Knowledge that Transforms

Regulators and small audit firms allege that audit firm size does not affect audit quality and therefore should be irrelevant in the selection of an auditor. Contrary to this view, the current paper argues that audit quality is not independent of audit firm size, even when auditors initially possesses identical technological capabilities. In particular, when incumbent auditors earn client-specific quasi-rents, auditors with a greater number of clients have ‘more to lose’ by failing to report a discovered breach in a particular client's records. This collateral aspect increases the audit quality supplied by larger audit firms. The implications for some recent recommendations of the AICPA Special Committee on Small and Medium Sized Firms are developed.

The impact that a firm's earnings releases have on the stock prices of other firms in its industry is examined. For an identifiable sub-set of firms, the results are consistent with a significant information transfer occurring between the earnings release firm and the other firms in its industry. This subset is identified by examining the impact of the release on the stock price of the announcing firm. The magnitude of this impact is more significant for a sample of firms which have a larger percentage of their revenues in the same line of business as the earnings release firm vis-á-vis a sample with a lower percentage of their revenues from the same line of business. Alternative interpretations of the empirical results are also discussed. The research findings have implications for information content and market efficiency research and for research on policy issues associated with disclosure regulation.

Until 1974, firms could choose, within GAAP, to capitalize or expense interest costs associated with capital expenditures. The predominant practice had been to treat interest as a period expense. However, in 1974, the Securities and Exchange Commission imposed a moratorium on further adoption of interest capitalization by non-regulated firms. This study empirically examines economic factors potentially influencing firms' decisions to expense or capitalize interest prior to the SEC moratorium. We hypothesize that the choice may be affected by (1) the existence of management compensation agreements tied to reported earnings, (2) debt covenant constraints, and (3) the political costs (for some firms) of reporting higher earnings. When compared to the control group, our findings are that (1) the frequency of explicit management compensation packages was not greater for the interest capitalization group, (2) firms with financial ratios closer to likely debt agreement constraints (on dividends, interest coverage, and leverage) tended to elect interest capitalization, and (3) other than the largest firms in the ‘politically sensitive’ petroleum refining industry, the larger firms were more likely to capitalize interest.

Cost allocation, Production process, Joint costs, Common costs

William S. Hopwood, James C. McKeown, An Evaluation of Univariate Time-Series Earnings Models and Their Generalization to a Single Input Transfer Function, Journal of Accounting Research, Vol. 19, No. 2 (Autumn, 1981), pp. 313-322

Stock price reaction, Association studies, Abnormal performance index, Firm specific news

Robert E. Verrecchia, On the Relationship Between Volume Reaction and Consensus of Investors: Implications for Interpreting Tests of Information Content, Journal of Accounting Research, Vol. 19, No. 1 (Spring, 1981), pp. 271-283

Dan Givoly, Dan Palmon, Classification of Convertible Debt As Common Stock Equivalents: Some Empirical Evidence on the Effects of APB Opinion 15, Journal of Accounting Research, Vol. 19, No. 2 (Autumn, 1981), pp. 530-543