Knowledge that Transforms

[This paper uses an experimental design to examine how income and consumption tax regimes and future tax rate uncertainty affect proportional savings and risk-taking. For the experiment, undergraduate subjects were given certificates redeemable for goods and services at two time periods. They were then asked to determine the time at which they wished to redeem the certificates and the manner in which they wished to allocate unredeemed certificates between safe and risky investment funds. The results indicate that when future tax rates are certain, an income tax regime reduces proportional savings and increases proportional risk-taking when compared to a consumption tax regime. When future tax rates are uncertain, the effects are more complex. They generally suggest, however, that future tax rate uncertainty adversely affects the savings and risk-taking neutrality of a consumption tax regime while diminishing the risk-taking incentive of an income tax regime.]

[This study examines several potential explanations for managers' choice between comprehensive and partial income tax allocation related to the indefinite deferral of income taxes allowed for Domestic International Sales Corporations (DISCs). Results from a sample of 320 firms with DISCs operational in 1972-74 are consistent with managers acting opportunistically to avoid debt covenant violations, political scrutiny, or to mask poor performance, even after controlling for firms' economic expectations and investment opportunity sets. In addition, a strong association is observed between external auditors' stated positions on the tax allocation issue and their client firms' method choice, a relatively new result in the literature.]

[Experienced auditors tend to structure their knowledge of financial statement errors with audit objective as the primary organizing dimension and transaction cycle as secondary. Yet, many audit tasks are structured in the opposite manner, requiring auditors to assess whether objectives are met for each transaction cycle. Our paper reports the results of an experiment which indicates that this mismatch between knowledge structure and task structure may hinder auditors' ability to draw on previous experiences when making conditional probability judgments and when allocating audit hours to various objectives within cycles. These results suggest one instance where knowledge structures that are often functional may have adverse effects when they do not match the task structure to which they are applied.]

[In our model of negotiated transfer pricing, divisional managers can make specific investments that enhance the value of intrafirm trade. However, these investments are irreversible and must be made before divisional managers have enough information to determine the desired intrafirm transfer. We find that a system of negotiated transfer pricing will lead to efficient outcomes provided the divisions can sign fixed-price contracts prior to making their investment decisions. While these contracts are likely to be renegotiated after the relevant information becomes known, they nonetheless provide the divisions with effective protection for their specific investments.]

[A general prediction from the economic theory of tax reporting is that taxpayers will report more income as the tax rate increases, but the related empirical evidence has been mixed. We conducted an experiment to examine whether taxpayers' responses to a tax-rate change depend on both economic effects and perceptions of horizontal and exchange inequity. Our findings reconcile the previously inconsistent empirical results by identifying conditions under which perceptions of inequity drive taxpayers' reporting decisions. In summary, subjects reported less (more) income as tax rates increased (decreased) when they were inequitably treated relative to others, but not when they were equitably treated relative to others.]

[This study uses the relation between firm leverage and systematic risk to provide empirical evidence on the economic substance of a hybrid security: redeemable preferred stock (RPFD). The tests are conducted on 239 firms with RPFD outstanding between 1979 and 1989 and examine variation in this relation conditioned on the magnitude of RPFD as an element of firms' capital structures. The empirical results suggest that, despite mandatory redemption payments, RPFD does not have a debt-like impact on systematic risk and that the market perception of a hybrid security is conditioned on attributes such as voting rights and conversion features. Thus, dichotomous classification of hybrid securities may lack representational faithfulness to the economic substance of these securities, as measured by their effects on systematic risk. More generally, it may be difficult for the FASB to develop a comprehensive classification rule for hybrid securities without requiring additional disclosure of important security attributes.]

[This research uses an experimental methodology to examine the "curse of knowledge" in judgment and the extent to which it is mitigated by accountability, experience, and counterexplanation. The curse of knowledge occurs when individuals are unable to (appropriately) disregard information already processed. Important audit implications of the curse of knowledge arise in going concern evaluation and analytical review. Experiments 1 and 2 examine these two contexts with both auditors and MBA students. Results show significant curse of knowledge effects among both auditors and MBA students. These effects are not mitigated by accountability, consistent with Kennedy's (1993) debiasing framework. A third experiment finds that counterexplanation (explaining why a particular outcome might not occur) does eliminate the curse of knowledge.]

[We examined management's discretionary disclosures prior to a special, yet important, event-a large earnings surprise. In what ways do managers alert investors to the surprise, and what is investors' reaction to such warnings? To address these questions, we analyzed all managerial disclosures prior to the surprising earnings release. Less than ten percent of our large-surprise firms published quantitative earnings or sales forecasts, while 50 percent of the firms kept silent. Firms facing earnings disappointments were more likely to make a disclosure, and larger disappointments were preceded more often by "harder" (more quantitative and earnings-related) warnings. We found the likelihood of warnings to be positively associated with firm size, the existence of a previous forecast, and membership in a high technology industry. Finally, warnings tend to be issued for permanent earnings disappointments, while transitory disappointments are more likely to occur without prior warning.]

[Oil and gas firms using the full cost method during 1985-1986 faced a choice between taking a write-down in oil and gas properties or changing to the successful efforts method. In a time-series analysis, the executive bonuses of firms switching to the successful efforts method are found to be associated with accounting income, suggesting the effects of bonus plans on the switch decision. We also show that the firms choosing write-down reported more losses before the write-down during the decision year, and that the bonuses of these firms' executives are not affected by the write-down.]

[We study whether capital expenditures provide value relevant information which is incremental to that of current earnings. Models in accounting or finance generally predict that investments such as capital expenditures yield information about a firm's future earnings that is not captured by current earnings, as managers respond to private information about future demand and costs through their investment decisions. Empirical research, however, has not provided consistent, strong evidence of this effect. After controlling for concurrent earnings information and size-related predisclosure information differences, we find that capital expenditures changes are strongly and positively associated with excess returns.]