bluuebunny/crossref_metadata_2025 huggingface dataset:
Conservatism and Book-Tax Differences
Authors: Heltzer Wendy
Published: July 2017

I investigate the relation between conservatism and book-tax differences (BTDs), where “conservatism” refers to conservatism in the financial statement context (as opposed to the taxable income context). Specifically, “conservatism” refers to conditional and unconditional conservatism per Basu (1997). The primary objective of my study is to further the use of BTDs in financial statement analysis. I find that, on average, the conditional and unconditional financial statement conservatism of firm-years with large positive BTDs (book income is greater than taxable income) is similar to that of other sample firm-years, while the conditional and unconditional conservatism in taxable income of firm-years with large positive BTDs is greater than that of other sample firm-years. Thus, contrary to teachings in popular accounting textbooks, my main findings suggest that large positive BTDs do not, on average, reveal information about a firm's relative level of financial statement conservatism. I additionally find that, on average, the unconditional financial statement conservatism among firm-years with large negative BTDs (LNBTDs, taxable income is greater than book income) is greater than that of other sample firm-years, and, at the same time, the conditional and unconditional conservatism in taxable income among firm-years with large negative BTDs is less than that of other sample firm-years. Because the increased financial statement conservatism among firm-years with LNBTDs is unconditional in nature, and is not conditional in nature, the increased conservatism among firm-years in this subsample does not translate into higher earnings quality.
Discussion of “The ‘Numbers Game’ in the Pre- and Post-Sarbanes-Oxley Eras”
Authors: Roychowdhury Sugata
Published: July 2017

Eli Bartov and Daniel Cohen (2009) test whether there has been a decline in the extent to which managers engage in opportunistic activities to meet or beat analyst benchmarks after the passage of the Sar-banes-Oxley Act (SOX) in response to the well-publicized corporate scandals of 2001 and 2002. They document a decline in the proportion of firms just meeting or beating analyst expectations (JMB firms) in the Post-SOX period. Focusing on the specific strategic actions taken by JMB firms, they find evidence of a shift away from expectations management and earnings management via accruals, towards earnings management via real activities. The research setting is intuitively appealing, and the results documented in the paper are very interesting.

However, there appear to be multiple inferences that can be drawn from these results. In particular, the patterns documented in the paper raise questions about whether the effects of regulation (in this case, SOX) are indeed beneficial for capital markets, an issue that is clearly an interesting topic for further examination.
Discussion of “Internal Control Weaknesses and Client Risk Management”
Authors: Dey Aiyesha
Published: July 2017

Randal Elder, Yan Zhang, Jian Zhou, and Nan Zhou (2009) study auditors' strategies to manage client risk resulting from internal control weaknesses in the first year of The Sarbanes-Oxley Act (SOX) 404 implementation. They first examine the relation between internal control weaknesses and audit fees, modified opinions, and auditor resignations, respectively, and establish that these are viable strategies to manage control risk on a stand-alone basis. They also document that that a pecking order exists among auditors' client control risk management strategies—as control risk increases, auditors are likely to respond in the order of audit fee adjustments, modified opinions, and auditor resignations. The authors' idea to look at a portfolio of decisions is an important step in the research in this area, and this approach can be generalized to similar studies. However, certain aspects of the hypothesis development and research design limit the authors' ability to adequately address their primary research objective.
Regulatory Incentives for Earnings Management through Asset Impairment Reversals in China
Authors: Chen Shimin , Wang Yuetang , Zhao Ziye
Published: July 2017

While asset impairment reversals are practiced in many jurisdictions, empirical evidence is rare. China provides us with a unique opportunity to examine both the determinants and consequences of impairment reversals resulting from recent developments in standard-setting and its specific performance-based listing requirements. Based on a sample of reversal firms in China, we report the following findings: First, Chinese-listed companies are motivated by regulatory incentives to reverse asset impairments to reduce or avoid the possibility of trading suspension or de-listing. Second, we provide some evidence that the value-relevance of reversal information appears to be negatively affected by the regulatory-motivated earnings management. Third, favorable internal and external monitoring mechanisms play a role in constraining this type of earnings management. Taken together, we conclude that while the intention of granting reversal discretion is for managers to reveal private value recovery information, our findings suggest that a seemingly improved accounting standard does not necessarily lead to its intended consequence in financial reporting.
Nickels Not Pennies: Granularity in Analysts' Earnings per Share Forecasts and Forecast Revisions
Authors: Zhou Ling
Published: July 2017

