Preeti Choudhary

Accelerated Vesting of Employee Stock Options in Anticipation of FAS 123-R*

In December 2004, the Financial Accounting Standards Board (FASB) mandated the use of a fair value based measurement attribute to value employee stock options (ESOs) via FAS 123-R. In anticipation of FAS 123-R, between March 2004 and November 2005, several firms accelerated the vesting of ESOs to avoid recognizing existing unvested ESO grants at fair value in future financial statements. We find that the likelihood of accelerated vesting is higher if (i) acceleration has a greater effect on future ESO compensation expense, especially related to underwater options; and (ii) firms suffer greater agency problems, proxied by fewer block-holders, lower pension fund ownership and top five officers holding a greater share of ESOs. We also find a negative stock price reaction around the announcement of the acceleration decision, especially for firms with greater agency problems. Furthermore, stock returns are significantly negative before the new vesting dates and positive afterward, suggesting that vesting dates could have been backdated.

Measuring Income Tax Accrual Quality

We develop and validate a measure of tax accrual quality. Tax accrual quality captures variation in the extent to which the income tax accrual maps into income tax-related cash flows, with lower variation indicating a higher quality tax accrual. Low tax accrual quality arises from (1) management estimation error and (2) financial reporting standards that lead to differences between income tax expense and income tax cash flows not captured by deferred tax assets and liabilities. We validate our tax accrual quality measure by showing it is associated with firm characteristics that capture both constructs and by demonstrating it predicts future tax-related restatements and internal control material weaknesses. We illustrate the importance of our measure by showing that investors view tax expense as more informative in firms with better tax accrual quality. Future researchers can use tax accrual quality to address questions related to estimation error in the income tax account.

Auditor-Provided Tax Services and Income Tax Estimation Error

This study examines the association between auditor-provided tax services (APTS) and financial reporting quality to determine if APTS impairs auditor independence or generates knowledge spillover. Lower (higher) financial reporting quality is generally viewed as evidence supporting auditor independence impairment (knowledge spillover). We use the quality of the income tax accrual estimate from Choudhary et al. (2013) as our measure of financial reporting quality because the tax account is where spillover should be most evident. We find a negative association between tax accrual quality and APTS, consistent with auditor independence impairment. Cross-sectional tests reveal that engaging an audit expert does not mitigate lower tax accrual quality for firms with APTS. Our findings are consistent with regulatory concerns that APTS have the potential to impair auditor independence. Acknowledgements: This paper has benefited from insightful comments by Michael Donohoe, Miguel Minutti-Meza, Katherine Schipper, and Georgetown University Accounting/Finance Brown Bag participants. http://finpolicy.georgetown.edu

Disclosure Timing and the Economic Role of Mandatory Reporting: Evidence from Managers’ Decisions to File Audited Reports Early

We investigate how managers’ decisions to file audited financial reports prior to SEC reporting deadlines relate to the economic role of mandatory reporting. Contrary to the view that audited financial reports will be more informative when they are filed earlier, we find that managers file audited reports early when they have less informative disclosures. It is unlikely that this result is due to managers filing reports early in a manner that impairs their potential to be informative; we find that early reports are more reliable and are similar to on-time reports in terms of year-over-year content revision. We further find that the percentage of information in the report relative to total information is lower for early reports, consistent with the greater preemption of information via other disclosure channels. Our collective evidence suggests that managers’ decisions to file early are more consistent with the confirmation role of reporting instead of the information role, suggesting that on-going regulatory efforts to enhance informativeness via shorter deadlines might not achieve the intended consequences.

Direct Measures of Auditors' Quantitative Materiality Judgments: Properties, Determinants and Consequences for Audit Characteristics and Financial Reporting Reliability

For a large sample of audits carried out during 2005-2015 by eight large accounting firms and inspected by the PCAOB, we provide evidence on the properties of auditors’ quantitative materiality judgments and the consequences of those judgments for financial reporting. We find that auditors’ quantitative materiality judgments do not appear to result only from applying conventional rules-of-thumb, specifically, 5% of pre-tax income, but instead are associated with qualitative factors suggested by authoritative guidance and with size-related financial statement outcomes (income, revenues and assets); weights placed by auditors on these outcomes vary with client characteristics such as financial performance. Using non-authoritative guidance in audit-firm policy manuals, we construct a materiality measure (materiality looseness) that is comparable across varying client sizes. We find that looser materiality is associated with fewer audit hours and lower audit fees, supporting the construct validity of this measure. We also find that looser materiality judgments are associated with lower amounts of detected errors and a greater incidence of restatements, highlighting the importance of these decisions for financial reporting reliability. This paper was written while Preeti Choudhary was a Senior Economic Research Fellow at the PCAOB. The PCAOB as a matter of policy disclaims responsibility for any private publication or statement by any of its economic research fellows, consultants and employees. The views expressed in this paper are the views of the authors and do not necessarily reflect the views of the Board, individual Board members, or staff of the PCAOB. We thank Michael Gurbutt, Patrick Kastein, Patricia Ledesma, Christian Leuz, Jessica Watts, Keith Wilson, Luigi Zingales, PCAOB staff and seminar participants at the PCAOB, University of Arizona, ESSEC Business School, University of Florida, George Mason University, HEC Paris, and The Center for Audit Quality Research Advisory Board for helpful discussions.