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In this study, we examine whether firms respond to internal control weaknesses (ICWs) by requiring accounting-specific skills when hiring rank-and-file employees. Using unique data containing an extensive collection of job postings, we document significant increases in firms’ job postings that list accounting skills after the disclosure of an ICW. This effect is more pronounced for firms with better financial resources and when ICWs are more severe or personnel-related. In addition, our results extend to employees that are not specifically designated as accountants, suggesting a broader role for rank-and-file employees in influencing internal control quality. Finally, we find that increases in job postings with accounting skill requirements are associated with improvements in internal controls and a higher likelihood of ICW remediation. Overall, our findings shed new light on how firms respond to ineffective internal controls by increasing their emphasis on accounting skills in their workforce. Data Availability: Data are publicly available from the sources identified in the text. JEL Classifications: G30; J23; M41; M42.

We examine whether delays in the expected release of annual earnings have implications for the future auditor-client relationship. Managers have strong incentives to release earnings on schedule, and auditors play an important role in helping their clients avoid costly earnings announcement delays. We find an increased likelihood of subsequent auditor-client realignments after earnings announcement delays. We further find that clients changing auditors realign with audit firms that better meet their earnings announcement timing demands, without finding evidence of a significant compromise in the reliability of the financial statement numbers in the earnings announcement. Our results help inform regulatory concerns about audit market concentration and how audit firm turnover has the potential to impact the auditor-client dynamic. While it is possible that auditor turnover could lead to a power imbalance where clients gain leverage in the relationship, our results suggest otherwise.

SYNOPSIS This study examines the effect of audit completeness at the annual earnings announcement date on audit quality and auditor/client retention decisions. The vast majority of companies now release earnings before the year-end audit is complete while, historically, companies would release earnings on or after the date of audit completion. Management's decision to release earnings when the audit is less complete can adversely impact audit quality and has negative implications for the overall auditor/client dynamic. We find that audits that are less complete at the earnings announcement date are associated with a higher likelihood of financial statement misstatements in audit areas that are typically performed toward the end of audit fieldwork. We also find a higher likelihood of auditor turnover during the following year. Taken together, the results suggest lower financial reporting/audit quality and higher auditor turnover for companies that release earnings when the audit is less complete. Data Availability: The data used are publicly available from the sources cited in the text.

Research suggests that greater earnings disaggregation in financial statements leads to favorable market outcomes. This perspective is based on a presumption that the disaggregation separates earnings components with heterogeneous characteristics. We hypothesize that the disaggregation of homogeneous earnings components is associated with greater investor disagreement and a less efficient market response to the earnings announcement. We estimate persistence regressions at the industry level and classify earnings components with persistence that differs significantly from the persistence of sales as heterogeneous and components with persistence that does not differ from the persistence of sales as homogeneous. Consistent with our hypothesis, we find a significant positive relation between the level of homogeneous earnings disaggregation and investor disagreement around earnings announcements. We also find significantly greater post-earnings announcement drift after earnings announcements with greater homogeneous earnings disaggregation. This evidence is consistent with homogeneous earnings disaggregation hindering investors’ ability to impound earnings information into price efficiently.

Over two-thirds of United States public companies now announce annual earnings prior to (versus with, or after) audit completion. We expect this practice has potential to increase pressure in auditor/client negotiations over post-announcement audit adjustments. In a controlled experiment with audit partners and senior managers, we find, in the presence of today’s typical level of audit committee engagement, auditors are significantly more likely to accept aggressive financial reporting when earnings have been released (versus drafted). Further, we test and find this effect is mitigated with strong audit committee effectiveness (i.e., including ideal, but achievable, characteristics typically currently lacking in today’s average committees). Our process-model tests find the joint effects are mediated by auditors’ directional goals such that in the absence of strong audit committees, released earnings increases auditors’ directional goals, leading to lower judgment quality. Our study provides evidence on the importance of investing in high-quality audit committees in promoting high-quality financial reporting.