This article extends the study of Herrmann and Thomas (2005) on granularity in analyst forecasts at multiples of nickels and finds that forecasts at multiples of nickels are more optimistic, and induce weaker market responses. Granularity in analyst forecasts combined with managers' incentive to meet forecasts help explain discontinuity in actual earnings per share (EPS) at multiples of nickels documented in Thomas (1989). In addition, this article documents a hitherto unrecorded phenomenon that forecast revisions also exhibit granularity at multiples of nickels and shows that analysts are more likely to make nickel forecast revisions when they lack precise information. Forecasts that revise prior forecasts by multiples of nickels are less accurate.
The Missing Link between Corporate Performance Measurement Systems and Chief Executive Officer Incentive Plans
Authors: Dossi Andrea , Patelli Lorenzo , Zoni Laura
Published: July 2017

While offering a literature review regarding several aspects and pitfalls of performance measurement and compensation literature and practice, we discuss the separation between corporate performance measurement systems (CPMSs) and incentive plans for chief executive officer (CEOIPs). Through performance measurement and compensation, organizations align competing interests and achieve management control. CPMS orient organizational actions toward organizational goals. CEOIP orient CEOs' actions toward shareholders' value. Despite the common nature (i.e., management control mechanisms) and, thus, purpose (i.e., influence on actions) of CPMS and CEOIP, both literature and practice neglect the link connecting the two mechanisms. In search for an explanation, we develop a framework that examines the link between CPMS and CEOIP under the three forms of governance proposed by transaction cost economics—namely, markets, hierarchies, and hybrids. Whereas in markets and hierarchies the control problem can be solved with a focus on one mechanism (i.e., CEOIP and CPMS, respectively), hybrid governance structures require the integration of CPMS and CEOIP. By exploring areas of integration between CPMS and CEOIP, we generate questions for future research. We expect that the integration between CPMS and CEOIP could benefit the alignment of interests and lead to more effective management control within modern organizations.
Performance-Dependent Incentives: Some Puzzles to Ponder
Authors: Merchant Kenneth A.
Published: July 2017

This article describes some “puzzles” with potentially important practical implications for the performance measurement and incentive compensation area of study. Lack of key bits of knowledge cause these puzzles. The goal of providing this list of puzzles is to provoke thought about these issues and to stimulate research.
Are Brand-Equity Measures Associated with Business-Unit Financial Performance? Empirical Evidence from the Netherlands
Authors: Verbeeten Frank H. M. , Vijn Pieter
Published: July 2017

We investigate the association between brand-equity measures and business-unit financial performance. Brand-equity measures may complement historic accounting information in explaining business-unit financial performance. Capitalizing on a unique data set, we find an association between some (yet not all) brand-equity measures and contemporaneous as well as future business-unit financial performance. Our results provide important insights for both managers and designers of performance-measurement systems.
Institutional Investors, Managerial Ownership, and Executive Compensation
Authors: Janakiraman Surya , Radhakrishnan Suresh , Tsang Albert
Published: July 2017

We examine the association between executive compensation and the interaction between the top-five institutional investor ownership and managerial ownership. We find that top-five institutional investors' ownership is more positively associated with pay-for-performance for small managerial ownership group than large managerial ownership group. We find that top-five institutional investors' ownership is more negatively associated with level of executive compensation for small managerial ownership group than large managerial ownership group. Neither dedicated nor active institutional investors are associated with an additional decrease in the level of executive compensation for large managerial ownership firms. We find that the level of pay is negatively associated with a high level of managerial ownership for the period after 2002. Collectively, the evidence is consistent with the managerial power theory.
Performance Measurement and Achievable Targets for Public Hospitals
Authors: Prior Diego , Surroca Jordi
Published: July 2017

This paper proposes an iterative process for determining what we define as a “reasonable frontier efficiency,” a concept that establishes future targets according to their current level of performance. Our “reasonable frontier” has the following properties: (1) it is underpinned on the efficiency framework, (2) it detects the presence of outliers and proposes a procedure to establish the influence introduced by extreme observations, and (3) it sorts out the problem of data masking. The proposed method is applied to a sample of Spanish hospitals. The results obtained confirm the applicability of the proposal made.
Earnings versus Cash Flow as a Predictor of Future Cash Flow Measures
Authors: Greenberg Robert R. , Johnson Glenn L. , Ramesh K.
Published: July 2017

The FASB has asserted, without proof, that information about an enterprise's earnings based on accrual accounting generally provides a better indication of a company's ability to generate favorable cash flows than information about cash flows themselves. This study tests that assertion, empirically. The test results provide empirical evidence supporting the FASB's contention.
An Application of Income Strategy to Cost Allocation and Segment Reporting
Authors: Sannella Alexander J.
Published: July 2017

