[Regulatory bodies that oversee the provision of audit services have recently expressed concern about the common practice of pricing initial audits significantly below cost (lowballing). Specifically, it is feared that lowballing could weaken auditor independence and reduce audit quality, since lowballing could provide clients with a credible threat of terminating incumbent auditors should they refuse accounting concessions. However, Magee and Tseng (1990) have shown that when auditors possess all bargaining power and there is no disagreement among auditors on the proper interpretation of GAAP, clients have nothing to gain by threatening termination of incumbent auditors and there is no weakening of auditor independence. Therefore, the concern expressed by regulators must presuppose that clients (i) possess bargaining power superior to that of auditors, and (ii) are free to change auditors at any time. But, if these features are true, it is puzzling why lowballing would occur in the first place. Lowballing can only occur if there are rents to be earned by auditors (DeAngelo 1981a), but such rents seem to be inconsistent with clients possessing most of the bargaining power (Dye 1991; Magee and Tseng 1990). We construct and analyze an economic model of audit pricing which shows how equilibrium audit prices would sustain rents and lowballing even when clients have most or all of the bargaining power and are free to change auditors every period. Our analysis also throws light on the related phenomenon of auditor turnover, and shows that the efficient pricing of audit services by itself precipitates some turnover apart from any turnover due to other forces such as client-auditor disagreements (Dye 1991) and client-auditor matching (Gigler and Penno 1993). Given auditor turnover, we analyze how audit prices, lowballing, and turnover rates evolve over time.]

Analyzes audit pricing, lowballing and auditor turnover services in accounting practices. Insight into audit pricing model; Effect of lowballing to auditor independence; Evolution of audit prices and auditor turnover; Empirical implications.

Corporate managers often express concern about accounting-induced volatility in financial statements. Accounting regulators, however, argue that the volatility in financial statements merely increases transparency by shining a light on risks that are inherent to the firm’s business. We show that in many situations managerial concerns about volatility are justified because the information that is being provided actually magnifies rather than merely reflects the volatility in a firm’s fundamentals. Corporate managers anticipate the magnified volatility and take preemptive actions to decrease the firm’s exposure to the accounting treatment that induces volatility. These actions may not be in the best interests of external stakeholders, making disclosure costly, while at the same time improving the decisions of external stakeholders. We develop and study the resultant tradeoff that accounting regulators should consider in setting accounting standards.

Views Icon Views Article contents Figures & tables Video Audio Supplementary Data Peer Review Share Icon Share Facebook Twitter LinkedIn Email Tools Icon Tools Get Permissions Search Site Cite View This Citation Add to Citation Manager Citation Chandra Kanodia, PIERRE JINGHONG LIANG; Accounting Disclosure and Real Effects. The Accounting Review 1 May 2010; 85 (3): 1119–1120. https://doi.org/10.2308/accr.2010.85.3.1119 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 filter your search All ContentThe Accounting Review Search Advanced Search

Corporate managers are often better informed than outside investors about the uncertain future benefits of investments. However, information about investment prospects is not verifiable and therefore not amenable to direct disclosure, but instead inferred by investors from other accounting disclosures. Given this situation, we study the normative question of how the market’s perceptions of uncertainty and its beliefs about the expected level of future benefits of investment should factor into mandatory financial reports of investment expenditures. We establish a threshold of uncertainty in future benefits beyond which it is better to aggregate investment expenditures with cash flow from ongoing operations, rather than measuring and reporting the two separately. We obtain the surprising result that the higher the expectation of future benefits, the lower this uncertainty threshold should be.