Knowledge that Transforms

Numerous empirical studies (Archibald [1972], Ball [1972], Sunder [1973], and Comiskey [1971], to mention a few) have demonstrated market efficiency with respect to accounting information. In general, these studies have shown that the market is not fooled by accounting changes which manipulate reported income. Despite these research findings, the that stock prices move in the direction of an accounting change's impact on reported income persists. This view is illustrated by the following statement, which appeared in the Wall Street Journal (October 7, 1974): Because of the negative impact on earnings LIFO conversions haven't always been welcome news to the stock market ... also companies worried about a takeover may be reluctant to risk the kind of downward pressure on stock prices that has greeted other companies when they recently converted to LIFO. Is the traditional merely incorrect, or does it have some demonstrable basis? Most of the previous research designed to analyze market reaction to accounting changes has employed a methodology which would tend to show long-range effects. This implies that support for the traditional view, if it exists, might come from observing short-range market reaction to accounting changes. Kaplan and Roll [1972] employed a shortrange methodology to study market reaction to changes in the treatment of the investment tax credit and changes in depreciation method. While they stated that they had difficulty discerning any statistically signifi-

Leverage, Market value of debt, Debt-Equity ratio, Risk

Interim reporting, OTC firms, Market efficiency

Information processing, Information economics, Human information Processing, Decision making

The auditor is interested in estimating many variables in performing his/her attest function. These estimates include such items as error rates, confidence intervals, maximum overor understated amounts, and account balances. These estimates along with other collateral evidence comprise a multivariate information set upon which the auditor concludes that a set of financial statements fairly presents the financial condition and operating results of the firm. In this multivariate context, the auditor should consider the efficiency of the procedures used to estimate the parameter set upon which the decisions are made. Traditional procedures for obtaining these estimates include the maximum likelihood estimation (MLE) procedure and Bayesian approaches. Bayesian techniques require a considerable amount of judgment and training. Moreover, Stein [1955] proved that the MLE was inadmissible (could be improved upon over some portion of parameter space without worsening over the remainder of the space) as an estimator for the mean vector of a multivariate normal distribution. James and Stein [1961] and Efron and Morris [1971; 1972; 1973; 1975; 1977], among many others, generalized and extended Stein's original proof.' The result

John H. Evans III, Optimal Contracts with Costly Conditional Auditing, Journal of Accounting Research, Vol. 18, Studies on Economic Consequences of Financial and Managerial Accounting: Effects on Corporate Incentives and Decisions (1980), pp. 108-128

Earnings forecasts, Analyst forecast, Time-series model, Multivariate techniques

Bala V. Balachandran, Ram T. S. Ramakrishnan, Internal Control and External Auditing for Incentive Compensation Schedules, Journal of Accounting Research, Vol. 18, Studies on Economic Consequences of Financial and Managerial Accounting: Effects on Corporate Incentives and Decisions (1980), pp. 140-171

Capital Budgeting, Investments, Opportunity costs, Decision making

This study investigates whether associations consistent with LIFO-FIFO tax incentives exist between management choices to adopt or not adopt the LIFO inventory costing method and characteristics of firms' year-end inventories. Both pre- and postchoice characteristics are ex- amined. Because the LIFO-FIFO choice is voluntary, a postchoice association would be consistent with managers both anticipating future inventory characteristics when making a LIFO-FIFO choice and changing inventory management policies in response to that choice. Evidence consistent with the hypothesis that LIFO adoptions are associated with changes in inventory management policies would have important macroeconomic implications. Zarnowitz and Moore [1977] have argued that a failure to recognize the major shift in inventory costing methods which occurred in 1973 and 1974 (primarily FIFO to LIFO) resulted in an underestimation of inventory accumulations by the U.S. Department of Commerce. This underestimation resulted from the different procedures used under LIFO and FIFO to assign costs to inventory units. While this effect of LIFO-FIFO choices can bias macroeconomic measurements and forecasts, an associated change in inventory management policies by a large number of firms could directly affect underlying macroeconomic stocks and flows.