Is a company's decision to allocate common costs to its industry segments related to its overall income strategy? The results of this study indicate that companies that allocate common costs tend to be larger, to have lower debt-equity ratios, to have higher rates of return on common stock, and to use the LIFO method of inventory valuation more than companies that do not so allocate or that report they do not have common costs. This evidence implies that companies that allocate common costs may be influenced by the same economic factors as companies following an overall income-reducing financial reporting strategy.
Structure Needed for Implementing Mandated Accounting Changes
Authors: Mellman Martin , Seiler Mona E.
Published: July 2017

This paper studies the FASB's first eighty-five standards to determine if implementations are ad hoc, or if there is a structure underlying the FASB's implementation practices. The study finds, on balance, that there is a structure in the Board's use of alternative approaches but not a uniform approach and that there are inconsistencies. The authors recommend that the Board formulate principles of implementation to avoid inconsistencies and to make users aware of the potential effects of contemplated changes.
Cross-Sectional Regularities in the Response of Stock Prices to Bond Rating Changes
Authors: Cornell Bradford , Landsman Wayne , Shapiro Alan C.
Published: July 2017

This paper examines whether a firm's stock price response to the new information provided by a bond rating change is related to its net intangible assets. A variable used to measure net intangible assets, which is based on current cost data, is found to have significant explanatory power in cross-sectional regressions for the set of rating downgrades.
Increasing Confirmation Response Rates: Prenotifications, Monetary Incentives and Addressee Differences
Authors: Engle Terry J.
Published: July 2017

This article reports the results of a research effort that measured the response enhancing effectiveness of two sizes of small monetary incentives and prenotification letters. The measurements were obtained during the audit of the installment and commercial loan balances of a medium-sized bank located in Central Florida. The data were analyzed with logistic regression. The analyses revealed that prenotification letters tended to encourage timely responses but they did not increase overall response levels. This was true for both types of loan balances. Small monetary incentives were found to be effective with installment loans in certain situations but ineffective with commercial loans.
Determinants of the Timing of Quarterly Earnings Announcements
Authors: Bowen Robert M. , Johnson Marilyn F. , Shevlin Terry , Shores D.
Published: July 2017

Previous empirical research provides descriptive evidence on the timing pattern of earnings announcements but does not attempt to investigate potential explanations. Because some stakeholders are not likely to find it cost-effective to monitor the firm actively, managers have the opportunity to influence the perceptions of relatively uninformed stakeholders through accounting decisions such as the timing of earnings announcements. We provide evidence on this stakeholder explanation of timing decisions by identifying a setting that has the potential to discriminate between this and a confounding explanation for the normal timing pattern suggested in prior studies. Specifically, if managers rushed to report bad news following the October 1987 stock market crash in the belief that the ongoing market chaos reduced the reactions of stakeholders to the news, “normal” timing patterns would be (at least partially) reversed.

Our results are generally consistent with prior research in that we document a (somewhat weak) association between earnings news and timing. However, consistent with the stakeholder explanation, we find that the earliest reporting group exhibited, on average, bad news. Thus, we infer that timing decisions for some firms are motivated by a desire to minimize the adverse reaction of stakeholders to bad news. In addition, we report evidence that suggests managers reduced the magnitude of reported earnings following the crash. This evidence corroborates our conclusion that managers are attempting to influence stakeholder perceptions of the firm's earnings performance.
What Matters from the Past: Market Value, Book Value, or Earnings? Earnings Valuation and Sufficient Statistics for Prior Information
Authors: Ramakrishnan Ram T.S. , Thomas Jacob K.
Published: July 2017

A number of recent analytical and empirical papers seek to identify the variables that best explain stock prices. We derive the relation between prices and earnings for three one-parameter “excess earnings” evolution processes that describe three different ways in which current period shocks to earnings persist in future. In each case, we show that price is a weighted average of capitalized current earnings and a sufficient statistic for all past information. The sufficient statistics are three amounts from last year: book value, market value, and capitalized earnings. Using time-series data over the 1969-1988 period for a sample of 511 firms, we estimate firm-specific excess earnings regressions and price regressions for the three cases. Although the book value model provides the best fit for a majority of firms for the excess earnings regressions, the market value model is far superior for the price regressions. We argue that this latter result is due to prior period price (included in the market value model alone), reflecting other information that is not explicitly modeled here. Despite this bias in favor of the market value model for the price regressions, we find a positive cross-sectional association between the relative explanatory power of the three models in the excess earnings regressions and the corresponding relative explanatory power in the price regressions. That is, if a firm's excess earnings series is best described by a particular model, its price series is also likely to be best described by the valuation relation derived from the same model.
Going Private Buyouts and Determinants of Shareholders' Returns
Authors: Travlos Nickolaos G. , Cornett Marcia Millon
Published: July 2017

