Anna M. Cianci

The Impact of Ethical Leadership and the Internal Audit Function on Financial Reporting Decisions

Two elements of corporate governance — the strength of ethical executive leadership and the internal audit function (IAF hereafter) — provide guidance to accounting managers making decisions involving uncertainty. We examine the joint effect of these two factors, manipulated at two levels (strong, weak), in an experiment in which accounting professionals decide whether to book a questionable journal entry (i.e., a journal entry for which a reasonable business case can be made but there is no supporting documentation). We find that ethical leadership and the IAF interact to determine the likelihood that accountants book the entry. Specifically, accountants are less likely to book a questionable journal entry when there is a weak ethical leader and a strong IAF compared to all other conditions. In addition, we find that accountants question the appropriateness and ethicalness of the request to book an undocumented journal entry more in the weak ethical leader and strong IAF condition than in the other conditions. These results suggest that the IAF has a different impact on financial reporting decisions depending on the ethicalness of executive leadership and that a strong IAF may cause accountants to question the appropriateness and ethicalness of an undocumented journal entry when combined with weak ethical leadership. We also find that the interactive effect of ethical leadership and the IAF on an accountant’s decision is fully mediated by his/her perception of the moral intensity of the issue. Thus, accountants, who perceive greater moral intensity associated with booking the entry, are less willing to do so.

The Interactive Effects of Perceived Environmental Uncertainty and Control System Type on Managers’ Willingness to Recommend Strategic Change

To remain competitive today, flatter organizations must rely more on middle management in order to adapt in response to demands in the dynamic environments in which they operate. Yet oftentimes organizations do not change even in the face of evolving markets. Using an experiment, we examine how the type of control system used by organizations can shifting middle manager perception of environmental stability as well as influencing their willingness to recommend organizational change. Consistent with our expectations, we find a positive association between middle managers’ perceived environmental uncertainty and their willingness to recommend organizational strategic change. This relationship is moderated by control system type, especially for those middle managers whose perceived environmental uncertainty is low. In particular, we find that relative to interactive control systems, diagnostic control systems are more effective in directing manager attention toward environmental uncertainties and increasing the willingness of those managers to recommend a strategic change. Our results are an initial step in understanding the relationships between environmental uncertainty and control systems and thus can help senior managers design and implement control systems for flatter organizations in dynamic environments where middle managers are critical to initiating adaptive strategic change.

Do Mandatory Risk Factor Disclosures Predict Future Cash Flows and Stock Returns? Evidence from Tax Risk Factor Disclosures

Prior research finds that mandatory risk factor disclosures are informative in that they increase investors’ assessments of the volatility of a firm’s cash flows. However, the literature is silent as to whether these disclosures provide information about the level of future cash flows and, ultimately, their implications for firm value. We address this question by examining the association between Form 10-K risk factor disclosures and future cash flows levels and stock returns. We use the setting of taxes because it is relatively easier to identify the specific income and cash flow statement line items to which these risks relate, and offer two main results. First, we find that tax risk factor disclosures are positively associated with future cash flows. This suggests that, on average, tax risk factor disclosures relate to tax positions that are rewarded with future tax savings. Second, we find that investors incorporate this relation into stock prices. In additional analysis, we find no evidence of a drift in stock prices, suggesting that investors incorporate the implications of tax risk factor disclosures in a timely manner. Overall, our results suggest that risk factor disclosures provide information about the level of a firm’s future cash flows, that the risks discussed in these disclosures are – on average – value-increasing, and that investors incorporate this information into current stock prices.

Control Systems and Incentives as Moderators of the Positive Association between Perceived Environmental Uncertainty and Willingness to Recommend Strategic Change

To remain competitive, organizations must change in response to demands in the dynamic environments in which they operate; yet oftentimes they do not change, perhaps due to an inability to first recognize, and then act on, the need for change. To combat this reluctance, organizational factors such as control systems and incentives may be effective since they are often used to direct managerial attention and thereby influence firm strategy (e.g., Simons 1990, 1995; Garg et al. 2003; Kober et al. 2007; Peterson and Luthans 2006). Indeed, prior research has found that control systems influence managers’ information search as well as firm-level strategic choice (e.g., Simons 1990, 1995) and incentives are closely tied to managers’ motivation to act (e.g., Bruggen and Moers 2007; Peterson and Luthans 2006). To further investigate this issue, we examine whether one individual-level variable – perceived environmental uncertainty (hereafter, “PEU”) – and two firm-level variables – control systems and incentives – are effective in overcoming managers’ insufficient motivation and/or their inability to recognize that change is needed, thereby increasing their willingness to recommend strategic change (hereafter, “WTRC”). Consistent with expectations, we find that the positive association between PEU and willingness to recommend strategic change is diminished by all combinations of control systems and incentives (except for an interactive system–social recognition incentive combination). Regarding this result, neither interactive systems nor social recognition incentives seem to provide a point of focus for managers to interpret strategic threats, thereby lowering the likelihood that managers will recommend strategic change. Thus, the positive association between PEU and WTRC remains intact. However, for low PEU managers, both diagnostic systems and financial incentives seem to make low PEU managers behave more like high PEU managers by focusing attention on performance metrics, thereby creating a strategic decision-making framework that increases the likelihood of recommending strategic change. Overall, these results suggest that the positive association between PEU and managers’ willingness to recommend strategic change can be enhanced, or muted, by control systems and incentives.