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This paper examines the role of costly audit signals in future external financing activity of financially constrained firms. We document that when facing higher financial constraints, firms pay higher audit fees and have their audit reports completed sooner. Equally important, we find that costlier and timelier audits are associated with a greater amount of future financing raised by equity-seeking, but not debt-seeking, constrained firms. Our results are robust to controlling for various audit characteristics and risk factors. Additional analyses show that equity-seeking constrained firms that underwent costlier audits exhibit more favorable outcomes with respect to long-run stock performance and investment efficiency following seasoned equity offerings. Our findings suggest that while financially constrained firms are pressured to make cuts across various expenditure categories, negotiating lower audit fees in the face of higher financial constraints may not be a wise strategy. [ABSTRACT FROM AUTHOR]

SUMMARY: The COVID-19 pandemic introduced unprecedented challenges to the audits of public companies. Audit firms, in response, dedicated significant resources to maintain high-quality audit procedures. We leverage a difference-in-differences design to examine the effects of the pandemic on audit outcomes. Despite audit firm efforts, we find evidence of a decline in audit quality in the initial months of the COVID-19 pandemic. Further, in the early days of the pandemic, the SEC made available a unique one-time, 45-day extension to file the audited annual report. In this time period, we observe a significant increase in the likelihood of delayed filings, including those attributed to the auditors' work. Our study informs regulators and audit firms about the broad impact of an unprecedented stressor on the audit process and on the efficacy of remote work. JEL Classifications: M4; M41; M42. [ABSTRACT FROM AUTHOR]

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We propose a pairwise measure of financial statement benchmarking (FSB) that captures the degree of overlap in the financial statement line items reported by two firms. We validate FSB by showing its association with actual peer choices of analysts and corporate boards. We then test the practical implications of FSB in the context of strategic peer selection by these parties. We find that analyst (board) chosen peers with low pairwise FSB are more likely to be strategic selections and that the set of peers assembled by an analyst (board) collectively having low FSB is associated with more optimistic earnings forecasts (higher CEO overpay). We also demonstrate alternative applications of FSB by aggregating the pairwise measure at the firm level and decomposing it into finer financial statement-specific components. Our evidence suggests that FSB can be a relevant tool for those using benchmarking applications, including practitioners and academics. Data Availability: Data are available from sources identified in the paper. JEL Classifications: M41. [ABSTRACT FROM AUTHOR]

SUMMARY: Limited availability of human capital data on the internal audit function (IAF) has constrained research on this topic. This study overcomes certain data limitations by using LinkedIn data from Revelio Labs. Using longitudinal data on individual IAF employees, we document that IAF experience, education, and size are associated with higher financial reporting quality. Specifically, we find that IAF competency is inversely associated with the propensity for material weaknesses and misstatements. We further document that firms respond to these adverse reporting events by investing in IAF competency, and these results are driven by improvements to IAF experience and size. Finally, we find that improvements in IAF competency are positively associated with the remediation of material weaknesses. Our findings can help internal audit leaders focus on shaping their functions and aid them in garnering support for investment in the IAF from management and the board. JEL Classifications: M40; M41; M42. [ABSTRACT FROM AUTHOR]

This study uses difference-in-differences (DiD) analyses to examine the consequences of adopting the U.S. critical audit matter (CAM) disclosure requirement for preparers and users of financial reports. The CAM requirement is one of the largest expansions of the U.S. audit report since the 1940s. We document significant changes to financial statement footnotes referenced by CAMs, which suggests an indirect consequence where management disclosure changes in areas that are expected to be scrutinized following auditor-provided disclosure. Results also suggest that, on average, CAM disclosures do not provide incremental information to the market. To further examine market reaction, we develop well-specified prediction models for the expected number and subject areas of CAMs. We find limited initial evidence that the market reacts negatively when unexpected CAMs are disclosed. Overall, our findings provide insights on the new CAM standard and particularly demonstrate its relevance to management disclosure decisions and to the market. [ABSTRACT FROM AUTHOR]

We investigate an increasingly prevalent CEO succession strategy: recruiting CEOs from the board of directors (director–CEOs). Director–CEOs might be hired in a planned succession because they combine outsiders’ new perspectives with insiders’ firm-specific knowledge. Alternatively, directors may be recruited when the board is unprepared for a leadership change. We find that unplanned successions, in which director–CEOs are appointed as a “quick-fix” solution, result in a negative market reaction, deterioration in performance, and ill-fitting candidates with shorter tenures. Conversely, firms recruiting director–CEOs in planned successions perform similarly to other firms. We find no evidence that poor firm quality drives these results. [ABSTRACT FROM AUTHOR]

