[This study examines how transfer pricing, in the presence of differential taxation, affects the resource allocation and profitability of a decentralized multinational enterprise (MNE) that uses the same transfer price for tax and performance evaluation purposes. An analytical model is built in which a foreign manufacturing division transfers a single product to a U.S. distribution division, which, in turn, sells it in the marketplace as part of a final product. It is assumed that both divisions have complete information concerning all cost and revenue functions and that tax rates are higher in the United States than abroad. Given this assumption, it is shown that it is in the interest of both divisions to cooperate with each other, and a cooperative equilibrium is used throughout the analysis. When differential tax rates exist, but there are no transfer-pricing rules imposed by the taxing authorities, it is shown that the MNE's optimal resource allocation is the same as in the absence of taxes; however, firmwide profits are not maximized. When the resale-price method of computing transfer prices (Reg. Section 1.482-2(e)(3)) is used, the results differ, depending on the manufacturing division's bargaining power. At low levels of bargaining power, the distribution division will "guarantee" a certain level of profit to the manufacturing division, and firmwide after-tax profits will be maximized. As the manufacturing division's bargaining power increases beyond a certain point, however, firmwide optimal profits will no longer be achieved. In addition, the final product and the most similar product (as defined by Reg. Section 1.482-2(e)(3)) will be produced beyond the firmwide after-tax optimum. When transfer prices are computed in accordance with the cost-plus method (Reg. Section 1.482-2(e)(4)), it is shown that production of the final product first decreases, then increases, and production of the most similar product increases as the distribution division's bargaining strength increases. In addition, there is no guarantee of profit to the manufacturing division. Accordingly, it is unlikely that firmwide after-tax profits will be maximized. Demonstration of these results is achieved with the use of numerical examples. The study concludes with a discussion of the tax policy implications of these results.]
[This article examines the characteristics of experienced and inexperienced auditors' retrieval of internal controls from memory. Because it is possible that knowledge retrieval is a function of the manner in which information is stored in memory, this study also investigates two kinds of knowledge organization: (1) a taxonomic representation, as typified by categoric checklists; and (2) a schematic representation, as typified by information flowcharts. Although the relationship between knowledge and expertise is well documented in the literature, few accounting researchers have attempted to study the memory structures of skilled individuals (Libby and Frederick 1990; Weber 1980). Thus, this work is motivated by two broad objectives: (1) to understand the nature of expertise, which will help in assessing the boundaries of auditors' abilities and performance; and, (2) to comprehend the cognitive skills of both expert and novice auditors, which will help in facilitating skill acquisition by unseasoned individuals. One hundred thirteen auditors and 97 auditing students were used to study the retrieval characteristics of the taxonomic and schematic knowledge structures and memory differences between experts and novices. Auditors freely recalled more internal controls when such controls were organized by transaction flow. Auditing students did not possess complete knowledge organizations, and the type of representation did not affect their free recall of the controls. Across a given knowledge representation, providing subjects with complete subsets of internal controls as a memory aid did adversely affect the retrieval of additional controls in the taxonomic but not the schematic organization. Within a specific class of internal controls, however, providing subjects with a portion of the controls was detrimental to the recall of the remaining controls in both types of representation. These results suggest that an auditor's retrieval of internal controls from memory depends not only on the auditor's level of experience but also on the way in which the auditor's knowledge of controls is organized.]
[The nature of information regulation depends on the informational efficiency of capital markets (see Beaver 1989, 152-71; Dyckman and Morse 1986, 82-91). Consequently, researchers in accounting and finance have spent considerable effort attempting to measure efficiency. Although this investigation has spanned many research designs and has been applied to many different information signals, empirical tests all suffer from the same basic problem: the benchmark of interest, an informationally efficient market, is unobservable. The asset price that would have prevailed in an efficient market must therefore be modeled, and the test of market efficiency is confounded with a test of the asset-pricing model. Because of this ambiguity, whenever a researcher claims to find an abnormal return based on some information signal another researcher invariably responds that risk was not adequately controlled. For instance, Bernard and Thomas (1989, 1990) present evidence that markets do not adequately adjust to quarterly earnings announcements (i.e., there is a significant post-announcement drift), while Ball et al. (1990) argue that the market adjustment may be correct if the level of risk during the announcement period is adequately controlled for. Unlike naturally occurring markets, the efficiency of a laboratory market can be measured directly by creating another "artificial" economy that is identical to the economy of interest, except that all information is fully disseminated. The price in the artificial economy is the efficient price by definition; it is determined endogenously and without reference to an asset-pricing model. Using this method of measuring a market's efficiency, this study investigates how efficiency is influenced by