Knowledge that Transforms

Abstract This paper examines experienced managers' judgments about the effects of market price and accounting profit information on negotiated transfer prices. Conventional economic arguments predict that market price should determine negotiated transfer prices by determining reservation prices for parties with outside options. We found, however, that experienced managers expected the influence of market price to be limited by divisional managers' concern about how their profits compare with each other. While market price did affect managers' reservation-price and transfer-price estimates, its influence was significantly less when market price resulted in a more unequal ("unfair") distribution of profits between divisions. Profit comparisons also affected the judgments that determine the efficiency of the bargaining process. We found that as market price diverged from a price that offered equal profits to both divisions, both variance and bias in managers' price estimates increased, indicating that it would be harder to reach agreement on a transfer price.

Abstract Reviews the book "Accounting History From the Renaissance to the Present: A Remembrance of Luca Pacioli," edited by T.A. Lee, A. Bishop and R.H. Parker.

Abstract Reviews the book "Clean Surplus: A Link Between Accounting and Finance," by edited by Richard P. Brief and K.V. Peasnell.

Abstract This paper studies information system design in a model of double moral hazard in which there is both a decision problem and a control problem. If either problem is considered in isolation, an information system that provides more public information is preferred. However, an information system that provides less public information can, in fact, be desirable because of an interaction between the two problems. The benefit of choosing an information system that provides less information is that it serves as a substitute for commitment for the principal. The cost is that neither the principal's decision (act) nor the agent's payments can be conditioned on the information. We provide sufficient conditions under which less information and more information are each optimal.

Abstract This paper examines whether accumulated postretirement benefit obligations (APBO) are useful in assessing equity market values. Using an extension of the econometric procedures outlined in Barth (1991), we use observed market capitalization rates on accounting measures to estimate "noise ratios" defined as the ratio of measurement error variance to the total variance of the accounting measure. Differences in estimated noise ratios are then used to make inferences about the relative reliability of APBO and pension liability measures. We find that APBO amounts are marginally significant in explaining cross-sectional differences in equity values, but are capitalized at a much lower rate than pension obligations. Consistent with predicted differences in reliability, the estimated noise ratio for APBO is significantly greater than that for pension obligations. Moreover, we find estimated APBO noise ratios vary predictably across firms as a function of the retiree/active employee ratio and the likelihood of health care benefit reductions.

Abstract We compare clients' realignment decisions in markets permitting direct uninvited solicitation (allowed markets) and markets prohibiting such practices (banned markets), providing insight into the effects of increased competition on client-auditor alignment. We argue that solicitation influences realignment decisions if clients do not invite nonincumbents to submit proposals, and if net economies are available (i. e., the cost savings from switching auditors exceeds any transactions costs incurred in realignment). By examining realignments among Big 8 auditors during the period 1980 through 1988, and by controlling for other variables associated with auditor switching, we are able to focus on the effects of solicitation in a setting of homogeneous audit quality and diversity in state boards' direct solicitation rules. We find that realignment occurs more frequently in the allowed market than in the banned market. Thus, in markets where auditors are allowed to approach prospective clients with proposals, clients become better informed and the outcome may be reduced inefficiencies.

Abstract The quality of capacity planning significantly affects firm profitability, particularly for firms in service industries. In practice, firms use product cost data to infer the expected cost of under- and over-stocking capacity and to determine installed capacity. Theory shows that this is not optimal practice. In light of the informational and computational complexities associated with the optimal theoretical formulation, the use of product cost may be justified as a heuristic. For a multi-product, multi-resource firm, we use simulations to investigate the efficiency of four cost-based decision rules in determining the expected cost of under- and over-stocking capacity. Results indicate surprisingly high performance levels, relative to a benchmark solution. The performance of the product-based planning rule deteriorates as products increasingly share capacity resources. The opposite is true for resource-focused rules. There appears to be significant value from identifying mechanisms to balance installed capacity across resources.

Abstract Stock dividends which increase outstanding shares by less than 25 percent require a transfer from retained earnings of the market value of the new shares, a much larger transfer than that required for stock dividends of 25 percent or more. Choosing a distribution factor near, but below, 25 percent may be an indication of management optimism that future income will replenish retained earnings, avoiding constraints on future cash distributions. In this study, firms declaring 20 percent and 25 percent stock dividends are compared. The 20 percent stock dividend firms exhibit significantly greater announcement-period abnormal returns and significantly greater post-declaration cash dividend growth. These effects are greatest for firms incorporated in states where the level of retained earnings more strictly constrains the payment of cash dividends.

Abstract This paper examines the voluntary disclosure of nonproprietary information using the model of uncertain information endowment developed by Dye (1985) and Farrell (1986), and extended by Jung and Kwon (1988). The paper focuses on a broad family of functions relating the probability of information acquisition to ex post information quality. The paper shows that for each function there is some region that displays a negative relation between ex ante information quality and the frequency of disclosure. In addition, a sub-family of functions is identified for which ex ante information quality and the frequency of disclosure are negatively related everywhere. These results indicate that the economic intuition that higher informational asymmetry is accompanied by more voluntary disclosure is not generally true.

Abstract Prior research has found that loan loss provisions are positively associated with bank stock returns and future cash flows, conditional on less discretionary information about loan default. We find that these positive valuation implications obtain only for loan loss provisions for low regulatory capital banks in the fourth fiscal quarter. Our regulatory capital-based tests are motivated by the idea that increased discretionary loan loss provisions are plausibly good news only for banks which appear to have loan default risk problems based on prior information. Our fiscal quarter tests are motivated by findings in prior literature that suggest that managers have incentives to delay income decreasing accruals until the fourth quarter when the audit occurs, implying that income decreasing accruals are more likely, and therefore more expected, in the fourth quarter than in other fiscal quarters (Mendenhall and Nichols 1988; Boyd et al. 1994).