We analyze whether tough IRS monitoring generates a positive externality by constraining managers' bad news hoarding activities. Supporting this prediction, we find a negative relation between the threat of an IRS audit and stock price crash risk. Our evidence is consistent with recent theory that outside investors learn more about firms when tax enforcement is stricter. Additionally, path analysis suggests that the monitoring channel (direct path) plays a critical role in shaping crash risk relative to information asymmetry channels of tax planning and accruals manipulation (indirect paths). Consistent with other predictions, we find that the monitoring role of IRS audits intensifies when firms experience worse agency conflicts stemming from CEO power and incentives. Collectively, our research implies that external monitoring by tax authorities protects shareholders against managers suppressing negative firm-specific information that engenders stock price crash risk, particularly when CEOs have wider scope and stronger incentives to hoard bad news.

We investigate whether corporate insiders attempt to circumvent insider trading restrictions by using their private information to facilitate trading in economically linked firms, a phenomenon we call “shadow trading.” Using measures of informed trading to proxy for shadow trading, we find increased levels of informed trading among business partners and competitors before a firm releases private information. To rule out alternative explanations, we examine two shocks to insiders' incentives to engage in shadow trading: high-profile regulatory enforcement against conventional insider trading, and staggered changes to their outside employment opportunities. Finally, we document attenuated levels of informed trading among business partners and competitors when firms prohibit shadow trading. Overall, we provide evidence that shadow trading is an undocumented and widespread mechanism that insiders use to avoid regulatory scrutiny. Data Availability: Data are available from the public sources cited in the text.

We exploit changes in a country's integration of corporate and shareholder taxes to identify the effect of investor-level taxes on costly corporate tax avoidance. Specifically, we rely on European countries eliminating imputation systems in different years in response to supranational judicial rulings. These eliminations, which are exogenous to the firm, remove managers' disincentive to engage in tax avoidance if they consider investor-level taxes. Using a difference-in-differences model with fixed effects, we find that the average firm affected by an elimination reduces its cash effective tax rate by 5.5 percent. Placebo tests support that this effect exists only for countries and years for which eliminations occur. Consistent with our cross-sectional predictions, we find that results are stronger for firms with lower growth opportunities, higher dividend payout, lower foreign income, and higher closely held ownership. Further analysis provides evidence consistent with shifting income to foreign countries as one method of tax avoidance.

Internal controls influence information quality, thus affecting the ability of supply chain partners, who rely on collaborative systems of information sharing, to reliably contract. Using SOX-related internal control assessments as a proxy for internal control quality and U.S. GAAP-mandated major customer disclosures, we find that supplier internal control quality influences supply chain relationship duration. Specifically, our evidence demonstrates that: (1) poor internal control quality increases the likelihood of subsequent customer-supplier relationship termination; (2) timely control weakness remediation attenuates termination likelihood; and (3) weaknesses affecting customer contracting drive the effect of internal control quality on relationship termination. Our results control for supplier operational quality and performance, and are robust to propensity score matching techniques, controls for reverse causality, and alternative proxies for relationship termination and internal control quality. Overall, our findings are consistent with customers viewing strong supplier controls as important, albeit overlooked, contracting elements with significant implications for supply chain relationships.

Standard setters contend that fair value accounting yields the most relevant measurement for financial instruments. We examine this claim by comparing the value relevance of banks' financial statements under fair value accounting with that under current GAAP, which is largely based on historical costs. We find that the combined value relevance of book value of equity and income under fair value is less than that under GAAP. We also find that fair value income is less value-relevant than GAAP income because of the inclusion of transitory unrealized gains and losses in fair value income. More surprisingly, we find that book value of equity under fair value is not more value-relevant than under GAAP, due both to divergence between exit value and value-in-use and to measurement error in fair value estimates. Overall, our results suggest that financial statements under fair value accounting provide less relevant information for bank valuation than financial statements under current GAAP.

