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We examine whether and how auditors incorporate rollover risk in assessing a client's risk. Rollover risk is the risk associated with long-term debt maturing in 1 year, which has to be refinanced or settled shortly. Debt has two counteracting effects on firms' riskiness: increased liquidity risk and increased monitoring. The finance literature suggests that rollover risk is an apparent risk factor because it results in high liquidity risk but only a weak (or limited) monitoring benefit. Consistent with that literature, we show that auditors increase audit fees, exhibit a higher likelihood of issuing a going-concern opinion, and terminate relations with their clients more frequently as rollover risk increases. Our study is the first in the audit research literature to document that auditors factor rollover risk in their pricing, going concern, and client portfolio decisions. [ABSTRACT FROM AUTHOR]

Using a cross-country setting, we document differences in the relation between earnings quality and the two components of trading volume around earnings announcements, one related to differential interpretation of the earnings signal and the other related to pre-event differential information precision. We find that in countries with stronger investor protection, less corrupt governments, and more liquid stock markets, a noisier earnings signal increases differential interpretation of the earnings signal but decreases investors' incentive for information acquisition before earnings announcements, leading to lower pre-event differential information precision. However, these trading patterns flip in countries with weaker investor protection, more corrupt governments, and less liquid stock markets. We also find that institutional investors in countries with stronger institutions are likely to benefit more from their superior information processing skills, leading to more information acquisition both at and before earnings announcements. Overall, our study adds to the literature by documenting significant cross-country variations in investors' trading volume reactions to earnings quality. [ABSTRACT FROM AUTHOR]

This study examines the economic implications of fair value liability gains and losses arising from the adoption of Statement of Financial Accounting Standards No. 159 (hereafter, FAS 159). We find a positive correspondence between a firm's FAS 159 fair value liability gains and losses and current period stock returns, consistent with the notion that these gains and losses are priced by equity investors. However, further analysis indicates that fair value gains and losses from liabilities have a statistically significant negative association with future returns, suggesting that investors misprice this earnings component and subsequently correct the mispricing. We also find that the negative association for fair value gains is stronger for firms with lower levels of institutional ownership. [ABSTRACT FROM AUTHOR]

We investigate voluntary disclosure strategies in contested takeovers and the associated economic consequences. Using a difference-in-differences research design and propensity score matching, we find that, relative to friendly takeovers, target management in contested takeovers provides more earnings guidance and conveys more good news during the takeover. Moreover, voluntary disclosure helps contested targets negotiate a better offer, and the results are stronger for targets with more information asymmetry. Collectively, targets adopt voluntary disclosure and alter their strategies under the threat of contested takeover to enhance their bargaining power. Voluntary disclosure by contested targets serves as a negotiation tactic that potentially benefits target shareholders. [ABSTRACT FROM AUTHOR]

We examine whether audit quality inputs are related to the conformity of financial statements to Benford's law. We find that overall financial statement conformity increases with audit fees, nonaudit fees, and audit report lag, and decreases with audit firm tenure. We also find that these audit quality inputs are more strongly associated with income statement conformity than with cash flow statement conformity. Our findings document the role that auditing plays in enhancing the conformity of financial statements to Benford's law. [ABSTRACT FROM AUTHOR]

Extant theories suggest that managers may use hedging either to alleviate underinvestment problems caused by costly external financing or to promote overinvestment by circumventing the scrutiny of external capital markets. We empirically investigate this issue using a hand-collected data set of hedging and investment behavior of oil and gas exploration and production firms. We do not find evidence that hedging alleviates underinvestment problems. However, we do find a strong positive relation between the extent of hedging and the propensity to overinvest. Further analyses indicate that the relation between hedging and overinvesting is stronger in settings where the firms' information environment is more transparent. A more transparent information environment makes it easier for outside capital providers to distinguish between value-enhancing and value-destroying investment decisions so that greater discretion over internally generated funds becomes more valuable to overinvesting managers. Our study highlights the role of hedging in facilitating overinvestment and the conditions under which this role is likely to be more salient. [ABSTRACT FROM AUTHOR]

We investigate the association between material weakness in internal controls (MW) disclosed under Section 302 of the Sarbanes–Oxley Act of 2002 (SOX) and future stock price crash risk. We argue that relative to firms with effective internal controls, firms with MW have lower financial reporting precision. The lower reporting precision (a) increases divergence of investor opinion with regard to firm valuation and (b) facilitates managers' withholding of negative information, which increases the information asymmetry between managers and outside investors. We hypothesize that both these effects increase the probability of a future stock price crash. We find empirical evidence consistent with our prediction. In additional analyses, we document that the positive association between MW and crash risk is primarily driven by company level rather than by account-specific weaknesses, increases with the number of material weaknesses, and intensifies during the financial crisis. In addition, we find that both the existence and the disclosure of MW incrementally affect crash risk, and that MW facilitates managers' withholding of bad news. Finally, we fail to find consistent evidence of a significant relation between MW disclosed under Section 404 of SOX and crash risk. [ABSTRACT FROM AUTHOR]

