Knowledge that Transforms

Firms that alter their divisional configurations on average increase shareholder wealth. Gains appear to come from information about investment opportunities and increases in efficiency. Performance before the restructurings suggests poorly organized firms are motivated by market pressures to change their organizations. Change also occurs in healthy firms as part of the growth process. Restructuring often occurs where there is no evidence of takeover threats. While stock prices increase around the restructurings, there is a contemporaneous decline in earnings due to increased expenses. These findings appear inconsistent with the contention that the market pressures managers into focusing on short-run earnings.

In the preceding paper Darrough and Stoughton suggest that firm interdependence, modelled as an entry game among firms in a product market, can yield endogenous proprietary costs. This allows the costs associated with the dissemination of information about the firm to depend upon the information's content in some direct way. My comments focus on: first, the structure of the game, which emphasizes the potential for full disclosure; second, the extent to which the entry game exaggerates the usefulness of ‘bad news’; and third, their suggestion that more competition among firms implies more, and not less, disclosure, an observation seemingly contrary to Verrecchia (1983).

This study examines a commercial bank manager's incentives to reduce regulatory costs imposed when the bank's capital adequacy ratio falls below its regulatory minimum. It also tests the general political sensitivity hypothesis that a manager seeks to reduce political costs incurred when revenue is unusually large. Tests of adjustments to the loan loss provision, loan charge-offs, and securities gains and losses attempt to control for exogenous economic conditions and previous investing decisions. Results are consistent with hypotheses associating accounting adjustments with capital adequacy ratio guidelines, but fail to support the political sensitivity hypothesis.

This paper describes the background and objectives of a series of papers written fifty years ago at the London School of Economics (LSE). One objective was to encourage the use of accounting numbers in economic research. A second objective was to improve the theory and practice of accounting. Understanding cost accounting and opportunity costs within a firm was tied to understanding the organization of firms. The theory of the accounting system is part of the theory of the firm. Like a similar request made fifty years ago, the paper concludes with a call for interdisciplinary studies between economics and accounting.

This paper empirically examines hypothesis from the accounting, manufacturing, and strategy literatures about volume-based, complexity-based, and efficiency-based drivers of manufacturing overhead costs. Cross-sectional data from a questionnaire of thirty-seven facilities of an electronics company are examined. Subject to caveats regarding the cross-sectional tests, strongest empirical association is found for volume-related cost drivers. There is not consistently strong empirical association for complexity- or efficiency-related drivers. Explanations for the limited association for the complexity- and efficiency-related drivers include proxy problems with the complexity and efficiency concepts and problems in developing uniform measures of variables across a broad cross-section of facilities.

The comparative ability of valuation rules using economy-weighted versus industry-weighted price indexes to estimate the unobserved economic value of a basket of assets in modelled. Industry-weighted indexes do not necessarily provide valuations of higher accuracy than economy-weighted indexes. Dominance depends on (1) the relative magnitude of the mean and variability of price changes and (2) the magnitude of errors of measurement in the current price data. Larger measurement errors favor economy-weighted indexes; larger mean and variability of prices changes favor industry-weighted indexes.

This paper explores how private contracts tailor GAAP and whether tailoring reflects the characteristics of the contracting parties. The analysis reveals that contracts of bank and insurance lenders are different with bank agreements closer to public debt. Tailoring is one of several characteristics associated with insurance lending agreements. The extensive tailoring of GAAP income in insurance contracts enforces dividend and payout restrictions that are consistent with the interest of long-term insurance lenders. In contrast, bank lenders deal with borrowers' default risk by negotiating shorter maturities, security, sinking funds, and loan syndication.

The cognitive bias theory of share price reversals predicts that the market forms overly optimistic (pessimistic) earnings expectations for firms that experienced high (low) stock returns. This paper finds evidence inconsistent with this theory. Analysts do not underpredict earnings following large stock price declines; instead, they remain overly optimistic about future earnings. Similarly, analysts do not overpredict earnings for firms after periods of extreme price rises. It appears, then, that other factors are responsible for the observed mean reversions in share prices.

More powerful tests of a theory of choice of accounting methods and the effect of changes in these choices on equity values are provided. The power increase comes from efficiently aggregating results across studies. One conclusion is that at least six variables common to more than one study have explanatory power. These variables are managerial compensation, leverage, size, risk, and constraints on interest coverage and dividends. Another conclusion is that the posterior probability that the theory taken as a whole has explanatory power is close to one. This conclusion includes the effect of variables that only appear in one study.

This study presents evidence on whether analysts' earnings forecasts anticipate management's discretionary accruals choices. If analysts anticipate discretionary accruals, earnings forecast errors are composed of at least two parts: cash-flow and discretionary-accruals forecast errors. Management's bonus-maximizing incentives allow for identification of circumstances in which discretionary-accruals forecast errors are expected to offset cash-flow forecast errors and circumstances in which they are expected to exacerbate cash-flow errors. Controlling for the unexpected cash-flow variability, the empirical results are consistent with these predictions.