Trulaske Accounting Faculty Publish Impactful Research

By Kelsey Allen

New research from faculty in the Trulaske College of Business’ School of Accountancy gives us insights into the best way to respond to a global financial crisis, how CFOs can develop skills for their modern roles and responsibilities, a new way to predict internal control quality, and how data visualization can make audits more effective. Here’s a look at four researchers and their findings.

The Best Way to Respond to a Global Financial Crisis

The global pandemic triggered a deep economic downturn in the U.S., leading some to compare the Great Lockdown to the Great Recession. Although the 2008 Global Financial Crisis and the pandemic have different causes, the consequences are similar.

New research from Felipe Bastos Gurgel Silva, an assistant professor in the School of Accountancy at the Trulaske College of Business, compares these crises and offers insights into how central banks can respond to future disasters in the financial market.

“Whenever we have two events that are similar, the similarities themselves don’t tell us much,” Silva says. It’s by comparing the differences between the financial crisis and the pandemic that Silva was able to identify important lessons for the U.S. and global economies.

The key difference between the Great Recession and the global pandemic were the responses by central bank governors and policymakers from major emerging market economies. During the Great Recession, when the epicenter of the crisis was the U.S. market, the Federal Reserve unilaterally responded, extending its balance sheet and using the money generated to purchase assets from the market, an intervention known as quantitative easing.

“The Fed acted like the protagonist of the policy response,” Silva says. “What happens is we have a bigger base of U.S. dollars relative to other countries. The U.S. dollar is relatively depreciated when compared to other currencies. This can come with negative consequences because it generates bubbles in other markets and destabilizes capital flows in other countries.”

The ongoing global recession caused by the pandemic, on the other hand, elicited a response by the Federal Reserve and 20 other central banks that not only intervened in their own domestic markets but also coordinated globally with one another.

Silva and his colleagues wanted to know if this multilateral response to the pandemic mitigated the losses experienced by emerging market economies during the subprime crisis. They found that while unconventional monetary policies like quantitative easing successfully lowered the disaster risk for the U.S. during both crises, the unilateral intervention from 2008 to 2014 increased disaster risk in emerging market economies. However, when multiple central banks act together, like during the global pandemic, there is a decline in disaster risk for both advanced economies and emerging markets.

“The advantage when you have a multilateral action by central banks is that you don’t have distortions because everybody is expanding,” Silva says. “It’s more destabilizing when you have a single central bank acting. If there is a major crisis, it is better to have the monetary policy responses coordinated across different central banks.”

The paper, “Unconventional Monetary Policy and Disaster Risk: Evidence from the Subprime and COVID-19 Crises,” appeared in the Journal of International Money and Finance.

 

Why CFOs Should Serve on Outside Boards

Over the past few decades, the role of the chief financial officer has expanded beyond budgeting and financial reporting. Today, a CFO might also focus on strategy, optimize investments and influence operational decision-making.

Elaine Mauldin would know. Before she was the BKD Distinguished Professor in the School of Accountancy at the Trulaske College of Business, she was a CFO. When the CEO of the company retired, he told Mauldin that she would need to get more operational experience to assume the position of CEO. Mauldin decided to go into academics instead.

So how do CFOs develop the skills for these modern roles and responsibilities? Mauldin and her colleague wondered if serving on outside boards might offer CFOs the experience necessary. “Even though you might be on the audit committee, you’re a full board member, so you’re in on the strategy conversations, and you might be learning something that could improve your own firm,” she says.

Historically, CFOs don’t usually sit on outside boards. A sample of firms from 2003 to 2014 shows that only about 9% of CFOs, compared to about 24% of CEOs, have outside board directorships. Using CEOs as a baseline, the researchers found that when a CFO sits on an outside board, their home board is less likely to underinvest in capital and to hold excessive cash, ultimately improving the firm’s long-term performance. Prior research found that CFOs are typically associated with more conservative financial policies. So these new findings suggest that having wider exposure to a variety of business practices through outside board experience provides a channel for knowledge transfer and enhances the skill sets of the CFO.

“When the CFO serves on another board, they get exposed to broader concepts and they’re less likely to do that underinvesting in their own home firm,” Mauldin says. “In contrast, when the CEO serves on another board, they did not have much effect on their home firm’s policies.”

Currently, about 77% of large firms maintain some restrictions on their executives’ service on outside boards, often because of concerns about additional time commitments. Yet the findings show that not only should organizations support CFO outside board service but also that CFO outside directorships provide more benefits to home-firm policies than do CEO outside directorships.

“There is this perception that it’s going to be too much of a burden, that the CFO is too busy to be on another board, but there are some benefits to being on that board,” Mauldin says. “Boards and organizations like the National Association of Corporate Directors might want to weigh the cost and the benefit and lighten up that restriction.”

The paper, “Benefit or burden? A comparison of CFO and CEO outside directorships,” appeared in the Journal of Business Finance & Accounting.

 

A New Way to Predict Internal Control Quality

When players in the capital market are making allocation decisions or when auditors are planning financial statement audits, they evaluate a firm’s internal control deficiencies to manage financial risk appropriately. But they often don’t have access to this information until after the fiscal year is complete.

