Showing papers in "The Accounting Review in 2010"
TL;DR: The authors review and evaluate the methods commonly used in the accounting literature to correct for cross-sectional and time-series dependence and find that the extant methods are not robust to both forms of dependence.
Abstract: We review and evaluate the methods commonly used in the accounting literature to correct for cross‐sectional and time‐series dependence. While much of the accounting literature studies settings in which variables are cross‐sectionally and serially correlated, we find that the extant methods are not robust to both forms of dependence. Contrary to claims in the literature, we find that the Z2 statistic and Newey‐West corrected Fama‐MacBeth standard errors do not correct for both cross‐sectional and time‐series dependence. We show that extant methods produce misspecified test statistics in common accounting research settings, and that correcting for both forms of dependence substantially alters inferences reported in the literature. Specifically, several findings in the implied cost of equity capital literature, the cost of debt literature, and the conservatism literature appear not to be robust to the use of well‐specified test statistics.
946 citations
TL;DR: In this article, the authors investigate whether individual top executives have incremental effects on their firms' tax avoidance that cannot be explained by characteristics of the firm, and find that executive effects appear to be an important determinant in firms’ tax avoidance.
Abstract: This study investigates whether individual top executives have incremental effects on their firms’ tax avoidance that cannot be explained by characteristics of the firm. To identify executive effects on firms’ effective tax rates, we construct a data set that tracks the movement of 908 executives across firms over time. Results indicate that individual executives play a significant role in determining the level of tax avoidance that firms undertake. The economic magnitude of the executive effects on tax avoidance is large. Moving between the top and bottom quartiles of executives results in approximately an 11 percent swing in GAAP effective tax rates; thus, executive effects appear to be an important determinant in firms’ tax avoidance.
782 citations
TL;DR: In this article, the authors examined whether the mandatory adoption of International Financial Reporting Standards (IFRS) in the European Union (EU) in 2005 reduces the cost of equity capital.
Abstract: This study examines whether the mandatory adoption of International Financial Reporting Standards (IFRS) in the European Union (EU) in 2005 reduces the cost of equity capital. Using a sample of 6,456 firm‐year observations of 1,084 EU firms during the 1995 to 2006 period, I find evidence that, on average, the IFRS mandate significantly reduces the cost of equity for mandatory adopters by 47 basis points. I also find that this reduction is present only in countries with strong legal enforcement, and that increased disclosure and enhanced information comparability are two mechanisms behind the cost of equity reduction. Taken together, these findings suggest that while mandatory IFRS adoption significantly lowers firms' cost of equity, the effects depend on the strength of the countries' legal enforcement.
537 citations
TL;DR: In this article, the authors investigate whether individual managers play an economically significant role in their firms' voluntary financial disclosure choices, and find that top executives exert unique and economically significant influence on their firms’ voluntary disclosures, incremental to known economic determinants of disclosure, and firm-specific effects.
Abstract: Financial economics has posited a limited role for idiosyncratic noneconomic manager-specific influences, but the strategic management literature suggests such individual influences can affect corporate outcomes. We investigate whether individual managers play an economically significant role in their firms’ voluntary financial disclosure choices. Tracking managers across firms over time, we find top executives exert unique and economically significant influence (manager-specific fixed effects) on their firms’ voluntary disclosures, incremental to known economic determinants of disclosure, and firm- and time-specific effects. Managers’ unique disclosure styles are associated with observable demographic characteristics of their personal backgrounds: managers promoted from finance, accounting, and legal career tracks, managers born before World War II, and those with military experience develop disclosure styles displaying certain conservative characteristics; and managers from finance and account...
504 citations
TL;DR: Wang et al. as mentioned in this paper examined how the legal and regulatory changes in China affect the relationship between client economic importance and audit quality and found that the propensity to issue modified audit opinions (MAOs) is negatively correlated with client importance from 1995 to 2000.
Abstract: This study examines how the legal and regulatory changes in China affect the relationship between client economic importance and audit quality. At the individual auditor level, we find that the propensity to issue modified audit opinions (MAOs) is negatively correlated with client importance from 1995 to 2000. However, from 2001 to 2004, when the institutional environment became more investor‐friendly, the propensity to issue MAOs is positively associated with client importance. These findings are corroborated by an analysis of regulatory sanctions. Although client importance measured at the office level is also negatively related to the propensity for MAOs from 1995 to 2000 without controlling for the auditor‐level client importance, this result is sensitive to model specification and sample composition. Our results suggest that (1) institutional improvements prompt auditors to prioritize the costs of compromising quality over the economic benefits gained from important clients; and (2) the imp...