SUMMARY: We contribute to the literature on auditor's task-specific expertise by examining the role of auditor experience in mergers and acquisitions (M&A), a complicated and increasingly prevalent corporate event that can give rise to misreporting. We find that in industries with more complex accounting, clients of M&A expert auditors are less likely to experience M&A-related misstatements. In industries with less complex accounting, M&A experts pass audit fee savings to their clients during acquisition years. Additional analyses suggest that firms are more likely to switch to an M&A expert auditor during an acquisition year, but only in industries with complex accounting. Overall, our results suggest that firms with an acquisitive strategy that engage with M&A expert auditors experience improved M&A-related audit outcomes. JEL Classifications: M41; M42. [ABSTRACT FROM AUTHOR]

We propose that firm complexity is best measured with accounting disclosures. Accounting is the "language of business," and accounting disclosures of most business activities are mandated. Therefore, relying on accounting disclosures is the best approach for consistently capturing a wide range of firm activities for a large cross-section of firms. Measuring firm complexity is important for many applications in research and practice. However, firm complexity is multifaceted, making it difficult to measure. We review past research on complexity and motivate the use of Accounting Reporting Complexity (ARC), proposed by R. Hoitash and U. Hoitash (2018), to measure firm complexity. In so doing, we discuss the advantages of ARC over other measures. We then review studies that use ARC and provide a detailed description and code to construct ARC (and related measures) based on publicly available data. The complete ARC dataset is also available for download at: https://www.xbrlresearch.com/. Data Availability: Data are publicly available from sources identified in the paper. ARC is based on XBRL filings downloaded directly from the Securities and Exchange Commission and is available for download at: https://www.xbrlresearch.com/. JEL Classifications: B40; D20; C10; G10; L25; M40. [ABSTRACT FROM AUTHOR]

We examine the relation between accounting reporting complexity and analysts' performance and whether analysts' qualifications, experience, and expertise in specific financial domains help them more effectively process complex information. We document an inverse relation between complexity and analysts' performance. Further, we show that analysts' firm-specific experience, industry focus, and CFA certification alleviate some of the adverse effects of complexity, whereas analysts' general experience does not appear to do so. Using an XBRL-based approach, we also develop new measures of analysts' expertise and find that expertise in the areas of fair value, derivatives and pension are more valuable than other analyst characteristics in attenuating the negative effects of complexity arising from transactions and events in these areas. Overall, this study underscores the importance of analyst characteristics and the need to simplify the complex disclosures in the notes to the financial statements. [ABSTRACT FROM AUTHOR]

SUMMARY: This study seeks to advance research related to eXtensible Business Reporting Language (XBRL). XBRL is an open standard for reporting structured financial information which enables the efficient gathering of data and automated comparison of financial information. To encourage research using XBRL we describe the richness of XBRL data and sources from which it can be obtained. We follow with a review of the literature, beginning with research examining the adoption and use of XBRL by capital market participants. Next, we discuss data quality concerns that may impact the use of XBRL data, followed by a discussion of how auditors use XBRL data and their potential role in the assurance of the data. We then present literature that uses meta and underlying XBRL data to examine financial statement characteristics and disclosure properties. Based on the review of the literature, we identify topics with the greatest potential for future research. [ABSTRACT FROM AUTHOR]

Considerable prior research investigates whether the extent of insider presence on corporate boards is detrimental. However, the majority of past research treats all inside directors as a homogenous group. This study considers that issue in the context of chief financial officers (CFO) serving on their own company's board. Our research is important because individuals in different executive roles bring different skills and knowledge to board interactions, highlighting the potential for differential contributions. As prior research does not specifically distinguish CFOs from other board insiders, the potential benefits of knowledge sharing due to increased communication with other board members may have been masked. Specifically, the CFO is directly responsible for the quality of the financial reporting process and can therefore be associated with specific outcome measures. Our results show that the percentage of CFOs serving on their own boards is not large, likely due to the perspective (consistent with agency theory and reflected in independence guidelines) that company insiders on boards could promote their own best interest at the expense of shareholders. Contrary to this perception, we find that companies whose CFO has a seat on the board are associated with higher financial reporting quality (i.e., a lower likelihood of reporting a material weaknesses in internal controls or having a financial restatement, and better accruals quality). Yet, we also find potential drawbacks in that CFOs with a board seat tend to have higher excess compensation and lower likelihood of termination following poor performance, signaling greater entrenchment. While our results provide information to companies considering appointing the CFO to the board, both costs and benefits are demonstrated, and thus we conclude that each board should consider this decision based on its own circumstances and composition. [ABSTRACT FROM AUTHOR]

