Knowledge that Transforms

[Relative performance evaluation (RPE) is the process of comparing performances across workers. Relative performance information (RPI) allows a superior to better infer a particular worker's unobservable effort level than would otherwise be possible, and analytical studies have demonstrated that RPE may be an optimal strategy for mitigating the effects of moral hazard if the workers face some common uncertainty (Baiman and Demski 1980; Holmstrom 1980, 1982; Wolfson 1985). Although these analytical studies provide important insights into the role of RPE, they ignore the intrinsic value of comparing workers' performances as asserted (Locke 1968) or demonstrated (Beck and Seta 1980; Harkins and Jackson 1985; Klinger 1969) in behavioral studies. Holmstrom (1982, 325) specifically states that "inducing competition among [workers] by tying their rewards to each other's performance has no intrinsic value." That is, formal models do not assign any intrinsic value to RPE because they emphasize the economic rather than behavioral factors that influence workers' responses to RPE. Consideration of the direct effects of both behavioral and economic factors on effort can provide a better understanding of the potential benefits from RPE. In this study, variables suggested by formal models-that of Holmstrom (1982) in particular-are used to examine the importance of economic and behavioral factors in explaining the motivational effects of comparing workers' performances. Specifically, the direct effects on effort of (1) the degree of common uncertainty among the workers and (2) compensation as a function of RPI are examined in a setting where workers know that they and their supervisor will receive RPI. Several assumptions of agency theory are used to develop hypotheses about the importance of economic factors, and social influence research is used to develop hypotheses about the importance of behavioral factors. The hypotheses were tested in a laboratory experiment that required subjects to act as managers and make production decisions for a hypothetical company. Half the subjects worked under a profit-sharing contract that based compensation solely on their absolute performance, and the remaining subjects worked under an RPE contract that based compensation on both their absolute performance and performance relative to the RPI. There were three levels of common uncertainty, and it was manipulated by varying the number of sources of uncertainty that subjects had in common. Subjects' risk and effort preferences were induced experimentally. The experimental results support the importance of both economic and behavioral factors, depending on the type of contract examined. Subjects' effort levels increased significantly as the degree of common uncertainty increased with the RPE contract, but not with the non-RPE contract. In addition, effort levels were higher under the RPE contract than under the non-RPE contract. These results imply that behavioral factors can be important determinants in motivating effort and that future attempts to model behavior analytically may need to consider these factors. The results also provide weak evidence that economic factors, such as contract type, may enhance or mitigate the importance of behavioral factors in motivating effort.]

[One indication of information usefulness is its ability to increase the precision of individuals' estimates of events of interest (FASB 1980; ljiri and Jaedicke 1966). In this context, earnings reports are useful if they increase the precision of investors' forecasts of future earnings when the latter proxy for the event of interest, future cash flows. The cross-sectional variance of analysts' earnings expectations often is used as a proxy for the unobservable precision of their earnings estimates (Ajinkya and Gift 1985; Brown et al. 1987; Imhoff and Lobo 1992). We show that, when combined with the time-series properties of accounting earnings and prior research in analyst forecasts, Bayesian revisions suggest that year t earnings reports should, on average, increase the convergence of analysts' year t + 1 earnings forecasts. Operationally, we examine whether the information contained in year t earnings decreases the cross-sectional variance of analysts' year t + 1 forecasts. Morse et al. (1991) use I/B/E/S Summary data, and conclude that the information contained in year t earnings announcements increases the cross-sectional variance of analyst forecasts of year t + 1. This is a surprising result. One feature of the I/B/E/S Summary data is that they do not contain dates of the analysts' earnings forecasts. Thus, researchers who use these data do not know the set of information upon which the analyst's earnings forecast is based. In contrast to the I/B/E/S Summary data, the I/B/E/S Detail data are precise regarding the date that the individual analyst's earnings forecast entered the I/B/E/S system. We use I/B/E/S Detail data to reexamine the relation between annual earnings announcements and convergence of beliefs. Using the Detail data, we show that the information contained in year t earnings decreases the cross-sectional variance of analysts' earnings forecasts of year t + 1. Moreover, our finding is insensitive to year of study. Using the Summary data, we find that the information contained in year t earnings increases the cross-sectional variance of analysts' earnings forecasts of year t + 1, but this finding is sensitive to year of study. Morse et al. (1991) hypothesize and provide evidence that reduction in variance is less likely to occur when "standardized" surprise is large. Using the Detail data, we show that significant decreases in variance occur for the seven smallest deciles of standardized surprise, and that significant increases in variance occur only for the largest decile. Using the Summary data for the same "window" as the Detail data, we find no deciles of standardized surprise associated with significant decreases in variance, and we observe significant increases in variance for the three largest deciles of standardized surprise. In sum, our results using I/B/E/S Detail data suggest that, on average: (1) annual earnings announcements increase convergence of analysts' forecasts of firms' future earnings; (2) annual earnings announcements decrease convergence only for the largest decile of earnings surprise. In contrast, we do not obtain consistent results with I/B/E/S Summary data.]