410 citations
TL;DR: In this article, the authors examined the effects of financial reporting complexity on investors' trading behavior and found that more complex (longer and less readable) filings are associated with lower overall trading, and that this relationship appears due to a reduction in small investors’ trading activity.
Abstract: This study examines the effects of financial reporting complexity on investors’ trading behavior. I find that more complex (longer and less readable) filings are associated with lower overall trading, and that this relationship appears due to a reduction in small investors’ trading activity. Additional evidence suggests that the association between report complexity and lower abnormal trading is driven by both cross-sectional variation in firms’ disclosure attributes and variations in disclosure complexity over time. Given regulatory concerns over plain English disclosures and the trend toward more disclosure, my investigation into the effects of reporting complexity on small and large investors should be of interest to regulators concerned with reporting clarity and leveling the playing field across classes of investors.
391 citations
TL;DR: In this article, the relevance of fair value measurements under FAS No. 157 was investigated using quarterly reports of banking firms in 2008 and found that the value relevance of Level 1 and Level 2 fair values is greater than the value importance of Level 3 fair values.
Abstract: Statement of Financial Accounting Standards No. 157 (FAS No. 157), Fair Value Measurements, prioritizes the source of information used in fair value measurements into three levels: (1) Level 1 (observable inputs from quoted prices in active markets), (2) Level 2 (indirectly observable inputs from quoted prices of comparable items in active markets, identical items in inactive markets, or other market-related information), and (3) Level 3 (unobservable, firm-generated inputs). Using quarterly reports of banking firms in 2008, we find that the value relevance of Level 1 and Level 2 fair values is greater than the value relevance of Level 3 fair values. In addition, we find evidence that the value relevance of fair values (especially Level 3 fair values) is greater for firms with strong corporate governance. Overall, our results support the relevance of fair value measurements under FAS No. 157, but weaker corporate governance mechanisms may reduce the relevance of these measures.
350 citations
TL;DR: In this paper, the authors examined how firms' asymmetric cost behavior influences analysts' earnings forecasts, primarily the accuracy of analysts' consensus earnings forecasts and found that firms with stickier cost behavior have less accurate analysts's earnings forecasts than firms with less sticky cost behavior.
Abstract: This study examines how firms’ asymmetric cost behavior influences analysts’ earnings forecasts, primarily the accuracy of analysts’ consensus earnings forecasts. Results indicate that firms with stickier cost behavior have less accurate analysts’ earnings forecasts than firms with less sticky cost behavior. Furthermore, findings show that cost stickiness influences analysts’ coverage priorities and investors appear to consider sticky cost behavior in forming their beliefs about the value of firms. This study integrates a typical management accounting research topic, cost behavior, with three standard financial accounting topics (namely, accuracy of analysts’ earnings forecasts, analysts’ coverage, and market response to earnings surprises).
318 citations
TL;DR: In this paper, the authors developed and validated an expanded model for inferring the likelihood that a firm engages in a tax shelter using confidential tax shelter and tax return data obtained from the Internal Revenue Service.
Abstract: Using confidential tax shelter and tax return data obtained from the Internal Revenue Service, this study develops and validates an expanded model for inferring the likelihood that a firm engages in a tax shelter. Results show that tax shelter likelihood is positively related to subsidiaries located in tax havens, foreign-source income, inconsistent book-tax treatment, litigation losses, use of promoters, profitability, and size, and negatively related to leverage. Supplemental tests show that total book-tax differences (BTDs) and the contingent tax liability reserve are significantly related to tax shelter usage, while discretionary permanent BTDs and long-run cash effective tax rates are not. Finally, the model is weaker, yet still significant, in the FIN 48 disclosure environment. This research provides investors and policymakers with an extended, validated measure to calculate the presence of extreme cases of corporate tax aggressiveness. Such information could also aid analysts and other ta...
295 citations
TL;DR: In this article, the authors examined the ability of revenue and accrual models to detect simulated and actual earnings management and found that revenue models are less biased, better specified, and more powerful than commonly used accruality models.