This study examines the relation between audit personnel salaries and office-level audit quality. We measure audit personnel salaries at the associate, senior, and manager ranks for Big 4 audit offices from 2004 to 2013, using unique individual-auditor-level data obtained from the U.S. Department of Labor. We find that offices that pay lower salaries have a higher percentage of clients that experience restatements. In related analyses, we also find lower levels of audit quality when audit employees are paid less, relative to other lines of service in accounting firms. Finally, we document positive and significant associations between salary and fees, suggesting that audit offices pass some of the cost of higher labor onto their clients. Overall, our findings provide important initial evidence on the role of audit salary and its relation to audit quality and audit fees.

Ineffective internal controls over financial reporting often relates to a lack of qualified personnel with sufficient accounting and technical expertise. In this study, we examine whether firms respond to internal control failures by increasing their demand for specific accounting and finance skills. Using unique data containing an extensive collection of job postings, we document significant increases in firms’ demand for employees with financial skills following the disclosure of an internal control weakness. This demand effect is more pronounced among jobs requiring accounting skills or accounting software knowledge, but also extends to non-accounting personnel that interface with accounting functions, suggesting an important role for all firm personnel in remediating internal control failures. We also find that increased financial skill demand is associated with a higher likelihood of internal control remediation, especially for firms with restatements. We also provide additional evidence consistent with increased financial skill demand relating to the disclosure of a material weaknesses rather than a proactive firm response to internal control issues. Overall, our findings shed new light on how firms internally respond to ineffective internal controls by increasing their demand for financial skills in their workforce.

We comment on the Securities and Exchange Commission’s (the “Commission”) proposed Amendments to the Accelerated Filer and Large Accelerated Filer Definitions. We provide comments and analysis relating primarily to the Request for Comments in Sections II.E and III.D of the proposed Amendments (“Proposal”). Our comments relate to the provisions of the Proposal that would eliminate internal control audits required under Section 404(b) of the Sarbanes-Oxley Act for companies with annual revenue less than $100 million. Part I provides comment on the central premise of the Proposal. Part II provides comments on various aspects of the Commission’s economic analysis. Although it might be socially desirable to encourage investment, and research and development, we believe there are ways to do so without sacrificing oversight.

We examine how third party verification of internal controls over financial reporting (ICFR) affects bank supervision by exploiting a change in size thresholds for required FDICIA-related internal control audits. We document that affected banks have higher reported levels of non-performing loans after the removal of internal control audit requirements compared to unaffected banks. This increase in non-performing loans is not accompanied by increases in past due loans, indicating more forthcoming reporting by management rather than operational deterioration. Furthermore, we find that the effects are concentrated in periods of heightened regulatory scrutiny and in banks with less stringent oversight in the pre-period. Examiners increase the length of targeted examinations and downgrade regulatory ratings, indicating an increase in stringency after the elimination of third-party verification of internal controls over financial reporting. Our findings suggest that third-party verification of internal controls is an imperfect substitute for bank supervision and efforts to rely upon externally generated assurance may heighten bank risk.

We address whether SOX 404(b) internal control audits under two auditing standards regimes and SOX 404(a) management assessments are associated with improved internal control system quality, an important and largely unstudied potential benefit. In 2013, the PCAOB disclosed that 15 percent of inspected control audits were ineffective, suggesting that the current control auditing standard may not be sufficient to induce implementation of high-quality control systems. We use an indirect measure of internal control system quality—future unaudited accruals quality—to proxy for internal control quality because sustained internal control improvements should be exhibited in future quarterly financial reports unaltered by contemporaneous financial statement audits. We find that internal control audits initially provided internal control quality benefits. After the 2007 auditing standards change, internal control quality deteriorated for ICFR audited versus unaudited firms. Finally, we find limited evidence that management assessments affect internal control quality. Results indicate that recent PCAOB concerns may have merit. Data Availability: Data are publicly available from the sources identified in the text.

