Knowledge that Transforms

Abstract This study examines the impact of alternative risk assessment (standard risk checklist versus no checklist) and program development (standard program versus no program) tools on two facets of fraud planning effectiveness: (1) the quality of audit procedures relative to a benchmark validated by a panel of experts, and (2) the propensity to consult fraud experts. A between‐subjects experiment, using an SEC enforcement fraud case, was conducted to examine these relationships. Sixty‐nine auditors made risk assessments and designed an audit program. We found that auditors who used a standard risk checklist, structured by SAS No. 82 risk categories, made lower risk assessments than those without a checklist. This suggests that the use of the checklist was associated with a less effective diagnosis of the fraud. We also found that auditors with a standard audit program designed a relatively less effective fraud program than those without this tool but were not more willing to seek consultation with fraud experts. This suggests that standard programs may impair auditors' ability to respond to fraud risk. Finally, our results show that fraud risk assessment (FRASK) was not associated with the planning of more effective fraud procedures but was directly associated with the desire to consult with fraud specialists. This suggests that one benefit of improved FRASK is its relation with consultation. Overall, the findings call into question the effectiveness of standard audit tools in a fraud setting and highlight the need for a more strategic reasoning approach in an elevated risk situation.

Abstract A strategic performance measurement system (SPMS) is a set of causally linked nonfinancial and financial objectives, performance measures, and goals designed to align managers' actions with an organization's strategy. This study identifies and tests features unique to the cause‐effect structure of an SPMS likely to affect an important antecedent to managerial performance: goal commitment. Companies often set difficult goals for the multiple performance measures contained in an SPMS, but research shows difficult goals are significantly more likely to lead to performance gains if individuals are committed to achieving them. Two features central to the SPMS approach are predicted to affect goal commitment: (1) the strength of the cause‐effect links among the nonfinancial and financial performance measures contained in an SPMS and (2) managers' beliefs in their ability to achieve the SPMS nonfinancial goals. Results from an experiment conducted with experienced managers show both SPMS features have a positive effect on goal commitment.

Abstract Recently, a growing body of literature has suggested that financial statements have lost their value‐relevance because of a shift from a traditional capital‐intensive economy to a high‐technology, service‐oriented economy. These conclusions are based on studies that find a temporal decline in the association between stock prices and accounting information (earnings and book values). This paper empirically tests a theoretical prediction arising from the noisy rational expectations equilibrium model that suggests that the decline could be driven by non‐information‐based (NIB) trading activity, because such trading reduces the ability of stock prices to reflect accounting information. Specifically, Dontoh, Radhakrishnan, and Ronen (2004) show that when NIB trading increases, the R 2 s of a regression of stock price on accounting information declines. Our empirical tests confirm this prediction; that is, the decline in the association between stock prices and accounting information as measured by R 2 s is driven by an increase in NIB trading.

Abstract While some field studies have suggested that management control systems can be used simultaneously to make organizations more efficient and more flexible, the contingency literature has found it difficult to address this issue in the absence of a clear and comprehensive typology for analyzing more processual uses of management control systems. This paper distinguishes between enabling and coercive (Adler and Borys 1996) uses of management control systems. Coercive use refers to the stereotypical top‐down control approach that emphasizes centralization and preplanning. In contrast, enabling use seeks to put employees in a position to deal directly with the inevitable contingencies in their work. The design principles that underlie the enabling use of management control systems are repair, internal transparency, global transparency, and flexibility. Through a detailed analysis of a single‐case field study carried out over a two‐year period, we illustrate how management pursued the objectives of efficiency and flexibility by using management control systems in enabling ways. We suggest that the four design principles of enabling use can facilitate field studies of management control systems, but that they can also be used to define an enabling typology for contingency researchers to analyze the ways in which organizations simultaneously pursue efficiency and flexibility through their management control systems.