PCAOB inspections repeatedly indicate deficiencies in audits of fair-value (FV) estimates, prompting regulators to improve the related auditing standards. We predict that auditor task-specific FV expertise, gained from work experience during the audit of FV measurements, can contribute to higher audit quality. Utilizing FV-related restatements and comment letters, we find that expertise in auditing Level 3 FV estimates at the office level is associated with greater FV audit quality. Level 2 FV expertise or national level FV expertise is not associated with higher FV audit quality. Following the receipt of a comment letter, we further find that auditor FV expertise is associated with lower comment letter remediation costs and higher FV disclosure quality. Finally, we find that the value relevance of Level 3 FV disclosures increases with the extent of auditor FV expertise. Collectively, our results highlight that auditor fair value expertise contributes to the credibility and usefulness of FV disclosures. [ABSTRACT FROM AUTHOR]

The article investigates the relationship between executive compensation and nonfinancial performance measures, particularly focusing on the link between chief financial officer (CFO) compensation and the economic impact of a disclosure of internal control material weakness (ICMW). It addresses the responsibility of CFOs for internal controls and the use of internal control effectiveness in CFO evaluation and compensation. It notes the impact of strength of governance on CFO compensation changes, as well as comments on the effects of misreporting financial information.

SYNOPSIS: We use new data to examine auditor response to negative media coverage of client environmental, social, and governance (ESG) practices. This coverage can be indicative of an increased risk of material misstatement, which is an important assessment in client retention and pricing decisions. Specifically, media criticism can threaten a client's financial condition, as well as reveal management effectiveness and integrity issues that are further compounded by negative attention and related financial problems. We therefore predict that auditors will notice and incorporate media-provided ESG information in their risk response, which has not been examined by prior research. Supporting this prediction, we find that ESG-related negative media coverage of an audit client is associated with a higher likelihood of auditor resignation and increased audit fees. This response is incremental to the issues that underlie this media coverage. Overall, these findings identify an additional economic incentive for companies to avoid poor ESG practices. [ABSTRACT FROM AUTHOR]

SUMMARY: This paper investigates the overall impact of and the information made available by the recent audit partner disclosure requirement in the U.S. After a contentious comment period, the PCAOB released Rule 3211, which requires registered public accounting firms to disclose the name of the audit partner for every audit report it issues. In the first year of adoption, we find a significant increase in audit quality and audit fees and a significant decrease in audit delay. We collect information on partner gender, busyness, education, and social connections to explore whether these newly observable characteristics are associated with audit outcomes. We find that several of these characteristics are associated with variations in audit fees and audit delay, but no evidence of an association with audit quality. Overall, our findings suggest that the disclosure of partner name in Form AP enhances the audit information environment, which supports PCAOB motivation for Rule 3211. [ABSTRACT FROM AUTHOR]

This paper explores an increasingly prevalent element of board-level commitment to sustainability. We propose a theoretical framework under which the existence and associated actions of board-level sustainability committees are motivated by shared value creation, where the interests of a diverse group of stakeholders are satisfied and sufficient profit is achieved. Using hand-collected data, we find that sustainability committees are heterogeneous in focus and vary in their effectiveness. Specifically, we disaggregate the sustainability committee construct based on stakeholder group focus (i.e., community, employee, environment, and consumer/supplier) and find that associations between sustainability committees and performance outcomes are stronger when committees focused on a specific stakeholder group are paired with relevant performance outcomes. We generally find that sustainability committees are effective at impacting relevant strengths, but do not mitigate relevant concerns. These results are consistent with the shared value framework, where committees both generate value by pursuing sustainability-related opportunities and protect value by monitoring, but not necessarily mitigating sustainability-related risks. Univariate tests suggest that effective committees are also larger, more independent, and meet more frequently. Finally, we propose a new method to classify industries based on their sensitivity to certain stakeholder groups and find that the effectiveness of committees focused on specific stakeholders is more pronounced in industries that are sensitive to these stakeholders. [ABSTRACT FROM AUTHOR]

SUMMARY: Voting in directors' elections is one of few mechanisms by which shareholders can influence corporate governance choices. We study elections of directors who serve on the audit committee (AC), a topic receiving little attention in past work. Our results show that AC members, especially those who do not serve on the compensation or nominating committees, receive greater shareholder support than other independent board members. We further find that among AC members, more qualified members, in terms of accounting expertise, receive greater support, while AC chairs without such expertise receive lower support. In addition, when the AC is less effective in monitoring the financial reporting process, its members receive lower shareholder approval, while other independent board members are less affected by these same financial reporting factors. Finally, when the AC is less effective, all of its members receive lower support, irrespective of their expertise or position within the committee. [ABSTRACT FROM AUTHOR]

