Nonprofessional investors' perceptions of the incremental value of continuous auditing and continuous controls monitoring: An experimental investigation

In this study, we investigate nonprofessional investors' perceptions of the incremental value of additional assurance provided by continuous auditing (CA) and continuous controls monitoring (CCM) relative to traditional periodic auditing. We also examine whether nonprofessional investors' perceptions of incremental value of CA and CCM depend on whether the procedure is performed by internal or external auditors, given that external auditors are likely to be perceived as more independent and objective than internal auditors. We conduct two experiments, one using 120 nonprofessional investors recruited by a national survey company, and the second using 184 participants recruited via Amazon's Mechanical Turk platform. The first experiment employed a 2 × 2 between-participants design in which we manipulate the type of assurance (CA or CCM) and the source of assurance (internal or external auditors). The second experiment was identical to the first experiment, with the addition of a fifth condition to test a conjecture stemming from the results of the first experiment. The results from both experiments indicate that although nonprofessional investors believe that continuous auditing decreases the likelihood of material errors and asset misappropriation, nonprofessional investors do not concomitantly increase their investment upon learning about the implementation of these sophisticated continuous assurance techniques. Evidence from the second experiment provides support for the contention that the reason why nonprofessional investors do not increase their investment pursuant to implementation of CA or CCM is due to the salience of the additional costs of these techniques. These results have important implications for firms considering the implementation of additional assurance procedures such as CA and CCM.     

Pro forma accounting disclosures: The effect of reconciliations and financial reporting knowledge on nonprofessional investors' judgments

Regulation G requires companies that report non-GAAP or “pro forma” earnings provide a reconciliation. While nonprofessional investors are a large, heterogeneous population with varying degrees of financial reporting knowledge, previous research treats them as a homogenous group. The study examines how differences in financial reporting knowledge and information viewing behavior affect the influence of reconciled pro forma earnings disclosures on nonprofessional investors' judgments. Lower-knowledge investors appear to incorporate information on differences between GAAP and pro forma earnings in their judgments as long as they view this information in the reconciliation. However, higher-knowledge investors appear to consistently incorporate information on differences between GAAP and pro forma earnings in their judgments regardless of the relative amount of time they spend viewing the reconciliation relative to other disclosures. Our results suggest that knowledge differences influence how nonprofessional investors acquire and use information on differences between GAAP and pro forma earnings.     

Financial statement presentation of discontinued operations: Determinants and consequences

US GAAP requires firms to separately report income from discontinued operations within the income statement. Current financial reporting guidance, however, allows managers to either aggregate or disaggregate operating income (or loss) and gain (or loss) from discontinued operations on the face of the income statement. Using this unique setting, we hand-collect data on the presentation of discontinued operations (i.e., aggregated versus disaggregated presentation) to understand factors that affect the discretionary presentation choices in financial statements. We show that managers' disaggregation preference in reporting discontinued operations reflect properties of prospect theory and mental accounting theory. We fail to find empirical evidence that investors' valuation of discontinued operations is different for aggregated and disaggregated presentations. These results should help managers, regulators, and investors understand the implications of discontinued operations' presentation choices in financial reporting.     

Level of business insights in the MD&A and nonprofessional investors' judgments

This study examines how the level of business insights in a firm's MD&A interacts with its current financial performance to influence nonprofessional investors' judgments. Following the observations and guidance of the ASIC and SEC to define low‐and high‐insight MD&A, this study finds that low‐insight MD&A, when provided for a negative earnings surprise, increases investors’ judgments of the negative earnings persistence and hurts management reputation more than if no MD&A had been provided. High‐insight MD&A, when including a plausible external attribution, increases investors’ judgments of management reputation in the negative earnings surprise condition and decreases investors’ judgments of positive earnings persistence.     