Abstract This paper examines a fundamental question of interest to researchers and regulators: Does the market treat disclosed financial statement information as if it is less reliable than information recognized in the body of the financial statements? Specifically, we compare the perceived reliability of liabilities for retiree benefits other than pensions (PRBs) disclosed prior to adoption of Statement of Financial Accounting Standards No. 106 (SFAS No. 106) with the perceived reliability of PRB liabilities subsequently recognized under SFAS No. 106. Overall, the evidence is consistent with the market treating disclosed PRB liabilities as less reliable than recognized PRB liabilities and pension liabilities. However, once PRB liabilities are recognized, they do not appear to be any less reliable than pension liabilities. These findings are inconsistent with the Choi, Collins, and Johnson 1997 conclusion that PRB liabilities are inherently less reliable than pension liabilities. The paper also investigates factors that may have contributed to the lower perceived disclosure reliability. Our results suggest that the market perceived PRB liability disclosures to be less reliable when firms provided range disclosures, had higher probabilities of reducing plan benefits, or had lower ratios of retiree to total PRB obligations. These findings suggest that reliability may have been enhanced if more supporting details had been provided in Staff Accounting Bulletin No. 74 disclosures.

Abstract Using a sample of UK firms for the period 1996‐98, we provide empirical evidence on the relation between nonaudit services (NAS) purchase and three proxies for earnings management: (1) the likelihood that client firm accounting practices during the sample period were publicly criticized or subject to regulatory investigation; (2) the likelihood that client firms were required to restate prior financial statements or adjust current year results upon adoption of Financial Reporting Standard (FRS) No. 12, which was intended to curb opportunistic use of provisions; and (3) the mean absolute value of client discretionary working capital accruals over the sample period. The level of NAS purchase is measured, alternatively, as (1) the ratio of nonaudit to total auditor fees, (2) the natural log of NAS fees, and (3) the decile rank of a particular client's NAS fees given all NAS fees received by the audit firm practice office. With one exception, we find that all three measures of earnings management are positively and significantly associated with the three measures of NAS purchase.

Abstract Using matched samples of JIT adopters and nonadopters, we examine the association of JIT adoption with firms' financial reporting and tax incentives, earnings‐management histories, and LIFO reserve levels. We find evidence that adoption decisions are influenced by the interaction of firms' LIFO reserves with their income smoothing, debt covenant, and tax incentives. We also find that adoption is less likely for firms historically engaging in high degrees of earnings management, particularly when such firms have no substantial LIFO reserves. Our study extends earlier research demonstrating a relation between inventory valuation method and year‐end inventory transactions, and documents a relation between earnings‐management incentives and a fundamental supply‐chain design choice.

Abstract Business schools evaluate publication records, especially for the promotion and tenure decision, by comparing the quality and quantity of a candidate's research with those of peers within the same discipline (intradisciplinary) and with those of academics from other business disciplines (interdisciplinary). A recently developed analytical model of the research review process provides theory about the norms used by editors and referees in deciding whether to publish research papers. The model predicts that interdisciplinary differences exist in quality norms, which could result in disparity among business disciplines in the number of top‐tier articles published. I examine the period from 1980 to 1999 and, consistent with the theory, find that significant differences exist in the number of articles and proportion of doctoral faculty who published in the “major” journals in accounting, finance, management, and marketing. Most notably, the proportion of doctoral faculty publishing a major article is 1.4 to 2.4 times greater in the other business disciplines than in accounting (depending on the set of journals). The theory also predicts an upward drift over time in the quality norms used by referees. Consistent with a drift, the number of articles published has declined substantially in marketing and, to a lesser extent, in the other business disciplines.

Abstract We assert that the tax expense is a powerful context in which to study earnings management, because it is one of the last accounts closed prior to earnings announcements. Although many pre‐tax accruals must be posted in the year‐end general ledger, managers estimate and negotiate tax expense with their auditors immediately prior to earnings announcements. We hypothesize that changes from third‐ to fourth‐quarter effective tax rates (ETRs) are negatively related to whether and how much a firm's earnings absent tax expense management miss analysts' consensus forecast, a proxy for target earnings. We measure earnings absent tax expense management as actual pre‐tax earnings adjusted for the annual ETR reported at the third quarter. We provide robust evidence that firms lower their projected ETRs when they miss the consensus forecast, which is consistent with firms decreasing their tax expense if non‐tax sources of earnings management are insufficient to achieve targets. We also find that firms that exceed earnings targets increase their ETR, but this effect is less significant. By studying the tax expense in total, rather than narrow components of deferred tax expense, our results provide general evidence that reported taxes are used to manage earnings.