This paper examines the effect on stock and nonconvertible bond prices of going private buyout proposals and explores sources of stock price reaction. Three alternative sources of abnormal returns are analyzed: the elimination of stockholders' servicing cost, the capital structure changes resulting from borrowings to take the firm private, and the elimination of agency costs associated with the prebuyout ownership structure. The findings indicate that going private buyouts generate large benefits to the firms' owners by eliminating the agency costs prevailing in the firms prior to going private.
Why Do Private Companies Demand Auditing? A Case for Organizational Loss of Control
Authors: Abdel-Khalik A. Rashad
Published: July 2017

The objective of this paper is to explain the motivation for owners of private companies to voluntarily demand audit (positive) assurance. It is hypothesized that the owner/manager seeks audits as compensatory control systems for the organizational loss of control inherent in hierarchical organizations. Thus, the expected value of wealth at risk due to loss of control sets a lower limit on the amount owners would be willing to pay for audits to compensate for that loss. The hypothesized relationship was tested using information for 103 private companies demanding audit (positive) assurance.

The obtained relationships were basically unaltered by the introduction of lenders' requirement of audits (n = 40). Furthermore, the hypothesized compensatory aspect of audit assurance was absent for the demand for negative assurance (reviews) in a sample of 31 companies. This is consistent with the fact that negative assurance is not viewed as a way of providing confidence so as to compensate owners for loss of direct supervision and control.
The Merger Tax Status Decision
Authors: Sullivan Michael J.
Published: July 2017

In this study, the influence of the federal tax code on reorganization tax status chosen for a merger is examined with a logit model. Findings indicate that the potential to step up the depreciable basis of acquired assets less depreciation recapture significantly influences the tax status chosen for a merger. Carryover attributes of the acquired firm do not affect the choice of tax status for a merger; thus, legislative concern over the transfer of tax losses and other carryover items may be unjustified. Immediate recognition of taxable gain by the acquired firm's shareholders does not appear to influence the choice of merger tax status, casting doubt on the theory that the medium of exchange used for a merger is determined after considering the amount of immediately recognized taxable gain if a taxable status is chosen.
Testing the Effect of Risk Attitude on Auditor Judgments Using Multiattribute Utility Theory
Authors: Farmer Timothy A.
Published: July 2017

The scaling constant of multiattribute utility functions derived for each of 15 practicing auditors was used to measure risk attitude for the subjects. The risk preference or risk aversion indicated by this metric allowed categorization of the auditors to test for an effect of risk attitude on audit judgments. The sample showed both risk aversion and risk preference among the auditors. The correlations among auditor evaluations of hypothetical internal control compliance test results were generally high and were different for audit seniors than for audit managers. Risk attitude was not found to explain the differences across rank nor the individual differences in consensus.
The Factors Associated with the Market's Reaction to New Information about Foreign Operations: Operational Savings versus Agency Interpretation
Authors: Haw In-Mu , Jung Kooyul , Pastena Victor
Published: July 2017

SFAS No. 52 establishes a new system for reporting the results of foreign operations by excluding translation gains and losses that relate to autonomous subsidiaries. Substantial evidence indicates SFAS No. 52 saved multinationals' resources by reducing the need for accounting hedging. Insofar as SFAS No. 52 generates both operational and reporting benefits, we test the association between market returns and both operational savings and agency variables. Empirical results indicate that measures of operational savings are positively associated with increases in the market returns but do not support the agency-based hypotheses. The current evidence on SFAS No. 52 taken together with Salatka (1989) on SFAS No. 8 mandates caution in concluding that agency considerations are driving the capital market's reaction to new information about foreign operations.
Can Prices Be Trusted? a Test of the Ability of Experts to Outperform or Influence the Market
Authors: Wright David W.
Published: July 2017

This paper reconsiders the efficiency of the market using the results from a Wall Street Journal contest of the ability of professional investment analysts to outperform the market with their monthly publicly announced stock selections. The monthly returns seem to indicate that the experts outperformed the market by a statistically significant margin, after adjusting for risk. However, analysis of the daily returns demonstrates that virtually all of this abnormal return arises in the first two trading days following the public announcement of their selections. More importantly, virtually all of this initial abnormal return is gradually retracted by the market over the succeeding 39 trading days.

The anomalous announcement day return has systematically increased over the duration of the contest. This is inconsistent with a market that, if not efficient from the outset, at least aspires to attain efficient behavior over time by reducing anomalous behavior from a systematically repeated event. Finally, the anomalous announcement day abnormal returns for experts who “won” the contest in the preceding month were twice that of the other contestants, despite evidence that placement in the monthly contest is determined by chance.

