Knowledge that Transforms

We compare the value and credit relevance of financial statements under fair-value and smoothing (SFAS-87) models of pension accounting. While fair-value improves the credit relevance of the balance sheet, it does not improve its value relevance. Further, fair-value impairs both the value and credit relevance of the income statement and the combined financial statements unless transitory gains and losses (G&L) are separated from more persistent income components. Overall, our results suggest there are no informational benefits to adopting a fair-value pension accounting model.

Evidence contrasting U.S. insider trades in high- and low-jeopardy periods and across firms at high and low risk for 10b-5 litigation indicates that insiders condition their trades on foreknowledge of price-relevant public disclosures, but avoid profitable trades when the jeopardy associated with such trades is high, such as immediately before earnings announcements. Insiders avoid profitable trades before quarterly earnings are announced and sell (buy) after good (bad) news earnings announcements. Insiders trade most heavily after earnings announcements and profit from foreknowledge of price-relevant information in the forthcoming Form 10-K or 10-Q filing.

We examine determinants of weaknesses in internal control for 779 firms disclosing material weaknesses from August 2002 to 2005. We find that these firms tend to be smaller, younger, financially weaker, more complex, growing rapidly, or undergoing restructuring. Firms with more serious entity-wide control problems are smaller, younger and weaker financially, while firms with less severe, account-specific problems are healthy financially but have complex, diversified, and rapidly changing operations. Finally, we find that the determinants also vary based on the specific reason for the material weakness, consistent with each firm facing their own unique set of internal control challenges.

I examine how CEO compensation is related to firms’ capital structures. My tests address the simultaneity of these decisions and distinguish between debt types with different theoretical implications for managerial incentives. Pay–performance sensitivity decreases in straight-debt leverage, but is higher in firms with convertible debt. Furthermore, stock option policy is the component of CEO pay that is most sensitive to differences in capital structure. The results strongly support the hypothesis that firms trade-off shareholder-manager incentive alignment in order to mitigate shareholder-bondholder conflicts of interest. The hypothesis that debt reduces manager-shareholder conflicts can explain some but not all of the results.

Conventional wisdom suggests that giving monitored agents an oversight role may blunt the effectiveness of the monitoring process. In contrast, I show that less independent boards can sometimes be more effective at monitoring. Fully independent boards have incentives to shirk monitoring ex post, after the agents’ productive inputs are sunk, if the boards cannot commit ex ante to monitoring. However, boards with inside directors may have incentives to monitor the agents ex post. The demand for insiders thus arises endogenously as they allow boards to indirectly commit to monitoring and thereby facilitate the monitoring process.

We analyze the loss-reserving practices of 562 insurance companies in 1993 to assess the relation between client influence and auditor oversight. Consistent with Petroni [1992. Management's response to the differential costs and benefits of optimistic reporting in the property-casualty insurance industry. Journal of Accounting and Economics 15, 485–508.], we find that financially struggling insurers tend to under-reserve. However, this behavior is attenuated when the weak insurer is important to the local practice office of the auditor. This result holds across various measures of client influence and supports the contention of Reynolds and Francis [2001. Does size matter? The influence of large clients on office-level auditor reporting divisions. Journal of Accounting and Economics 30, 375–400.] that auditors allow less accounting discretion to their larger clients.

The extensive research toward an understanding of corporate voluntary disclosure strategies has primarily aimed at explaining why firms do not fully disclose their private information in capital markets with rational expectations. Following a variety of theories that explain the withholding of information, this paper highlights the uncertainty of investors about the reporting objective of managers as another explanation. The paper also studies how uncertainty about the reporting objective interacts with other factors known to suppress disclosure, exploring that the common intuition regarding these factors does not always carry over to environments with an uncertain reporting objective.

Using an accounting conservatism theory that reflects accounting's role in practice, we investigate the relation between two extensively used measures of conservatism: asymmetric timeliness of earnings and the market-to-book ratio (MTB). We predict and observe that when asymmetric timeliness is measured cumulatively over long periods, its relation with end-of-period MTB is positive. When asymmetric timeliness is measured over short periods, its dependence on beginning-of-period composition of equity value (EV) is responsible for its negative association with MTB. Further, asymmetric timeliness appears to measure conservatism more efficiently when it is estimated cumulatively over multiple periods.

While some studies suggest that industry product market competition can substitute for managerial incentives, other studies suggest a complementary relation. The underlying assumption behind these studies is that competition can be uni-dimensionally proxied for by industry concentration. However, recent studies suggest that competition can reflect several dimensions: product substitutability, market size, and entry costs, given the level of industry concentration. Using these determinants of competition, this study contributes to the literature by showing that (a) firms provide stronger incentives when industry competition is greater, (b) competition is multi-dimensional in its relation to incentives; and (c) industry characteristics play a major role in influencing incentives.

Ashbaugh, Collins, and Kinney, henceforth ACK, and Doyle, Ge, and McVay, henceforth DGM, provide the first evidence relating firm characteristics to internal control deficiencies (ICDs) reported under new disclosure requirements. Both studies document that control risk factors associated with organizational complexity and significant organizational change, as well as relative investment in internal control systems, are related to disclosure of internal control. ACK also test whether factors associated with incentives to discover and report ICDs affect disclosure of ICDs but this evidence is less compelling. I present alternative explanations and provide some descriptive evidence that is consistent with these alternative explanations.