[This study examines participative budgeting in the context of the psychology of risk. As Young (1985) and Waller (1988) report, there is some preliminary evidence that risk-averse workers create more budgetary slack than risk-neutral ones. They show that "truth inducing incentive schemes" (e.g., Soviet incentive schemes; see Weitzman 1976) reduce budgetary slack for risk-neutral subjects but not for risk-averse subjects. If this is true, it means that resource allocations within organizations are mediated by perceptions of risk. Young (1985) and Waller (1988) define risk preference as a dispositional variable, which presumes that it is a stable personal trait, a latent variable, traditionally inferred from observed behavior of risk propensity in such settings like lotteries. This study tests whether risk preferences are domain-specific; that is, latent risk preferences translate into differing manifest risk preferences according to the context. Domain-specific risk preference can be understood as a manifest psychological variable that may well be the result of the combination of latent risk propensity and the situation. Kahneman and Tversky's prospect theory (1979) suggests that manifest risk preferences depend upon whether the subject frames his or her task in the context of gain or loss prospects, where gains and losses are defined in relation to a neutral reference point. If risk preferences are domain-specific, then past studies' suggestion that incentive schemes should be designed in consideration of dispositional, or latent, risk preferences needs to be reexamined (Waller 1988; Kaplan 1982). The question before this study is: If subordinates are influenced by prior period performance in setting current period budgets for themselves, will that influence take the form predicted by prospect theory and thus lead to riskier preferences (tight budgets) when the subordinates perceive themselves in a losing situation? This is an important question considering Young's (1985) alluding to the possibility that inducing subordinates to less risk-averse behavior may be a way to favor tight budgetary standards and reduce slack. This prediction is consistent with prospect theory's implication that losers who are slow to adjust their reference point act in a more risk-seeking manner. Thus, the induction of losing prospects might be a way to minimize budgetary slack. An additional concern in this study is to jointly test domain-specific risk preferences and dispositions toward risk as influences over budgetary decisions. Whereas prospect theory explains risk preferences as domain-specific contingencies, other theories construe risk preferences as dispositional. It is likely that both domain-specific and dispositional factors influence budgetary decisions. This study deploys a conventional lottery procedure to elicit and test dispositions toward risk. An experiment simulating the public accountants' budgeting of billable hours was designed to test the hypothesis that subject preference for tight or safe budget behavior depends on the performance of coworkers and domain-specific risk preferences. The hypotheses were tested in an experiment employing 81 students. The results generally support the view that subordinates' risk preferences are influenced by a situation-dependent variable. The reversal of risk preferences around a neutral reference point is statistically significant for both dispositionally risk-averse and dispositionally risk-seeking subjects. The dispositional variable also contributes to the explanation of variations in subjects' manifest risk preferences. Thus the propensity to induce budgetary slack seems to be a joint function of situations and dispositions.]

Examines participative budgeting in the context of the psychology of risk. Theoretical background on risk preferences; Empirical evidence of domain-specific risk preferences; Study design; Dispositional risk attitude measurement; Preference ratings of risk-averse versus risk-taking groups; Limitations of the study.

Reviews the book `Marking to Market: Accounting for Marketable Securities in the Financial Services Industry,' by Richard Macve and Jonathan Jackson.

[A number of formal models have been used to reflect the fact that people generally require less time to perform a complex task after they acquire some familiarity and experience with the task. These models are referred to as learning curves, and a sizable literature exists on their properties and uses (Yelle 1979). In contrast, little has been written on the nature of relearning curves, which are formal models used to estimate the reduction in task time that occurs while relearning skills that have been forgotton due to interruption. The relatively few studies addressing this aspect of interrupted production advocate "backing up" the original learning curve (typically a log-linear model) in some fashion and using it to model the relearning process (Adler and Nanda 1974; Carlson and Rowe 1976; Cherrington et al. 1987; Cochran 1968; Hoffmann 1968; Keachie and Fontana 1966; Lippert 1976). This article reports on a laboratory study designed to provide some evidence on the nature of relearning curves. Subjects were paid a realistic wage to assemble structures with Erector Set parts. They repeated the task for approximately four hours, and three forms of marginal-time learning curves were fit to their performance data. After breaks ranging from seven to 175 days, they repeated the construction projects. The two sets of times were used to compute a measure of skill decrement and to fit nine forms of learning curves. Issues of interest are: (1) similarity of the functional forms of the best-fitting relearning and learning curves, (2) whether backing up the learning curve is a reasonable method of modeling relearning, and (3) effects of skill decrements on the relative goodness-of-fit of relearning curves. The results show that the best-fitting relearning curves are not of the log-linear form commonly used to model learning, but are of a form that is nonlinear on both a log-log and an arithmetic scale. Further, this new form developed in our study also provided a better fit than the log-linear model when applied to learning (pre-interruption) data. Additionally, backing up the best-fitting learning curve or starting anew with this same curve form also provided a good-fitting relearning curve model; however, backing up the classical log-linear model did not fit the data as well as other models. Finally, differences between the goodness-of-fit of the various models became more pronounced with the increase in amount of skill decrement. These findings should be of interest to those who use learning curves to estimate labor time, especially under conditions of interrupted production.]

