Journal of Accounting,Auditing & Finance

In this study, we examine whether and how SEC regulators adjust their oversight processes when there are conflicting risks, specifically among sin stock firms operating in potentially controversial industries, such as alcohol, gaming, and tobacco. On the one hand, we would expect increased scrutiny from SEC staff if they believe that companies willing to offer these sin-related products and services are more likely to skirt SEC disclosure guidelines. On the other hand, if the SEC staff leverage the additional scrutiny these firms are already subjected to from investors, industry regulators, and auditors, we would expect decreased scrutiny from SEC staff. Consistent with the latter, we observe that the SEC is less likely to issue comments on the annual report of sin stock firms. Among those receiving a comment letter, there are no statistically significant differences in rigor or tone, on average. In additional analyses, we find limited evidence that specific reviewer characteristics are associated with differential treatment for sin stock firms in terms of rigor. Finally, we find that among firms that did not receive a comment letter, sin stock firms are less likely to restate their financial statements in the future. Collectively, we interpret this evidence as the SEC efficiently reducing scrutiny on sin stock firms, relative to non-sin stock firms, during the earlier phases of the review process, with minimal differences in the later phases of the review process.

In this study, we explore the expanded role of chief financial officers (CFOs) in facilitating corporate disclosure by examining how their accounting expertise influences the resolution process of Securities and Exchange Commission (SEC) comment letters issued on 10-K reports. Using CFO professional profile data collected extensively through EDGAR, Lexis-Nexis, and several online searches, we find that CFO accounting expertise improves the resolution of SEC comment letters by reducing the remediation costs and the likelihood of unfavorable resolution outcomes. We also show that the effect of CFO accounting expertise is more pronounced when the CFO’s involvement in the resolution process is greater, and the SEC comment letter includes comments on accounting topics. Our findings are robust to a battery of robustness tests. Overall, this study highlights the importance of CFOs’ role and function in regulatory compliance.

JEL codes: G14; G30; M40; M41; M48

Using a comprehensive measure, the Macroeconomic News Index (MNI), we examine how analysts use macroeconomic news in their earnings forecasts. We find that analysts incorporate but underreact to quarterly macroeconomic news. Cross-sectionally, analysts’ reaction to macroeconomic news varies in a predictable way. Analysts incorporate macroeconomic news more efficiently when firms have lower exposure to the macro economy, when macroeconomic uncertainty is low, and when analysts have more industry-specific experience. Finally, we examine the implications of macroeconomic news on earnings formation and stock returns. We find that quarterly MNI is informative about the procyclicality of firms’ sales and costs and analysts underreact only to sales-side information. We also document that quarterly MNI is predictive of subsequent earnings announcement returns, indicating that investors also underreact to macroeconomic news.

JEL Classifications: G12; G14; G24

We investigate whether a proactive reputation-building strategy exists in misreporting firms and study the effect of such a strategy on misreporting managers. Using a sample of fraudulent U.S. firms from 2000 to 2013, we find that firms significantly increase their proactive corporate social responsibility (CSR) activities during periods when they misreport financial information. This finding is consistent with anecdotal evidence that firms may opportunistically invest in CSR reputation-building. We then examine the effects of this strategy on misreporting managers and find that (a) it delays the detection of misreporting, and (b) it reduces the possibility of forced CEO turnover upon the discovery of financial misreporting. Collectively, our results provide empirical evidence that managers could use proactive CSR strategies for self-serving purposes. This finding merits the attention of both researchers and regulators.

JEL Classifications: M14; M41; G34

Recent research provides evidence consistent with tax-motivated income shifting taking place in Big 4 networks. Non-Big 4 networks have global footprints and audit a significant proportion of private-firm clients. Thus, we cannot make sense of audit-firm networks’ tax avoidance proclivities and the impacts their tax advice may have on aggregate client-firm income-shifting figures without examining non-Big 4 affiliates’ tax planning strategies. This study uses a private-firm dataset of Big 4 and non-Big 4 associated firms from 26 European countries finding evidence consistent with non-Big 4 affiliates being more aggressive income shifters than their Big 4 counterparts. Using a battery of supplemental analyses we demonstrate that the negative association between Big 4 membership and tax-motivated income shifting is weaker when network exposure to the political costs of aggressive tax planning is lower. We also show that political cost considerations are more likely to moderate debt allocation policies in Big 4 than non-Big 4 networks. Our findings suggest that political cost considerations are an important driver of the relation between Big 4 affiliation and tax-motivated income shifting even in our setting where firm size is strongly positively associated with tax expertise, political power, and global footprint and have important implications for anti-avoidance legislation.

