This study examines how organized labor affects selling, general, and administrative (SG&A) cost behavior. Human capital is emerging as firms' most valuable asset, and we further the understanding of the interaction between employees and SG&A cost behavior. We predict and find that labor cost stickiness is higher for firms facing stronger unions, but the stickiness of SG&A costs is lower. This is consistent with our arguments that in firms with stronger unions, managers' discretionary decision to retain SG&A resources is negatively affected by higher labor adjustment costs that result in the retention of slack labor resources during periods of decreased demand. To assess the robustness of our main findings, we conduct an event analysis of labor union elections and find that SG&A cost stickiness decreases after firms experience new union certification. Cross-sectional tests also show that the effect of labor union strength on SG&A cost stickiness is more pronounced for firms that are in better financial condition, have higher analyst coverage, and have higher net operating assets. We find a similar effect of union strength on discretionary spending when examining R&D costs. Overall, we contribute to the literature by showing that organized labor has a significant effect on cost behavior, which has implications for financial statement users and financial forecasting.
We find that firms with preliminary earnings that are expected to just meet analyst forecasts are more likely to only disclose (i.e., not accrue) litigation loss contingencies, claiming that the litigation event falls below the qualitative thresholds necessitating accrual. We also find that this opportunistic treatment of a subjective estimate is reduced when firms’ auditors have expertise in the defendant’s industry or have experience auditing litigation contingencies. Furthermore, we find that opportunistic disclosure usage increases when firms are more economically important to auditors’ client portfolios. Our results are robust to a series of additional tests. We provide evidence to support the Public Company Accounting Oversight Board’s (PCAOB) call for increased auditor professional skepticism toward management bias and opportunism when evaluating subjective estimates.
We examine how internal control effectiveness influences the audit completeness of earnings announcements and the consequences on earnings reliability. One of the intentions of the Sarbanes Oxley Act of 2002 (SOX) was for internal controls to improve financial reporting. While we show that effective internal controls directly reduce earnings announcement revisions as SOX would intend, we also find evidence that it provides management with the confidence to release their earnings disclosure earlier (with a less complete audit), indirectly increasing the likelihood of earnings announcement revisions. As a result, the beneficial impact of internal control effectiveness on earnings reliability is significantly undermined in a regulatory environment where companies are permitted to disclose preliminary earnings to the public. Our study provides important insights for regulatory policymaking and for accounting practitioners who are responsible for producing reliable financial disclosure.
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