[Much of the past research in accounting ethics has focused on whether accountants conform to prescribed codes of professional ethics. Other research has been normative in nature, recommending what constitutes appropriate ethical conduct or focusing on the accountant's responsibility in society. This study selects a different approach by testing a multivariate measure of how accountants make ethical judgments. Data were gathered with the assistance of the Institute of Certified Management Accountants and the Institute of Management Accountants (formerly the National Association of Accountants). Accountants were asked to respond on bipolar scales to realistic scenarios involving ethical decisions. Several tests for construct validity produced supportive results for the hypothesized three-dimensional measure, with the dimensions being moral equity, relativism, and contractualism. First, we developed a questionnaire with four scenarios concerning ethical issues. Each scenario ended in a particular action taken by an individual. Responses to that action were recorded on eight bipolar scales, representing the three dimensions above. The questionnaire was mailed to 500 randomly selected certified management accountants resulting in a 62.8 percent response rate. Second, the results from a factor analysis and a traditional reliability coefficient test suggest that a high degree of internal consistency exists for each dimension of the measure. The appropriate factor loadings ranged from a low of 0.68 to a high of 0.92, while the reliability coefficients varied from 0.75 to 0.92. Next, the content validity of the three-dimensional measure was checked by comparing it with a global ethical/unethical measure. Again, the results support the hypothesis that the multivariate measure captures the appropriate domain of content. Adjusted R2 -values ranged from 0.59 to 0.76 when the global measure was regressed against the multivariate measure. Finally, a sense of predictive validity was obtained by comparing the multivariate measure with a behavioral intention measure for the respondent. Adjusted R2 -values ranged from 0.45 to 0.76 for the four scenarios tested, indicating that the three-dimensional measure "explains" a respectable portion of the variance in the behavioral intention of the individual. The multidimensional measure developed in this study may be a guide for future research into how accountants make ethical judgments. Such knowledge can be used in turn to develop useful codes of conduct, create ethical organizational cultures, and direct ethical training for and by accountants.]

[This article presents an empirical exploration of a specific market-inefficiency explanation for the observed post-earnings-announcement drift in stock prices. The research question is whether or not the observed relation between unexpected earnings in quarter t and stock-price changes in quarter t + 1 represents a failure of the market to characterize the time-series properties of earnings correctly. The article contributes to the existing literature in two ways. First, it provides corroborating evidence of the failure of the market to characterize the properties of the process underlying earnings correctly. Second, and more importantly, it directly tests the conjecture that this failure explains the post-announcement drift. Corroborating evidence of the market's failure to characterize the properties of the process underlying earnings correctly is derived from a distributed lag model; a LOGIT model is employed to regress unexpected earnings on their four most recent past realizations. The results indicate that the probability of positive unexpected earnings in quarter t + 1 is increasing in its (lagged) values for quarters t through t - 2 and decreasing in its (lagged) value for quarter t - 3. The ability of the model to predict future earnings changes and stock returns outside of the estimation period was examined as well. The results show that the model robustly predicts both one-quarter-ahead earnings changes and future (abnormal) stock returns. Furthermore, future stock returns remain predictable even after current unexpected earnings are controlled. This last relation further corroborates the incremental explanatory power of the lagged unexpected earnings over the unexpected earnings of the current quarter with respect to the post-announcement drift in stock prices. Although this predictability of future earnings changes and stock returns is consistent with the results of prior research (see, e.g., Foster 1977; Griffin 1977; Foster et al. 1984, table 1; Bernard and Thomas 1990, tables 1 and 5), there is an important difference between previous and present methodology. The tests here involve predicting future earnings changes and stock returns by using data from a holdout period, rather than by documenting correlations in the sample. Thus, the tests used here increase the confidence that the results are not driven by modeling or sampling errors. Evidence from this study and prior research is consistent with the conjecture that the market systematically errs in predicting one-quarter-ahead (quarter t + 1) earnings and stock prices. Such an error implies that a drift would be observed during quarter t + 1, as the market uses predisclosure information to update expectations for earnings in quarter t + 1. To my knowledge, the extent to which this error explains post-announcement drift has not been directly tested. I formally test the extent to which this systematic error in predicting future earnings explains the drift by exploring the relation between the drift in stock prices observed in quarter t + 1 and unexpected earnings in quarter t, while controlling for the implications of past earnings for future earnings. In particular, cumulative abnormal returns (CARs) for the period commencing three days after the earnings announcements of quarter t and ending one day following earnings announcements for quarter t + 1 were computed for four portfolios that were constructed on the basis of unexpected earnings in quarter t. Once the implications of past earnings for future earnings are controlled, the positive relation between unexpected earnings in quarter t and the drift in stock prices observed in quarter t + 1 no longer exists. This finding suggests that the observed relation between unexpected earnings in quarter t and stock price changes in quarter t + 1 is fully explained by a systematic error in forecasting earnings.]

