Knowledge that Transforms

We show harmonizing domestic GAAP with foreign GAAP can have deleterious effects on security market performance, specifically price informativeness and trading volume. Harmonization effects result from interaction between two forces. Direct informational effects depend on whether harmonization increases or decreases GAAP precision. Expertise acquisition effects depend on benefits and costs to foreign investors of becoming domestic GAAP experts. These countervailing forces can result in harmonization to more (less) precise GAAP increasing (decreasing) or, unexpectedly, decreasing (increasing) price informativeness and trading volume. We also observe this for a cost of capital metric. Thus, harmonization is not necessarily a desirable singular goal.

We predict and find that firms use annual grants of options and restricted stock to CEOs to manage the optimal level of equity incentives. We model optimal equity incentive levels for CEOs, and use the residuals from this model to measure deviations between CEOs’ holdings of equity incentives and optimal levels. We find that grants of new incentives from options and restricted stock are negatively related to these deviations. Overall, our evidence suggests that firms set optimal equity incentive levels and grant new equity incentives in a manner that is consistent with economic theory.

This paper exploits the 1990 change in capital adequacy regulations to construct more powerful tests of capital and earnings management effects on bank loan loss provisions. We find strong support for the hypothesis that loan loss provisions are used for capital management. We do not find evidence of earnings management via loan loss provisions. We also document the reasons for the conflicting results on these effects observed in prior studies. Additionally, we find that loan loss provisions are negatively related to both future earnings changes and contemporaneous stock returns contrary to the signaling results documented in prior work.

In this discussion I comment on the contribution of two papers toward our understanding of how disclosure affects the cost of capital. Specifically, in the context of these papers, I comment on whether disclosure ameliorates or exacerbates the cost of capital that arises from the existence of information asymmetries in capital markets. This is a notion that should be of fundamental interest in that it provides an economic basis for evaluating the costs and benefits of accounting information.

Suil Pae, Acquisition and Discretionary Disclosure of Private Information and Its Implications for Firms' Productive Activities, Journal of Accounting Research, Vol. 37, No. 2 (Autumn, 1999), pp. 465-474

Auditing, Auditor attention, Auditor judgment, Aggressive financial reporting

Auditing, Analytical review judgement, Hypothesis set size, Time efficiency

Ray J. Pfeiffer, Jr., Pieter T. Elgers, Controlling for Lagged Stock Price Responses in Pricing Regressions: An Application to the Pricing of Cash Flows and Accruals, Journal of Accounting Research, Vol. 37, No. 1 (Spring, 1999), pp. 239-247

Auditing, Auditor-Auditee interactions, Misstatements, Strategic behavior

Disclosures, 8-K filing, Form 8-K, Timeliness