This study examines the role of the external audit in management's decision about the amount of GAAP financial statement information to disclose in the annual earnings announcement. The earnings announcement is a key disclosure provided by public companies. Yet, there is no requirement that earnings announcements contain audited GAAP numbers; in fact, recent trends indicate that a majority of companies release earnings before the completion of year-end audit fieldwork. I predict and find that companies that wait until the audit is more complete at the earnings announcement date and receive higher quality audits provide more detailed balance sheet, cash flow statement, and overall GAAP disclosures. I also provide evidence that complete audits and higher quality audits impact the information content of the earnings announcement. The combined results indicate that audit completeness and quality help facilitate more detailed earnings announcement disclosures and have implications for the equity market. Data Availability: Data are publicly available from sources identified in the text.

While the shareholder benefits of audits are well documented, evidence on whether audits can facilitate opportunistic behavior by corporate insiders is scarce. In this paper, we examine whether the audit process facilitates one particular form of opportunism: informed trading by corporate insiders. We focus our analysis on insider trading around the audit report date. We find an increase in trading around the audit report date and that the increase is abnormally large for firms that subsequently report modified opinions. The abnormal increase in trading is concentrated among officers and non-audit committee independent directors, and most pronounced in first-time modified opinions and modified opinions in years where financial results are subsequently restated. These trades are highly opportunistic: they predict restatements, and as a consequence, we show they avoid significant losses. Collectively, our findings provide novel evidence that insiders appear to exploit private information about the audit process––a process ostensibly designed to protect shareholders––for opportunistic gain.

This study investigates the effect of property taxes on real business decisions. Consistent with tax avoidance, we posit that personal property tax rates are associated with decreases (increases) in inventory prior to (following) assessment dates. We empirically test this prediction using both United States and Canadian monthly crude oil inventory data. We find that in locations where raw materials inventory is subject to taxation, total and refinery-level crude oil inventories are reduced prior to assessment dates and increased in the following period, when compared to locations with no (or lower) tax rates. The results provide empirical evidence that property taxes play a role in the operating decisions of firms. We also examine the pricing implications of these tax driven changes in crude oil inventory and find that the market seemingly adjusts crude oil prices around assessment dates demonstrating that the market acts as if it understands these changes in crude oil inventory are not simply due to supply/demand effects.

We document a growing disparity in earnings disclosure mechanisms. Firms are increasingly disclosing earnings announcements (EA) concurrently with the 10-K filing instead of first issuing a ‘stand-alone’ EA. Firm adoption of concurrent EA/10-Ks is associated with lower investor sophistication, greater impediments to producing timely and reliable earnings information, and greater industry-level concurrent reporting. Concurrent EA/10-Ks differ from stand-alone EAs in that investors anticipate more information in the EA, disclosures are preempted by industry peer EAs, the market reaction is muted even when controlling for EA timing, and post-earnings-announcement drift is greater.

SUMMARY We examine the impact of PCAOB Auditing Standard No. 5 (AS5) and the economic recession on risk characteristics and degree of auditor/client misalignment in the publicly traded client portfolios of Big 4 firms. AS5 and the economic recession both likely resulted in an increase in audit firm personnel capacity as well as a decline in current and future revenue prospects, leading to concerns that the Big 4 firms may pursue clients that present greater risk to the portfolio. We find that the overall portfolio in 2009 presents greater financial risk, attributable to the impact of the recession on continuing clients. A net decrease in audit and auditor business risks is also attributable to continuing clients over this period, as increases for new clients are offset by reductions due to departing clients. Overall, the results, which should be of interest to regulators, indicate that Big 4 firms continued to balance their portfolio with risk in mind. Data Availability: Data are publicly available from sources identified in the paper.