Abstract: This study examines the ability of revenue and accrual models to detect simulated and actual earnings management. The results indicate that revenue models are less biased, better specified, and more powerful than commonly used accrual models. Using a simulation procedure, I find that revenue models are more likely than accrual models to detect a combination of revenue and expense manipulation. Using a sample of firms subject to SEC enforcement actions for a mix of revenue‐ and expense‐related misstatements, I find that, although revenue models detect manipulation, accrual models do not. These findings provide support for using measures of discretionary revenues to study earnings management.
287 citations
TL;DR: In this paper, the authors investigate why firms choose to evaluate a tax department as a profit center (contributor to the bottom line) as opposed to as a cost center and the association between this choice and effective tax rates (ETRs).
Abstract: We investigate why firms choose to evaluate a tax department as a profit center (“contributor to the bottom line”) as opposed to as a cost center and the association between this choice and effective tax rates (ETRs). Using data from a confidential survey taken in 1999 of Chief Financial Officers, we develop and test a theory for choosing between these two methods of evaluating a tax department. We find that the likelihood of evaluating the tax department as a profit center is increasing in firm decentralization characteristics and tax-planning opportunities. We then employ instrumental variables to investigate whether evaluating a tax department as a profit center provides an effective incentive for the tax department to contribute to net income through lower ETRs. We find that our instrument for profit center firms is associated with significantly lower ETRs than cost center firms.
TL;DR: This paper found that the reaction is more negative if the GCAR cites a problem with obtaining financing, suggesting that the audit report provides new information to investors, and that the market reaction gets more negative as the level of institutional ownership increases, and there is a decline in institutional ownership after a GCAR is issued.
Abstract: The literature provides mixed evidence on whether investors find audit reports modified for going concern reasons to be useful. Using a substantially larger sample than previous studies, we observe negative excess returns when the going concern audit report (GCAR) is disclosed. We find that the reaction is more negative if the GCAR cites a problem with obtaining financing, suggesting that the GCAR provides new information to investors. Also, the reaction is more adverse if the GCAR triggers a technical violation of a debt covenant that restricts the firm from getting a GCAR. The evidence suggests that institutional investors drive the reaction to the GCAR, since there is no detectable reaction at low levels of institutional ownership. The market reaction gets more negative as the level of institutional ownership increases, and there is a decline in institutional ownership after the GCAR is issued. We attribute these results to sophisticated investors’ awareness of the firm’s financing needs and ...
TL;DR: This article found that whistle-blowing announcements were associated with a negative 2.8 percent market-adjusted five-day stock price reaction; this reaction was especially negative for allegations involving earnings management (−7.3 percent).
Abstract: We document the first systematic evidence on the characteristics and economic consequences of firms subject to employee allegations of corporate financial misdeeds. First, compared to a control group that avoided public whistle-blowing allegations, firms subject to whistle-blowing allegations were characterized by unique firm-specific factors that led employees to expose alleged financial misdeeds. Second, on average, whistle-blowing announcements were associated with a negative 2.8 percent market-adjusted five-day stock price reaction; this reaction was especially negative for allegations involving earnings management (−7.3 percent). Third, compared to a control group that exhibits similar characteristics, firms subject to whistle-blowing allegations were associated with further negative consequences including earnings restatements, shareholder lawsuits, and negative future operating and stock return performance. Finally, whistle-blowing targets exposed by the press were more likely to make sub...
Abstract: We examine the value relevance of a comprehensive set of summary performance measures including sales, earnings, comprehensive income, and operating cash flows. We find that, while value relevance peaks for measures “above the line,” no single measure dominates around the world. Instead, a measure is more relevant when it captures, directly and quickly, information about firms’ cash flows. Specifically, for each performance measure by country, we estimate eight attributes commonly used to assess earnings quality. We find these attributes highly correlated—most of their variance is explained by only two principal factors. A factor capturing articulation with cash flows is positively associated with a measure’s value relevance; a factor reflecting the measure’s persistence, predictability, smoothness, and conservatism is negatively associated. Our results suggest that, when it comes to equity valuation, accounting researchers and standard-setters should focus not on what performance measure is “be...
TL;DR: The authors compare the quality of accounting numbers produced by two types of public firms, those with publicly traded equity and those with privately held equity that are nonetheless considered to be "pregressive".
Abstract: We compare the quality of accounting numbers produced by two types of public firms—those with publicly traded equity and those with privately held equity that are nonetheless considered p...
