This paper presents evidence that the positive association between firm size and price leads of earnings is not solely a function of private search incentives for firm-specific information. Specifically, we find that small-firm prices also lag large-firm prices with respect to industry-wide information. Our empirical analysis extends Collins, Kothari, and Rayburn 1987 and Freeman 1987, who document that security-price leads of earnings are positively associated with market capitalization. In particular, we examine the association between firm size and the timing of security returns for two components of annual earnings changes: the average change for a firm's industry and the firm's idiosyncratic change. We find that large firms' prices have a longer lead than small firms' prices with respect to both components. Large firms' early lead on industry-wide earnings suggests that returns of large firms predict returns of same-industry small firms. To test this implication, we construct a portfolio of long (short) positions in small firms when the prior month's returns of large firms in their industry are above (below) average for large firms in other industries. This zero investment portfolio earns 4.5 percent over 12 months.

Abstract. Option market activity increases by more than 10 percent in the four days before quarterly earnings announcements. We show that the direction of this preannouncement trading foreshadows subsequent earnings news. Specifically, we find option traders initiate a greater proportion of long (short) positions immediately before “good” (“bad”) earnings news. Midquote returns to active‐side option trades are positive during nonannouncement periods and are significantly higher immediately prior to earnings announcements. Bid‐ask spreads for options widen during the announcement period, but traders do not gravitate toward high delta contracts. Collectively, the evidence shows option traders participate generally in price discovery (the incorporation of private information in price), and more specifically in the dissemination of earnings news.

Abstract In this paper, we embed the double entry accounting structure in a simple belief revision (estimation) problem. We ask the following question: Presented with a set of financial statements (and priors), what is the reader's “best guess” of the underlying transactions that generated these statements? Two properties of accounting information facilitate a particularly simple closed form solution to this estimation problem. First, accounting information is the outcome of a linear aggregation process. Second, the aggregation rule is double entry.

Abstract. The Cohen Commission and previous research have suggested that auditors' opinions are inferior indicators of bankruptcy relative to the predictions of statistical models. This research reexamines this question in light of two important considerations that make the comparison between audit opinions and model predictions considerably more reflective of the auditors' real‐world decision environment. First, the sample is partitioned into stressed and nonstressed observations and the importance of doing so is demonstrated; second, the statistical models and the forecast errors are adjusted so that they reflect the proportion of bankrupt firms actually faced by auditors. The empirical results provide convincing evidence suggesting that the notion established in previous research that auditors' opinions are interior to models in predicting bankruptcy is unfounded. It should be noted, however, that neither the auditors' opinions nor the bankruptcy prediction model are very good predictors of bankruptcy when population proportions, differences in misclassification costs, and financial stress levels are considered. Résumé. Les travaux de recherche de la Commission Cohen et d'autres travaux qui les ont précédés semblent indiquer que les opinions des vérificateurs sont des indicateurs de faillite moins efficaces que les prédictions des modèles statistiques. Les auteurs se penchent à leur tour sur cette question, à la lumière de deux éléments importants qui font en sorte que la comparaison entre les opinions des vérificateurs et les modèles prévisionnels s'inscrit beaucoup plus dans le contexte décisionnel véritable dans lequel travaillent les vérificateurs. D'abord, l'échantillon est scindé en deux groupes d'observations selon la présence ou l'absence de contrainte financière, partage dont les auteurs expliquent l'importance; ensuite, les modèles statistiques et les erreurs prévisionnelles sont ajustés de manière & refléter la proportion des sociétés dont la faillite a été envisagée par le vérificateur. Les résultats empiriques démontrent de façon probante que les conclusions tirées des travaux précédents selon lesquelles les opinions des vérificateurs sont moins efficaces que les modèles en matière de prévision des faillites ne sont pas fondées. Il convient de noter, cependant, que ni les opinions des vérificateurs ni les modèles prévisionnels ne sont des prédicteurs très efficaces des faillites si l'on tient compte des proportions de la population, des différences dans le coût des erreurs de classification et du niveau de contrainte financière.

Abstract. A major function of financial statement analysis is to assess the risk of financial distress. Since Beaver's (1966) and Altaian's (1968) pioneering works, voluminous studies have been devoted to exploring the use of accounting information in predicting business failure. We apply survival analysis to study a class of financial distress when a financial analyst can identify an event that sets off the dynamic process of business adversity and would like to find out how long a firm can endure the adversity. We use the case of the oil and gas industry during the turmoil of the early 1980s and apply survival analysis to study how long a firm can endure this drastic oil price decline before facing financial distress. Our results indicate that the liquidity ratio, leverage ratio, operating cash flows, success in exploration, age, and size are significant factors affecting corporate endurance. Résumé. Une fonction majeure de l'analyse des états financiers consiste à évaluer le risque de difficultés financières. Depuis les travaux d'amorce de Beaver et Altman, de volumineuses études ont été consacrées à l'analyse approfondie de l'utilisation de l'information comptable dans la prédiction des faillites d'entreprises. Les auteurs appliquent l'analyse de survie à l'étude d'une catégorie de difficultés financières pour laquelle l'analyste financier parvient à déterminer un événement qui déclenche le processus dynamique des difficultés de l'entreprise et aimerait déterminer pendant combien de temps cette dernière pourra résister à ces difficultés. Les auteurs évoquent le cas du secteur pétrolier et gazier au cours de la période tumultueuse du début des années 80 et appliquent l'analyse de survie à l'étude du temps pendant lequel une entreprise pouvait résister à un déclin radical du prix du pétrole avant d'éprouver des difficultés financières. Les résultats de l'étude démontrent que le ratio de liquidité, le ratio de levier, les flux monétaires provenant de l'exploitation, le succès des activités d'exploration, l'âge et la taille de l'entreprise sont des facteurs importants qui influent sur sa résistance.

