an accounting expense. Our results suggest that reporting incentives reduce repatriations by about 17 to 21 percent annually. Data Availability: Bureau of Economic Analysis (BEA) data were made available to the authors under a legal confidentiality arrangement; all non-BEA data are available from public sources.

This study examines disaggregated management forecasts as a mechanism to reduce investors’ fixation on announced earnings. Our experimental results suggest that investors’ earnings fixation is reduced when they initially observe a disaggregated management forecast (earnings and its components) versus when they observe an aggregated forecast (earnings only). We also provide theory-consistent evidence that this reduction in earnings fixation is associated with investors interpreting the summary net income figure as one of several similarly important evaluation inputs rather than a substantially more important input (relative to its components). Finally, we provide evidence that suggests our results are not bounded by the level of emphasis on net income in the subsequent earnings announcement, and not fully explained by three plausible alternative explanations. Our study extends the voluntary disclosure literature by providing evidence that the form of management disclosures can influence investors’ interpretation of subsequently announced information, and contributes to practice by providing a potential alternative to stopping earnings guidance.

This study examines whether peer reviews conducted under the AICPA's self-regulatory model have been effective at signaling audit quality. Prior research has examined whether peer-review reports are associated with perceived audit quality. We examine whether peer-review reports are associated with actual audit quality. Using a unique data set obtained from the files of an insurance company, we find that peer-review findings are indeed useful in predicting audit failure (i.e., malpractice claims alleging auditor negligence), and that certain types of findings are particularly useful in this regard. We also find that peer-review findings are associated with other firm-specific indicators of potentially weak quality control or risky practices within accounting firms. Taken together, we interpret our findings to indicate that self-regulated peer review as mandated by the AICPA does provide effective signals regarding audit-firm quality.

Internal auditors perform work that is relevant to their host entities' financial reporting processes; yet, little research attention has focused on the effects of internal auditing on companies' external financial reporting. Using a unique and previously unavailable data set, we investigate the relation between internal audit function (IAF) quality and earnings management. We measure IAF quality using a composite measure comprising six individual components of IAF quality based on SAS No. 65, which guides external auditors in assessing the quality of an IAF with respect to its role in financial reporting. Earnings management is measured using two separate proxies: (1) abnormal accruals and (2) the propensity to meet or barely beat analysts' earnings forecasts. We find evidence that IAF quality is associated with a moderation in the level of earnings management as measured by both proxies.

We report evidence on the determinants of whether the relationship between a firm and its Chief Executive Officer (CEO) is governed by an explicit (written) or an implicit agreement. We find that fewer than half of the CEOs of S&P 500 firms have comprehensive explicit employment agreements. Consistent with contracting theory, explicit agreements are more likely to be observed and are likely to have a longer duration in situations in which the sustainability of the relationship is less certain and where the expected loss to the CEO is greater if the firm fails to honor the agreement.

The price formation process of JASDAQ IPOs is more transparent than in the United States. The transparency facilitates analysis of important issues in the IPO literature—why offer prices only partially adjust to public information and adjust more fully to negative information, and why adjustments are related to initial returns. The evidence indicates that early price information conveys the underwriter's commitment to compensate investors for acquiring and/or disclosing information. Offer prices reflect pre‐IPO market values of public companies and implicit agreements between underwriters and issuers that originate well before the offering. Underadjustment of offer prices is substantially reversed in the aftermarket.