This study examines the role of financial reporting conservatism in mitigating underinvestment problems. Recognizing that volatile cash flows increase the need to access external capital markets and that agency conflicts and information asymmetry make external capital costlier than internal capital, which leads managers to forgo valuable investment projects, Minton and Schrand document a negative relation between cash flow volatility and investment. We draw on Minton and Schrand's framework to isolate underinvestment problems and hypothesize and document that conservatism mitigates the negative relation between cash flow volatility and investment and that this mitigative effect is more pronounced for firms with ex ante more severe agency conflicts. We also document that conservatism mitigates the sensitivity of investment to cash flow volatility by facilitating access to external capital. [ABSTRACT FROM AUTHOR]

The article presents a study on how the stock market was affected by China's convergence to International Financial Reporting Standards (IFRS) in 2007. It looks at how Chinese stock markets reacted favorable to events prior to the IFRS convergence with particular attention given to firms wither greater dependence on external capital.

Previous research shows that accounting conservatism facilitates debt contracting. Extending this line of literature, we examine whether the role of accounting conservatism in accessing external debt to attain firm growth varies with its maturity. We find evidence of a positive relationship between conservatism and debt maturity. We also observe a positive relationship between conservative accounting and future growth funded by all classes of debt, but this relation is due to long-term rather than short-term debt, which is less prone to agency risk. Furthermore, the associations between conservatism and debt maturity and conservatism and growth financed by long-term debt are mostly observed for firms with fewer anti-takeover provisions in place. These findings suggest that the demand for accounting conservatism is not uniform across different debt maturity horizons. [ABSTRACT FROM AUTHOR]

The scandals surrounding questionable accounting practices and corporate wrongdoing during 2000-2008 have often been attributed to the lack of effective internal controls. We examine the relations between national culture and the incidence and number of reported internal control material weaknesses (ICMWs). We focus on three dimensions of national culture—individualism, uncertainty avoidance, and power distance (as identified by Hofstede)—which we hypothesize are related to ICMW. Consistent with our hypotheses, cross-country analysis indicates that individualism and power distance are positively related, and uncertainty avoidance is negatively related, to the existence of ICMW. We also find a significant positive relation between individualism and the number of ICMWs. These results are robust to a variety of sensitivity tests. In addition, we document that all three dimensions of national culture influence the propensity to remediate previously identified ICMW. [ABSTRACT FROM AUTHOR]

We examine the effect of the Sarbanes-Oxley Act (SOX) on the extent of aggressive versus conservative reporting behavior of public companies. SOX imposes considerably greater potential penalties on chief executive officers (CEOs) and chief financial officers (CFOs) who engage in financial wrongdoing. Therefore, risk-averse managers are likely to report lower earnings by reducing discretionary accruals following SOX. Our results, based on a matched sample of dual-listed Canadian firms and their domestically listed counterparts, indicate that (1) firms subject to SOX are more conservative in financial reporting in the post-SOX period as evidenced by lower signed discretionary accruals, the Ball and Shivakumar (2005) conditional conservatism measure, and the Penman and Zhang (2002) unconditional conservatism measure; and (2) the impact of SOX on firms' conservative reporting through discretionary accruals in the post-SOX period is not homogeneous—that is, it is more pronounced for firms that were aggressive in the pre-SOX period. [ABSTRACT FROM AUTHOR]

The objective of this research is to assess whether the incremental information content of current cost (CC) income and constant dollar (CD) income is time-period specific. Based on work by Lim and Sunder (1990), we predict that CC (CD) income is more likely to exhibit incremental information content over CD (CC) income when the dispersion in annual price changes across industries is large (small). Evidence provided using FASB Statement No. 33 data is consistent with these predictions. That is, CD (CC) income is shown to exhibit incremental information content over CC (CD) income in the years 1980 and 1983 (1981 and 1982). We then extend this analysis to a disclosure environment that includes historical cost (HC) income, and find that CD (CC) income also has incremental information content over HC income in those same years-1980 and 1983 (1981 and 1982). Thus, by identifying time periods when either CC income or CD income is the preferred income measure, we also are able to provide sample-wide evidence that accounting data adjusted for changing prices of productive assets provide incremental information over HC income. [ABSTRACT FROM AUTHOR]