This study examines the relationship between audit personnel salaries and office-level audit quality. Audit personnel are a key input in the audit process and expectations of personnel have been increasing since the inception of the PCAOB. Despite these increased expectations and workloads, audit salaries have remained relatively flat over the past decade. Using salary data collected from H1-b visa applications obtained via the Freedom of Information Act, we measure audit personnel salaries at the Associate, Senior and Manager ranks for local Big 4 audit offices during the years 2004 to 2013. We first examine the determinants of audit personnel salaries finding that some individuals are willing to trade-off higher salaries for the opportunity to work for offices that are local market leaders and have a history of performing high quality audits. We next examine the relationship between audit personnel salaries and office level audit quality finding a negative association. That is, offices that pay lower salaries to its rank-and-file employees tend to have a higher percentage of clients that experience restatements. Finally, we examine the ability of audit offices to pass the costs of audit labor onto their clients. We document positive and significant associations between salary and fees, suggesting that audit offices pass the cost of labor onto their clients. Overall, our findings provide initial evidence on the role of audit salary and its impact on audit quality and audit fees.

While prior research generally concludes that there are significant benefits to increased earnings disaggregation within earnings announcements, we document adverse market consequences associated with the disaggregation of line items with similar characteristics. Specifically, we find significantly greater excess volume that is unproductive in terms of changing prices or providing information content (‘unproductive volume’) at the time of the earnings announcement for firms with greater operating earnings disaggregation. Our results highlight an important distinction for managers or regulators considering whether to increase disaggregation: while increasing the disaggregation of dissimilar items may be associated with favorable market outcomes (as documented in prior research), increasing the disaggregation of similar items can lead to unfavorable market outcomes. In short, more disaggregation is not always better.

We show that the conventional disclosure strategy, in which a ‘stand-alone’ earnings announcement pre-empts the SEC-mandated filing (e.g. 10-K), has been steadily disappearing over time and is instead being replaced by a concurrent earnings announcement, in which the earnings announcement and the 10-K filing are released on the same day. We document that the prevalence of concurrent earnings announcements has increased significantly over time. Importantly for investors, we find that concurrent earnings announcements are less timely and less decision useful than stand-alone earnings announcements. Specifically, we document that concurrent earnings announcements are associated with attenuated market reactions to and greater anticipation of earnings news by investors compared to stand-alone earnings announcements. Finally, we find that firms with greater impediments to producing timely earnings information are more likely to have switched from a stand-alone to a concurrent strategy. Collectively, we document a distinct divide in the marketplace, with a growing number of firms switching to the less decision useful practice of concurrent earnings announcements, relative to stand-alone earnings announcements.

This study documents that the market places more reliance on earnings announcements with a completed audit than on earnings announcements with an incomplete audit. The PCAOB’s Auditing Standards No. 2 and 3 (AS2/3) resulted in the majority of firms issuing annual earnings announcements prior to audit completion. Prior research documents an increase in earnings revisions around the implementation of AS2/3, a negative market reaction to earnings revisions, and lower investor reliance on earnings announcements that foreshadow an impending earnings revision. We argue that the issuance of earnings announcements with a completed versus an incomplete audit has a more fundamental impact on the market. Specifically, earnings announcements with an incomplete audit lead investors to perceive lower financial reporting quality and to place less reliance on the earnings announcement even in the absence of an impending or ex post earnings revision. Using both difference-in-difference and cross-sectional analyses, we find that earnings announcements with a completed audit are associated with a larger market reaction than earnings announcements with an incomplete audit. This differential market reliance on earnings announcements with a completed versus an incomplete audit persists after the implementation of AS2/3 into a more steady-state regulatory environment from 2007 through 2013.

This study investigates the effect of property taxes on real business decisions. Consistent with tax avoidance, we posit that personal property tax rates are associated with decreases (increases) in inventory prior to (following) assessment dates. We empirically test this prediction using both United States and Canadian monthly crude oil inventory data. We find that in locations where raw materials inventory is subject to taxation, total and refinery-level crude oil inventories are reduced prior to assessment dates and increased in the following period, when compared to locations with no (or lower) tax rates. The results provide empirical evidence that property taxes play a role in the operating decisions of firms. We also examine the pricing implications of these tax driven changes in crude oil inventory and find that the market seemingly adjusts crude oil prices around assessment dates demonstrating that the market acts as if it understands these changes in crude oil inventory are not simply due to supply/demand effects.