Stevie Neuman, associate professor and Tax Excellence Professor in the School of Accountancy at the Trulaske College of Business, and her colleagues have discovered a new way to identify firms with ineffective internal controls in a timely manner: interim effective tax rate estimates.

Every quarter, companies are required to issue financial statements, which include an estimate of their annual effective tax rate, or the rate at which they expect to pay tax on all of their earnings for the entire year. At the end of the second quarter, armed with more information, companies do another forecast and revise their effective tax rate.

“It's basically a forward-looking estimate for earnings,” Neuman says. “It should really contain information about where the company is headed.”

And it does. The researchers found that if a company is good at forecasting its effective tax rate — if there’s not a lot of volatility from quarter to quarter — it suggests that the firm’s forecasting systems are good and it has better internal control systems. On the other hand, if there is a lot of volatility — say the company estimates its interim tax rate to be 20% in the first quarter, 15% in the second quarter and 30% in the third quarter — then that company is much more likely to have significant internal control weaknesses.

“If there’s a lot of volatility, it might suggest that there’s a lot of operational volatility going on,” Neuman says. “There are changes in the company, they’re buying or acquiring another company, or the systems they use to forecast earnings just aren’t that good and they don’t really have a good idea of what the income is going to be, which would then imply that internal control systems aren’t very good, that those financials-generating systems aren’t very good.”

The volatility of the effective tax rate not only predicts tax-related internal control issues. The researchers also found that it predicts non-tax-related weaknesses.

“Everything ultimately flows into taxes,” Neuman says. “Every dollar that the company earns or every dollar of expense that they report ultimately affects that tax number. So not only is it able to predict issues with respect to reporting taxes but also some of these other areas that we might be more interested in because they're potentially much larger dollar amounts, such as predicting misstatements of revenue.”

Now regulators and investors can use interim estimates of the annual effective tax rate as signals of the likelihood that a firm’s internal controls are ineffective.

“Your average investor can take two companies, compare the volatility of those numbers and make a decision about which one they think has better financial reporting quality, which means that they can rely on those financial statements a little bit more,” Neuman says. “Regulators are always interested in trying to identify which companies should be audited. So if they are considering a pool of 50 companies and they only have the resources to look at 20, well, this might be one way that they go about narrowing that group down. If that estimate is really volatile, they might want to be a little bit concerned about numbers being reported on the financial statements because they might not be completely accurate.”

The paper, “Interim Effective Tax Rate Estimates and Internal Control Quality,” appeared in Contemporary Accounting Research.

 

Data Visualization as an Auditing Tool

During a busy season, an auditor might work 70 to 80 hours a week. In 2020, two then-master’s students in the School of Accountancy at the Trulaske College of Business, Nick Higginbotham and Luke Nash, wondered how they might use their time more effectively and efficiently.

Enter data visualization.

In the past few years, more and more accounting firms have been graphically representing data to spot trends and anomalies, says Will Demeré, an assistant professor of accountancy and RubinBrown Faculty Scholar who served as the students’ faculty adviser on the project. “Based on conversations with partners from some of the big accounting firms, data visualization is something that they are increasingly using,” he says. “This was a great opportunity to help promote some of these tools and give some examples of how they could be used in practice.”

In an applied article published in the Journal of Accountancy, “Making Audits More Effective Through Data Visualization,” the co-authors highlight four ways in which auditors can leverage client data.

One way auditors can use data visualization is for journal entry testing. For companies that process a large volume of transactions and have numerous accounts, data visualization can make outliers obvious and help the auditor quickly identify unusual patterns and potential risks that may have otherwise been difficult to catch. For example, a chart might show that an accounting clerk has an usually high number of transactions in a quarter, much larger than any previous period or other accounting clerks. “There could be a good reason for that,” Demeré says. “But at the very least, it helps the auditor identify where they want to focus their attention.”

Another task made easier by data visualization is cutoff testing, which is when the auditor determines whether transactions have been recorded within the correct reporting period. Comparing shipping, delivery and sales dates from underlying documents can be an incredibly time-consuming task. “With data visualization, it makes it really easy to see if there’s a drastic cutoff between accounting periods, which makes it more obvious to the auditor that there may be a higher risk of sales being recorded in an incorrect period,” Demeré says.

Similarly, data visualization is commonly used in risk assessment. For example, audit teams can quickly identify unusual trends or large deviations from forecasted levels. They might also filter and sort based on underlying accounts or classes of transactions, again enabling them to  determine where to focus their attention during risk assessment.

Data visualization isn’t just a tool to increase the efficiency and effectiveness of an audit. It’s also a helpful tool when it comes to communicating insights and findings from the audit to clients. A graphic, chart or dashboard can be easier to interpret than traditional tables and help clients better understand what the auditor found.

In Demeré’s advanced auditing course at the Trulaske College of Business, he helps students think through how to communicate data effectively and they spend time working with visualizations. “A lot of the firms are increasingly looking for students who have strong skill sets in data analytics, and data visualization is certainly a piece of that,” he says. Today, Higginbotham, BS Acc, M Acc ’20, is an assurance associate at PwC, and Nash, BS Acc, M Acc ’20, is an audit associate at KPMG.