Online labor markets allow rapid recruitment of large numbers of workers for very low pay. Although online workers are often used as research participants, there is little evidence that they are motivated to make costly choices to forgo wealth or leisure that are often central to addressing accounting research questions. Thus, we investigate the validity of using online workers as a proxy for non-experts when accounting research designs use more demanding tasks than these workers typically complete. Three experiments examine the costly choices of online workers relative to student research participants. We find that online workers are at least as willing as students to make costly choices, even at significantly lower wages. We also find that online workers are sensitive to performance-based wages, which are just as effective in inducing high effort as high fixed wages. We discuss implications of our results for conducting accounting research with online workers. Data Availability: Contact the authors.

We document that insider trading is significantly higher than normal levels prior to the public disclosure of SEC comment letters relating to revenue recognition. Furthermore, insider trading is triple its normal level for firms with high short positions. We find a small negative return at the comment letter release date and a negative drift in returns of 1 to 5 percent over the next 50 days following the release. We also find that greater pre-disclosure sales are associated with a stronger negative drift. This evidence suggests that insiders appear to benefit from trading prior to revenue recognition comment letters. We investigate whether the delayed price reaction to comment letter releases is due to investor inattention. Consistent with this explanation, we document that comment letters are downloaded infrequently from EDGAR in the days following their public disclosure.

Our study examines how the uniform rules of FIN 48, which governs accounting for income tax uncertainty, affect the relevance of income tax accounting. By requiring all firms to follow the same recognition and measurement process, the FASB intended FIN 48 to improve the relevance of income tax accounting. However, practitioners argue that reserves reported under FIN 48 lack relevance because they represent liabilities that will never be paid to tax authorities. Consistent with these concerns, we estimate that over a three-year period, only 24 cents of every dollar of reserves unwind via settlements. Moreover, contrary to the FASB's intention, we find no evidence that FIN 48 increased the ability of tax expense to predict future tax cash flows. Rather, we find that the predictive ability of tax expense for future tax cash flows decreases among firms for which FIN 48 is most restrictive. Finally, we find no evidence that investors identify firms for which reserves overstate future tax cash outflows and incorporate this into their valuations. Our results provide evidence that the uniform accounting rules of FIN 48 negatively affect the relevance of income tax accounting.

In recent years, regulators have considered several initiatives to lower the threshold for disclosing risks to investors. We examine two ways in which disclosing more risks can actually lower investors' perceptions of risk. Utilizing an experiment, we find evidence of two unintended consequences on different types of investors. First, we demonstrate that the addition of low-probability risks to a disclosure can dilute (rather than add to) more probable losses, leading certain investors to lower their perceptions of overall risk. Second, since lowering the threshold changes the overall composition of the disclosure by adding low-probability losses, firms could adopt a tactic of minimization that characterizes the entire disclosure as unimportant, presenting the lowest risks most saliently, using compliance with the low threshold as a plausible reason for giving a lengthy disclosure of generally unimportant risks. Our findings suggest that such a tactic can be persuasive. Data Availability: Contact the authors.

According to auditing standards, explanatory language added at the auditor's discretion to unqualified audit reports should not indicate increased financial misstatement risk. However, an auditor is unlikely to add language that would strain the auditor-client relationship absent concerns about the client's financial statements. Using a sample of 30,825 financial statements issued with unqualified audit opinions during 2000–2009, we find that financial statements with audit reports containing explanatory language are significantly more likely to be subsequently restated than financial statements without such language. We find that this positive association is driven by language that references the division of responsibility for performance of the audit, adoption of new accounting principles, and previous restatements. In addition, we find that (1) “emphasis of matter” language that discusses mergers, related-party transactions, and management's use of estimates predicts restatements related to these matters, and that (2) the financial statement accounts noted in the explanatory language typically correspond to the accounts subsequently restated. In sum, our results suggest that present-day audit reports communicate some information about financial reporting quality.