In the preceding paper Christie provides three tests to facilitate formal inferences in survey papers that examine related empirical studies. Those tests reinforce the view that accounting technique choice is related to variables that may proxy for contracting and monitoring costs in the market and political processes. However, the contribution of the tests is limited because the fundamental question of the relation between the empirical regularities and the theory remains unexamined.

Abstract ABSTRACT: This paper contains evidence of accounting measurement rules that are negotiated in private corporate lending agreements. The negotiated sets of rules differ from the regulated set of accounting rules (generally accepted accounting principles). Moreover, the differences between regulated and negotiated rules are systematic and consistent with the economic incentives of borrowers and lenders. Private parties in the market for accounting information are able to produce for themselves at least some of the information required for monitoring lending agreements. The evidence and analysis have implications for: 1. The voluntary choice of accounting rules, 2. The superiority of alternative accounting rules, and 3. The demand for a diverse set of accounting rules.

In this paper, we review research into the economic consequences of voluntary and mandatory choices of accounting techniques and standards. We discuss how the predictions of extant economic consequence theories are driven by contracting and monitoring costs associated with management compensation contracts, bond covenants, regulation, and/or political visibility. We review empirical tests of economic consequence theories, categorize those tests, and discuss their strengths and weaknesses. The empirical tests reveal two systematic associations with accounting choice: size, a proxy for political visibility, and leverage, a proxy for contracting and monitoring costs of lending agreements. Interpretation of the results is difficult, due to general limitations of the tests. We conclude by suggesting some directions for future research, based on our analysis of the potential payoffs associated with different types of empirical tests.

Annual earnings, Time-series, Random walk, Predictive ability

The evidence in this paper suggests that downgrades by both Moody's and Standard and Poor's are associated with negative abnormal stock returns in the two-day window beginning the day of the press release by the rating agency. Significant negative abnormal performance can still be detected after eliminating observations containing obvious concurrent (potentially contaminating) news releases. There is little evidence of abnormal performance on announcement of an upgrade. Significant abnormal returns are associated with announcements of additions to the Standard and Poor's Credit Watch List, if either a potential downgrade or a potential upgrade is indicated.

This paper contains evidence of a significant negative stock price reaction to media disclosures of ‘subject to’ qualified audit opinions. Disclosures of qualifications in the financial news media (the Wall Street Journal and the Broad Tape) are rare relative to the frequency of audit qualifications. Other studies do not detect an impact of qualified opinions on stock prices. None of the explanations for the difference in the results between this study and prior studies is consistent with the data. We are unable to draw strong inferences because we cannot identify the selection process that produces the sample of media disclosures.

We investigate whether announcements of ‘subject to’ audit opinions and disclaimers of opinions affect stock prices. The results indicate that many firms experience negative abnormal performance prior to the release of qualified opinions, and that the magnitude of prior abnormal performance differs across types of qualifications. However, there is little evidence of a stock price effect when qualifications are disclosed publicly. It is difficult to construct powerful tests of the announcement effect of a qualified opinion for three reasons. First, the announcement date of the qualification is not easily identified. Second, measuring the unanticipated component of the announcement requires a model of market expectations. Third, controls must be employed for concurrent disclosures. The problems concerning event date identification have ramifications for other accounting event studies, particularly studies of disclosures typically contained in the annual report or 10-K.

The relative performance of several portfolio selection strategies is assessed empirically. These strategies vary in sophistication from a ‘naive’ strategy of maintaining equal dollar investments in each stock available to a strategy that periodically uses updated parameter estimates to calculate new optimal proportions of portfolio value to be invested in the stocks available. Although it is to be expected a priori that relatively sophisticated strategies will perform at least as well as the more naive strategies, implementation costs will clearly differ across strategies and across investor-specific parameters such as total portfolio value. Thus estimation of the various strategies' performance gross of these costs is a necessary consideration in rational strategy selection by any given investor.