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.

Many firms that take restructuring charges reverse a portion of those restructuring charge accruals in a later quarter. These reversals increase net income, often substantially. In this study, I investigate whether restructuring charge reversals are associated with incentives to meet or exceed analysts' forecasts, avoid earnings declines relative to prior-year levels, and avoid losses. I examine both the decision to record a reversal and the amount of the reversal, using a sample of 121 reversals recorded between 1990 and 1999. The results suggest that some firms record reversals to beat analysts' forecasts and to avoid reporting net losses. There is also some evidence that firms record reversals to avoid earnings declines. Overall, the results are consistent with firms using restructuring accrual reversals to manage earnings.

In this paper, we derive a measure of diluted EPS that incorporates the economic implications of the dilutive effects of employee stock options. We show that the existing FASB treasury-stock method of accounting for the dilutive effects of outstanding options systematically understates the options' dilutive effect, and thus overstates reported EPS. Using firm-wide data on 731 employee stock option plans, our proposed measure suggests that economic dilution from options is, on average, 100 percent greater than dilution in reported diluted EPS using the FASB treasury-stock method. We examine the implications of our analysis for stock price valuation, the price-earnings relation, and the return-earnings relation. We demonstrate analytically that when firms have options outstanding, empirical applications of equity valuation models that use reported per-share earnings as an input (e.g., Ohlson 1995) yield upwardly biased estimates of the market value of common stock. We predict that when the difference between our measure of economic dilution from options and the FASB treasury-stock method dilution from options is greater, the observed return-earnings and price-earnings coefficients will be smaller, and we provide some (albeit weak) empirical support for this prediction.

Empirical research provides scant evidence that just-in-time (JIT) adopters outperform their non-adopting industry peers. Using a sample of 201 JIT adopters and matched non-adopters, we examine the relation between financial performance and JIT. Our sample-wide results indicate that JIT adopters improve financial performance relative to non-adopters, and that profit margin, rather than asset turnover, is the primary source of such improvement. However, results of additional analyses suggest that JIT adopters below a firm-size threshold do not improve financial performance, a finding that reconciles our study to Balakrishnan et al. (1996), which examined a JIT adopter sample that included a greater proportion of small firms.

We examine how tax legislation that restricted firms' deductions of CEO compensation above $1 million reduced the implicit contracting cost of compensation for firms that were expected to pay below that amount and that were not directly affected by the law change. We find that firms that expected to pay their CEOs less than $1 million actually increased their CEOs' cash compensation, contrary to Congress's expectations. Moreover, the magnitude of the unexpected increase in compensation is proportional to how far the CEO's expected compensation fell below Congress's new $1 million reasonable-compensation standard. Thus, our study provides evidence that some of the largest U.S. corporations responded in a manner contrary to policymakers' expectations. Our findings also support the theory of implicit contracting costs, by demonstrating that many firms reacted in an economically rational fashion when a change in the tax law decreased their implicit costs of CEO compensation.

We investigate the effect of an increase in the individual (shareholder-level) income tax rate on share values. We regress cumulative daily abnormal stock returns surrounding the passage of the Revenue Reconciliation Act of 1993 on firm dividend yield, tax status of the investor as represented by level of institutional ownership, the interaction of these two variables, and control variables. Consistent with our expectations, we find that (1) the higher the firm's dividend yield, the more negative the firm's stock price reaction to the increase in the individual income tax rate (i.e., the dividend tax rate) enacted in the Revenue Reconciliation Act of 1993, and (2) institutional holdings mitigate this negative reaction. Our results suggest that both the dividend policy of the firm and the tax status of the marginal investor influence the extent to which dividend taxes are reflected in share values. Our evidence is consistent with the traditional view that firm dividend policy influences the extent to which tax rate changes affect share values.

We investigate how unique features of charities affect the manner in which they compensate their executives. We find that changes in compensation are significantly positively associated with changes in spending on programs that advance organization objectives, whether changes in program spending are attributable to changes in revenue raised or to changes in the relative costs of administering the charity. The results suggest that accounting performance measures can play a role in nonprofit organizations whose objectives are typically subjective and nonfinancial, and thus, whose progress toward objectives is difficult to quantify.

This study compares samples of publicly and privately held bank holding companies to examine whether the high frequency of small earnings increases relative to small earnings decreases reported by public firms is attributable to earnings management. We expect public banks' shareholders to be more likely than private banks' shareholders to rely on simple earnings-based heuristics in evaluating firm performance, so we expect public banks to have more incentives to report steadily increasing earnings. Consistent with this expectation, we find that relative to private banks, public banks: (1) report fewer small earnings declines, (2) are more likely to use the loan loss provision and security gain realizations to eliminate small earnings decreases, and (3) report longer strings of consecutive earnings increases. These results suggest that the asymmetric pattern of more small earnings increases than decreases, first documented by Burgstahler and Dichev (1997), is attributable to earnings management and is not simply a reflection of the underlying distribution of earnings changes.

We use the Ohlson (1995, 1999) and Feltham and Ohlson (1999) valuation models to investigate the market's perception of the economic effect of employee stock options (ESOs) on firm value for a sample of 85 profitable computer software companies. Our results suggest that the market appears to value these firms' ESO expense not as an expense but as an intangible asset (even after controlling for the endogeneity bias arising from the mechanical relation between ESOs and the underlying stock prices). However, we also find a conflict between: (1) the positive manner in which investors appear to value ESO expense, and (2) the negative relation between current ESO expense and future abnormal earnings. This conflict not only could be an artifact of the restrictiveness of the abnormal earnings forecasting equation we estimate, but it also calls into question whether investors assess correctly the effect of ESOs on profitable software firm value.