Knowledge that Transforms

Executive stock options differ from exchange-traded options because of vesting and portability restrictions. Executive departure from the firm forces early exercise, reducing the value of executive options. Current methodology calculates the option value by multiplying the Black-Scholes option price by the departure probability. This ignores the possibility that executive departure is less likely when stock price is high, and thus is correlated with the stock price. We show that this correlation implies a substantial increase in option values. A similar situation occurs in performance-based option packages, where the actual number of options granted depends on stock performance.

This study investigates the effects of state taxes and regulation on an organizational structure decision for expanding property-casualty insurers (subsidiary versus license). Tests are conducted of the relation between the organizational structure of 2,335 property-casualty insurers and state tax and regulatory conditions in 1991. Evidence is provided that property-casualty insurers structure their cross-state expansion to mitigate both state tax and regulatory costs.

The theories of supermodular optimization and games provide a framework for the analysis of systems marked by complementarity. We summarize the principal results of these theories and indicate their usefulness by applying them to study the shift to ‘modern manufacturing’. We also use them to analyze the characteristic features of the Lincoln Electric Company's strategy and structure.

Based on theory and anecdotal evidence, we argue that ongoing implicit claims between a firm and its customers, suppliers, employees, and short-term creditors create incentives for management to choose long-run income-increasing accounting methods. Variables selected to proxy for the extent to which a firm depends on these implicit claims are found to be significant in explaining cross-sectional variation in inventory and depreciation methods. These variables remain incrementally significant when we include traditional variables found to have explanatory power in prior studies (i.e., leverage, bonus compensation, tax, and regulatory/political exposure variables).

This study hypothesizes that because shareholders have a liquidation option, losses are not expected to perpetuate. They are thus less informative than profits about the firm's future prospects. The results are consistent with the hypothesis. They also show that the documented increase in the earnings response coefficent as the cumulation period increases appears to be due exclusively to the effect of losses. The liquidation option effect extends to profitable cases where earnings are low enough to make the option attractive. Alternating explanations for the low informativeness of losses such as mean reversal of earnings are not supported by the tests.

This paper constructs a model of accrual measurement and tests its implications for the evolution of the book-to-market ratio. The model captures the intuition that book value is untimely or smoothed relative to market value, so that movements in market value have relatively high variance and low predictability, compared with movements in book value. Empirical tests of the model use lagged market value changes to forecast the mean reversion of the book-to-market ratio. This paper complements recent research investigating the role of book-to-market ratios in security analysis. Accounting theorists (e.g., Edwards and Bell [1961] and Feltham and Ohlson [1995]) have long recognized the critical role of book-to-market ratios as predictors of abnormal earnings in earnings-based valuation models. Tests of such valuation models (e.g., Ou and Penman [1993]) confront the practical problem of determining the horizon beyond which abnormal earnings are expected to be zero. The model in this paper implies that this horizon is determined by the remaining useful life of assets, and that the expected path of abnormal earnings over this horizon reflects the pattern of expiration of the useful lives of assets in place.

Voluntary disclosure, Insider trading, Noncompetitive trading model, Uninformed trader

Auditing, Audit evidence, Audit judgement, Review awareness

Masako N. Darrough, Nahum D. Melumad, Divisional versus Company-Wide Focus: The Trade-Off between Allocation of Managerial Attention and Screening of Talent, Journal of Accounting Research, Vol. 33, Studies on Managerial Accounting (1995), pp. 65-94

Paul A. Copley, Jennifer J. Gaver, Kenneth M. Gaver, Simultaneous Estimation of the Supply and Demand of Differentiated Audits: Evidence from the Municipal Audit Market, Journal of Accounting Research, Vol. 33, No. 1 (Spring, 1995), pp. 137-155