Knowledge that Transforms

ABSTRACT: We examine the financial reporting practices of small privately held businesses that are not subject to SEC regulation. Specifically, we determine the factors associated with the production and use of financial statements for firms that have discretion in the preparation of financial statements and do not face the demands of public equity markets. In addition, for firms that prepare financial statements, we determine the factors associated with the sophistication of the financial statements in terms of whether the financials are compiled, reviewed, and/or audited by a professional accountant and whether the firm produces accrual-based financial statements. Finally, we examine the potential benefits afforded firms producing financial statements, having audited financial statements, and having accrual-based financial statements. We find that firms with audited financial statements benefit in the form of greater access to credit and that firms with accrual-based financial statements benefit in the form of a lower cost of credit.

ABSTRACT: Using a comprehensive sample of switches to and from the largest auditors (i.e., the Big N), we examine empirically whether the sensitivity of Big N auditor switches to client risk and misalignment changed between the pre- and post-Enron periods. Although we find an increase in the sensitivity to client misalignment, the sensitivity to client risk generally decreases. The results are consistent with Big N auditors rebalancing their audit client portfolios in response to post-Enron capacity constraints arising from the supply of former Arthur Andersen clients and the audit demands imposed by Sarbanes-Oxley rather than increasing their sensitivity to client risk. Additional evidence indicates that the Sarbanes-Oxley demand shock did not affect Big N auditor switching behavior incremental to the initial Andersen supply shock.

ABSTRACT: This study examines the association between corporate governance and disclosures of material weaknesses (MW) in internal control over financial reporting. We study this association using MW reported under Sarbanes-Oxley Sections 302 and 404, deriving data on audit committee financial expertise from automated parsing of member qualifications from their biographies. We find that a lower likelihood of disclosing Section 404 MW is associated with relatively more audit committee members having accounting and supervisory experience, as well as board strength. Further, the nature of MW varies with the type of experience. However, these associations are not detectable using Section 302 reports. We also find that MW disclosure is associated with designating a financial expert without accounting experience, or designating multiple financial experts. We conclude that board and audit committee characteristics are associated with internal control quality. However, this association is only observable under the more stringent requirements of Section 404.

ABSTRACT: Optimal agency contracts pay the lowest wage necessary to induce profit-maximizing effort. Employees could view such contracts as violating reciprocity because, relative to more reciprocal contracts, they offer a lower wage in exchange for higher effort. Consequently, the profit-maximizing effectiveness of optimal contracts could be impaired if employees reject them or reduce their effort. We use experimental labor markets to examine (1) how employees respond to an optimal versus a suboptimal reciprocity-based contract when each contract is the only contract available, (2) how employees respond to these contracts when firms choose which one to offer, (3) whether the firms' contract offers depend on employees' reactions to those offers, and (4) how employees and firms react to a hybrid contract that incorporates features of both contracts. We find that the optimal contract is less effective than agency analysis predicts, the reciprocity-based contract can be equally effective, and the hybrid contract dominates a market in which all three contracts are available. Implications of these results are discussed.

Views Icon Views Article contents Figures & tables Video Audio Supplementary Data Peer Review Share Icon Share Facebook Twitter LinkedIn MailTo Tools Icon Tools Get Permissions Cite Icon Cite Search Site Citation Gregory B. Waymire; Exchange Guidance is the Fundamental Demand for Accounting. The Accounting Review 1 January 2009; 84 (1): 53–62. doi: https://doi.org/10.2308/accr.2009.84.1.53 Download citation file: Ris (Zotero) Reference Manager EasyBib Bookends Mendeley Papers EndNote RefWorks BibTex toolbar search Search Dropdown Menu toolbar search search input Search input auto suggest Search

ABSTRACT: Managers exercise considerable discretion over how they announce an accounting restatement in a press release. Some firms issue a press release that discloses the restatement in the headline (high prominence). Others provide a press release with a headline on a different subject (for example, earnings news) but describe the restatement in the body of the release (medium prominence). The remaining firms discuss the restatement at the end of the press release in a footnote to operating results (low prominence). Mean three-day returns differ considerably across these three categories of prominence (−8.3, −4.0, and −1.5 percent, respectively). We find that disclosure prominence is significantly negatively associated with returns in a model that controls for the seriousness of the GAAP violation, restatement magnitude, other restatement characteristics, and potential endogeneity. Similarly, we find the likelihood of class action lawsuits is significantly reduced with less prominent disclosure.

ABSTRACT: We present a model and provide empirical evidence showing that auditor quality affects the financing decisions of companies, and that higher audit quality reduces the impact of market conditions on client financial decisions and capital structure. Consistent with our analytical predictions, we find that companies audited by Big 6 firms are more likely to issue equity as opposed to debt than are those audited by small audit firms. We also find that companies audited by Big 6 auditors are able to make larger equity issues than are those audited by small auditors, but the difference narrows when market conditions improve. Additional results show that the debt ratios of companies decrease less in response to favorable market conditions when auditor quality is high, at least over the medium term.

ABSTRACT: We examine how shareholder-level taxes affect the contemporaneous pricing of foreign firms' U.S. cross-listed and underlying home-country securities surrounding the 1997 reduction in U.S. capital gains tax rates. Consistent with tax capitalization, we find that the performance of cross-listed shares is negatively related to dividend yield, suggesting an abnormal price increase for shares with greater anticipated taxable capital gains. Due to barriers to cross-border arbitrage, underlying home-country securities, on average, do not react during the event, creating a temporary tax-induced pricing spread. When costs of arbitrage are low, the pricing disparity quickly dissipates and home-country shares closely mirror the pricing of their cross-listed counterparts. In further tests, we are unable to document lock-in behavior, which predicates a decrease in prices attributable to a surge in volume for shares with greater accrued taxable capital gains. Overall, our findings suggest that an exogenous shock to the U.S. tax regime reverberates in international asset prices, thereby affecting foreign firms' costs of capital.

ABSTRACT: This study examines the determinants of municipal cash holdings and the implications of holding high levels of cash. The first part of the analysis investigates municipal manager incentives to accumulate cash as part of normal operations. Results indicate that municipalities with a higher variation in revenues, fewer sources of revenues, and higher growth accumulate more cash. Larger governments and those receiving relatively more state revenue accumulate less cash. Further analysis considers whether high levels of cash indicate agency problems, and finds municipalities with high cash holdings spend more on administrative expenses, city manager salaries, and bonuses. I find no evidence that municipalities with excess cash reduce taxes. The presence of staggered councils and councils that are not independent tend to exacerbate excessive cash holdings. These results are consistent with the proposition that municipalities with high cash levels have agency problems relative to those with lower cash holdings.

ABSTRACT: From 1994 to 1998, Bradshaw (2004) finds that analysts' stock recommendations relate negatively to residual income valuation estimates (scaled by current price) but positively to valuation heuristics based on the price-to-earnings-to-growth ratio and long-term growth. These results are surprising, especially considering that future returns relate positively to residual income valuation estimates and negatively to heuristics. Using a large sample of analysts for the 1993–2005 period, we consider whether recent regulatory reforms affect this apparent inconsistent analyst behavior. Consistent with the intent of these reforms, we find that the negative relation between analysts' stock recommendations and residual income valuations is diminishing following regulations. We also show that residual income valuations, developed using analysts' earnings forecasts, relate more positively with future returns. However, we document that stock recommendations continue to relate negatively with future returns. We conclude that recent regulations have affected analysts' outputs—forecasted earnings and stock recommendations—but investors should be aware that factors other than identifying mispriced stocks continue to influence how analysts recommend stocks.