Financial Reporting Opacity and Expected Crash Risk: Evidence from Implied Volatility Smirks

The recent financial crisis has stimulated a renewed interest in understanding the determinants of stock price crash risk (i.e., left tail risk). Recent research shows that opaque financial reports enable managers to hide and accumulate bad news for extended periods. When the accumulated bad news reaches a certain tipping point, it will be suddenly released to the market at once, resulting in an abrupt decline in stock price (i.e., a crash). This study extends this line of research by examining the impact of financial reporting opacity on perceived or expected crash risk. Prominent economists, such as Olivier Blanchard, argue that removing the perception of tail risks (in addition to realized tail risks) is crucial in restoring investor confidence and stabilizing the stock market. Using the steepness of option implied volatility skew as a proxy for perceived crash risk, we find that accrual management, the presence of financial statement restatements, and auditor‐attested internal control weakness are all positively and significantly associated with the level of perceived crash risk. Our results suggest that improving financial reporting transparency is an important mechanism for firms and policymakers to reduce the perception of tail risks and stabilize the stock market.     

Accounting Conservatism and Stock Price Crash Risk: Firm‐level Evidence

Using a large sample of U.S. firms during 1964–2007, we find that conditional conservatism is associated with a lower likelihood of a firm's future stock price crashes. This finding holds for multiple measures of conditional conservatism and crash risk and is robust to controlling for other known determinants of crash risk and firm‐fixed effects. Moreover, we find that the relation between conservatism and crash risk is more pronounced for firms with higher information asymmetry. Overall, our results are consistent with the notion that conditional conservatism limits managers’ incentive and ability to overstate performance and hide bad news from investors, which, in turn, reduces stock price crash risk.     

Can Shareholders Be at Rest after Adopting Clawback Provisions? Evidence from Stock Price Crash Risk

Using a propensity score matched sample and a difference‐in‐differences research design, we find that stock price crash risk increases after a firm voluntarily incorporates clawback provisions in executive officers' compensation contracts. This heightened crash risk is concentrated in adopters that increase upward real activities‐based earnings management and those that reduce the readability of 10‐K reports. Based on cross‐sectional analyses, we also find that the increased crash risk is more pronounced for adopters with high ex ante fraud risk, low‐ability managers, high CEO equity incentives, and low dedicated institutional ownership. Collectively, our results suggest that the clawback adoption per se does not curb managerial opportunism but rather induces managers to use alternative channels for concealing bad news, which may contribute to a greater stock price crash risk; and the increase in crash risk is more likely in cases where incentives are strong or monitoring is weak. Our results should be of interest to regulators and policymakers considering the effects of clawback adoption on the investing public.     

Is Real Earnings Smoothing Harmful? Evidence from Firm‐Specific Stock Price Crash Risk

This study examines whether and when real earnings smoothing influences firm‐specific stock price crash risk. Using a sample of U.S. public firms for the years 1993 through 2014, we find real earnings smoothing to be positively associated with firm‐specific stock price crash risk. This finding is consistent with the view that real earnings smoothing helps managers withhold bad news, keep poor‐performing projects, conceal resource diversion, and engage in ineffective risk management, which increases crash risk. Further, we find a stronger relation between crash risk and real earnings smoothing when firm uncertainty is higher, product market competition is lower, and balance sheet constraint is higher. Overall, our study suggests that real earnings smoothing destroys shareholder value in that it increases stock price crash risk.     

CEO Overconfidence and Stock Price Crash Risk

This study examines the association between chief executive officer (CEO) overconfidence and future stock price crash risk. Overconfident managers overestimate the returns to their investment projects and misperceive negative net present value (NPV) projects as value creating. They also tend to ignore or explain away privately observed negative feedback. As a result, negative NPV projects are kept for too long and their bad performance accumulates, which can lead to stock price crashes. Using a large sample of firms for the period 1993–2010, we find that firms with overconfident CEOs have higher stock price crash risk than firms with nonoverconfident CEOs. The impact of managerial overconfidence on crash risk is more pronounced when the CEO is more dominant in the top management team and when there are greater differences of opinion among investors. Finally, it appears that the effect of CEO overconfidence on crash risk is less pronounced for firms with more conservative accounting policies.     