Reviews the book "Handbook of International Accounting," by Frederick D.S. Choi.

[The recognition of economic events in accounting earnings tends to lag that of the market. An informed market recognizes the effects of economic events when they occur, but earnings recognition must await compliance with formal accounting recognition criteria. The application of these criteria involves such basic concepts as reliability, objectivity, conservatism, and verifiability, and affects earnings in two ways: (1) current earnings will include recognition of certain prior periods' economic events, and (2) current earnings does not recognize all of the current period's economic events until future periods (see also Easton et al. 1992). Economic events for which accounting recognition tends to lag market recognition include purchase and sale commitments, contingencies, post-employment employee obligations, investments in human capital, and variations in the market values of assets and liabilities. The purpose of this article is to investigate accounting recognition as a major determinant of earnings' explanatory power for returns. Our hypotheses are threefold. First, if accounting recognition lags that of the market, then its effect is predictably greater in shorter reporting periods. The shorter the reporting period, the lower the percentage of economic events recognized in both earnings and returns. For example, if all economic events that are immediately recognized in returns are recognized in earnings one quarter hence, then the current quarterly earnings' explanatory power would be zero, whereas annual earnings would reflect the recognition of three-fourths of all the economic events recognized in returns. Second, if the criteria for accounting recognition yield a multiperiod lag in earnings recognition of economic phenomena, then future periods' earnings possess explanatory power for current returns. A corollary hypothesis predicts that the incremental explanatory power of future periods' earnings varies inversely with the length of the reporting period. Third, if the influence of accounting recognition criteria for earnings measurement differs by companies' economic circumstances, then cross-sectional differences in these circumstances are predictably linked with earnings' explanatory power for returns. Economic circumstances that affect earnings recognition include companies' operating cycles, riskiness of cash flows, and the reliability, objectivity, availability, and verifiability of accounting and market data. We document evidence consistent with a substantial lag in earnings recognition. Findings reveal an inverse relation between earnings' explanatory power for returns and the length of the reporting period, which is consistent with a lag in earnings recognition that deteriorates in longer reporting periods. Specifically, the explanatory power of earnings for returns in quarterly periods is about one-fourth that for semiannual periods, less than one-tenth that for annual periods, and less than one-thirtieth that for two-year periods. Moreover, the explanatory power of the regression (adjusted R2 when using quarterly earnings is less than 1 percent, but exceeds 39 percent when using four-year earnings and returns. We attribute this phenomenon to accounting criteria that recognize economic events with a lag and to the disaggregation of earnings (through time), which accentuates this lag. Easton et al. (1992) offer some evidence consistent with the first hypothesis, but their evidence is limited to reporting periods of one to ten years in length. This is the first evidence we are aware of for reporting periods of less than one year. We also present evidence that earnings lag current returns for several future periods. In certain instances, the recognition lag is of such magnitude that the explanatory power of future periods' earnings for current returns more than triples that of current earnings. For example, with quarterly reporting periods, the inclusion of future periods' quarterly earnings increases the adjusted R2 of the returns-earnings relation by more than 400 percent. This evidence is consistent with a substantial lag in accounting recognition of economic events that spans a number of reporting periods. To the extent that accounting regulatory agencies want earnings to reflect current changes in the market values of companies, this evidence implies significant potential for enhancing earnings' usefulness. Finally, we show that, when earnings measurements are less sensitive to accounting recognition criteria, earnings have greater explanatory power for returns. For example, with biennial reporting periods, current earnings' explanatory power for current returns exceeds 50 percent for companies whose earnings measurements are less sensitive to accounting recognition criteria, but is less than 20 percent for companies more sensitive to these criteria. This result is consistent with a joint relation between (1) the application of accounting principles in practice and (2) the explanatory power of earnings for returns. Evidence of systematic cross-sectional differences in accounting recognition suggests that deliberations on accounting policy must consider characteristics of the reporting and operating environments; for example, the desire for verification, reliability, or conservatism might explain the accounting practices observed. The evidence reported emphasizes the significant role that accounting recognition plays in determining earnings' explanatory power for returns. The evidence also relates the lag in accounting recognition of economic events to cross-sectional differences in fundamental economic determinants of earnings recognition. This evidence of a link between earnings' explanatory power and basic concepts of accounting recognition and measurement should encourage further efforts at mapping the complex accounting structure that determines the usefulness of earnings. In light of the Securities and Exchange Commission's recent emphasis on market-based measures of performance, which is referred to as "possibly the most significant initiative in accounting principles development in over 50 years" (Wyatt 1991, 80), our results highlight the potential for substantial improvement in earnings' explanatory power. Evidence on the reporting lag inherent in the application of accounting recognition criteria, and its cross-sectional determinants, is relevant for these policy deliberations.]

