Knowledge that Transforms

The theories of supermodular optimization and games provide a framework for the analysis of systems marked by complementarity. We summarize the principal results of these theories and indicate their usefulness by applying them to study the shift to ‘modern manufacturing’. We also use them to analyze the characteristic features of the Lincoln Electric Company's strategy and structure.

The paper analyzes the use of reported accounting earnings and price as a basis for compensating a manager when he trades on private information, and share price is set rationally based on privately held information, publicly available and contractible information, and publicly available but noncontractible information. In addition, we analyze the comparative statics of the compensation on reported earnings and price with respect to changes in the economy.

Based on theory and anecdotal evidence, we argue that ongoing implicit claims between a firm and its customers, suppliers, employees, and short-term creditors create incentives for management to choose long-run income-increasing accounting methods. Variables selected to proxy for the extent to which a firm depends on these implicit claims are found to be significant in explaining cross-sectional variation in inventory and depreciation methods. These variables remain incrementally significant when we include traditional variables found to have explanatory power in prior studies (i.e., leverage, bonus compensation, tax, and regulatory/political exposure variables).

This study hypothesizes that because shareholders have a liquidation option, losses are not expected to perpetuate. They are thus less informative than profits about the firm's future prospects. The results are consistent with the hypothesis. They also show that the documented increase in the earnings response coefficent as the cumulation period increases appears to be due exclusively to the effect of losses. The liquidation option effect extends to profitable cases where earnings are low enough to make the option attractive. Alternating explanations for the low informativeness of losses such as mean reversal of earnings are not supported by the tests.

We analyze how analysts' forecasts relate to investor beliefs and describe the implications of these relations for price and volume reactions to earnings surprises. We show that dispersion among forecasts does not fully capture investor uncertainty. We also show how the relations between market reactions and forecast properties differ under the alternative assumptions of exogenous and endogenous private information acquisition. Finally, the analysis suggests refined tests for volume reactions at the time of an announcement. Our results indicate that the model is useful for understanding and interpreting empirical work and developing empirical tests of market reactions to announcements.

This paper constructs a model of accrual measurement and tests its implications for the evolution of the book-to-market ratio. The model captures the intuition that book value is untimely or smoothed relative to market value, so that movements in market value have relatively high variance and low predictability, compared with movements in book value. Empirical tests of the model use lagged market value changes to forecast the mean reversion of the book-to-market ratio. This paper complements recent research investigating the role of book-to-market ratios in security analysis. Accounting theorists (e.g., Edwards and Bell [1961] and Feltham and Ohlson [1995]) have long recognized the critical role of book-to-market ratios as predictors of abnormal earnings in earnings-based valuation models. Tests of such valuation models (e.g., Ou and Penman [1993]) confront the practical problem of determining the horizon beyond which abnormal earnings are expected to be zero. The model in this paper implies that this horizon is determined by the remaining useful life of assets, and that the expected path of abnormal earnings over this horizon reflects the pattern of expiration of the useful lives of assets in place.

Voluntary disclosure, Insider trading, Noncompetitive trading model, Uninformed trader

Auditing, Audit evidence, Audit judgement, Review awareness

Masako N. Darrough, Nahum D. Melumad, Divisional versus Company-Wide Focus: The Trade-Off between Allocation of Managerial Attention and Screening of Talent, Journal of Accounting Research, Vol. 33, Studies on Managerial Accounting (1995), pp. 65-94

Paul A. Copley, Jennifer J. Gaver, Kenneth M. Gaver, Simultaneous Estimation of the Supply and Demand of Differentiated Audits: Evidence from the Municipal Audit Market, Journal of Accounting Research, Vol. 33, No. 1 (Spring, 1995), pp. 137-155