货币政策、股票流动性与股票价格暴跌风险

目前中国股市还存在较多制度性缺陷,股价波动频繁且暴跌风险较高。本文以2003年至2013年中国A股上市公司为样本,检验作为激发机制的货币政策以及作为外部生成机制的股票流动性对中国股票价格暴跌风险的影响。研究发现：股票流动性与公司股票价格暴跌风险具有显著的敏感性,即随着股票流动性的下降,公司股票价格暴跌风险显著上升;货币政策越宽松,股票价格暴跌的风险越大;而且宽松的货币政策增强了股票流动性与股票价格暴跌风险的敏感性。区分市场势态的进一步分析表明,市场为熊市时,股票流动性对股票价格暴跌风险的影响更显著,货币政策的放松越容易激化股票价格暴跌风险,且对股票流动性与股票价格暴跌风险的敏感性的放大作用更为突出。     

Readability of 10‐K Reports and Stock Price Crash Risk

This study shows that less readable 10‐K reports are associated with higher stock price crash risk. The results are consistent with the argument that managers can successfully hide adverse information by writing complex financial reports, which leads to stock price crashes when the hidden bad news accumulates and reaches a tipping point. Cross‐sectional analyses show that the effect of financial reporting complexity on crash risk is more pronounced for firms with persistent negative earnings news or transitory positive earnings news, greater chief executive officer stock option incentives, or lower litigation risk. Finally, accrual manipulation appears to be positively related to crash risk, even since the Sarbanes‐Oxley Act, if the manipulation is accompanied by complex 10‐K reports.     

The Consequences of Audit‐Related Earnings Revisions

In this study, we investigate the consequences that auditors and their clients face when earnings announced in an unaudited earnings release are subsequently revised, presumably as a result of year‐end audit procedures, so that earnings as reported in the 10‐K differ from earnings as previously announced. Specifically, we examine whether the likelihood of an auditor “losing the client” is greater following such revisions, and whether the likelihood of dismissal is influenced by revisions that more negatively impact earnings, that cause the client to miss important earnings benchmarks, by greater local auditor competition, or by auditor characteristics. We also examine audit pricing subsequent to audit‐related earnings revisions for evidence of pricing concessions to retain the client. Finally, we examine whether client executives experience a greater likelihood of turnover following an audit‐related earnings revision. Consistent with expectations, we find that auditor dismissals are more likely following audit‐related earnings revisions. We also find that dismissals are more likely when revisions cause clients to miss important benchmarks and when there is greater local auditor competition. Among nondismissing clients, we find that future audit fees are lower when the effect of the revision on earnings is more negative, consistent with auditors offering price concessions to retain clients when revisions are more displeasing. We also find a greater likelihood of future chief financial officer (CFO) turnover as the effect of the revision worsens. Our findings offer important insights into the consequences that auditors face when balancing their responsibility for high audit quality and client satisfaction, as well as into the consequences that CFOs face when releasing inflated but not fully audited earnings.     

Future Nonaudit Service Fees and Audit Quality

Prior to the Sarbanes–Oxley Act of 2002, audit partners experienced economic pressure to grow revenue from the sale of nonaudit services to their audit clients. To an auditor who is highly rewarded for revenue generation and growth, nonaudit services may represent a particularly strengthened economic bond with the client. Prior research shows that, in general, nonaudit service fees received in the current period do not impair audit quality. We examine a different setting. We propose that auditor independence can become impaired, and audit quality compromised, when clients that currently purchase relatively low amounts of nonaudit services, increase their purchases of nonaudit services from the auditor in the subsequent period. We test our prediction in the context of earnings management as a proxy for audit quality, measured by (a) performance‐adjusted discretionary accruals and (b) classification shifting of core expenses. Our results indicate that prior to the Sarbanes‐Oxley Act, rewards to the auditor in the form of future additional nonaudit service fees from current‐year high fee‐growth‐opportunity clients adversely affects audit quality. This effect is particularly strong among companies with powerful incentives to manage earnings. Our findings indicate that regulators should consider the multiperiod nature of the client–auditor relationship when contemplating policies that restrict nonaudit services, as well as the overall environment in which audit partners operate. This might include partner compensation arrangements that put pressure on audit partners to focus on increasing revenue at the expense of audit quality.     

Audit Office Reputation Shocks from Gains and Losses of Major Industry Clients

Our study reports evidence on the dynamic effects of client switches on auditor reputations and fee premia. Offices of large accounting firms that lose (gain) major industry clients experience a reputation shock leading to more same‐industry client losses (gains) over the next two years. There is also a shift in audit fees charged to other same‐industry clients when a major client loss (gain) results in an audit office losing (gaining) city‐level industry leadership. A major client loss or gain also creates a short‐term capacity shock to an audit office's ability to supply high‐quality audits. However, there is no evidence of reputation spillovers to other‐industry clients in the audit office, or to clients in other offices of the accounting firm.     

纵向兼任高管能降低股价崩盘风险吗?