These results indicate a market inefficiency under which the market can be temporarily overly influenced by the announced opinion of an “expert.” Hence, the results are consistent with recent conjectures that overreaction to information may explain a growing body of literature documenting mean reversion in stock prices. Moreover, these findings suggest that an “expert” who publicly announces a pick that, by chance, produces an abnormal positive return would thereafter be in an enhanced position to influence the market by ever-increasing margins with subsequent recommendations.
Disclosure Costs, Regulation, and the Expansion of the Private-Placement Market
Authors: Melnik Arie L. , Plaut Steven E.
Published: July 2017

The private-placement debt market has grown dramatically in recent years. Private placements have a “competitive advantage” over public placements in being exempt from many regulations, including disclosure procedures and auditing requirements. Here, a model is developed to explain the growth in the private-placement market. Corporate borrowers choose between public and private placement of debt so as to minimize borrowing costs. Borrowers in the public-placement market incur higher regulatory cost, but are also able to signal accurately their true risk of default. In private placements, there is an asymmetric information problem. This results in an equilibrium where the debt market gets partitioned between private and public placements. It is shown that raising regulatory costs will lead to an expansion of the market share of private placements. It will also lead to an increase in the overall default rate on corporate debt.
The Nature of the Market's Response to the Earnings Effects of Voluntary Changes in Accounting for Foreign Operations
Authors: Pourciau Susan , Schaefer Thomas F.
Published: July 2017

This paper provides empirical evidence regarding the market's reaction to firms' reported income effects of early adoption of SFAS No. 52, Foreign Currency Translation. A cross-sectional regression model was utilized to investigate the market reaction to the reported earnings effects of the accounting change for 97 firms that voluntarily adopted SFAS No. 52 in 1981. Evidence presented here suggests that although the change in accounting method increased earnings, the market did not react to the resulting increase in earnings in a positive fashion.
A Note on Identifying Likely IPO Bankruptcies: A Symphonic Paradox
Authors: Platt Harlan D.
Published: July 2017

This paper analyzes prospectus data for initial public offerings (IPOs) to develop an analytical tool to predict IPO survival beyond the first three years following the year of issuance. A logit regression yielded four significant ratios, three of which are related to capital structure decisions. The model correctly classified 31 percent of bankrupt IPOs and over 90 percent of survivors. Prediction of IPO failure within three years is difficult because IPOs are often “packaged” to sell.
Auditor Independence as a Unique Equilibrium Response
Authors: Yost Jeffrey A.
Published: July 2017

This paper demonstrates how strong auditor independence, as defined by Antle (1984), can be achieved through an indirect reporting mechanism. A stylized principal-agent model based on Antle (1982) is analyzed. In the model, an owner hires a manager and an auditor. In the optimal contracts for the manager and the auditor, an equilibrium is desired where both the manager and the auditor provide high levels of effort and report their findings truthfully. However, two alternative equilibria exist where the auditor and the manager coordinate their strategies and perform tasks undesirable from the owner's perspective.

Indirect reporting mechanisms are then constructed and shown to implement the owner's preferred equilibrium. The owner provides both the manager and the auditor an additional reporting signal. Each of the two signals removes one of the two undesirable equilibria. Because, in an equilibrium, neither the manager nor the auditor uses the additional signal or cheats, the additional signals are costless to the owner. The model demonstrates how allowing the manager to impose additional costs onto the auditor effectively increases rather than decreases the auditor's incentives to remain independent.
The Earnings Event-Time Seasonal and the Calendar-Time Seasonal in Stock Returns: Naive Use of Earnings Information or Announcement Timing Effect?
Authors: Ball Ray , Bartov Eli
Published: July 2017

We document a pattern in the day-of-the-week timing of future earnings announcements that is predictable from knowledge of the current quarter's earnings. The pattern mimics the predictable (+, +, 0, -) dependence previously reported in both seasonally differenced quarterly earnings themselves and in estimated abnormal returns at future quarterly earnings announcement dates (the “SUE effect”; see Rendleman, Jones, and Latané [1987]; Bernard and Thomas [1990]). The predictability of abnormal returns at future earnings announcement dates therefore is not independent of the well-documented day-of-the-week seasonal in stock returns (the “DOW effect”; see Osborne [1962]; Cross [1973]; French [1980]; Gibbons and Hess [1981]). Although the DOW effect is too small to fully explain the SUE effect, it appears to contribute to it, since both past SUE and current earnings announcement DOW are incremental in explaining announcement-day estimated abnormal returns. The unclear role of size and the presence of errors in estimating both unexpected earnings and its announcement day suggest caution in interpreting these results.
Prior Financial Ratio Information and Differential Market Response to Regulatory Changes
Authors: Banker Rajiv D. , Das Somnath , Ou Chin S.
Published: July 2017

