Knowledge that Transforms

[This study examines thrifts' supplemental disclosures with respect to default risk (scheduled items) and interest rate risk (repricing data). It represents an extension of a recent study (Beaver, Eger, Ryan, and Wolfson 1989; hereafter BERW), which also examines the relationship between banks' share prices and supplemental disclosures with respect to default risk (nonperforming loans) and interest rate risk (maturity data). However, there are differences between the research designs and the findings of the studies. The research design differences between the bank and thrift studies include: (1) the use of per share deflation instead of book value deflation; (2) the use of seemingly unrelated regressions (SUR), as well as a fixed-effects model; and (3) a partitioning of the sample according to availability of supplemental data to assess the impact of nondisclosure on the estimated coefficients. A sample of 165 publicly traded thrifts was used to regress market values on several variables, including supplemental disclosures. The findings differ from those of the bank study in several respects. First, the coefficient on the supplemental disclosure on interest rate risk is significant in the case of the banks but not in the case of thrifts. Second, the coefficient on the default risk variable is smaller for thrifts than for banks. Third, the following three additional findings extend the bank study. (1) Thrifts that do not disclose the default risk variable appear to be valued at a discount relative to disclosing thrifts. (2) The estimated effects of the incremental explanatory power of the default risk variable is robust with respect to two nonnested estimation methods, a fixed effects model, and a seemingly unrelated regression. (3) The finding regarding scheduled items is robust with respect to an alternative specification, which assesses differences in estimated coefficients for "good" loans versus "bad" loans.]

[Stratified sampling for inventories, as discussed in the literature, usually employs the recorded book value as the stratification variable (Neter and Loebbecke 1975; Roshwalb et al. 1987). Stratification by book value along with an appropriate estimator provides a cost effective and precise estimate of the total inventory cost. Other stratification variables, such as volume of activity, provide information not provided by the book value about the variability of the errors in inventories, but little is known about the effectiveness of designs based on them. Greater improvement in efficiency may be possible by simultaneously including book value and volume into one sample design. In this paper, the effectiveness of volume is investigated as a stratification variable. A bivariate stratification method based on a model-based sampling framework is developed which effectively folds both book value and volume into one collective and simple stratification scheme. Using a bivariate sample design is not without any cost, because it requires that both the book and the volume values for an item to be positive. However, another extension of the model is proposed to include all items with zero book value or zero volume into a single stratified design. To examine the effectiveness, sample designs based on book value alone, volume alone, and the bivariate method are constructed for three inventory populations. Since the errors are known for every item in these inventories, the exact efficiency of a sample design can be determined. By designing a sample to achieve a specified precision with known reliability, the resulting sample size is a measure of efficiency. The design for a population with the smallest sample size is the most efficient and cost effective. To test whether the sampling methodologies actually achieve their precision and reliability targets, the audit sampling process is repeated in a simulation. Random samples are repeatedly selected from the inventories using the alternative sample designs, estimates for the inventory total are calculated using each set of sample data, and the accuracy of the estimates are recorded. Designs based on the bivariate stratification method required up to 62.5 percent fewer items to achieve the same level of precision and reliability than designs based on book value alone or volume alone. The simulation results show that these bivariate stratified designs attain the same targer level of precision and reliability as designs based on book value alone or volume alone. In some cases, the bivariate designs improve the actual confidence interval coverage more than designs based on book value alone.]

[Using laboratory market data, this study demonstrates that consumers respond differently to a market event depending on the information reported about the event. Specifically, they respond more rapidly to an economically predicted price increase when they are informed that sellers' marginal costs have increased, but they resist price increases if they know that the sellers' profits have increased. These information effects are based on the principle of dual entitlements, which posits that purchase decisions are influenced not only by the direct economic utility of the purchase, but also by consumers' perceptions of the equity or fairness of a negotiated price. Survey evidence from prior studies indicates that consumers (buyers) justify price increases driven by increases in sellers' costs, but resist price increases that increase sellers' profits. This study goes beyond surveys to investigate these predictions in a market setting affected by an economic event that simultaneously increases both the marginal costs incurred and the profits earned by sellers. Specifically, we examine the combined effect of a change in the sellers' tax rate and tax base. Nine laboratory markets in three separate financial information structures were conducted to investigate the predicted information effects. Each market had ten traders (five buyers and five sellers), for a total of 90 subjects. In three markets, buyers were apprised of an increase in sellers' marginal tax costs. In three other markets, buyers were informed of an increase in sellers' after-tax profits. Finally, three control markets with no information disclosures served as a baseline. Subjects in each market were student volunteers who received their market profits in real cash, in conformance with the tenets of induced-value theory. The results have implications for the financial disclosures volunteered by firms or mandated by regulatory bodies. While the accounting literature has traditionally stressed information effects on investors (Lev 1989), the body of users affected by financial reporting is much larger and includes the consumers who purchase the goods and services of disclosing firms (Financial Accounting Standards Board 1978, par. 24). This study suggests that financial disclosures can influence consumer behavior in competitive markets for goods and services.]

