[This paper examines the relation between stock returns and accounting earnings under the assumption that the market observes current-period information other than earnings. This assumption is motivated by existing empirical evidence that stock returns lead accounting earnings. The analysis shows that the returns-earnings relation depends on the relative ability of earnings versus alternative information to predict future earnings as well as the time-series persistence of earnings. Assuming that the researcher does not observe the alternative information, the earnings response coefficient should be increasing both in the ability of past earnings to predict future earnings and in earnings persistence. The variance of stock price changes during the announcement of earnings should be decreasing in predictability and increasing in persistence. Empirical tests of these four hypotheses are generally consistent with the theory. Also discussed is how the assumption of alternative information may be useful in examining the information environment hypothesis, in assessing ad hoc methods of reducing measurement error bias, and in formulating how economic earnings differ from accounting earnings.]
[Productivity measurement has not generally been considered part of the information that managers use in planning and control decisions. Kaplan (1983) criticizes accounting research for the lack of studies on production efficiency stating that the effects of output volume and substitution possibilities among key production inputs on productivity measures have not been the subject of any accounting research. Hasseldine (1967), Mensah (1982), and Marcinko and Petri (1984) have addressed the short-comings of traditional financial measures of productive efficiency. Barlev and Callen (1986) show that input standards should not be defined independent of input prices, the state of technology, and the level of output. These authors, however, provide no empirical applications. This study provides empirical evidence related to performance measures of efficiency of production. Traditional budgeting methods and measures used for analysis may provide inadequate information for effective performance evaluation and control monitoring. This is particularly true if the budget model assumes that input cost shares are fixed. Analytical methods including budget analysis that fail to consider available input substitution possibilities in response to changes in relative input prices, and methods that fail to consider changes in operating conditions, may result in lost opportunities for cost savings. For example, traditional methods of assigning responsibility for accounting variances tend to focus attention on meeting the budget and may divert attention from production input-mix decisions when relative input prices change. For this study, we obtained data on the output produced and the input consumed via on-site visits to 33 county correctional institutions (jails) in Tennessee. A multivariate regression system of simultaneous equations and a translog cost function specification were employed to analyze these data. Our empirical model specification required input prices, output levels, and the state of technology as independent variables (not summary financial measures) to explain total operating expenditures for the budget period. Agency theory provides a means for inferring managerial behavior. The translog cost function coefficients provide essential information about variability in input cost shares for the sample data. Based on the hypotheses tested, we rejected the reasonableness of the conventional budget model assumption of fixed cost shares. We provide empirical evidence that managerial decisions based on matching expenditures and appropriations in line item budgets may not be cost-minimizing. The evidence suggests that a translog budget model may produce additional useful performance evaluation and control monitoring information that is not available from budget models which assume that cost-minimizing input cost (budget) shares are fixed.]
[Auditing has been characterized as a sequential process of obtaining and evaluating evidence (Gibbins 1984). During this process, auditors continually update their beliefs about the audit assertion being examined. Recently, Hogarth and Einhorn (1989) have posited a belief-adjustment model for updating beliefs. Based on a sequential anchoring and adjustment strategy, the model has important implications for auditors concerning the effects of the order in which evidence is evaluated. The model predicts that the order in which evidence is received has no effect on the belief-revision process when the evidence is consistent (either all positive or all negative). However, when the evidence is mixed (positive and negative), the model predicts that a recency effect will occur. Ashton and Ashton (1988) tested an earlier version of this model with experienced auditors in "simplified, well-defined settings" and found results consistent with the model's predictions. They suggested that their findings should be tested in more realistic audit contexts. Hogarth and Einhorn (1989) have suggested that findings of recency or primacy may be influenced by task complexity. Therefore, the current study tests the predictions of the model using content-rich audit scenarios. Four experiments were conducted involving 251 experienced auditors. The first experiment tested for a lack of order effect using consistent positive evidence, and the second experiment tested for a lack of order effect using consistent negative evidence. The third and fourth experiments tested for recency effects using mixed evidence with either two or four pieces of evidence. The results of the first two experiments indicated that order of evidence was not significant. Order of evidence was significant in experiment 3 in the step-by-step response condition but not in the end-of-sequence response condition. In experiment 4, order of evidence was significant in both response conditions. Therefore, the results of this empirical work support the predictions of the model, thus reinforcing the findings of Ashton and Ashton (1988).]
[This study investigates the relation between financial analyst earnings forecast revisions and two independent variables: (1) a measure of management earnings forecast news issued prior to analyst revisions, and (2) measures derived from the security market price reaction to that news. Results indicate that security price reactions to management forecasts are useful in predicting subsequent analyst forecast revisions. Furthermore, the explanatory power of price reaction is a function of the timing of the management forecast release.]
