Knowledge that Transforms

[This study investigates empirical relations that are consistent with the hypothesis that variance in analysts' forecasts of earnings (i.e., disagreement among analysts) is useful as an ex ante measure of the market's aggregate uncertainty regarding a future earnings signal. We hypothesize and test for a positive association between the variance of analysts' forecasts and (1) the ex post magnitude of unexpected earnings, (2) the ex post variance of returns around the actual earnings announcement date, and (3) the average variance of return to maturity implied by prices of options maturing after the earnings announcement date. Our results generally confirm that the disagreement among analysts' earnings forecasts is a useful indicator of the market's aggregrate uncertainty regarding future earnings announcements.]

[A theoretical model that explicitly incorporates the relation between investment banker and auditor is developed to provide a framework for testing the effect of auditor selection in the initial market for unseasoned equity issues. The theoretical model generates a number of testable propositions. Consistent with stylized facts, the theory suggests that high reputation investment bankers will more frequently use high reputation auditors, and that both investment banker and auditor reputation help to reduce underpricing. As either reputational variable increases, the model predicts that the impact of the other variable will diminish. The empirical results confirm this more complex relation. The structure of the model documented in this research may explain the difficulties of previous studies in identifying an empirical relation between auditor reputation and underpricing.]

[Five experiments that examined sequential belief revision in simplified auditing contexts are reported. The results suggest that auditors' belief revisions depend on both the order in which evidence is received and the manner in which it is presented, and they provide preliminary insights into auditors' "attitudes" toward evidence. The results also suggest that audit judgment may differ from judgment in general in two ways. First, the subjects were "prone" to revise their beliefs when new evidence was received, while the behavioral decision theory literature suggests that persons in general tend to "avoid" new evidence. Second, the subjects revised their beliefs to a greater extent when they received evidence that tended to disconfirm their current beliefs, whereas the literature suggests that persons in general are more strongly influenced by confirming evidence.]

[This Note reports that the frequency of occurrence of certain second digits (especially zero) contained in earnings numbers of New Zealand firms departs significantly from expectations. Specifically, there is a much higher than expected frequency of zeros and a less than expected frequency of nines as the second-from-the-left most digit in reported earnings. This abnormality may provide evidence of goal oriented or goal achieving behavior.]

[The economic theory of the firm suggests that a profit-maximizing product price may be determined by equating marginal cost and marginal revenue. Yet recent surveys suggest that most firms use cost-based pricing strategies where product costs are determined using absorption costing. Lere [1986] has drawn upon the economic theory of the firm, as well as extensive work on heuristic decision processes, to develop an empirically testable theory of product pricing based on accounting costs. This paper reports the results of an experiment in which Lere's theory was empirically tested.]

[Both descriptive and statistical analyses of the pattern of accounting changes of successful and unsuccessful firms indicate that unsuccessful firms are more likely than successful firms to make accounting changes that increase income. Sample firms are matched by industry membership to control for macroeconomic factors. Success is measured by the total market return to shareholders over a ten-year period. The empirical findings are consistent with the assertion that managers can modify reported income through judicious accounting changes.]

[This study tests whether there is a positive association between a firm's agency costs and its demand for a quality-differentiated audit. Audit firm quality is represented in two ways: a continuous size model in which a direct association is posited between auditor size (measured by clients' sales) and audit quality, and a "brand name" model in which the Big Eight group of auditors is defined as higher quality suppliers. The tests are supportive of the brand name model of audit quality: agency cost proxies are significant as a group, after controlling for client size and growth, only in the brand name model. The results are also supportive (albeit weakly in some instances) of the following individual agency-related incentives for higher quality audits: monitoring of incentive performance contracts, diffusion of ownership, owner-debtholder conflict, and the subsequent issue of public securities after the auditor change. However, the explanatory power of the models tested is low, after controlling for client size and growth.]

[The Commission on Auditors' Responsibilities expressed concern for the adverse effect of audit fee price cutting on auditor independence. In the present study, tests were conducted to determine both the presence and magnitude of audit fee price cutting on 1984 audit fees for a sample of 214 firms having changed auditors over the period 1979-1984. A control sample of 226 firms not changing auditors over the same period was used in order to estimate price cutting. Results indicated a significant fee reduction in the initial engagement year that averaged 24 percent of normal fee levels for ongoing engagements, an average fee reduction of 15 percent for each of the next two years, but by the fourth year of the new auditor the fee had increased to normal levels for continuing engagements. The Commission's concern for price cutting's effect on auditor independence is then reconsidered in the context of recent work on the psychology of sunk costs.]

[The purpose of this paper is to examine controllability: the notion a manager should be evaluated based on that which she or he controls. We embed the managerial evaluation problem in a principal-agent setting and ask whether the optimal agency solution bears any logical relation to a casual definition of controllability. It does not. More to the point, the agency framework compels us to look at information content. This information content perspective, upon reflection, agrees with our intuition, with our anecdotal impressions of practice, and with the dictates of the principal-agent model. Moreover, there is a well-defined relation between information content and a notion of control. Thus, the information content perspective may be thought of as offering a precise definition of controllability.]

[Behavioral aspects of production variance investigations have been the focus of several recent articles. This research reports on a field experiment designed to obtain empirical evidence concerning the initial attributions made by a superior and a subordinate upon the occurrence of an unfavorable variance, as well as the processes they utilize when testing their initial attributional hypotheses. Evidence indicated that superiors made initial attributions that were internal relative to the subordinates, and also tended to seek additional information which was internal relative to the subordinates. This observed confirmatory hypothesis testing procedure is consistent with other research in non-accounting related settings. Implications for the design of accounting information systems are briefly discussed.]