Did the PCAOB's 2009 Office Expansion Improve Audit Quality?*

We investigate whether the PCAOB's decision to expand the number and location of its inspection offices in 2009 improved the reliability of US audits. We use a difference-in-differences empirical design to consider the impacts of the expansion on audit quality and find that audit quality significantly improved following the PCAOB's expansion in markets where new offices opened relative to markets without an office opening. We find that the improvement in audit quality appears to be driven by auditors' reaction to real changes in PCAOB oversight and that triennially inspected auditors appear to be impacted the most by this office expansion. Our findings provide new insights into the PCAOB's operational decision-making and suggest that the regulator's additional investment in audit oversight was effective in improving audit quality.     

Endogeneity and the Dynamics of Voluntary Disclosure Quality: Is there Really an Effect on the Cost of Equity Capital?*

Research on the effects of voluntary disclosure quality on the cost of equity capital is often plagued by endogeneity concerns. In this paper, I use a dynamic panel system GMM estimator, which provides internal instruments from the firm's history that directly address endogeneity arising from unobserved heterogeneity and simultaneity. By using hand-collected voluntary disclosure scores for firms listed in the Swiss stock exchange, I examine the dynamic relation between voluntary disclosure quality and the cost of equity capital in a panel over a period of 10 years. The results suggest that the relation between voluntary disclosure quality and the cost of equity capital becomes insignificant after controlling adequately for potential dynamic endogeneity, simultaneity, and unobserved heterogeneity.     

When Do Firms Adjust Bonus Targets Intrayear? Evidence from Sales Executives' Targets*

This study investigates when and why intrayear bonus target revisions occur. This is important as intrayear target revisions occur regularly in practice but are not well understood. Specifically, we analyze two potential drivers of intrayear bonus target revisions: reduced managerial incentives owing to managers dropping out of the incentive zone of their piecewise defined bonus function and potential spillovers from planning target revisions that reflect changes in performance expectations during the year. We also investigate the effects of organizational characteristics on intrayear bonus target revisions. Using data collected from sales executives via multiple waves of surveys, we find evidence for both predicted drivers. In addition, consistent with our predictions, we find that the levels of delegated decision authority, intrafirm interdependencies, and information asymmetry negatively moderate the positive association between reduced managerial incentives and revision likelihood. Our paper contributes to the target setting literature by being the first study to investigate intrayear bonus target revisions and shed light on when firms commit to not revising such targets intrayear.     

Do Shareholders Assess Managers' Use of Accruals to Manage Earnings as a Negative Signal of Trustworthiness Even When Its Outcome Serves Shareholders' Interests?*

We examine how shareholders' trust in managers is affected by (i) the outcome of earnings management (inconsistent vs. consistent with shareholders' interests) and (ii) the method of earnings management (accruals vs. real methods). Using a controlled experiment, we predict and find that trust is impaired when the outcome of earnings management suggests that managers have put their interests above shareholders' interests and/or when the method of earnings management suggests that managers misreported the firm's economic performance. We argue that shareholders assess managers putting their interests above shareholders' interests as a signal of untrustworthiness because it involves a transfer of the firm's resources away from shareholders to managers. We argue that shareholders also assess managers' use of accruals to manage earnings as a signal of untrustworthiness because, in this instance, managers misreport the firm's economic performance. Finally, we show that trust mediates the combined effects of the outcome of earnings management and the method of earnings management on investment decisions. Our study incrementally contributes to the literature by highlighting the adverse implications of managers' use of accruals to manage earnings even when its outcome serves shareholders' interests.     

Auditing Goodwill in the Post‐Amortization Era: Challenges for Auditors

The elimination of goodwill amortization in 2001 brought about significant change in how companies are required to account for goodwill. This change in accounting also brought with it new challenges for auditors, namely evaluating the reasonableness of management's assumptions related to goodwill valuation. In addition to introducing technical challenges, this task is particularly difficult given the misalignment in incentives it creates between managers who likely prefer to avoid recording an impairment and auditors who seek to minimize the bias in management's impairment testing. This study focuses on the consequences of the misaligned incentives that auditors face under the current goodwill assessment process. We find that the decision to record a goodwill impairment is associated with an increase in the probability of auditor dismissal. Consistent with the presence of significant friction with clients, our results also indicate that the likelihood of auditor dismissals is negatively related to the favorability of the impairment decision. Furthermore, we find that companies impairing goodwill prior to dismissing auditors subsequently employ auditors that are, on average, more favorable to clients in their impairment decisions.     

Do Accounting Firm Consulting Revenues Affect Audit Quality? Evidence from the Pre‐ and Post‐SOX Eras

In recent years, public accounting firms have experienced a steady increase in the proportion of their revenues generated from consulting services. Although growth in consulting revenue following the Sarbanes‐Oxley Act (SOX) has been generated primarily from services provided to nonaudit clients, regulators have expressed concerns about the potential implications of this increase for audit quality. In contrast, accounting firms assert that the expertise developed by their consulting professionals helps them to provide better quality audits. We examine the relation between the proportion of accounting firm consulting revenue to total revenue and audit quality and investor perceptions of audit quality. Because SOX drastically altered the source of consulting revenues for public accounting firms, we also separately examine these relations in the pre‐ and post‐SOX eras. We find evidence suggesting that before SOX, higher proportions of audit firm consulting revenues negatively impacted both audit quality and investor perceptions of audit quality. However, we do not find a statistically significant association between audit firm consulting revenues and either audit quality or investor perceptions of audit quality following SOX. Our analyses suggest that even if these relations exist following SOX, the potential economic magnitude of the effect is small.