Abstract. The auditor must trade off potential losses from both ineffectiveness (failure to detect client errors) and inefficiency. However, auditing standards do not specify how the auditor is to achieve an appropriate balance between these two conflicting objectives. This paper presents a multiple criteria decision‐making (MCDM) model of an audit planning decision in which an effectiveness vs. efficiency trade‐off is required. The key advantage of the MCDM model developed here is that an optimal solution is obtained without requiring ex ante specification of a loss function by the auditor. Thus, the model addresses a previously recognized problem (e.g., Menzefricke, 1984) that loss functions may vary depending on characteristics of the audit. In this paper, we develop a model of the auditor's sampling plan selection problem incorporating multiple decision criteria, use the model under a variety of simulated audit conditions, and compare our results with previous research. Résumé. Le vérificateur doit parvenir à un compromis entre les pertes pouvant être occasionnées à la fois par l'inefficacité (non‐détection d'erreurs commises par l'entreprise cliente) et l'inefficience. Les normes de vérification ne précisent cependant pas comment le vérificateur doit parvenir à un équilibre approprié entre ces deux objectifs conflictuels. Les auteurs proposent un modèle de dècision à critères multiples qui s'applique à la décision de planification de la vérification exigeant un compromis efficacité‐efficience. Le principal avantage de ce modèle est qu'il permet d'obtenir une solution optimale sans exiger la formulation ex ante par le vérificateur d'une fonction de perte. Le modèle porte done sur une question sur laquelle se sont déjà penchés les chercheurs (Menzefricke, 1984, par exemple): les fonctions de perte peuvent varier selon les caractéristiques de la vérification. Les auteurs élaborent ici un modèle qui s'applique au problème de sélection par le vérificateur d'un plan d'échantillonnage incorporant des critères de décision multiples. Ils utilisent le modèle en simulant diverses situations de vérification et comparent les résultats obtenus avec ceux des travaux précédents.

ABSTRACT We test the association between CFO effort and the quality of public firms' financial information environments. We evaluate this relation using a measure of CFO leisure consumption—specifically, the amount of golf played—as an inverse proxy for effort. We find a negative relation between CFOs' compensation incentives and golf play, suggesting they exert more effort when they have greater incentives to increase firm value. High CFO leisure consumption is associated with lower earnings quality, less accurate earnings guidance, and reduced CFO conference call participation. Additionally, CFO leisure appears to affect external monitors, as it is associated with greater analyst forecast dispersion and increased audit fees. We do not find similar relations when evaluating the amount of golf played by CEOs, suggesting the unique importance of CFO effort in the financial reporting process.

ABSTRACT This study examines whether the volatility of interim estimates of the annual effective tax rate (ETR) provides ex ante information about the quality of firms' internal control environments. Recent research suggests that some firms selectively disclose internal control weaknesses (ICWs). Given the negative consequences associated with ICWs, it is important for capital market participants to be able to identify firms with ineffective internal controls in a timely manner. We find that firms with more volatile annual ETR estimates are more likely to report both tax‐ and nontax‐related ICWs in the current year. Our results also indicate that the volatility of annual ETR estimates declines following the remediation of tax‐related ICWs, but not following the remediation of nontax‐related ICWs. In addition, we find that ETR volatility in the current year is associated with the likelihood that a firm will report an ICW in the following year. Finally, we provide evidence that the volatility of annual ETR estimates is associated with the likelihood that a firm has an undisclosed ICW. In combination, our results suggest that the volatility of interim estimates of the annual ETR provides an ex ante signal of the likelihood that a firm's internal controls are ineffective.

ABSTRACT This study uses a confidential data set of firms assigned to the Internal Revenue Service's Coordinated Industry Case (CIC) program to examine the effect of audit certainty on firms' tax reporting behavior. We first model the determinants of assignment to the program. Although the ability and incentive to avoid taxes are related to CIC assignment, we find that the IRS assigns firms primarily based on size and complexity. We then test whether audit certainty has a detectable effect on tax payments. Our results show that tax payments do not change when firms enter the CIC program, suggesting the CIC program does not have higher deterrence or enforcement effects relative to the IRS's standard selection and audit process for large corporations not included in the CIC program. However, supplemental analysis suggests that audit certainty does alter managers' expectations regarding future tax payments. Our paper provides new empirical evidence on the strategic game between the taxpayer and the tax authority and has important implications for tax authorities as they consider the costs and benefits of certain audit programs.