I report the results of an experiment designed to investigate the influence of noncredible communications and group affiliation on auditors' formation of self-serving bias. I find that manager-subjects use noncredible communications to induce auditors to develop an unwarranted trust of managers (i.e., a biased judgment). However, the bias is neutralized when auditor-subjects belong to groups that create social pressure to conform to group norms. Thus, my finding calls into question the Bazerman et al. (1997) conclusion that auditors cannot conduct impartial audits due to self-serving biases resulting from repeated interactions between auditors and their clients.

Studies the extent to which corporate information senders develop reputations for truthful reporting. Reputation formation; Incentives for voluntary dissemination of information; Buyers' forecasting and bidding strategies.

[This paper presents the results of an experiment designed to investigate the extent to which information senders develop reputations for truthful reporting. The results indicate that senders were more likely to report truthfully when their misrepresentations imposed costs on the receivers of their reports. With repeated interactions, receivers of the reports were able to discern the sender's reporting strategies, but provided no economic reward for truthfulness.]

A contingent claims valuation model is used to estimate the values of a sample of convertible bonds and to partition those values into their debt and equity portions. The model and market values of the bonds are compared and model estimates are found to be approximately unbiased relative to market values, with about 90 percent of the values within ten percent Of market values. The average equity values of the convertible bonds are found to constitute 16.7 percent and 18.4 percent of the book and market values of the bonds, respectively. When leverage and dilution measures for the sample are restated by excluding the estimated equity value of convertibles from debt, differences are small on average, but for some firms they are substantial. A comparison of reported earnings per share (EPS) with EPS using model equity values reveals that model EPS differs cross-sectionally from both primary and fully diluted EPS but is much closer on average to primary EPS. The findings of the study provide reason for optimism regarding applications of contingent claims models to practical valuation problems, particularly with regard to more meaningful measures of dilution of earnings and leverage.

The article focuses on the current accounting problems in the U.S. Most of the current problems arise in the appraising of transactions reflecting new methods of doing business or matters upon which there has been a wide difference of opinion among recognized accounting authorities for many years. Thorough analysis and discussion of the new problems and reappraisal of the old controversial problems are matters of mutual interest for all of us here, as well as for the registrants and certifying accountants directly concerned. Experience seems to indicate that most registrants and their independent public accountants prefer to have the financial statements and accountants' opinion contained in the report to stockholders in substantial agreement with the report to be filed with the U.S. Securities and Exchange Commission (SEC). There is no real difference in our requirements for disclosure of inconsistencies in accounting from those which prevailed in the accounting profession prior to the existence of the SEC.

From the outset the U.S. Securities and Exchange Commission has been sympathetic to this point of view and has sought the advice of leading accounting authorities in teaching, public practice, and among executives of corporations investment bankers, and financial analysts in the preparation of rules, regulations, and forms necessary in the administration of the acts which authorize the Commission to prescribe the forms, items, and details of financial statements to be filed generally, uniform systems of accounts, principles to be followed by registered investment companies in maintaining their accounting records and in preparing financial statements. On individual problems, however, where experience has disclosed serious discrepancies in practice as between companies and accountants and one has felt that uniformity in procedure would benefit investors by rule or regulation of the Commission or in an opinion of the chief accountant. It is imperative, therefore, that the Commission make certain that the financial statements contained in registration statements be completely unequivocal and are not used as a proving ground for innovational presentations.

Any company which sells merchandise to which it has a title ordinarily has inventories on hand at the beginning and end of each accounting period. The inventory on hand at the end of the period appears on the balance sheet as an asset, and is also taken into consideration in the income statement in determining cost of goods sold. It is immediately apparent, therefore, that the method of pricing the inventory at the beginning and end of each accounting period will have an important effect on both the balance sheet and the income statement. Stated in another way, if the method of pricing inventories allows an overstatement of the final inventory, then the asset value appearing on the balance sheet will be overstated. Similarly, the cost of goods sold on the income statement will be improperly stated, the amount depending upon the pricing errors in both the opening and closing inventories. It is a matter of extreme importance, therefore, that every company in which inventories play an important part should, in preparing its financial statements, follow a consistent and well-devised method of inventory pricing. Failure to do so will result in inaccurate and inconsistent financial statements, and will also result in inaccurate costing of goods sold during any accounting period.

This paper reports the results of an experiment designed to investigate how legal regimes affect social welfare. We investigate four legal regimes, each consisting of a liability rule (strict or negligence) and a damage measure (out-of-pocket or independent-of-investment). The results of the experiment are for the most part consistent with the qualitative predictions of Schwartz's (1997) model; however, subjects' actual choices deviate from the point predictions of the model. We explore whether these deviations arise because: (1) subjects form faulty anticipations of their counterparts' actions and/or (2) subjects do not choose the optimal responses given their anticipations. We find that subjects behave differently under the four regimes in terms of anticipation errors and departures from best responses. For example, subjects playing the role of auditors anticipate investments most accurately under the regime with strict liability combined with out-of-pocket damages, but are least likely to choose the optimal response given their anticipations. This finding implies that noneconomic factors likely play a role in determining subjects' choices.

Assesses how different regimes of auditor liability affect the demand for and supply of auditing services. Adoption of complex strategies by economic agents; Usefulness of the experimental approach in aiding the understanding of the functioning of auditing markets; Strict liability regime as an alternative by auditors.

[In this study we assess how different regimes of auditor liability affect the demand for and supply of auditing services. The assessment was made with 15 experimental markets, each of which involved two sellers of assets, two auditors (verifiers), and four buyers. The experimental markets paradigm allowed us to compare the negligence liability regime (six markets) that auditors currently face with two alternatives not currently in existence-a strict liability regime (six markets) and a no-liability regime (three markets). We focused on the extent to which the experimental results conformed to our predictions of (1) sellers' frequency of hiring verifiers and of selecting a costly investment that improved aggregate welfare, (2) verifiers' service fees and their frequency of testing the truthfulness of the sellers' disclosures, and (3) buyers' reliance on the sellers' disclosures and verifiers' reports when pricing the sellers' assets. The predictions varied across the liability regimes primarily because differences in the degree of the verifiers' liability changed their economic incentives to test the truthfulness of the sellers' disclosures. The results show that the no-liability and negligence markets operated in a manner consistent with the predictions, whereas the strict markets deviated from the predictions on several dimensions. Specifically, verifiers in the strict liability markets were hired less often than predicted because they submitted higher offers for their services than sellers were willing to pay. This in turn led to fewer than predicted costly investments by the sellers. Although our general conclusion recognizes that a legal system is an integral part of the auditing institutional infrastructure, we found no evidence of any systematic benefits from imposing a strict liability rule on the verification service. In fact, the results suggest that the negligence liability markets operated at a level of economic efficiency as high or higher than those in the other two regimes. This suggests that the current tendencies of courts and the auditing profession to expand the scope of auditors' liabilities may not achieve the net benefits expected from such expansions.]