TL;DR: In this paper, the authors examined the information content of Form 4 filings under the more timely disclosure regime introduced by Section 403 of the Sarbanes-Oxley Act of 2002 (SOX), and found that abnormal returns and trading volumes around filings of insider stock purchases are significantly greater after SOX than before.
Abstract: This study examines the information content of Form 4 filings under the more timely disclosure regime introduced by Section 403 of the Sarbanes‐Oxley Act of 2002 (SOX). Abnormal returns and trading volumes around filings of insider stock purchases are significantly greater after SOX than before. Abnormal trading volumes around filings of insider sales are also greater post‐SOX, on average, but stock returns are not more negative. However, once controlling for pre‐planned transactions, reporting lag, litigation risk, and news following insider trades, I find a negative association between returns around filings of insider sales and SOX. Overall, the evidence suggests that the prompt public disclosures about insider transactions mandated by the new rule are relevant to the pricing of securities. The results are also consistent with SOX and regulatory actions reducing the incentives to sell ahead of privately known negative news.
TL;DR: This article found that the negative relation between short-term debt and audit fees is stronger for firms with low-quality credit ratings, consistent with auditors pricing lender monitoring and more monitoring and better governance mechanisms.
Abstract: Short-term debt and credit ratings have benefits for financial reporting quality that may be associated with lower audit fees. Using U.S. data for 2003 through 2006, we find that short-term debt is negatively related to audit fees for firms rated by Standard & Poor’s, consistent with more monitoring and better governance mechanisms in firms with higher short-term debt. Credit ratings quality is negatively related to audit fees, consistent with ratings quality reflecting a firm’s liquidity risk, governance mechanisms, and monitoring from rating agencies. We also find that the negative relation between short-term debt and audit fees is stronger for firms with low-quality credit ratings, consistent with auditors pricing lender monitoring.
TL;DR: In this paper, the authors examine auditor independence in the banking industry by analyzing the relation between fees paid to auditors and the extent of earnings management through loan loss provisions (LLP), and find that auditor fee dependence on the audit client is associated with abnormal LLP and is a potential threat to auditor independence for small banks.
Abstract: We examine auditor independence in the banking industry by analyzing the relation between fees paid to auditors and the extent of earnings management through loan loss provisions (LLP). We also examine whether this relation differs across large banks whose managements are required under the Federal Deposit Insurance Corporation Improvement Act to evaluate internal control over financial reporting and whose auditors must attest to the effectiveness of such internal controls, and small banks that are not subject to those requirements. We find that unexpected auditor fees are unrelated to earnings management for large banks. For small banks, we find greater earnings management via under-provisioning of LLP by banks that pay higher unexpected total and nonaudit fees to the auditor. These results suggest that auditor fee dependence on the audit client is associated with earnings management via abnormal LLP and is a potential threat to auditor independence for small banks. Our findings are relevant to...
TL;DR: In this article, the authors show that classification shifting is more likely in the fourth quarter than in the interim quarters when the ability of managers to manipulate accruals appears to be constrained and in meeting a range of earnings benchmarks.
Abstract: McVay (2006) concludes that managers opportunistically shift core expenses to special items to inflate current core earnings, resulting in a positive relation between unexpected core earnings and income-decreasing special items. However, she further notes that this relation disappears when contemporaneous accruals are dropped from the core earnings expectations model. McVay (2006) calls for research to improve the core earnings expectations model and to provide additional cross-sectional tests of classification shifting. Using a core earnings expectations model that is not dependent on accrual special items, we show that classification shifting is more likely in the fourth quarter than in interim quarters. We also find more evidence of classification shifting when the ability of managers to manipulate accruals appears to be constrained and in meeting a range of earnings benchmarks. Overall, our evidence provides broad support for McVay’s (2006) conclusion that managers engage in classification s...
TL;DR: In this paper, the authors examine the issue of auditor independence in a unique setting, and find that auditors who receive higher fees are less likely to issue modified opinions, despite the low litigation risk and reduced reputation risk.
Abstract: We examine the issue of auditor independence in a unique setting. Specifically, we test for auditor independence impairment among (1) private client firms, for which the risk of auditor reputation loss is lower than for publicly traded firms, and (2) in a low litigation environment (i.e., Norway) that further reduces the expected costs to the auditor associated with independence impairment. We have thus chosen a setting that gives independence impairment its best chance of being detected if it exists. Using a large sample of private Norwegian firms, we analyze whether auditors who receive higher fees are less likely to issue modified opinions. Despite the low litigation risk and the reduced reputation risk, our empirical results provide no evidence that auditors compromise their independence through fee dependence. These results are robust to controlling for the expected portion of fees, to different sample specifications, to the use of both levels and changes specifications, and to a number of ...