different information or market structures. Although such an investigation will not resolve the issue of whether naturally occurring markets are efficient, laboratory results can identify features of a market or information structure that aid or impede efficiency. The study compares two information structures that differ by whether there is aggregate certainty in the market; that is, whether the union of all traders' information signals perfectly identifies the value of the risky asset. Previous experimental research in market efficiency has used markets with aggregate certainty. However, many of the difficulties of decision making under uncertainty disappear when the information in the market collectively reveals the asset's payoff. On the other hand, for the experiments conducted here, there are relatively more signals to aggregate in the markets with aggregate certainty. The results show that in markets where different traders have different information signals, the presence of aggregate uncertainty significantly reduces efficiency relative to similar markets with aggregate certainty. However, the results also show that markets are very efficient when some traders have a common but imperfect information signal and other traders are uninformed. In these markets there is aggregate uncertainty but no diversity of information among informed traders. Thus, diversity of informed traders' information and aggregate uncertainty together lead to inefficient markets, but neither treatment by itself causes inefficiency. The study also manipulates the number of traders in the market. It is sometimes argued that markets are efficient because there are a large number of traders whose individual errors average out. However, there is no reason to believe that the asset-pricing relation applies equal weight to each trader's belief, so a central limit result may not hold. The results show that the number of traders has no significant impact on the efficiency of the final prices in a trading period. Within a trading period, however, markets with only a few traders converge to the efficient price much more quickly than do markets with many traders. The results also show that there is a greater diversity of behavior in the markets with many traders. It is possible that this increased diversity increases the number of "noisy" transactions, making it more difficult to infer information from market data. In any investigation of a market's efficiency, different traders must have different information at the time efficiency is being assessed; otherwise the market is efficient by definition. Although accounting disclosures are publicly available they can effectively generate different information signals to different traders. The markets presented here give two examples. In the aggregate certainty treatment, some traders received good news signals and other traders received bad news signals. An example of this type of information system is an economy where different traders having different earnings expectation models. In such an economy the same earnings report can be good news to some traders and bad news to other traders. As long as the "correct" earnings expectation model is unknown, each trader would find the other traders' signals-in this case their forecast errors-informative. In the number-of-traders treatment, some traders receive a signal while other traders do not. An example of this type of information system is an economy where some traders receive accounting disclosures very quickly by subscribing to a wire news while other traders receive the information via third-class mail. Here the uninformed traders would benefit by learning the informed traders' signal.]
[Varian (1985) and Karpoff (1986) showed analytically that trading volume is positively related to the degree of differing beliefs. This study provides empirical evidence on the postulated relationship. The extent of disagreement or dispersion in financial analysts' forecasts of annual EPS for a firm is employed as the proxy for agents' differing beliefs about the firm's prospects. The revision in analysts' mean EPS forecasts, from one month to the next, is used to control for the volume effects of the net information signals emanating during the period. While some researchers have addressed the relation between the level of trading and earnings announcements (Beaver 1968; Morse 1981), and between trading volume and the magnitude of earnings forecast errors (Bamber 1986, 1987), the impact of discordant expectations on trading volume has been the subject of more recent empirical examination (Comiskey et al. 1987; Ziebart 1990; Lang and Litzenberger 1989). The hypothesis tested in this study posits that the fraction of outstanding common shares traded is a positive function of both forecast dispersion and mean forecast revision. While most previous studies of volume have concentrated on specific accounting disclosures, this study examines the trading associated with an almost continuous flow of information about the sampled firms that analysts implicitly use in their periodic revisions of earnings forecasts. Hence, tests of the model become possible at several times during the year, independent of formal accounting events/disclosures. Monthly observations in each of the four years 1978 to 1981 are used for the sample of 420 calendar-year firms; total number of observations is 16,747 over 48 months. Generalized least squares (GLS) estimation is applied to observations pooled over time and cross-sections and for each of the four years separately. Ordinary least squares (OLS) estimations are also performed and reported for comparative purposes and also to assess the stability of the models in monthly cross-sections. The results indicate a significant positive association between the dispersion in analysts' forecasts of annual EPS and the volume of trading. A relatively stable and positive association is found even after controlling for the volume effects of the magnitude of monthly revisions in the mean analysts' (annual) EPS forecast. The evidence corroborates the theoretical result that the degree of heterogeneity in beliefs is a determinant of the intensity of trading.]
