Financial accounting standard setters recently changed the accounting for estimates involving credit risk. The change shifted the accounting from an incurred-loss model (ILM), which is based on credit-risk conditions that exist at the time of the estimate, to a model based on expected credit losses over the life of the asset in question (ELM), which considers expectations of future conditions. Our paper is based on the theoretical premise that ELM will reduce surprise via its Day 1 forewarning, which, in turn, should lessen the potential for hindsight bias (i.e., Monday-morning quarterbacking) and judging management as having made a poor quality lending decision if an actual credit loss later occurs. Three experiments support this premise, revealing when ELM accounting should have a differential impact relative to the prior accounting.
This paper examines managers' strategic use of counterpoised disclosure, defined as the concurrent dissemination of product information to mitigate the expected impact of a material negative disclosure about another product. We focus on the biopharmaceutical industry, where individual drug outcomes have significant valuation implications. As such, investors rely heavily on product-level disclosures in this industry, which is characterized by high uncertainty, information asymmetry, and limited traditional financial metrics. Using 8-K filings and press releases (8-Ks/PRs) reporting drug development milestones, we empirically support three predictions. First, managers are more likely to provide counterpoised disclosures in 8-Ks/PRs revealing negative news (e.g., Food and Drug Administration [FDA] rejections) than those revealing positive news (e.g., FDA approvals). Second, we confirm that such disclosures attenuate negative market reactions. Last, we document that counterpoised drugs are more likely to progress through subsequent FDA approvals as compared with those that do not receive counterpoised disclosure. Combined, our findings suggest counterpoised disclosure reflects a strategic managerial disclosure mechanism used to assist investors in assessing the valuation implications of a negative product signal within the firm's broader drug development portfolio.
ABSTRACT We examine whether PCAOB inspection deficiencies related to management review controls (MRCs) affect financial reporting decisions. Using the goodwill impairment setting, we find that firms are more likely to record goodwill impairments when their auditors have received more PCAOB inspection deficiencies related to goodwill MRCs. The association is stronger when inspection deficiencies are more likely to lead to changes to the design or implementation of an internal control (repeat deficiencies and deficiencies related to MRC precision). We observe some evidence that MRC inspection deficiencies increase the likelihood of goodwill impairment even when unrelated to goodwill, indicating that improving the audit of MRCs can broadly affect financial reporting. Our findings provide evidence that PCAOB inspections affect not only auditor behavior but also the financial reporting behavior of audit clients. Specifically, inspection feedback appears to influence reporting outcomes through changes in the audit and evaluation of MRCs, identifying a channel through which regulatory oversight affects issuers. The results have implications for audit firms seeking to remediate inspection deficiencies, for management and audit committees responsible for overseeing significant estimates and impairment analyses, and for regulators evaluating the broader effectiveness of the PCAOB inspection process.
ABSTRACT Using online job postings data, we explore whether auditors adjust their human capital in response to clients' cyber breach incidents. We find that audit offices increase their demand for cybersecurity specialists after their clients' cyber breaches, implying that cyber breaches change not only client risk but also their auditor's production function. Consistent with expectations, we document that this impact is larger when breaches involve their own clients (rather than those of peer offices within the same audit firm) and when breaches directly involve financial information. Our evidence holds for both cyber‐focused and non‐cyber‐focused offices, highlighting the broad impact of cybersecurity risks on audit practices. Additionally, we find that audit offices with relatively high investment in cybersecurity human capital are better able to preserve their market share among clients in high‐cyber‐risk industries after a client's cyber breach.
ABSTRACT Litigation risk is an important source of motivation for auditors to conduct high‐quality audits, but theory suggests that certain lawsuits will have a more salient disciplining effect on auditor behavior. To this end, we identify lawsuits naming an individual partner as a co‐defendant along with the audit firm. We then examine how these lawsuits affect subsequent behavior of other auditors in the office of the sued partner. Relative to lawsuits naming only the firm, our results indicate that lawsuits naming individual partners as co‐defendants are significant office‐level events that motivate a meaningful response from non‐sued audit partners in the form of higher quality and fees on existing clients and more careful client portfolio management. These results have practical implications about how auditor litigation incentivizes individual auditors to fulfill their professional duties. For regulators and audit firms seeking to promote audit quality, these findings highlight the disciplining effect of auditors' concern for their personal reputation and litigation exposure. Furthermore, audit committees, clients, and investors may observe elevated audit quality, effort, and fees following partner‐level litigation in the local office.