This paper presents empirical evidence that previously disclosed financial ratio information is useful in explaining differential market reactions for a cross-section of firms facing subsequent common industry-level changes. We focus our attention on the Airline Deregulation Act of 1978 (Public Law 95-504), which was aimed at complete deregulation of the U.S. airline industry after 40 years of federal regulation. Our empirical results indicate that market reaction to the deregulatory changes is positively associated with operating performance and asset utilization. This suggests that an airline firm's operating efficiency as measured by these ratios is a key determinant of how investors expect it to perform in a deregulated competitive environment.
The Effects of Mandated versus Voluntary Auditing Policy on the Quality of Auditing
Authors: Ronnen Uri
Published: July 2017

In this paper, I develop a formal model of the auditing market that is useful in predicting the economic consequences of the Securities Acts of 1933-34. The demand side of the market I study consists of a large number of firms, and the supply side consists of two auditors who compete in quality and price. I use the model to examine the impact of certain regulatory actions on (1) the quality of the auditing that each auditor chooses to offer, (2) the quality of the auditing that each firm chooses to undergo, and (3) welfare related variables. In particular, the following results are obtained. Under all regulatory regimes the auditors choose to differentiate their audits by quality. Relative to an unregulated market, the mandating of auditing widens the disparity between the qualities by inducing an improvement in the high-quality audit and a degradation in the low-quality audit; as a result, some firms undergo more effective auditing (including those firms which switch from the low-quality auditor to the high-quality auditor), whereas some firms undergo less effective auditing. These results are helpful in assessing the costs and benefits of the Securities Acts of 1933-34.
Banks, Risk, and FAS105 Disclosures
Authors: McAnally Mary Lea
Published: July 2017

This study examines whether Statement of Financial Accounting Standard No. 105 (FAS105) footnote disclosures of off-balance-sheet financial instruments and derivatives provide risk-relevant information in addition to that provided by the balance sheet alone. A theoretical model relates market and industry risk measures to FAS105 disclosures. Empirical tests of the model reveal that these disclosures do provide risk-relevant numbers although the results are not uniformly strong. The balance sheet financial instruments explain 42 percent of the variation in market risk and 45 percent of the variation in industry-level risk among 499 U.S. commercial bank holding companies. FAS105 disclosures of off-balance-sheet instruments and derivative positions explain an additional 5 to 7 percent of the variation. Stronger evidence is presented that shows that certain controversial classes of derivatives are not associated with increased levels of market and industry-level risk. This latter evidence stands in contrast to the current notion that derivative contracts, especially interest rate and currency swaps, increase overall bank riskiness. Results also corroborate the FASB categorization of classes of financial instruments along two important risk dimensions: credit risk and market risk.
Reporting Choice and the 1992 Proxy Disclosure Rules
Authors: Murphy Kevin J.
Published: July 2017

Disclosure rules adopted by the Securities and Exchange Commission in 1992 allowed limited managerial discretion in reporting the value of stock options granted. I provide evidence that managers adopted valuation methodologies that reduced reported or perceived compensation and that also reduced potential accounting charges for stock options. I interpret this evidence as supporting the hypothesis that managers bear nonpecuniary costs from high reported levels of compensation—through increased political or shareholder pressure—and adopt reporting methodologies that reduce these costs.
Using an Augmented Revelation Mechanism to Resolve Tacit Collusion in Auditing
Authors: Sen Kaustav
Published: July 2017

This paper reexamines the problem of multiple equilibria in an audit setting. When both the manager and the auditor are subject to moral hazard and truth-telling problems, one undesirable equilibrium that may arise results in both parties exerting low effort and reporting high output, interpreted here as tacit collusion. The Ma, Moore and Turnbull (1988) augmented revelation mechanism is used to remove the undesirable equilibrium. To keep the mechanism simple, only one agent (the manager) is given an expanded message space.
The Impact of Litigation against an Audit Firm on the Market Value of Nonlitigating Clients
Authors: Franz Diana R. , Crawford Dean , Johnson Eric N.
Published: July 2017

This study investigates how litigation against an audit firm affects the market value of its publicly traded clients. We examine the impact of private litigation alleging audit failure on the audit firm's clients not involved in the lawsuit. Our results indicate that clients not involved in the litigation experience significant negative returns at the announcement of litigation against their audit firm. These results suggest that the market interprets litigation against an audit firm as a signal of decreased audit quality and that the market places a value on audit quality when pricing a firm's securities. The results are also consistent with an audit insurance explanation, which views the audit firm as a source of potential financial indemnification to investors and predicts that damage to the auditor's underwriting ability will be reflected in reduced securities prices for the firm's clients. When the analysis was restricted to companies in the same industry where the alleged audit failure occurred, the market response is significantly more negative when the audit firm is considered a specialist in that industry than when the audit firm is not a specialist. Finally, the market response is weaker later in the sample period, consistent with the findings of prior research that the frequency of nonmeritorious suits has increased over time.
The Association between Auditor Quality and Auditor Size: An Analysis of Small CPA Firms
Authors: Colbert Gary , Murray Dennis
Published: July 2017

