[The accounting profession is witnessing an increase in both the number of lawsuits against auditors and the settlements associated with those suits. As an example, partners with Laventhol & Horwath cited litigation claims against their firm as a major factor in the nation's seventh largest accounting firm's decision to file for bankruptcy protection. Disclosures by Big Eight (now Six) firms show that between 1980 and 1984 nearly 180 million dollars were paid to settle audit-related litigation (Public Accounting Report 1985). An additional cost to firms associated with this litigation is reflected in the rise of malpractice insurance rates. For example, during 1984 the AICPA's professional liability insurance plan doubled its insurance premiums while at the same time increasing deductibles and decreasing coverage (Collins 1985). Auditing firms also suffer indirect costs as a result of increasing litigation. Prior research (St. Pierre and Anderson 1984; Palmrose 1988) examined audit litigation cases and provided descriptions of characteristics of auditors in those cases. Palmrose (1988) suggests that an increasing frequency of litigation against an auditing firm is viewed as a negative signal about the quality of auditing services provided by the firm, thereby impairing its reputation. Two conditions are likely to exist in order for a lawsuit to be filed against an auditor: (1) an allegation of audit failure, and (2) legal action provides a cost-effective alternative for potential plaintiffs. This study hypothesizes that the client's financial condition, asset structure, and sales growth affect the likelihood of erroneous financial statements being issued and that the auditor's ability to detect and willingness to disclose errors are related to the probability of an audit failure. This study also suggests that the greater the market value of the client and the higher the variability of the client's returns, the more likely the auditor of that client will be a target of litigation. A matched-pairs design is used to analyze a sample of companies involved in lawsuits against auditors and a sample of companies matched with the experimental sample on industry and time period. The results provide evidence of an association between pre-audit engagement characteristics of both the client and the auditor, and the subsequent filing of a lawsuit against the auditor. After controlling for industry effects, the ratios of accounts receivable and inventory to total assets, the client's variance of abnormal returns, financial condition, and market value are found to be significantly associated with lawsuits against auditors. A test of the model's predictive ability using various relative error costs and assuming various prior probabilities of auditor litigation results in concluding that model's ability to outperform a naive strategy is sensitive to the parameters selected. However, when realistic priors and error costs are assumed, the model is effective in identifying high-risk audit engagements.]
The article identifies several client and auditor characteristics as being associated with lawsuits against auditors. The accounting profession is witnessing an increase in both the number of lawsuits against auditors and the settlements associated with those suits. An additional cost to firms associated with this litigation is reflected in the rise of malpractice insurance rates. During 1984 the AICPA's professional liability insurance plan doubled its insurance premiums while at the same time increasing deductibles and decreasing coverage. Auditing firms also suffer indirect costs as a result of increasing litigation. An increasing frequency of litigation against an auditing firm is viewed as a negative signal about the quality of auditing services provided by the firm, thereby impairing its reputation. Two conditions are likely to exist in order for a lawsuit to be filled against an auditor: an allegation of audit failure, and legal action provides a cost-effective alternative for potential plaintiffs.
Poppers falsificationism is apparently being adopted as an Ideal by accounting researchers. For example, Christenson [1983] has criticized Watts and Zimmerman's [1978, 1979] theories for not conforming to Poppers approach. This paper argues that Poppers falsificationism should not be viewed as an attainable ideal by accounting researchers, and that standard of rigor and research and experimental design are sufficient to support Christenson's criticisms without recourse to Poppers methodology.
[Popper's falsificationism is apparently being adopted as an ideal by accounting researchers. For example, Christenson [1983] has criticized Watts and Zimmerman's [1978, 1979] theories for not conforming to Popper's approach. This paper argues that Popper's falsificationism should not be viewed as an attainable ideal by accounting researchers, and that standard of rigor and research and experimental design are sufficient to support Christenson's criticisms without recourse to Popper's methodology.]
A contingent claims valuation model is used to estimate the values of a sample of convertible bonds and to partition those values into their debt and equity portions. The model and market values of the bonds are compared and model estimates are found to be approximately unbiased relative to market values, with about 90 percent of the values within ten percent Of market values. The average equity values of the convertible bonds are found to constitute 16.7 percent and 18.4 percent of the book and market values of the bonds, respectively. When leverage and dilution measures for the sample are restated by excluding the estimated equity value of convertibles from debt, differences are small on average, but for some firms they are substantial. A comparison of reported earnings per share (EPS) with EPS using model equity values reveals that model EPS differs cross-sectionally from both primary and fully diluted EPS but is much closer on average to primary EPS. The findings of the study provide reason for optimism regarding applications of contingent claims models to practical valuation problems, particularly with regard to more meaningful measures of dilution of earnings and leverage.
The article presents the author's response to comments on his paper "Coalition Formation in the APB and FASB: Some Evidence on the Size Principle," by accounting expert James A. Anderson. These comments given by Anderson are partitioned into two major areas and the article provide a few general arguments in defense of the size principle and the particular investigation. In particular, topics including assumptions of the model and methodological issues on observation of coalitions, specifying payoffs and operationalizing tendency seem to capture the major points. The article also provides some remarks regarding the simplistic nature of the size principle versus more developed models of coalition formation based on policy dimensions. Anderson raises a number of points regarding the conditions required to test the predictions of the size principle and the information and threat effects. Some concerns are over the surrogates utilized in the tests. These comments focus on the inability to observe a winning coalition, the nature of a "tendency" toward minimum winning coalitions and the payoffs to participants in the standard-setting process.