[This research investigates the degree to which the superiority of analysts' earnings forecasts (relative to a univariate time-series model) is associated with certain firm characteristics. The analysts' information advantage is characterized as being related to private information-gathering incentives, and to the amount of information disseminated about the firm. The objective is to determine whether analyst forecast superiority is related to firm characteristics not examined in previous research. Specifically, the investigation relates the analyst advantage over a time-series model to past earnings variability and the extent of coverage in The Wall Street Journal. Statistical controls were employed for the market value of the firm's common stock, the firm's number of lines of business, and the time lapse between the end of the previous fiscal quarter and the release of the earnings forecast. The methods of data analysis consist of estimating OLS regressions, heteroscedasticity-consistent estimators, and bootstrapping techniques. The results indicate, first, that the analyst advantage in forecast accuracy over a time-series model is materially related to the historical variability in the earnings time series. Second, no positive relation is evident in our data between the analyst advantage and firm size, a result that is at variance with some previous research. Third, the analyst advantage is positively related to the amount of coverage in The Wall Street Journal Index, which is consistent with the intuitive notion of prior research that analysts' forecasts improve as more information becomes available. Finally, an attempt was made to ensure that the results were not caused by violations of classical regression assumptions. This was accomplished by explicitly correcting for a nonconstant variance, and by allowing for cross-correlation using bootstrapping. The asymptotic results are very similar to the bootstrapping results, but neither adjustment has altered the primary findings using OLS.]
[Much accounting research is based on the premise that monetary rewards are used to direct and control individual actions. The assumption is that such rewards motivate individuals to exert additional effort and achieve higher levels of performance. Several studies have recently shown that the effects of monetary incentives on judgment and effort are contingent on a number of factors. In this study the contingent factors used are the cognitive characteristics of the decision maker. The cognitive characteristic under examination is perceptual differentiation (PD), an individual's ability to perceptually abstract from a complex setting certain familiar concepts or relationships. The experimental tasks involve applying three decision rules frequently used in accounting settings: conjunction probability, sample size, and sunk cost. In the development of the hypotheses, PD is posited to relate positively to decision performance, and monetary incentives are expected to induce all subjects to exert additional effort, but to increase the performance levels of only those who possess the requisite cognitive skill. Seventy full-time undergraduate students at a major U.S. university voluntarily participated in the experiment. All subjects received a one dollar participation fee, and one half of them (incentive condition) were given an opportunity to win an additional six dollars. The subjects first completed the Group Embedded Figures Test, which provided scores used to classify them as high and low PDs. The subjects then responded to a series of questions to test their understanding of the conjunction probability, sample size, and sunk cost decision rules as well as their ability to apply these rules in three different accounting settings: an estimate of past due accounts receivable, an evaluation of internal control, and a fixed asset replacement. The results indicated that high PDs performed better than low PDs only in the decision context where conjunction probability was applied. No differences in performance were observed between high and low PDs in the contexts requiring the application of sample size and sunk cost. Error rates in the sample size and sunk cost contexts exceeded those of conjunction probability, and high PDs showed a greater understanding than did low PDs of the sunk cost decision rule. The subgroup of subjects offered a monetary incentive spent significantly more time on the tasks than subjects not offered the incentive. In the low PDs, monetary incentives were not associated with higher levels of performance across all three decision contexts. In the high PDs, monetary incentives were associated with higher levels of performance in the contexts that required applications of the conjunction probability and sample size decision rules. The contributions of the study include (1) demonstrating that the effectiveness of a monetary incentive may depend on the cognitive skill of the decision maker, and (2) extending the research on the role of PD in decisions made in accounting contexts.]
[Effective January 1985, SFAS No. 80 requires banks to recognize changes in the market value of futures contracts that qualify (a) as micro hedges as adjustments to the carrying amount of the hedged item ("hedge accounting"), and (b) as macro hedges currently in income ("immediate recognition"). The distinction between micro and macro hedges depends on whether the futures contracts are linked with identifiable hedge transactions (micro hedge) or not (macro hedge). Three factors motivate commercial banks to use macro hedges: (1) it may be difficult to isolate hedge transactions; (2) since 1983, required disclosures provide readily available measures of macro exposure; and (3) it is possible to increase exposure by micro hedging some items but not others. Consequently, commercial banks, as large macro hedge users, are concerned that immediate recognition accounting causes gains and losses on futures contracts and hedged items to be recognized in different periods. This asymmetry, they argue, increases the variability of earnings and discourages effective use of futures contracts to hedge interest rate risk. Brokerage firms have similar concerns about immediate recognition accounting for futures contracts used for investment or speculation. This paper examines commercial banks' and brokerage firms' claim that the current accounting rules for futures contracts increase earnings variability. As such, this analysis departs from prior studies that focus on the security market's reaction to an accounting change. Simulations calibrated with empirical data collected from a sample of 76 commercial banks are used to generate earnings streams computed under immediate recognition and hedge accounting. The variability of the simulated earnings patterns is then compared using parametric and nonparametric tests. These tests show that immediate recognition accounting significantly increases the dispersion of annual earnings vis-�-vis the earnings stream produced under hedge accounting. This finding, which is robust to the size of the hedge and the measure of earnings, suggests at least one motivation for a change in commercial banks' hedging behavior. Empirical tests are used to compare earnings patterns of a sample of 27 brokerage firms. These results indicate no significant difference between the variability of earnings before and after the effective date of SFAS No. 80. Although based on a small number of time series observations, this finding does not support critics' concern over the accounting treatment for futures contracts used for investment or speculation.]