Recent surveys indicate that industry expertise is the most sought-after director qualification. Yet evidence on the value of such expertise is limited. This paper shows that firms that are difficult for non-experts to monitor and advise are more likely to appoint industry expert directors. Such appointments also depend on the supply of industry-experienced candidates in the local director labor market. Board industry expertise reduces R&D-based real earnings management and increases R&D investments. The increase in R&D spending is value-enhancing: firms with industry expert directors receive more patents for the same level of R&D, their R&D spending is associated with lower volatility of future earnings, and their value is higher. Finally, industry expertise is associated with CEO termination and pay incentives that encourage R&D investments. [ABSTRACT FROM AUTHOR]

We propose a new measure of accounting reporting complexity (ARC) based on the count of accounting items (XBRL tags) disclosed in 10-K filings. The preparation and disclosure of more accounting items is complicated because it requires greater knowledge of authoritative accounting standards. This aspect of complexity can increase the likelihood of mistakes, incorrect application of GAAP, and can ultimately lead to less credible financial reports. Consistently, we find that ARC is associated with a greater likelihood of misstatements and material weakness disclosures, longer audit delay, and higher audit fees. In comparison to commonly used measures of operating and linguistic complexity, the associations between ARC and these outcomes are more consistent, exhibit greater explanatory power, and have stronger economic significance. These and additional validation and robustness tests suggest that ARC more completely reflects accounting complexity. In addition, ARC exhibits several advantageous properties, including across- and within-firm variation, availability for the universe of SEC filers, and a direct connection to accounting, inherent in its derivation from detailed accounting disclosures. Finally, because it relies on a comprehensive set of detailed accounting data, ARC broadly captures accounting complexity, while, at the same time, it can be disaggregated into account-specific measures of complexity. [ABSTRACT FROM AUTHOR]

We examine whether shareholder votes can influence the audit committee and whether this influence is uniform across non-staggered and staggered boards. We find that through voting, shareholders can increase the efficacy of the audit committee, leading to improvements in audit committee structure, diligence, and financial reporting quality. These results hold only in firms with non-staggered boards, underscoring the need to separately examine staggered and non-staggered boards. Importantly, the non-responsiveness of staggered audit committees to shareholder disapproval presents an additional explanation for the weaker performance that is often documented for firms with staggered boards. Overall, our results support the movement to de-stagger boards. [ABSTRACT FROM AUTHOR]

Calls from practice suggest that audit committee members with industry expertise can improve audit committee effectiveness. Nevertheless, regulators and the extant literature have focused on the financial expertise of the audit committee. We posit that audit committee industry knowledge is valuable because accounting guidance, estimates, and oversight of the external auditor are often linked to a company's operations within a particular industry. Taking a holistic view, we examine two measures of financial reporting quality (financial restatements and discretionary accruals) and two measures of external auditor oversight (audit and nonaudit fees). As predicted, we find that audit committee members who are both accounting and industry experts perform better than those with only accounting expertise. We also find that in certain instances, supervisory experts who are also industry experts perform better than supervisory experts alone. Overall, these results suggest that industry expertise, when combined with accounting expertise, can improve the effectiveness of the audit committee in monitoring the financial reporting process. [ABSTRACT FROM AUTHOR]

This paper investigates remediation of Sarbanes-Oxley Section 404 material weaknesses (MWs). Prior research examines full remediation of all MWs or broad categories thereof. We build on these studies by investigating remediation of specific types of MW, thus measuring progress in improving controls made by companies that have not fully remediated all problems. Specifically, we investigate whether specific MW types differ in remediation likelihood and in the association of remediation with earnings quality. Results show that remediation rates of specific MW types vary, and that remediation of specific types is differentially associated with availability of company resources and corporate governance quality. We also find that remediation of some MW types is significantly associated with changes in abnormal accruals (e.g., entity-level problems in reconciliation and information technology, along with account-specific problems in revenue and tax). Finally, results show that problems remaining unremediated for two years are significantly associated with increased abnormal accruals, regardless of type. [ABSTRACT FROM AUTHOR]