The effects of disclosing critical audit matters and auditor tenure on nonprofessional investors’ judgments

In an effort to provide more meaningful information to financial statement users, the Public Company Accounting Oversight Board (PCAOB) recently adopted sweeping changes to the audit report, requiring the audit firm to disclose whether or not it identified a critical audit matter (CAM) and its tenure with the client. To our knowledge, ours is the first study to explore how nonprofessional investors’ judgments are influenced by (1) the relative effects of a CAM disclosure versus a disclosure that the auditor did not identify a CAM, and (2) the disclosure of the audit firm’s tenure. We find that, relative to disclosing that no CAMs were identified, disclosing a CAM reduces investment intentions. We do not find a significant effect of tenure disclosure on investment intentions, despite evidence that participants attended to and understood the tenure manipulation. Concerning investors’ cognitive processes, we find that perceptions of both risk of material misstatement and management disclosure credibility mediate the effect of CAM disclosure on investment intentions, while perceived audit quality suppresses this effect. Our contributions include furthering the understanding of cognitive mechanisms through which CAM disclosure influences investment intentions, identifying a relatively unique setting in which perceptions of management disclosure credibility and audit quality move in opposite directions, and providing evidence that auditor tenure disclosure does not appear to affect investment intentions. Our findings should be of interest to regulators, auditors, issuers, and investors.     

Individual and institutional herding and the impact on stock returns: Evidence from Taiwan stock market

Using high frequency intraday data, this paper investigates the herding behavior of institutional and individual investors in the Taiwan stock market. The study finds evidence of herding by both investors but a stronger herding tendency among institutional than among individual investors. Institutional investors herd more on firms with small capitalizations and lower turnovers and they follow positive feedback strategies. The portfolios that institutional investors herd buy outperform those they sell by an average of 1.009% during the 20 days after intense trading episodes. By contrast, individual investors herd more on firms with small sizes and higher turnovers, and they crowd to buy (sell) stocks with negative (positive) past returns. The portfolios that individual investors herd buy underperform those they sell by an average of − 0.829% during the following 20 days. Moreover, these return differences of both investors are more pronounced under a market with higher pressure and among small stocks. These findings suggest that the herding of institutional investors speeds up the price-adjustment process and is more likely to be driven by correlated private information, while individual herding is most likely to be driven by behavior and emotions.     

How Disaggregation Enhances the Credibility of Management Earnings Forecasts

An important problem facing managers is how to enhance the credibility, or believability, of their earnings forecasts. In this paper, we experimentally test whether a characteristic of a management earnings forecast—namely, whether it is disaggregated—can affect its credibility. We also test whether disaggregation moderates the relation between managerial incentives and forecast credibility. Disaggregated forecasts include an earnings forecast as well as forecasts of other key line items comprising that earnings forecast. Our results indicate that disaggregated forecasts are judged to be more credible than aggregated ones and that disaggregation works to counteract the effect of high incentives. We also develop and test an original model that explains how disaggregation positively impacts three factors that, in turn, influence forecast credibility: perceived precision of management's beliefs, perceived clarity of the forecast, and perceived financial reporting quality. We show that forecast disaggregation works to remedy incentive problems only via its effect on perceived financial reporting quality. Overall, our study adds to our understanding of how managers can credibly communicate their expectations about the future to market participants.     

The risk level discriminatory power of mutual fund investment objectives: Additional evidence

We reexamine the information content of mutual fund investment objectives to learn whether investors can use them to infer risk. For investment objectives to properly convey risk, risk must be heterogeneous between investment objective groups and homogeneous within them. The present study differs from earlier work in two important ways: (1) it reaches a generally different conclusion about within-objective class fund risk, and (2) it is being done against a backdrop of industry-wide incentive compensation structures that rely on these classifications as proxies for fund volatility. Empirical testing suggests that risk is heterogeneous within groups.     

Biases in international portfolio allocation and investor protection standards

Economic reasoning suggests that financial globalization that encourages optimal international portfolio investments should improve investor protection standards (IPS) of a country. In practice, however, investors manifest varying degrees of suboptimal international portfolio allocations. Using a panel dataset covering 44 countries spanning over 15 years we examine whether suboptimal equity portfolio allocation in part is associated with the cross-country variations in IPS. Consistent with economic reasoning we find robust indications that international portfolio allocation may play an important role in the development of IPS. More specifically, the quality of IPS improves with higher degrees of optimal international equity portfolio allocation of domestic and foreign investors.     