纵向兼任高管究竟会加强大股东对管理层的监督,减少管理层机会主义行为,提升公司治理水平;还是会强化大股东对上市公司的控制,提升其私有权收益的获取能力,增加企业风险？为此,文章将以2007年-2017年中国A股上市公司为研究样本,探究纵向兼任高管如何影响企业的股价崩盘风险。研究发现,纵向兼任高管显著降低了公司未来股价崩盘风险;在进行Heckman两阶段模型、倾向得分匹配等稳健性检验后,这一结论依然成立。同时,文章进一步研究发现,纵向兼任高管在"监督效应"和"更少掏空效应"共同作用下降低了股价崩盘风险;且当纵向兼任高管权力越大时,即纵向兼任董事长时,对公司未来股价崩盘风险的降低作用越明显。文章不但深化了股价崩盘风险影响因素的研究,而且有助于我们全面认识纵向兼任高管这一关系在公司治理中的作用,这对于完善公司治理、防范股价崩盘风险,进而促进我国资本市场的健康发展有重要的意义。     

Audit Partner Tenure and Internal Control Reporting Quality: U.S. Evidence from the Not‐For‐Profit Sector

This study examines the effects of audit partner tenure and audit partner changes on internal control reporting quality for large U.S. not‐for‐profit (NFP) organizations. Regulators contend that audit partners lose their objectivity over successive audits, reducing audit quality. A large body of research has examined this issue, primarily in non‐U.S. jurisdictions, with mixed results. We examine the associations between audit partner tenure and audit partner changes and the incidence of reported internal control deficiencies (ICDs), the quality of internal control reports (following PCAOB audit quality indicators), and the severity of reported ICDs. We find negative associations between audit partner tenure and the incidence of reported ICDs, the quality of internal control reports, and the severity of reported ICDs. Together, these findings indicate that internal control reporting quality deteriorates with audit partner tenure. However, we find no association between audit partner changes and internal control reporting, which is consistent with partners lacking client specific knowledge in their first year with a client. Finally, we find no association between either audit partner tenure or changes and the likelihood of remediation. Our findings contribute large‐sample U.S. evidence on the association between audit partner tenure and internal control reporting quality and provide useful information to government regulators, NFP boards charged with the oversight of the external auditor and internal controls, and NFP stakeholders.     

Audit Firm Tenure,Bank Complexity,and Financial Reporting Quality

Theory from organizations and economics research posits that in an inter‐organizational relationship, both parties invest in relationship‐specific knowledge, which in turn facilitates the effectiveness of the relationship while strengthening the attachment between the parties. In complex settings where there are more opportunities for knowledge creation, the investments will be larger and the attachment stronger. Because banks are complex institutions that present unique challenges to auditors, we suggest that effective audits critically depend on the accumulation of significant investments in client‐specific expertise through a long association with the client. We find a positive association between audit firm tenure and financial reporting quality, and this association is particularly strong in banks that are more complex. Also, contrary to recent research we find that benefits of audit firm tenure for complex banks accrue even for long tenure and are not limited to medium tenure. Our findings largely support the notion that a long relationship with the client reflects the underlying demand for expertise, which is critical for high‐quality audits of complex organizations. Imposing short‐term limits on audit firms would adversely affect the investments in client‐specific expertise especially in the cases where this expertise is needed the most. Our findings do not support calls for mandatory audit firm rotation for large complex institutions.     

The Influence of Nonaudit Service Revenues and Client Pressure on External Auditors' Decisions to Rely on Internal Audit*

This paper investigates how external auditor provision of significant nonaudit services and client pressure to use the work of internal audit influence external auditors' use of internal auditors' work. More specifically, we study how external audit evidence gathering choices are influenced by nonaudit fees and client pressure. Our research is motivated by an observation that the magnitude of nonaudit services provided to audit clients introduces the risk that client management may leverage its position with the external auditor and potentially affect the audit process. We address this issue by extending prior research and focusing on the importance of various explanatory variables, including nonaudit service revenues, client pressure, internal audit quality, and coordination, to the external auditor's decision to rely on the work of internal audit. We use data primarily obtained through surveys completed by internal and external auditors. The survey responses represent 74 separate audit engagements. Our findings reveal that when significant nonaudit services are not provided to a client, internal audit quality and the level of internal‐external auditor coordination positively affect auditors' internal audit reliance decisions. However, when the auditor provides significant nonaudit services to the client, internal audit quality and the extent of internal ‐ external auditor coordination do not significantly affect auditors' reliance decisions. Furthermore, when significant nonaudit services are provided, client pressure significantly increases the extent of internal audit reliance. Thus, external auditors appear to be more affected by client pressure and less concerned about internal audit quality and coordination when making internal audit reliance decisions at clients for whom significant nonaudit services are also provided.     