This paper examines the role of supply chain common institutional investors (i.e., who own stocks of both upstream suppliers and their downstream customers in a supply chain) in the valuation of upstream supplier firms’ order backlog information. Based on the theory and evidence that backlog orders’ predictive power is diminished further in a supply chain due to the bullwhip effect, we hypothesize and find that the overpricing of order backlog is mainly driven by upstream rather than downstream firms. More importantly, we use both hedge portfolio methods and Fama-MacBeth regressions to show that common institutional investors in a supply chain can utilize their knowledge to better incorporate the bullwhip effect and mitigate the magnitude of order backlog mispricing. Further, we find that the overpricing of second-tier suppliers’ backlog orders and thus, the role of supply chain common institutional investors is more pronounced during expansion periods than during recession periods. Overall, we highlight the role of institutional supply chain knowledge in improving pricing efficiencies of complex supply chain dynamics.

This research investigates how bank regulation, specifically the stress test conducted by the Federal Reserve (FED), influences the financial reporting decisions of borrowers. Previous studies indicate that the FED’s stress test can lead to a reduction in credit supply and stricter lending standards for banks. Expanding on this body of literature, our study shows that the impact of the stress test reaches beyond lenders, prompting borrowers to embrace increased conditional conservatism in their financial reporting. This spillover effect is particularly pronounced for riskier borrowers. Our findings suggest a far-reaching impact of FED regulation on firms’ financial reporting choices. Further analysis indicates that borrowers transitioning from tested banks to untested banks experience higher interest rates following the stress test, highlighting an extended spillover effect on borrowers.

We provide direct evidence that analysts engage in information discovery, and that investors value this discovery. The innovation in our article is to read through the summaries of over 3,500 analyst reports to identify whether analysts engage in discovery and/or interpretation. Analysts discover new information from management sources (example: personal meetings) and non-management sources (example: channel checks). Information discovery is prevalent in 17% of the reports. Investors react more strongly to analyst reports containing changes in price targets or Earnings per Share if those reports are accompanied by information discovery. Economic determinants predict whether a report contains discovery.

Using the staggered changes in unemployment insurance (UI) benefits across states in the United States as an exogenous shock to employees’ costs of unemployment and the hiring firm’s costs of disclosure, this study investigates whether and how a firm’s relationship with its employees impacts its strategic disclosure through press releases. We find that firms increase (reduce) bad (good) press releases after their employees’ UI benefits become more generous. This finding is consistent with the notion that larger UI benefits reduce the costs of employee unemployment risk borne by hiring firms and thus reduce firms’ costs to release bad news items. Interestingly, we find that the large increase in UI benefits is associated with more discretionary, but not nondiscretionary, bad press releases. The findings are robust when we exclude earnings-related press releases from our sample. Further evidence shows that the increase in negative press releases is mainly driven by news regarding earnings, products-services, marketing, credit ratings, assets, and legal issues, which are more closely related to employee perceptions of unemployment risk.

JEL classification : G10; M41; J31; J65.

This article offers the novel insight that loan pricing is affected by the redeployability of borrowers’ capital assets and labor. We find that both capital and labor redeployability are negatively related to loan spread, suggesting that borrowers with higher redeployability enjoy more favorable loan pricing. This finding is consistent with redeployability promoting reduced cost stickiness and enhanced liquidity, which in turn reduces borrowers’ probability of default and lenders’ loan losses given default. Our cross-sectional test results reveal that the relation between redeployability and loan pricing is stronger for firms with more growth opportunities, which is consistent with lenders viewing redeployability as an important way to minimize potential loan losses from risky investments. Also, the relation between redeployability and loan pricing is weaker for loans with more stringent nonpricing terms, suggesting that strict terms may protect lenders and make redeployability less important in loan pricing.

JEL Classification: D22, G21, G32, J62.