TL;DR: The authors found no relation between earnings smoothness and average stock returns over the last 30 years and found that owners of firms with volatile earnings are not compensated with higher returns, as one would expect if volatile earnings lead to greater risk exposure.
Abstract: Despite a belief among corporate executives that smooth earnings paths lead to a lower cost of equity capital, I find no relation between earnings smoothness and average stock returns over the last 30 years. In other words, owners of firms with volatile earnings are not compensated with higher returns, as one would expect if volatile earnings lead to greater risk exposure. Although prior empirical work links smoother earnings to a lower implied cost of capital, I offer evidence that this link is driven primarily by optimism in analysts' long‐term earnings forecasts. This optimism yields target prices and implied cost of capital estimates that are systematically too high for firms with volatile earnings. Overall, the evidence is inconsistent with the notion that attempts to smooth earnings can lead to a lower cost of equity capital.
TL;DR: This paper showed that managers who are involved in selecting strategic initiatives perceive those initiatives as having been more successful than managers who were not involved in the initiative-selection process (holding constant actual scorecard performance).
Abstract: Using an experiment, I examine whether involvement in scorecard implementation can mitigate the effects of motivated reasoning that occur when the scorecard is framed as a causal chain rather than merely as a balanced set of measures. Psychological research on motivated reasoning suggests that managers will evaluate and interpret data in ways consistent with preferences, increasing their tendency to arrive at conclusions that are consistent with their desired conclusions (Kunda 1990). Consistent with that research, results of my study show that managers who are involved in selecting strategic initiatives perceive those initiatives as having been more successful than managers who are not involved in the initiative-selection process (holding constant actual scorecard performance). Results suggest further that simply framing the scorecard as a causal chain is not sufficient to mitigate these effects. However, framing the scorecard as a causal chain, in conjunction with involving managers in the sel...
TL;DR: In this article, the authors consider the adoption of accounting standards (such as the lease standard) opportunistically to move debt off balance sheet, which is a common practice in financial management.
Abstract: Managers sometimes implement accounting standards (such as the lease standard) opportunistically to move debt off balance sheet. Regulators and standard-setters are considering the adopti...
TL;DR: In this article, the authors identify a sample of firms that implemented internal control monitoring technology in response to the internal control requirements of the Sarbanes-Oxley Act and find that the implementation of such monitoring technology is associated with lower likelihood of material weaknesses, smaller increases in audit fees, and smaller increase in audit delays during the post-SOX time period.
Abstract: We analyze the potential benefits that firms can realize from implementing technology specifically aimed at monitoring the effectiveness of their internal control systems. The Committee of Sponsoring Organizations of the Treadway Commission asserts that effective internal control monitoring should enhance the efficiency of internal control processes, and, in turn, the assurance over such processes (COSO 2009a). We develop hypotheses to test the realization of these potential benefits. Specifically, we identify a sample of firms that implemented internal control monitoring technology in response to the internal control requirements of the Sarbanes-Oxley Act. Consistent with our hypotheses, we document that the implementation of internal control monitoring technology is associated with lower likelihood of material weaknesses, smaller increases in audit fees, and smaller increases in audit delays during the post-SOX time period. We discuss the potential implications of our findings for research rel...
TL;DR: In this article, the authors examine whether and how earnings quality, measured as accruals quality (AQ), affects the cost of equity capital and find that the AQ risk factor is significantly priced, after controlling for low-priced stocks.
Abstract: This study examines whether and how earnings quality, measured as accruals quality (AQ), affects the cost of equity capital. Using two-stage cross-sectional regression tests, we find that the AQ risk factor is significantly priced, after controlling for low-priced stocks. This result is robust in tests using individual stocks, various portfolio formations, and different beta estimations. Furthermore, we show that AQ and its pricing effect systematically vary with business cycles and macroeconomic variables. In particular, this pricing effect is prominent in total AQ and innate AQ but not in discretionary AQ. The risk premium associated with AQ exists only in economic expansion but not in recession periods. Poorer AQ firms are more vulnerable to macroeconomic shocks. The risk premium and the dispersion of AQ are also related to future economic activity. Overall, our results suggest that AQ contributes to the cost of equity capital and that its pricing effect is associated with fundamental risk.
