Nonfinancial Measures and Fraud Risk:Evaluating Investors’ Reactions to Greater Transparency

We examine whether increased transparency in the comparison of financial measures and nonfinancial measures (NFMs) influences nonprofessional investors’ reactions to the risk of fraudulent financial reporting. We consider a comparison of key financial measures and NFMs to be transparent when the relevant information is presented in close proximity and formatted to provide an easy comparison of the individual measures. We manipulate the presence of an NFM red flag and the transparency of the comparison of financial measures and NFMs. We find that when the NFM red flag is present (i.e., higher fraud risk) and transparent, investors choose lower investment levels. However, without increased transparency, as is typical in the current reporting environment, we observe that investors are more likely to increase their investment levels in firms with elevated fraud risk. Additionally, we observe that the effect of transparency on investment levels is driven by investors with greater investing experience.

Pentingnya Ukuran Kinerja Nonfinansial dalam Balanced Scorecard, Komitmen Organisasi, dan Kinerja Manajerial

This study investigates the role of the degree of importance of using nonfinancial performance measures (in Balanced Scorecard) by superiors for performance evaluation in influencing employee performance through organizational commitment. This study adopted a quantitative research design and conducted a cross-sectional survey by questionnaire to collect responses from 118 local managers in Samarinda, Indonesia. Based on PLS analysis, the results of this study indicate that the use of nonfinancial measures in Balanced Scorecard for performance evaluation is significantly affect employee organizational commitment and directly affect managerial performance through organizational commitment. The results also prove that organizational commitment has a mediation role in the relationship between nonfinancial measures and performance. This study provides valuable insight that the degree of importance of the use of nonfinancial measures by superiors to evaluate performance can improve employee commitment and performance. Practically, the results provide an overview for superiors to be more comprehensive in developing a performance measurement system because the system has a crucial role in influencing employee behavior.

How the Interplay between Financial and Nonfinancial Measures Affects Management Forecasting Behavior

ABSTRACT This study examines how the interplay between financial and nonfinancial measures (NFMs) affects management forecasting behavior. Building on the knowledge that NFMs are typically aligned with actual earnings and are likely incorporated into earnings forecasts, we investigate if the level of divergence between changes in NFMs and contemporaneous changes in earnings influences management forecasting behavior. We hand collect company-specific NFMs disclosed in 10-K filings and describe how a greater divergence between NFMs and earnings (i.e., NFM changes substantially outpacing earnings growth, or vice versa) is associated with greater uncertainty about the underlying business. As such, in more divergent settings, we observe that management is less likely to issue guidance. Consistent with our theory, for managers that do provide guidance in more divergent settings, management forecast errors increase. Last, we provide evidence that external stakeholders can use the level of divergence to predict future management forecasting behavior. JEL Classifications: G14; M40; M41. Data Availability: The data used in this study are publicly available from the sources indicated in the text.

A Dollar for a Tree or a Tree for a Dollar? The Behavioral Effects of Measurement Basis on Managers' CSR Investment Decision

ABSTRACT We experimentally investigate how managers' decisions to invest discretionary resources in the company's corporate social responsibility (CSR) initiatives are affected by whether the investment decision is denominated in financial or nonfinancial measures (i.e., the measurement basis used for decision making). We posit that nonfinancial measures bring attention to the society-serving nature of CSR investments, thus activating the pro-CSR social norms of the company and managers' personal CSR norms. Norm activation, in turn, influences managers' investment decisions to the extent that social norms are congruent with personal norms. As predicted, we find that the level of CSR investment is higher under a nonfinancial measurement basis than under a financial measurement basis, but only when the manager is personally supportive of CSR. Supplemental analysis indicates that CSR-supportive managers continue to invest more under a combined financial/nonfinancial measurement basis than under a financial measurement basis only. Theoretical and practical implications are discussed. JEL Classifications: C91; M41.

Do Auditors and Audit Committees Lower Fraud Risk by Constraining Inconsistencies between Financial and Nonfinancial Measures?

SUMMARY Prior research finds that companies committing fraud exhibit large inconsistencies between reported revenue growth and growth in revenue-related nonfinancial measures (e.g., number of stores, employees, patents). Prior research also suggests that auditors, on average, are not adept at identifying and constraining these differences. This article summarizes a recent study by Brazel and Schmidt (2018) that examines whether certain auditors and audit committees are able to lower fraud risk by constraining inconsistencies between financial and related nonfinancial measures (NFMs). This practitioner summary first summarizes the motivation for the study, then discusses the methods used, explains the results, and concludes with a discussion of the study's implications. Brazel and Schmidt (2018) find that auditors with greater industry expertise and tenure, and audit committee chairs with greater tenure are less likely to be associated with companies that exhibit large inconsistencies between their reported revenue growth and related NFMs (higher fraud risk). Surprisingly, they observe that audit committees with industry expert chairs are more likely to be associated with large inconsistencies than audit committees without industry expert chairs. Overall, Brazel and Schmidt (2018) conclude that the audit process can constrain fraud risk, but not all forms of audit committee expertise may be beneficial.

The Importance of Task Complexity When Rewarding Nonfinancial Performance

ABSTRACT In this study, I investigate whether the effectiveness of rewarding performance of nonfinancial measures varies across levels of task complexity. I use a multi-period experiment where participants are assigned a highly or moderately complex task and an incentive contract where only financial measures or both financial and nonfinancial measures are rewarded. I find that in a moderately complex task, individuals perform better when only the financial measures are rewarded in the incentive contract. However, in a highly complex task, individuals perform better when both financial and nonfinancial measures are rewarded. Collectively, the results identify task complexity as an important task characteristic that impacts the effectiveness of incentives on nonfinancial measures of performance.

Disclosure and Audit Implications of Nonfinancial Measures: A Teaching Case

SUMMARY This case introduces students to nonfinancial measures (NFMs) and encourages thoughtful consideration and discourse surrounding their reporting and use by managers and auditors. NFMs are commonly reported by companies to provide increased transparency of operations and to more effectively describe performance. External parties such as analysts and auditors make use of NFMs in performing valuation assessments, fraud risk assessments, and substantive analytical procedures. In completing this case, students will be exposed to actual NFMs disclosed in SEC filings and employ Microsoft Excel knowledge to perform foundational analytical procedures. Students will also analyze how these NFMs link to the financial statements, as well as reflect upon the implications of NFMs for both internal and external users.

Do Auditors and Audit Committees Lower Fraud Risk by Constraining Inconsistencies between Financial and Nonfinancial Measures?

SUMMARY Prior research finds that companies committing fraud exhibit large inconsistencies between reported revenue growth and growth in revenue-related nonfinancial measures (e.g., number of stores, employees, patents). However, prior research also suggests that auditors, on average, are not adept at identifying and constraining these differences. This study investigates whether certain auditors and audit committees are able to lower fraud risk by constraining inconsistencies between financial and related nonfinancial measures (NFMs). For a sample of companies across a variety of industries, we find that auditors with greater industry expertise and tenure and audit committee chairs with greater tenure are less likely to be associated with companies that exhibit large inconsistencies between their reported revenue growth and related NFMs. Surprisingly, we observe that audit committees with industry expert chairs are more likely to be associated with large inconsistencies (higher fraud risk) than audit committees without industry expert chairs. JEL Classifications: M4.