Knowledge that Transforms

We experimentally examine determinants of the transferability and durability of an assurer's flagship-service reputation for competence in a multi-service context. Economic and psychology theories agree that transferability will increase when a new service and a flagship service require relatively similar, as opposed to relatively dissimilar, competencies. These theories disagree, however, regarding the durability of an assurer's flagship-service reputation following a performance failure in a new service. Economic theory requires some reciprocity for transferability and durability, and, accordingly, predicts that a new-service failure will inflict more damage on a flagship-service reputation when the new and flagship services require relatively similar, as opposed to relatively dissimilar, competencies. Psychology theory, in contrast, predicts that a new-service failure will tend not to damage the flagship-service reputation, even when the new and flagship services require relatively similar competencies. Thus, unlike economic theory, psychology theory predicts that relatively similar competencies between a new and a flagship service can improve the transferability of an assurer's flagship-service reputation for competence without reciprocally threatening its durability. Experimental findings indicate that reputation transferability increases when the new and flagship services require relatively similar, as opposed to relatively dissimilar, competencies. They also indicate that a new-service failure damages the flagship-service reputation only when, and to a greater degree when, the new and flagship services require relatively dissimilar, as opposed to relatively similar, competencies. Thus, empirically, greater similarity in the competencies required by a new and flagship service simultaneously enhances the transferability and durability of the assurer's flagship-service reputation. These empirical findings are better explained by psychology theory than by economic theory.

The lock-in effect proposes that capital gains taxes represent transaction costs that increase the reservation price for security owners and, ceteris paribus, reduce trading volume. Consistent with the lock-in effect, previous empirical research documents price and reactions to enacted changes in the capital gains tax rate. We investigate whether the volume hypothesis predicted by the lock-in effect extends to corporate acquisition activity. In particular, we analyze whether aggregate corporate acquisition activity is inversely associated with shareholder capital gains tax rates. We measure quarterly corporate acquisition activity from 1973 through 2001 using (1) the percentage of traded firms acquired in a calendar quarter and (2) the percentage of market value of traded firms acquired in a calendar quarter. In supplemental analysis, we measure acquisition activity at the industry level (i.e., as the percentage of firms and percentage of market value acquired by industry annually). In each analysis we model acquisition activity as a function of the maximum long-term capital gains tax rate for individuals and other macroeconomic factors previously hypothesized to be associated with acquisition activity. Consistent with a lock-in effect for corporate acquisitions, we find a significant negative association between corporate acquisition activity and the capital gains tax rate whether we measure acquisition activity in the aggregate or at the industry level. In addition, we find that this negative association is attributable to increased (decreased) taxable acquisition activity during periods of low (high) capital gains tax rates. These results suggest that, ceteris paribus, capital gains taxes represent significant transaction costs that influence the level of corporate acquisition activity.

Auditor-client negotiation about difficult client accounting issues involves both the auditor and the client. On the client side, the Chief Financial Officer (CFO) plays a central role in the financial reporting process, yet is rarely the focus of academic study. This paper reports how a sample of Canadian CFOs viewed the negotiation process and context, using an experiential questionnaire to build on the negotiation model developed and demonstrated for the auditor side of the negotiation by Gibbins, Salterio, and Webb 2001, and corroborated by a comparison of common questionnaire items across auditor and CFO samples by Gibbins, McCracken, and Salterio 2005. The CFOs saw negotiation with the auditors as a consequence of change in accounting and disclosure standards or personnel influential to their financial reporting, or business changes, such as, new business deals or acquisitions. Negotiation was thrust upon the CFO, and the CFO then had to manage it. The CFOs informed other management (such as the CEO) and was aware of their interests, but did not generally seek their help. Informing the Board or the audit committee of the issue was much less frequent. The issue being negotiated was seen as complex, requiring research and analysis, and dependent on knowledge and expertise, with the result more likely reflecting form over substance (a result some CFOs suggested was more agreeable to the auditor than to the CFO).

This paper investigates how French underwriters value the stocks of companies they bring public. Underwriters often use several valuation methods to determine their fair value estimate of the initial public offering (IPO) firm's equity. We investigate five of these valuation methods: peer group multiples valuation, the dividend discount model, the discounted cash flow model, the economic value-added method, and underwriter-specific methods. We document that underwriters base their choice for a particular valuation method on firm characteristics, aggregate stock market returns, and aggregate stock market volatility in the period before the IPO. In addition, we examine how underwriters combine the value estimates of the valuation methods they use into a fair value estimate by assigning weights to these value estimates. We demonstrate that these weights also depend on firm-specific factors, aggregate stock market returns, and aggregate stock market volatility. Finally, we show that underwriters discount their fair value estimate to set the preliminary offer price of the shares. This discount is higher for IPO firms with greater valuation uncertainty and lower for companies that are brought to the market by more reputable underwriters and that are forecasted to be more profitable.

This paper examines linkages between audit and nonaudit fees and accrual quality. We measure accrual quality by the Francis, Lafond, Olsson, and Schipper 2005 modification of the Dechow and Dichev 2002 measure. We posit that in settings where audit quality is compromised by a loss of auditor independence, managers use accruals more opportunistically and thereby drive down the accrual quality. Conversely, higher audit effort and quality translate to better accrual quality. Our dependent variables are the relative magnitude of nonaudit fees to audit fees and the absolute magnitudes of audit, nonaudit, and total fees. Results show that accrual quality has a significant negative association with the magnitude of nonaudit fees and a significant positive association with audit fees. This latter result is consistent with the proposition that higher audit fees reflect higher audit effort and better judgements about the propriety of accruals, but is not consistent with the proposition that audit fees are associated with economic bonding.