[Evaluating the strength of audit evidence is a primary activity of auditors, but little is known of the factors that affect these evaluations. This article identifies and investigates two factors that affect auditors' evaluations of evidence strength. The first factor deals with underlying constructs of evidence, called strength dimensions in this study. Although the auditing literature suggests that evidence strength is determined by such underlying constructs (see, e.g., AAA ASOBAC 1973; AICPA 1980, 1988), prior research has focused on the surface characteristics of evidence. Hence, "source of evidence" has been studied (see, e.g., Joyce and Biddle 1981; Knechel and Messier 1990; Rebele et al. 1988) rather than the underlying strength dimension of "validity" (see AICPA 1980, AU 326). The present study focuses on the underlying dimensions to determine whether they provide a basis for understanding auditors' evaluations of evidence strength. The second factor concerns accounting firms' policies for auditing procedures. Firms' policies represent different methods of conducting efficient and effective audits (Cushing and Loebbecke 1986), and it is likely that these policies influence field auditors' judgments. Therefore, prior research on how accounting firms' degrees of structure affect auditors' judgments is extended to include the effects of specific policies. Auditors' evaluations of test-of-control strength were used to assess whether underlying dimensions of evidence strength and the specific policies of accounting firms affect auditors' judgments. Tests of controls (TCs) are auditing procedures that determine the effectiveness of an internal control; TC strength is the degree of assurance about a control's effectiveness provided by evidence generated by a TC. In this study, TC strength is defined and evaluated along the dimensions of validity, verifiability, and coverage. Auditors evaluated five TCs along the three strength dimensions to provide dimension-based rankings of TC strength. Other auditors participated in a laboratory experiment that involved control risk assessment. Correlations between the implied ranking of TC strength from the experiment and the dimension-based rankings are high, positive, and statistically significant, which suggests that auditors' judgments of evidence strength reflect the professional standards. Conversely, studies of audit adjustments have shown that evidence strength (measured as the ability to initially detect errors) does not strongly reflect the standards. The discrepant results suggest that characterizations of evidence strength may need to be studied further. To assess the effect of accounting firm policies on judgments, I develop predictions about the effects of policies that require reperformance and those that caution about the relative weakness of inquiry and observation. Because the predictions are largely confirmed by auditors' judgments in the laboratory experiment, accounting firms' policies are deemed to influence audit judgments. If generalizable, this finding suggests that results of research studies may be affected by the policies of accounting firms supplying subjects or data, to the extent that firms' policies differ. Researchers should therefore become familiar with firm-specific policies. For practitioners, this finding indicates that setting firm-wide policies may be effective in influencing field auditors' judgments.]
[Researchers generally agree that culture affects the behavior and attitudes of individuals within organizations (Hofstede 1980; Adler et al. 1986). Therefore, it may be assumed that an organizational system such as a participative budget-process will have different effects in different cultures. Recent research has indicated that a personality variable, internal-external locus of control, impacts the relationship between budgetary participation and both managers' performance and job satisfaction (Brownell 1981, 1982b). The locus of control construct categorizes individuals as (1) externals, those who believe that events are controlled by fate, luck, chance or powerful others, or (2) internals, those who believe that they have some control over events (Rotter 1966). This article examines whether cultural differences affect the previously identified interrelationship of individual locus of control and participation in the budgeting process as it impacts managerial performance and satisfaction. The prior research (Brownell 1982b) used middle-level managers in U.S. manufacturing organizations. In this study, Mexican managers were selected because Mexico provides an interesting cultural contrast to the U.S. on three dimensions identified by Hofstede (1980) which are considered relevant to participative budgeting issues. In contrast to the "Anglo" Cluster, the Latin Cluster of which Mexico is a unit differs on the dimensions of "uncertainty avoidance" and "power distance." An additional factor in the selection of Mexican managers was the magnitude of economic ties between Mexico and the U.S. The importance of this relationship continues to grow as more multinationals establish "maquilladoras" within the border region and as the Mexican government frees some of its constraints on foreign investment. The responses of 83 Mexican managers to survey instruments were analyzed using regression to test the interrelationship of locus of control and budgetary participation and their impact on managerial performance and job satisfaction. While the results of this study are generally consistent with previously reported findings for managerial performance, the impact of locus of control on managerial satisfaction was not significant, reflecting an ostensible difference in culture. In addition, the effect of locus of control on the performance of high-level managers was significantly stronger than its impact on the performance of lower-level managers. Finally, contrasting significantly to other Mexican managers, the performance of those Mexican managers employed in 100 percent foreign-owned firms was not discernibly affected by either budgetary participation or locus of control. This last result may be due to the cognitive dissimilarities relating to the cultural interface in these foreign-owned firms. This suggests that, within the Mexican culture, different conclusions are obtained depending on whether the firm is controlled by local or foreign interests.]
[Accounting histories have dated the advent of sophisticated cost management from the mid-1880s (Solomons 1952). The scientific management movement is credited with instituting and popularizing cost management techniques. However, it might be suspected that British entrepreneurs of the Industrial Revolution would have developed sophisticated costing techniques earlier, given their significant methodological advances in other economic areas. This article reports the findings from surviving business records of 25 sizeable British industrial firms (mostly in the iron and textile industries) from 1760 to 1850. Substantial evidence of a relatively mature cost management has been found in four major areas of activity: cost control techniques, accounting for overhead, costing for routine and special decision making, and standard costing. Speculations about the motivations for cost management and about specific factors influencing the iron and textile industries are considered. Because the accounting practices of these firms predated the genesis of "the costing renaissance" a century later, our understanding of cost management practices in the Industrial Revolution is augmented by the survey.]