We study the impact of internal control disclosure in a model in which a client company privately invests corporate resources in its internal control system that subsequently determines its financial reporting precision. Without internal control disclosure, the capital market cannot observe the precision and must price the client value based on its conjecture. With internal control disclosure requirements, the effectiveness of internal controls is disclosed, which reveals the precision to the market. Thus, internal control disclosure provides the client with another channel to influence the market pricing. Contrary to the conventional wisdom, we find that the client tends to invest less in its internal control system with disclosure requirements. As a result of lower precision, internal control disclosure may lower the informativeness of audited financial reports, albeit ex-post communicating more information to the market. We also find that internal control disclosure reduces the client’s ex-ante payoff when the auditor bears a high misstatement cost due to audit failure.

JEL Classification: M41, M48

We examine whether labor skills affect managers’ income-smoothing activities. We hypothesize firms that rely on skilled labor have greater incentives to smooth earnings to reduce labor turnover and facilitate replacements. Consistent with our hypothesis, we find that firms’ labor skills are positively associated with managers’ income-smoothing activities. Leveraging the staggered rejection of the Inevitable Disclosure Doctrine (IDD) by 16 U.S. states, which exogenously increases external job opportunities for high-skill employees, we find that the positive relation between labor skill and income smoothing is stronger for firms in the IDD rejection states. Our results are also stronger during nonrecession periods characterized by higher differential costs of turnover between high-skill and low-skill employees and robust to controlling for employees’ education. The mechanism for the positive relation between labor skills and income smoothing is attributable to the higher cost incurred by firms in the turnover of high-skill labor compared with low-skill labor and is consistent with the information-garbling story. Furthermore, we show that future employment volatility decreases with income smoothing. Collectively, our findings are consistent with the view that income smoothing stabilizes skilled workers’ employment by reducing turnover and facilitating the hiring of replacements.

JEL classification: J24; G30; M41; M54.

This study examines whether the issuance of capital expenditure forecasts facilitates debt contracting by acting as a commitment to not engage in the expropriation of lenders through opportunistic investment activities. We find that firms with higher leverage and lower credit quality are more likely to issue capital expenditure forecasts. Furthermore, for firms that issue capital expenditure forecasts, loan spreads are lower and investment efficiency is greater, and these associations are stronger when the forecasts are more credible. We do not find similar results for earnings forecasts. When comparing the roles of capital expenditure covenant (which typically specify the upper limit of the allowed amount) with capital expenditure forecast, we find that the former reduces overinvestments and the latter reduces underinvestments. These results suggest that capital expenditure forecasts can be a commitment mechanism to reduce contracting costs with creditors.

JEL Classification: G31; M4

This study explores the effects of partnership disparity within Chinese audit firms on audit quality using novel data on their partnership arrangements. The results indicate a U-shaped relationship between the partnership disparity extent and the violations assessed by regulators, including financial misstatements of clients. Audit firms with mid-level unequal partnership structures achieve superior audit quality than their counterparts with either “flat” or “high-skewed” partnership structures. Additional analyses confirm the role of client complexity as the boundary condition and indicate that the geographical remoteness of audit firms asymmetrically moderates partnership disparity. These results are robust to different audit quality proxies and alternative research designs including change analyses and after controlling for the effects of engagement partners. This study contributes to research on diversity and performance in the partnership context. This approach opens the “black box” of power-related culture in audit firms and carries managerial implications for the managing partners and audit regulators of audit firms.

The professional literature has provided evidence of discrimination against ethnic minority professionals in a number of research contexts, including law, architecture, construction, and health care. However, research on ethnicity-based discrimination in the accounting profession has been sparser and has generally relied on ethnic minorities’perceptions of discrimination rather than actual discrimination. In this study, we complement and extend this research by investigating whether ethnic minority audit partners are associated with lower audit fees than nonethnic minority audit partners. We also consider whether the association between ethnicity and audit fees depends on the status of the audit firm in which audit partners work. We find that ethnic minority audit partners are associated with lower audit fees and that this holds true only when they work in lower-status audit firms. Supplementary analyses carried out on our data suggest that discrimination is more likely to be performed by audit clients than by audit firms as we do not find evidence that audit firms systematically and selectively allocate ethnic minority audit partners to clients with specific characteristics (e.g., potentially less lucrative clients). Our study contributes to the literature on ethnicity-based discrimination in the accounting profession, to the literature on professional stereotypes, and to the audit pricing literature.

JEL Classification: C33, J71, M42.