Mandatory CSR disclosure and analyst forecast properties: Evidence from a quasi-natural experiment in China

Based on a quasi-natural experiment that mandates a subset of listed firms to issue standalone corporate social responsibility (CSR) reports, we examine whether mandatory CSR disclosure improves analysts’ information environment. We focus on two properties of analysts’ earnings forecasts: forecast error and forecast dispersion. We find that the mandatory issuance of standalone CSR reports is related to less forecast error and less dispersed forecasts, and the effect varies with the firm-level information environment and province-level marketization. Additional tests show that the improvement in forecast properties is mainly driven by CSR reports that i) are of high quality and ii) contain more long-term-oriented information than other CSR reports. Our findings provide evidence that mandatory CSR disclosure plays an important informational role for financial analysts.     

How costly is the Sarbanes Oxley Act? Evidence on the effects of the Act on corporate profitability

The Sarbanes-Oxley Act (SOX) was intended to protect investors by improving the accuracy and reliability of corporate disclosures. However, critics have argued that the costs of SOX far outweigh its intended benefits. Prior studies based on stock-price reactions to SOX-related events document mixed evidence on the expected impact of SOX. In contrast, we provide evidence on the net realized costs of SOX by examining its impact on operating profitability. We find that average cash flows decline by 1.3% of total assets after SOX. These costs are more significant for smaller firms, for more complex firms, and for firms with lower-growth opportunities. Annually, these costs range from $6 million for smaller firms to $39 million for larger firms. Further, we document that net SOX-related costs are not limited to one-time expenses associated with internal-control design and implementation. In aggregate, for the 1428 firms in our sample, these costs amount to about $19 billion per year. Profitability is lower for up to four years post-SOX. To our knowledge, ours are the first estimates of the realized net costs imposed by SOX.     

The influence mechanism of financial shared service mode on the competitive advantage of enterprises from the perspective of organizational complexity: A force field analysis

Financial transformation is a major organizational change that enterprises face today. Under the influence of information technologies, financial shared service mode has become a better option for enterprise financial transformation. Financial shared service mode has a positive or negative influence on the competitive advantage of enterprises under the promotion of internal and external factors. At the same time, the ever-changing complex environment makes the influence of financial shared service mode on the competitive advantage of enterprises more uncertain.Based on organizational complexity theory, this paper uses both a multi-case study approach and a force field analysis to explore the influence mechanism of financial shared service mode on the competitive advantage of enterprises and constructs the force field model of the influence mechanism. Under the premise of being influenced by the driving forces and restraining forces in the force field model, this paper focuses on the moderating forces associated with organizational complexity on the relationship between financial shared service mode and competitive advantage.The research shows, it is evident that the driving forces and restraining forces in the force field model exert dominant and restrictive effects on competitive advantage respectively through the financial shared service mode. It is vital to find that organizational complexity factors in the force filed model have moderating effect on the influence relationship between competitive advantage and financial shared service mode. Enterprises need to seek solutions to deal with organizational complexity factors under the joint influence of driving forces and restraining forces to maximize the positive influence of financial shared service mode on the competitive advantage of enterprises.     

The importance of size in private equity: Evidence from a survey of limited partners

Using a comprehensive survey, we show that investors with a larger capital allocation to private equity are more specialized − measured by the degree to which the investor focuses on private equity rather than other classes of investments − and have a wider scope of due diligence and investment activities. Other investor characteristics (experience, type, location, compensation structure, number of funds under management) play no role. In particular, endowments are not special according to the survey measures. These results are consistent with the changing LP–GP relationship in private equity as capital is increasingly concentrated in the hands of large investors.     