Prior research has documented a positive association between audit quality and auditor size. While some studies have used audit fee as a surrogate for audit quality, other studies have employed more direct measures, such as the outcomes of quality control reviews. Those latter studies, however, used samples that suffer from severe geographic or client-type restrictions. Moreover, most studies of the quality-size relationship have focused on relatively large CPA firms. The present study extends this literature by using a nationwide sample of 422 small CPA firms selected from the American Institute of Certified Public Accountants' (AICPA) Private Companies Practice Section peer review program, which provides comprehensive measures of CPA firm quality. This study also investigated (1) whether peer review ratings improve with successive reviews and (2) if oversight organization (the AICPA or state societies of CPAs) systematically affects peer review ratings.

The results show that for firms that perform audits, reviews, and compilations (but not for firms that perform reviews and compilations, but no audits) auditor quality is positively associated with firm size, the number of previous reviews, and oversight by state societies. These findings suggest that (1) firm size is a useful quality surrogate only for firms that conduct audits, (2) the AICPA's peer review program has been successful in that firms improved their peer review ratings over time, and (3) state-society-sponsored reviews should be examined to assess if they are conducted with the same rigor and intensity as AICPA-sponsored reviews.
Who Uses Interest Rate Swaps? a Cross-Sectional Analysis
Authors: Visvanathan Gnanakumar
Published: July 2017

Empirical analysis in this study examines factors that explain the use of interest rate swaps by nonfinancial firms in the Standard & Poor's 500. Consistent with asymmetric information and agency cost theories, firms with significant expected financial distress costs use swaps to transform short-term debt into long-term fixed-rate debt. Debt maturity structure, but not interest rate sensitivity, is significant in the decision to use a swap. Credit quality differentials or expectations of improving financial prospects are not significant in distinguishing among swap users.
Dispersion in Analysts' Earnings Forecasts as a Measure of Uncertainty
Authors: Barron Orie E. , Stuerke Pamela S.
Published: July 2017

This study examines whether dispersion in analysts' earnings forecasts reflects uncertainty about firms' future economic performance. Prior research examining this issue has been inconclusive. These studies have concluded that forecast dispersion is likely to reflect factors other than uncertainty about future cash flows, such as uncertainty about the price irrelevant component of firms' financial reports (Daley et al. [1988]; Imhoff and Lobo [1992]). Abarbanell et al. (1995) argue that, if forecast dispersion after (i.e., conditional on) an earnings announcement reflects uncertainty about firms' future cash flows and this uncertainty causes investors to desire additional information, then dispersion will be positively associated with both (a) the level of demand for more information and (b) the magnitude of price reactions around the subsequent earnings release. In this study, we construct a measure of informational demand using the incidence of analyst forecast updating after dispersion is measured. We find a positive association between dispersion in earnings forecasts after an earnings release and this measure of informational demand. We also find a positive association between forecast dispersion and the magnitude of price reactions around subsequent earnings releases. These associations are most apparent when potentially stale (or outdated) forecasts are removed from measures of forecast dispersion. These associations also persist after controlling for other measures of uncertainty (e.g., beta and the variance of daily stock returns), consistent with dispersion in analysts' earnings forecasts serving as a useful indicator of uncertainty about the price relevant component of firms' future earnings.
Discussion: “Individual-Firm Style Loadings, Unrecorded Economic Assets, and Systematic Risk”
Authors: Trzcinka Charles
Published: July 2017

Classifying stocks and stock portfolios into “investment styles” is widely practiced in portfolio management. The most common styles are “growth” versus “value” and “small capitalization” versus “large capitalization.” There are several purposes for this classification, but generally practitioners seem to believe that various segments of the markets are inefficient and that it is appropriate to judge a portfolio manager against peers in the segment. The classification is also widely used as a communication tool between portfolio managers and their clients. Practitioners believe that the firms in each style classification have different return and risk characteristics from firms in other styles and that communicating style gives useful information about the portfolio manager. Finally styles are usually defined by variables such as market value of equity to book value of equity and cash flow variable but typically, styles are not deterministic functions of these variables since subjective judgment is used by whoever defines the style.
Valuation of Permanent, Transitory, and Price-Irrelevant Components of Reported Earnings
Authors: Ramakrishnan Ram T. S. , Thomas Jacob K.
Published: July 2017