[This study adds to recent research that assesses the value implications of earnings changes. Stock price changes associated with reported earnings innovations (typically assessed by estimating earnings response coefficients) have been characterized as related to the persistence of earnings, which is defined as the revision in expected future earnings that is implied by a current earnings innovation. Permanent earnings innovations are associated with higher multipliers than transitory ones. This stream of research stems from Kormendi and Lipe (1987) and Easton and Zmijewski (1989). These studies characterize earnings persistence as a stationary, firm-specific phenomenon that describes the evolution of earnings over time. They estimate parameters of earnings persistence from time-series data on earnings and then show that the market's pricing of earnings innovations are related to the persistence measures. Typically, this evaluation involves ex post information, so the approach is not relevant for investors' ex ante determination of pricing multipliers. This article reports three findings on the pricing of annual earnings changes. First, pricing multipliers can be evaluated contemporaneously by other information published in annual financial statements along with earnings. An investor who seeks to assess persistence and the price effect of a reported earnings change can do so by referring to other information in the financial statements. Second, in contrast to previous research, this study shows that the earnings persistence indicated by financial statements is not a fixed attribute, but changes over time and tends to revert to the mean of all firms. Correspondingly, pricing multipliers follow a similar pattern, which requires their periodic updating through financial statement analysis. Third, the multiplier of earnings changes is also related to information published in the previous year's annual report. To the extent that previous accounting reports provide forecasts of earnings that are already incorporated in prices, multipliers are lower.]

[Organizational theorists have posited a positive relationship between employee performance and participation in budgeting or goal setting (Argyris 1952; Becker and Green 1962). In examining this proposition, empirical research has studied the motivational and cognitive mechanisms by which participation may be related to employee performance (Locke et al. 1986; Murray 1990). Cognitive mechanisms include factors such as the acquisition and use of information and comprehension of job requirements (Locke et al. 1986). Kren and Liao (1988) argue that empirical accounting research has generally focused on the motivational effects of participation. In general, results have been mixed (Murray 1990). While Merchant (1981) found a positive relationship between motivation and participation, Brownell and McInnes (1986) did not find such a relationship. The results prompted Brownell and McInnes to suggest that future research should examine performance benefits of participation that are not mediated by motivation. Recently, accounting researchers have studied the role of cognitive factors in explaining the relationship of participation to performance. Chen-hall and Brownell (1988), for example, found that budgetary participation provided information that reduced role ambiguity that contributed to improved performance, and Mia (1989) found the relationship between participation and performance to be moderated by job difficulty. The objective of this article is to examine the perceived level of job-relevant information as an intervening variable between budgetary participation and individual performance. Job-relevant information (JRI) is information that facilitates job-related decision making. The results of this study, based on a questionnaire survey of division managers in large corporations, suggest that participation affects performance, not directly, but through JRI. In addition, this positive performance effect of participation persists and is more pronounced when environmental volatility is high, although the results do not provide unambiguous evidence.]

[According to the December 1991 issue of the Survey of Current Business, expenditures of state and local governments account for more than 11 percent of the U.S. gross domestic product. Moody's 1991 Municipal Manual indicates that these governmental entities have an outstanding debt now approaching $800 billion, and a report by the Public Securities Association (1987) indicates that this debt grew at a compound annual rate of 12 percent from 1966 to 1986. State and local governmental activities continue to increase in magnitude, and evidently form an important part of the political and economic environment in which accounting operates. Important accountability issues distinctive to these organizations need accounting research attention. The articles by Feroz and Wilson and Deis and Giroux in this issue, which we have been invited to review, address some of these topics. The study by Feroz and Wilson can be regarded as an extension to the public sector of capital-market-based research that examines the effects of financial-accounting disclosures on security prices and returns. They hypothesize segmentation of the market for municipal obligations along national and regional lines and study the effects of differential information disclosure on borrowing costs. In the other study, Deis and Giroux utilize quality reviews that were conducted by the Texas Education Agency to evaluate and rate the audits (by public accountants) of public schools' financial reports. They test hypotheses about audit quality that were originally developed in the context of commercial firms. Both studies thus represent extensions of theories and methods used in research of private-sector accounting and auditing issues. The contributions of the two articles are discussed, and modifications that consider the unique aspects of governmental accounting are presented in sections I and II. Other possible avenues for research are discussed in section III.]