This paper examines whether independent directors who have social ties to management (inside directors) can effectively perform their fiduciary duty to monitor management on behalf of shareholders. Ex ante, it is not clear whether social ties will enhance or obstruct the quality of board performance. Theory suggests that directors who are socially tied to management are ineffective and would make decisions favoring management. However, social ties can increase trust and information sharing between management and independent directors, improving directors' ability and effectiveness in governing the company (Westphal, J.D.: , The Academy of Management Journal 42(1), 7-24). To examine these contradicting predictions I use social network analysis and construct proxies for social ties between management and independent board members. Using these proxies, I first demonstrate that social ties are associated with higher managerial compensation. Further analyses reveal that these results are driven by social ties that include members of the compensation committee. Conversely, I demonstrate that financial reporting quality is improved when social ties exist. Specifically, I find that the likelihood of material weaknesses in internal controls and the likelihood of financial restatements are lower in companies with social ties. I further observe that this improved quality of financial reporting holds only when social ties include members of the audit committee. I conclude that ethically, socially tied independent directors should disqualify themselves from serving on compensation committees where social independence is essential. However, in tasks where collaboration with management is essential, directors with social links to each other can be of added value to shareholders. [ABSTRACT FROM AUTHOR]

Securities regulators around the world are considering the costs and benefits of alternative policies for providing information to financial markets on corporate internal control. These policy options differ on the level of auditor involvement, among other dimensions. We examine the association of relative auditor involvement and auditor characteristics with Section 302 internal control disclosures made by US ‘non-accelerated filers’ from 2003 to 2005. We find more material weaknesses disclosed in the fourth quarter, when there is relatively more auditor involvement, relative to the first three quarters. Clients of larger audit firms have higher disclosure rates (although they are probably less risky due to more stringent client acceptance standards), but this difference is due to fourth quarter disclosures. Audit firms with Section 404 experience also have greater material weakness disclosure, implying process improvement associated with knowledge sharing across engagements. Collectively, our results shed light on ways to increase the effectiveness of internal control regulation. [ABSTRACT FROM AUTHOR]

This study examines the association between corporate governance and disclosures of material weaknesses (MW) in internal control over financial reporting. We study this association using MW reported under Sarbanes-Oxley Sections 302 and 404, deriving data on audit committee financial expertise from automated parsing of member qualifications from their biographies. We find that a lower likelihood of disclosing Section 404 MW is associated with relatively more audit committee members having accounting and supervisory experience, as well as board strength. Further, the nature of MW varies with the type of experience. However, these associations are not detectable using Section 302 reports. We also find that MW disclosure is associated with designating a financial expert without accounting experience, or designating multiple financial experts. We conclude that board and audit committee characteristics are associated with internal control quality. However, this association is only observable under the more stringent requirements of Section 404. [ABSTRACT FROM AUTHOR]

The board of directors is an elite group that faces multifaceted tasks. The board needs to implement decisions on a wide variety of subject matter. These decisions are often delegated to specialized sub-committees within the board. The different objectives of each sub-committee can result in conflicting interests leading to decisions that are sub-optimal. For example, at times, the objectives of the compensation and the audit committee are not aligned. The objective of compensation committees is to grant CEOs compensation packages reflective of their performance. Yet, these compensation packages might contain incentives that could motivate CEOs to influence the financial reporting process in order to reflect better performance, increasing the risk of poor quality financials. In contrast, the objective of audit committees is to oversee the quality of the financial reports and the process that leads to them. Therefore, they would favor compensation packages that reduce the risk of earnings manipulation. We examine public companies that have overlapping compensation and audit committee members and find a higher proportion of CEO incentive compensation in companies with less overlap among audit and compensation committee members. These results suggest that separating the members within these committees might contribute to the effectiveness of board decisions. [ABSTRACT FROM AUTHOR]

This paper extends prior research on audit risk adjustment by examining the association of audit pricing with problems in internal control over financial reporting, disclosed under Sections 404 and 302 of the Sarbanes-Oxley Act [SOX]. While studies of auditors' responses to internal control risk provide mixed evidence, it is important to re-examine this issue using data on specific client problems not available prior to SOX. As a baseline, we first establish a strong association of audit fees with internal control problems disclosed in the first year of implementation of Section 404, consistent with prior research (e.g., Raghunandan and Rama 2006). We then address two issues on which prior results are contradictory. In a broadly based sample of accelerated filers, we find that audit pricing for companies with internal control problems varies by problem severity, when severity is measured either as material weaknesses versus significant deficiencies, or by nature of the problem. Also, while audit fees increase during the 404 period, our tests show less relative risk adjustment under Section 404 than under Section 302 in the prior year. Further examining intertemporal effects, we find that companies disclosing internal control problems under Section 302 continue to pay higher fees the following year, even if no problems are disclosed under Section 404. Overall, our findings provide detailed insight into audit risk adjustment during the initial period of SOX implementation. [ABSTRACT FROM AUTHOR]