[This research examines the information content of the bank earnings components entitled "Securities Transactions Gains and Losses" (STGL). STGL reflect the accounting gain or loss that arises when a bank sells an investment security at a price different from the book value. Institutional as well as anecdotal evidence suggests that investors may price STGL differently from the operating earnings component entitled "Income before Securities Transactions" (IBST). For example, prior to 1983, bank regulators viewed the IBST and STGL components as reflecting unique aspects of bank activities and, therefore, required that total bank earnings be disaggregated into IBST and STGL components (SEC 1983). In addition, because of investment market volatility and the discretionary nature of investment securities sales, STGL may convey limited information about current changes in bank value (Linden 1990). Indeed, with banks, security analysts often focus on IBST (Barth et al. 1990), and managers have been accused of selectively selling appreciated investment securities to increase reported levels of accounting earnings (Berton 1991; Wyatt 1991). Research by Barth et al. (1990) has assessed the relative ability of the IBST and STGL income components to explain cross-sectional variation in annual common stock prices. They predicted, for many of the reasons cited above, that the STGL earnings/security price multiple should be less than the multiple assigned to the IBST component. Their results confirm this prediction: IBST played an important role in explaining bank stock prices, but the earnings/security price multiple assigned to STGL did not differ significantly from zero. There are several reasons why STGL might not have exhibited information content in this research. First, as Barth et al. suggest, the incremental information content of the STGL component may have been diminished because STGL appear to be realized to smooth income. In this situation, STGL are likely to provide little incremental information about changes in bank equity values. Second, Barth et al. measure stock returns over a 12-month interval corresponding to the bank's fiscal year. When returns are measured over such a long period, the likelihood increases that information unrelated to earnings will also be reflected in equity prices, thereby (potentially) reducing the ability of earnings to explain security returns. Third, significant tax-related, cross-sectional differences may exist in the STGL earnings component/security price relationship, and these are "averaged away" when one overall earnings/security price coefficient is estimated. For example, Scholes et al. (1990) suggest that STGL may be realized to minimize taxes. Based on this tax-planning scenario (described in section I), security transaction losses (gains) for tax-paying (non-tax-paying) banks are predicted to be negatively (positively) related to bank equity values. The objective of this study is to assess whether the STGL earnings component is priced by investors in a manner consistent with this tax-planning rationale. Empirical tests measure the market reaction to IBST and STGL earnings information over the two-day interval consisting of the day before and day of the preliminary quarterly earnings release, and the results provide evidence that STGL are priced by investors in a manner consistent with the tax-planning hypothesis. However, these results appear to hold only in the first three quarters of the fiscal year. In the fourth quarter, there is no evidence that the STGL component is priced by bank investors. These fourth-quarter results are consistent with an increase in earnings-management activity related to STGL near the fiscal year-end]