Both the economic nature of events and extant accounting rules cause reported earnings to have different components, each with different valuation implications. The price-earnings link is described better by separating components of unexpected earnings and multiplying each by a different response coefficient, rather than applying a single earnings response coefficient (ERC) to aggregate unexpected earnings. Using a simple model that assumes three types of innovations to reported earnings (permanent, transitory, and price-irrelevant), we develop systematic links among current earnings components, future earnings, and stock prices. Empirical tests of the model's predictions confirm the validity of our characterization of the price-earnings link. Attempts to understand better the effects of growth and (beta) risk result in little improvement.
An Analysis of the Usefulness of Debt Defaults and Going Concern Opinions in Bankruptcy Risk Assessment
Authors: Foster Benjamin P. , Ward Terry J. , Woodroof Jon
Published: July 2017

This study extends the research of Hopwood et al. (1994) and Mutchler et al. (1997) by empirically investigating the relationships between loan defaults, violation of loan covenants, going-concern opinions, and bankruptcy in bankruptcy prediction models. One objective of this study is to empirically test the ability of loan defaults/accommodations and loan covenant violations to assess the risk of bankruptcy. Another objective of this study is to investigate the impact of failing to control for these two distress events on results from tests of the usefulness of going-concern opinions in assessing bankruptcy risk. Results suggest that loan default/accommodation and loan covenant violation are both significant explanatory variables of bankruptcy at the time of the last annual report before the event. While a going-concern opinion variable appears to significantly explain bankruptcy, it is not significant when included in a model with loan default/accommodation and covenant violation variables. Consequently, our results suggest that researchers should include both loan default/accommodation and covenant violation as control variables when using bankruptcy to test the usefulness of going-concern opinions.
The Formation and Role of Reputation and Litigation in the Auditor–Manager Relationship
Authors: Datar Srikant , Alles Michael
Published: July 2017

In light of recent changes limiting auditors' legal liabilities, we examine the role of audit reputation on the interaction between the auditor and the manager whose actions he is attesting to. This contrasts with the literature that analyses how the firm's owner uses auditor reputation as a means of signalling to external constituencies. One of the roles of auditing is the production of information that facilitates contracting between the firm's owner and its managers. Management typically has an incentive to bias reports in its own favor. This creates a demand for confirmation of the financial reports provided by managers. An auditor can provide such a confirmation, but only if the auditor himself is induced to work hard and report truthfully. We show that reputation formation by the auditor serves as a substitute for costly contracting, monitoring, and litigation by the owner. By deterring misreporting, reputation reduces the inherent risk of the audit, allowing the auditor to cut back on substantive testing without increasing the probability of biased reports. The presence of audit institutions that promote and facilitate the building of auditor reputations mitigate both the auditor's and the manager's moral hazard on actions and reports. This role of reputation has implications for auditor legal liability, because the need for penalties is tempered by the auditor's desire to maintain a reputation.
Corporate Environmental Disclosure Strategies: Determinants, Costs and Benefits
Authors: Cormier Denis , Magnan Michel
Published: July 2017

In response to investors' and other stakeholders' concerns about corporate environmental policies, many firms are voluntarily increasing their level of environmental disclosure since there is a scarcity of alternative information sources. Using a cost-benefit framework, this study intends to identify determinants of corporate environmental reporting by Canadian firms subject to water pollution compliance regulations during the 1986–1993 period. Results suggest that information costs and a firm's financial condition are key determinants of environmental disclosure. Firm size, the regulatory regime governing corporate disclosure, and industry, also contribute to explaining environmental disclosure.
Determinants of the Adoption of Director Incentive Plans
Authors: Vafeas Nikos
Published: July 2017

This study investigates the determinants of the adoption of director incentive plans. The tests compare the financial and governance characteristics of 122 firms adopting director incentive plans between 1989 and 1995 to a sample of control firms matched on industry affiliation and sales. The multivariate test results suggest that the likelihood of plan adoption increases with the fraction of outside directors serving on the board and a certain form of director cash compensation. Three years after plan adoption there is a significant increase in the share and option holdings of the outside directors of adopting firms, a relative decline in their cash compensation, and a reduction in the adopting firm's inside ownership and board size. In general, these results suggest the plans are adopted by firms that rely more on the board as a monitoring device and that related governance improvements bring the adopting firm's director compensation structure closer to that of control firms.
Pediatric TPN: Efficacy and Toxicity of a New Fat Emulsion
Authors: Connors Robert H. , Coran Arnold G. , Wesley John R.
Published: July 2017

Fat emulsions are particularly valuable in pediatric total parenteral nutrition (TPN) because they provide an isotonic solution rich in calories. Little is known about the ideal composition of fatty acid emulsions, however, and very few formulations are commercially available. A new fat emulsion using a safflower oil base has recently been approved. We have used this new emulsion to provide a significant percentage of the nonprotein caloric requirements (24 to 42%) in 4 patients requiring TPN. These patients ranged in age from 1 to 15 years and received no enteral nutrition during the 3‐week course of the study. Nutritional improvement without major toxic effects was documented in each patient.