The impact of religious practice on stock returns and volatility

With a psychological and behavioral perspective, this paper examines whether religious practice, through its influence on investors' moods and emotions, affect the behavior of the stock markets and investors in 15 Islamic countries over the period December 31, 2005 to December 31, 2015 and over four sub-periods (before and after both the global financial crisis and the Arab spring). The results indicate that volatility decreases during the month of Ramadan and is significantly different from the volatility observed in the other 11 months of the Islamic calendar year in most Muslim countries. We also identify that changes in stock returns and volatility during the month of Ramadan are related to religious practice and not due to the global financial crisis or the Arab spring. The findings significantly improve the understanding of the role of religious practice on stock market behavior and as such may be of great interest to investors and market regulators.     

The effect of recognition vs. disclosure on investor valuation: The case of pension accounting

Whether or not the format of financial reporting influences user assessment of the reported information is an important issue to the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), and managers. Do investors, in determining security prices, differentiate between information recognized in the balance sheet and that disclosed in the footnotes? The findings indicate that investors appear to consider pension information disclosed in the footnotes as value-relevant, given that an accrued (prepaid) pension liability (asset) is also recognized in the balance sheet. Second, investors attach equal importance to both sorts of pension information.     

The effect of investor sophistication on the influence of nonfinancial performance indicators on investors’ judgments

This paper presents an experiment that examines how enhanced disclosure of nonfinancial performance indicators affects the stock‐price estimates of nonprofessional and professional investors. Participants were provided with a case study containing excerpts from a hypothetical company’s annual report. The experiment was a 2 (nonprofessional and professional) × 3 (positive nonfinancial performance indicators, negative nonfinancial performance indicators, and financial information only) between‐subjects design. Consistent with conservatism, the nonprofessional investors underreacted in their stock‐price estimates to the positive nonfinancial disclosures, compared with professional investors with task‐specific knowledge. The results from this study suggest that the value of enhanced disclosure of this type may not flow equally to all users of financial reports, if conservatism, and lack of task‐specific knowledge, adversely affect their decision‐making.     

Implementation Guidance for Standards and Revenue Trend in Aggressive Reporting

This study examines the interactive effect of including the implementation guidance in accounting standards (with and without indicators) and different reported revenue trends (increasing, decreasing, and volatile) in aggressive reporting. For this purpose, we adopt a 2 × 3 between-subjects experiment. Aggressive reporting is measured by managers' perception of control and judgment regarding revenue recognition. The results of this experiment indicate that including the implementation guidance can constrain managers' revenue recognition judgments. The results show that for decreasing revenue trends, the inclusion of indicators for implementation does not influences managers' judgments regarding revenue recognition. For increasing revenue trends, the inclusion of guidance indicators matters in that the managers' judgments regarding revenue recognition are more aggressive in conditions without indicators than in conditions with indicators. The findings of this study extend the literature on implementation guidance in accounting standards and aggressive reporting.     

Google Internet search activity and volatility prediction in the market for foreign currency

I study whether evolution in the number of Google Internet searches for particular keywords can predict volatility in the market for foreign currency. I find that data on Google searches for the keywords economic crisis + financial crisis and recession has incremental predictive power beyond the GARCH(1,1). These results support the mixture of distributions hypothesis in that volatility is linked to the stochastic rate at which information flows into the marketplace. These results also demonstrate the potential for Google to become a storehouse of information for financial markets.     

Do investors misprice components of net periodic pension cost?

We examine whether and how investors misprice the components of net periodic pension cost under SFAS No. 87 and 158. We find that investors appear to have difficulty in understanding the transitory feature of other net periodic pension cost (PPOPCC) and thus overestimate its persistence, which in turn leads to the mispricing of PPOPCC in the pre‐158 period. We also find that SFAS No. 158 appears to reduce the mispricing of PPOPCC, suggesting a positive effect of SFAS No. 158 on investors' valuation of pension items in the income statement. Additional analysis suggests that investors also overestimate the persistence of, and thus misprice, pension‐related cash flows and accruals in the pre‐158 period and that SFAS No. 158 reduces the mispricing of pension‐related cash flows and accruals.