[One indication of information usefulness is its ability to increase the precision of individuals' estimates of events of interest (FASB 1980; ljiri and Jaedicke 1966). In this context, earnings reports are useful if they increase the precision of investors' forecasts of future earnings when the latter proxy for the event of interest, future cash flows. The cross-sectional variance of analysts' earnings expectations often is used as a proxy for the unobservable precision of their earnings estimates (Ajinkya and Gift 1985; Brown et al. 1987; Imhoff and Lobo 1992). We show that, when combined with the time-series properties of accounting earnings and prior research in analyst forecasts, Bayesian revisions suggest that year t earnings reports should, on average, increase the convergence of analysts' year t + 1 earnings forecasts. Operationally, we examine whether the information contained in year t earnings decreases the cross-sectional variance of analysts' year t + 1 forecasts. Morse et al. (1991) use I/B/E/S Summary data, and conclude that the information contained in year t earnings announcements increases the cross-sectional variance of analyst forecasts of year t + 1. This is a surprising result. One feature of the I/B/E/S Summary data is that they do not contain dates of the analysts' earnings forecasts. Thus, researchers who use these data do not know the set of information upon which the analyst's earnings forecast is based. In contrast to the I/B/E/S Summary data, the I/B/E/S Detail data are precise regarding the date that the individual analyst's earnings forecast entered the I/B/E/S system. We use I/B/E/S Detail data to reexamine the relation between annual earnings announcements and convergence of beliefs. Using the Detail data, we show that the information contained in year t earnings decreases the cross-sectional variance of analysts' earnings forecasts of year t + 1. Moreover, our finding is insensitive to year of study. Using the Summary data, we find that the information contained in year t earnings increases the cross-sectional variance of analysts' earnings forecasts of year t + 1, but this finding is sensitive to year of study. Morse et al. (1991) hypothesize and provide evidence that reduction in variance is less likely to occur when "standardized" surprise is large. Using the Detail data, we show that significant decreases in variance occur for the seven smallest deciles of standardized surprise, and that significant increases in variance occur only for the largest decile. Using the Summary data for the same "window" as the Detail data, we find no deciles of standardized surprise associated with significant decreases in variance, and we observe significant increases in variance for the three largest deciles of standardized surprise. In sum, our results using I/B/E/S Detail data suggest that, on average: (1) annual earnings announcements increase convergence of analysts' forecasts of firms' future earnings; (2) annual earnings announcements decrease convergence only for the largest decile of earnings surprise. In contrast, we do not obtain consistent results with I/B/E/S Summary data.]

Examines the influence of annual earnings announcements on financial forecasts. Convergence of beliefs; Earnings surprise; Suggestion that annual earnings announcement should increase the convergence of analysts' forecasts of future earnings.

[According to the December 1991 issue of the Survey of Current Business, expenditures of state and local governments account for more than 11 percent of the U.S. gross domestic product. Moody's 1991 Municipal Manual indicates that these governmental entities have an outstanding debt now approaching $800 billion, and a report by the Public Securities Association (1987) indicates that this debt grew at a compound annual rate of 12 percent from 1966 to 1986. State and local governmental activities continue to increase in magnitude, and evidently form an important part of the political and economic environment in which accounting operates. Important accountability issues distinctive to these organizations need accounting research attention. The articles by Feroz and Wilson and Deis and Giroux in this issue, which we have been invited to review, address some of these topics. The study by Feroz and Wilson can be regarded as an extension to the public sector of capital-market-based research that examines the effects of financial-accounting disclosures on security prices and returns. They hypothesize segmentation of the market for municipal obligations along national and regional lines and study the effects of differential information disclosure on borrowing costs. In the other study, Deis and Giroux utilize quality reviews that were conducted by the Texas Education Agency to evaluate and rate the audits (by public accountants) of public schools' financial reports. They test hypotheses about audit quality that were originally developed in the context of commercial firms. Both studies thus represent extensions of theories and methods used in research of private-sector accounting and auditing issues. The contributions of the two articles are discussed, and modifications that consider the unique aspects of governmental accounting are presented in sections I and II. Other possible avenues for research are discussed in section III.]