[Research on analysts' earnings forecasts has produced two major results. First, security analysts provide more accurate forecasts than do time-series models (Brown et al. 1987) and, second, analysts' forecasts become more accurate and less dispersed as the forecast horizon decreases (Brown et al. 1985). This study examines the effect of an annual earnings announcement on the dispersion of analysts' one-year-ahead forecasts. It seems logical that forecasts should be less dispersed after the release of a value-relevant publicly observable signal. However, we find the opposite; i.e., that forecasts become more dispersed than would be expected in the absence of an earnings announcement. Security analysts' forecasts have often served as a proxy for the unobservable market expectation of earnings. Similarly, the dispersion of analysts' forecasts may proxy for the diversity of investor beliefs about future earnings. A number of studies have suggested that diversity of beliefs is important in security pricing as well as being a determinant of trading volume. Insight into the effects of earnings announcements on the heterogeneity of investors' beliefs will improve our understanding of how information gets impounded into prices and how information alters investors' portfolio decisions. The Bayesian belief revision model developed in this study suggests that the surprise content of the signal and the diversity of the perceived precision of the signal are important factors in determining whether the information event will cause a convergence or divergence of forecasts. Holthausen and Verrecchia (1990) reach similar conclusions when they examine the effect of information on consensus. In their model, a decrease in consensus (increase in diversity of beliefs) is possible if there is disagreement about the effect of the signal on the value of the firm. Bamber (1987) argues that the surprise content of the announcement and disagreement about the interpretation of the signal are related; i.e., "more surprising or informative announcements are likely to spawn a wide variety of interpretations...." Empirical results are consistent with the insights provided by our model. There is a greater divergence of forecasts when the earnings announcement contains a bigger surprise, where surprise is defined as the difference between reported earnings and analysts' predictions of those earnings. An alternative explanation for the empirical results is nonsynchronous updating of forecasts by analysts. By partitioning the sample on the length of time between the announcement date and the next IBES report, we are better able to identify which IBES report (the first or second after the announcement) contains updated forecasts. This partitioning provides a more accurate measure of changes in the dispersion of forecasts due to an earnings announcement.]
[This research examines and interprets the security market response around annual report release dates. Annual reports contain data beyond that reported in preliminary earnings announcements. While prior research has concentrated on the price response to annual report releases and the issue of information content with mixed results, this paper extends earlier work by employing both price and trading measures. The trading measures, which include number of transactions, size-stratified transactions, and mean transaction size, enable the analysis to address not only information content issues, but also social welfare issues in the sense of Lev and Ohlson (1982) and to coarsely identify what type of investor responds to the annual report by trading. Inferences as to the relative usefulness of annual reports to different investor groups are also made based on these trading measures. A number of studies address, often indirectly, annual report informativeness by examining the price response accompanying the report's release. Of these, studies by Wilson (1987) and Lobo and Song (1989) suggest a price response to the earlier of the annual report or 10-K. However, other studies, including Foster et al. (1986), Mynatt (1988), and Bernard and Stober (1989), fail to detect such a price response. The informativeness of annual reports from a price-based perspective remains an open question and from a trading-based perspective it is an unaddressed question. In this study, price response to the annual report is measured using both absolute value and squared unexpected returns. A market model approach is used to estimate unexpected returns. A simulation analysis is included to substantiate the ability of these two metrics to detect a price response. Unexpected volume and unexpected number of transactions, both in general and for size-stratified trading, are estimated via market model regressions. Unexpected mean transaction sizes are estimated from a temporal drift regression. No evidence of a price response and little evidence of a volume of shares response at annual report dates is found. Number of transactions, however, increases significantly around annual reports, peaking four to five trading days after the annual report release date. This trading response suggests that investors find annual reports informative. The simultaneous absence of an economically significant price response is interpreted as indicating that annual reports provide social welfare value in the sense proposed by Lev and Ohlson (1982). Most notably, the analysis of trading response stratified by transaction size suggests that the trading response occurs mostly within the smallest size strata (i.e., 100 and 200 share transactions, transactions of less than $30,000 in value). Consistent with this, mean transaction sizes during the annual report period are less than expected. This is contrary to mean transaction size behavior at earnings announcement dates (Cready 1988) and suggests that annual reports are of greater value to less wealthy individual investors relative to wealtheir individual and institutional investors. Such a finding is consistent with Hakansson (1977) in that it suggests that "small" investors rely on the public information system (i.e., the annual report) while "large" investors rely more on predisclosure information in making investment decisions.]