TL;DR: The authors identify two factors (equity-based incentives and concerns over job security) that help explain why most firms do not follow policymakers' preference to report comprehensive income in a performance statement.
Abstract: Firms can report comprehensive income in either an income‐statement‐like performance statement or the statement of equity. Traditional theories of contracting incentives cannot explain this reporting location choice that only affects where comprehensive income data appear, because the contractible values of net income, other comprehensive income items, and comprehensive income are exactly the same regardless of the location where the firm reports comprehensive income. Drawing on theory, analysis of comment letters, and results of survey‐based and behavioral research, we identify two factors—equity‐based incentives and concerns over job security—that help explain why most firms do not follow policymakers' preference to report comprehensive income in a performance statement. Our empirical evidence on a broad cross‐section of firms shows that managers with stronger equity‐based incentives and less job security are significantly less likely to use performance reporting. Overall, our study suggests t...
TL;DR: This article investigated whether managers use classification shifting to manage earnings when reporting discontinued operations and found evidence consistent with the hypothesis that firms shift operating expenses to income-decreasing discontinued operations to increase core earnings.
Abstract: This study investigates whether managers use classification shifting to manage earnings when reporting discontinued operations. Using a methodology similar to McVay (2006), we find evidence consistent with the hypothesis that firms shift operating expenses to income-decreasing discontinued operations to increase core earnings. Our findings also indicate that managers use classification shifting to meet or beat analysts’ forecasts. Finally, we find that, since the introduction of SFAS No. 144, the reporting frequency of discontinued operations has increased; however, the magnitude of classification shifting has decreased. We provide potential explanations for this finding.
TL;DR: In this article, the authors show that disclosure quality improves investor welfare by reducing cost of capital, but only in limited circumstances, and that the argument is valid only for limited circumstances.
Abstract: One might expect that disclosure quality improves investor welfare by reducing cost of capital. This study shows that the argument is valid only in limited circumstances. Based on a production economy with perfect competition among investors, the analysis demonstrates three points. First, cost of capital could increase with disclosure quality when new investment is sufficiently elastic. Second, there are plausible conditions under which disclosure quality reduces the welfare of current and/or new investors. Finally, cost of capital could move in opposition to the welfare of either current or new investors as disclosure quality changes.
TL;DR: In this paper, the authors find no evidence consistent with ex post settling up for poor firm performance, even among the very worst performing firms with strong corporate governance, and find that CEO cash compensation is less sensitive to poor earnings performance than it is to better earnings performance.
Abstract: Leone et al. (2006) conclude that CEO cash compensation is more sensitive to negative stock returns than to positive stock returns, due to Boards of Directors enforcing an ex post settling up on CEOs. Dechow (2006) conjectures that Leone et al.’s (2006) results might be due to the sign of stock returns misclassifying firm performance. Using three-way performance partitions, we find no asymmetry in CEO cash compensation for firms with low stock returns. Further, we find that CEO cash compensation is less sensitive to poor earnings performance than it is to better earnings performance. Thus, we find no evidence consistent with ex post settling up for poor firm performance, even among the very worst performing firms with strong corporate governance. We find similar results when examining changes in CEO bonus pay and when partitioning firm performance using earnings-based measures. In sum, our results suggest that CEO cash compensation is not punished for poor firm performance.
TL;DR: The authors found that evaluators in a natural (i.e., between-participants) environment are more likely to hold auditors liable for failing to detect fraud when auditors investigated for the perpetrated fraud, relative to when the auditors did not investigate for the fraud.
Abstract: Legal scholars and accounting practitioners have expressed concern that the U.S. legal system might, in cases of undetected fraud, effectively penalize auditors for identifying and investigating fraud risks (AICPA 2004; Coffee 2004; Golden et al. 2006). This study draws on counterfactual reasoning theory to provide experimental evidence indicating that this concern is warranted. Consistent with counterfactual reasoning theory, I find that evaluators in a natural (i.e., between-participants) environment are more likely to hold auditors liable for failing to detect fraud when the auditors investigated for the perpetrated fraud, relative to when the auditors did not investigate for the fraud. Findings from a less natural within-participants experiment, however, indicate that the between-participant findings likely were unintentional: That is, the same evaluators, when later asked to judge alternative levels of fraud investigation simultaneously, are less likely to hold auditors liable for failing t...