会计信息质量对股价崩盘风险的影响研究

本文以2017-2021年中国上市公司为研究样本,探究会计信息质量对公司股价崩盘风险的影响。研究发现会计信息质量越高,公司所面临的股价崩盘风险就越低。主要通过降低公司内部人与外部投资者之间的信息不对称程度,缓解了管理者对外隐瞒坏消息的倾向降低股价泡沫发生的可能性。从管理者代理的视角出发,发现管理费用越高,会计信息质量对股价崩盘风险的抑制作用越显著。     

Independence Threats,Litigation Risk,and the Auditor's Decision Process*

This study examines the effect of independence threats and litigation risk on auditors' evaluation of information and subsequent reporting choices. Using a Web‐based experiment, I tracked auditors' information gathering and evaluation leading to a going‐concern reporting decision. Specifically, 48 audit managers assessed client survival likelihood, gathered additional information, and suggested audit report choices. I found that auditors facing high independence threats (fear of losing the client) evaluated information as more indicative of a surviving client and were more likely to suggest an unmodified audit report, consistent with client preferences. In contrast, auditors facing high litigation risk evaluated information as more indicative of a failing client and were more likely to suggest a modified audit report. In addition, the association between risk and report choice was fully mediated by final information evaluation. This suggests that it is unlikely that different reporting choices resulted from a conscious choice bias, but rather that motivated reasoning during evidence evaluation plays a key role in the effect of risk in auditor decision making.     

MACROECONOMIC UNCERTAINTY AND CONDITIONAL STOCK MARKET VOLATILITY IN SOUTH AFRICA*

This paper analyses how systematic risk emanating from the macroeconomy is transmitted into stock market volatility using augmented autoregressive Generalised Autoregressive Conditional Heteroscedastic (AR‐GARCH) and vector autoregression (VAR) models. Also examined is whether the relationship between the two is bidirectional. By imposing dummies for the 1997‐1998 Asian and the 2007‐2009 sub‐prime financial crises, the study further analyses whether financial crises affect the relationship between macroeconomic uncertainty and stock market volatility. The findings show that macroeconomic uncertainty significantly influences stock market volatility. Although volatilities in inflation, the gold price and the oil price seem to play a role, it is found that volatility in short‐term interest rates and exchange rates are the most important, suggesting that South African domestic financial markets are increasingly becoming interdependent. Finally, the results show that financial crises increase volatility in the stock market and in most macroeconomic variables, and, by so doing, strengthen the effects of changes in macroeconomic variables on the stock market.     

Effect of Concession‐Timing Strategies in Auditor–Client Negotiations: It Matters Who Is Using Them

In this study, we examine how norms about the use of negotiation strategies by different parties in an auditor–client negotiation influence the relative efficacies of these negotiation strategies. We conduct an experiment with experienced auditors/financial managers as participants, who enter into a negotiation on an income‐decreasing audit adjustment with a hypothetical client/auditor who uses a strategy where the same concessions are given either at the start, gradually, or the end of the negotiation. We find that the concession‐end strategy is more effective than the concession‐start strategy when used by auditors; however, the reverse is true when these same strategies are used by financial managers. The concession‐gradual strategy leads to superior outcomes when used by either auditors or clients. We also provide evidence that auditors’ and financial managers’ perceptions of the norms relating to the use of these strategies correspond to what we propose in our theory.     

Do Investors Care about the Auditor's Economic Dependence on the Client?*

In this study, we investigate whether investor perceptions of the financial reporting credibility of Big 5 audits are related to the auditor's economic dependence on the client as measured by nonaudit as well as total (audit and nonaudit) fees paid to the incumbent auditor. We use the client‐specific ex ante cost of equity capital as a proxy for investor perceptions of financial reporting credibility and examine auditor fees both as a proportion of the revenues of the audit firm and as a proportion of the revenues of the audit firm's practice office through which the audit was conducted. Our findings suggest that both nonaudit and total fees are perceived negatively by investors' that is, the higher the fees paid to the auditor, the greater the implied threat to auditor independence, and the lower the financial reporting credibility of a Big 5 audit. Furthermore, our findings appear to be largely unrelated to corporate governance: investors do not perceive the auditor as compensating for weak governance. Separately, recent anecdotal evidence suggests that declining revenues from nonaudit services' as a result of recent regulatory restrictions” are being offset by substantial increases in audit fees. Other things being equal, rising audit fees imply higher profit margins for audit services, indicating that the audit function may no longer be a loss leader. Thus, to the extent that investors perceive total fees negatively, recent regulatory initiatives to limit nonaudit fees may not have adequately addressed the perceived, if not the actual, threat to auditor independence posed by fees.