We examine the application of real options within two contexts of motion picture investment decisions by studio executives. The first is whether to continue marketing a film following its initial release in theaters (an abandonment option). The second centers on the decision to produce a sequel to an original film (a growth option). Few accounting studies have examined the use of real options but they are of considerable importance to companies managing risk through their cost structure and capital investment decisions. Specifically, a real option allows decision makers to postpone further expenditure commitment until a substantial portion of the uncertainty surrounding the investment has been resolved. Our evidence from the motion picture industry indicates that studios leave a portion of their marketing budget uncommitted until its spending is warranted. We also show that studios invest more in original films that they believe will lead to a sequel. Specifically, we find that studios spend higher production and marketing costs on films with sequels than those without, and that sequels generate higher returns on investment than non-sequels. Overall, our results suggest that the real options framework has applications for accounting research and practice by providing a basis for studying and understanding cost commitments in product or project-based settings.

Female directors and earnings quality

We examine whether Canadian firms issuing convertible debt over the period 1996–2003 structured issuances to minimize reported leverage. Over this sample period, some firms using payment-in-kind (PIK) provisions providing them with the option to make interest and/or principal payments in company shares were able to record significant amounts of the issuance as equity. In a sample of 195 convertible debt offerings, we find significant variation in accounting treatment, ranging from firms recording the entire issuance as debt to some recording the entire issuance as equity. We find evidence consistent with the contention that reporting benefits are an important reason why high-leverage corporations with material convertible debt transactions used PIK provisions. In contrast, our evidence suggests that the future financial flexibility ensuing from the use of PIK provisions was an important determinant of income trusts’ use of this feature. We acknowledge, however, that during our sample period PIK provisions simultaneously provide both financial flexibility and reporting benefits to any issuer, whether corporation or trust. Finally, we document a negative share price reaction on the part of convertible debt issuers employing PIK provisions at the time when the likelihood of the introduction of more restrictive accounting rules increased. This negative reaction is driven by the corporations in our sample, with the income trusts largely unaffected. Our findings are relevant to standard setters as they debate alternative models for distinguishing between equity and liabilities.

Motivated by evidence from the empirical accounting and finance literatures suggesting that short sellers target firms with suspect financial reporting, we investigate whether short interest provides a signal of the degree of audit risk. We find a positive association between audit fees and short interest (total shares sold short scaled by total shares outstanding) after controlling for other determinants of audit fees. This finding suggests that short interest is an indicator of audit risk that reflects information not captured by traditional client risk measures. We also find an increase in the magnitude of the association between audit fees and short interest after events in the early 2000s (corporate scandals, the collapse of Arthur Andersen, and the implementation of new auditing standards) which increased auditors’ responsibilities to deter fraud and made the implications of fraud particularly salient to external auditors. Our findings are important because they suggest that auditors’ sensitivity to client risk information increased post-2002, indicating that efforts by regulators and standard setters (e.g., the PCAOB and the AICPA) to increase auditors’ attention to risk have been successful.