Knowledge that Transforms

This paper adds to recent evidence on market inefficiency in processing information in earnings reports. It documents that short positions taken in sample stocks which did not report earnings by the date expected during the sample period, 1971–1976, would have been abnormally profitable, before transaction costs. This is because late reports, on average, revealed bad news which was not anticipated in market prices prior to the report date. The magnitude of the average abnormal returns is in the order of 1.0% over 20 days but is larger for smaller firms in the sample and positively related to the length of the reporting delay. The paper also documents that long positions taken in stocks reporting early with good news would have generated abnormal returns of approximately 1.0% on average over a 20-day holding period.

This paper examines the association between one specific change in executive compensation contracts (adoption of performance plans), changes in corporate capital investment, and security market performance. The empirical results indicate that (when compared to similar non-adopting firms) firms adopting performance plans exhibit a significant growth in capital expenditures and a favorable security market reaction to the announcement of the performance plan adoption. These results provide evidence that changes in executive compensation contracts are associated with changes in managerial decisions.

The earnings ‘time-series literature’ in accounting focuses on the statistical characteristics of the processes which generate corporate earnings. In order to further our understanding of earnings behavior, this study investigates the question whether inter-firm differences in these statistical characteristics (autocorrelations and variances of earnings changes) can be explained by economic factors. Various relationships between economic factors and earnings behavior are derived from the economic literature and examined empirically in this study. Findings indicate that autocorrelations and variability of annual earnings and earnings over equity changes are systematically associated with the following factors: the type of product, the height of industry barriers-to-entry (a surrogate for degree of competition), the degree of capital intensity (‘operating leverage’), and the firm size.

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.

Firm size has been used as a proxy for the firm's political costs and hence managers' proclivity to choose income reducing accounting procedures. This study provides additional evidence on this topic by examining the association between firm size and effective corporate tax rates. The latter are one component of a firm's political costs. The roughly fifty largest U.S. exchange-listed firms, in particular oil and gas companies and manufacturing firms, have significantly higher worldwide tax rates than other firms. These higher tax rates are observed primarily after the implementation of the U.S. 1969 Tax Reform Act and after the OPEC countries raised their tax rates on U.S. oil producers. The findings, which are insensitive to alternative sources of data, alternative measures of firm size, and alternative measures of effective tax rates, are consistent with the use in previous studies of firm size as a proxy for the firm's political costs.

This paper shows how the existence of disclosure-related costs offers an explanation for why a manager exercise discretion in disclsing information even though traders have rational expectations about his motivation to withhold unfavorable reports. In effect, disclosure-related costs introduce noise by extending the range of possible interpretations of withheld information to include news which is actually favorable. Therefore, traders are unable to interpret withheld information as unambiguously ‘bad new’ and thereby discount the value of the firm to the point that the manager is better served to disclose what he knows.

This study addresses the relationship between the supply of auditing in the public sector and political competition expected in future elections. Empirical tests that use cross-sectional data from state governments reveal positive correlations between state audit budgets and measures of political competition. These results are consistent with an argument that public officials' incentives to supply auditing arise from contracting between the officials and their supporting interests.

The purpose of this research is to explain municipalities' voluntary participation in the MFOA Certificate of Conformance Program (CCP) during 1976–1980 as a function of the economic incentives of municipal officials. Our operational model predicts that cities with more debt, CCP participation prior to 1976, professionally active municipal officials, and a manager form of government are more likely to participate. In addition, cities in states with GAAP (non-GAAP) reporting requirements were expected to be more (less) likely to participate. Taken as a whole, the empirical results are consistent with the proposed model of the CCP participation decision.

Until 1974, firms could capitalize or expense all or part of their research and development (R&D) costs. Managerial choice between these two alternatives is hypothesized to be affected by the existence of debt covenants which employ accounting numbers relating to leverage, interest coverage, and ability to pay dividends. In addition, the use of public versus private debt is hypothesized to affect the accounting choice due to differential renegotiation costs. Lastly, a political cost hypothesis is tested. This study uses a multivariate statistical technique, the generalized jackknife. The results suggest that firms which capitalized R&D costs were more highly levered, used more public debt, were closer to dividend restrictions, and were smaller than firms which expensed R&D costs.

This study provides a test of the relationship between changes in a firm's disclosure environment and its security price behavior. The initiation of interim reporting is examined. Theory suggests that the marginal information content of an annual report is greater when it has not been preceded by interim reports and that greater return variability will be observed at the annual report announcement date. The variance of returns upon release of the annual report is compared in the ‘annual-report-only’ and ‘annual-plus-quarterly-reports’ environments. As predicted by the theory, variability is significantly greater in the ‘annual-report-only’ environment.