[Firms sometimes file their 10-K or 10-Q with the Securities and Exchange Commission (SEC) several days before the corresponding earnings announcement appears in The Wall Street Journal (WSJ). In these cases, the 10-K or 10-Q filing constitutes the first public announcement of earnings. This study addresses the question of whether the price and volume reactions to these earnings announcements occur at the SEC filing date or at the subsequent WSJ announcement date. This research can be viewed as a limited test of whether the securities markets are efficient with respect to the data contained in 10-K and 10-Q filings. The generalizability of the test results is limited because of the nonrandom nature of the sample. Tests were performed on daily price and volume data for 342 firmquarters for which the SEC filing date preceded the WSJ earnings announcement by at least four trading days. The results suggest that there was no significant market reaction, on average, at the SEC filing date, even though the filing was the first public announcement of earnings for the quarter. However, there is evidence of the existence of a market reaction to the subsequent WSJ earnings announcement. The direction of the price reaction at the WSJ announcement date is consistent with the sign of unexpected earnings. Wright and Groff (1986) present evidence indicating that the existence of a market reaction to the public release of price-relevant information does not depend on exactly how that information is made public. In contrast, the results presented in this paper suggest that, in some limited cases, the method of disclosing accounting earnings is related to whether the information embodied in those earnings will be reflected in security prices in a timely fashion. The results also suggest that, at least in one specific set of circumstances, data disclosed as part of an SEC-mandated filing are not fully reflected in prices until a subsequent media disclosure is made.]

[The American Institute of Certified Public Accountants (AICPA) and its affiliated state societies promote restrictive accountancy laws that limit both the right to express opinions on financial statements and the use of certain occupational titles to licensed public accountants. Although occupational licensing, like other forms of government regulation, is justified as being in the "public interest," critics (e.g., Stigler 1971; Peltzman 1976) suggest that licensing arises because of the professional groups' interest in using the coercive power of government for their own economic advantage. Until 1979, CPAs were content to limit state regulation to the audit function, permitting unlicensed accountants to perform other accounting tasks. With the growing importance of review and compilation services, however, CPAs have sought to restrict the performance of these services too. In addition, the AICPA and state CPA societies have used their influence with state legislatures and licensing boards to impose limitations on the use of professional titles such as "public accountant," "accountant," and "auditor." Whereas some states have adopted relatively permissive licensing laws, others restrict all analytical work and professional titles to licensees. This study explains why some states have adopted more restrictive licensing regimes than others. Hypotheses are developed to test the power of interest groups, political systems, and socioeconomic variables in explaining such differences. The evidence, based on both univariate and multivariate techniques, supports the following general conclusions. Restrictive licensing regimes are more likely in states where the interest-group strength of CPAs is high, as measured by their numbers relative to public accountants who are not CPAs. Restrictiveness is inversely related to statewide competition between Republicans and Democrats and is slightly related to legislative turnover.]

[Firms' investment practices often seem to be suboptimal; for example, they may ration capital or underinvest in risky projects. Recent research (e.g., Antle and Eppen 1985, Antle and Fellingham 1990, Harris et al. 1982) argues that these practices might be optimal responses to contracting frictions that arise from information asymmetry among the members of the firm. Analyzing a two-person firm, these studies endow the manager with pre-decision information about the returns from a given project and examine the owner's optimal response to the information asymmetry. This article expands the problem in two ways. First, it considers the choice between two competing projects. Second, it explicates the source of the manager's information superiority: proximity to the firm's operations advantage the manager in both acquiring and knowing the cost-benefit of additional information pertinent to project choice. Because of the manager's advantage, the owner cannot infer why the project was selected. The owner's response to the information asymmetry must optimize over both the information-acquisition and resource-allocation decisions. This article considers a model in which the manager must choose between a risk-free and a risky project. The owner delegates project selection because of the manager's pre-contract information superiority and because only the manager can obtain post-contract additional, costly information. Delegating project choice, however, creates a coordination problem because of the owner's inability to observe whether the manager expended effort on information search and because the value of additional information depends on the manager's pre-contract information (i.e., on the manager's type). Using the observed variables (project choice and realized profit), the optimal contract must (1) motivate a subset of manager types to select the project after expending effort on information search, and (2) motivate the complementary set to condition project selection on their pre-contract information alone. The model considered here is related to that of Demski and Sappington (1987) which considers issues involved in contracting with an "expert" who is uniquely qualified to acquire pertinent information, and Lambert (1986) applying this concept to a project-selection setting. Pre-contract asymmetry about the value of search is the crucial difference between previous research and this study. Absent information asymmetry (in the first-best solution), the information-acquisition problem is separable from the resource-allocation problem. The owner asks for search only from those manager types for whom the value to search exceeds cost. (The set of such manager types is convex because the value to search is concave in manager type.) Also, the manager uses all available information to choose the more profitable project. However, the owner cannot attain this first-best solution without information about manager type and information search. The two problems cannot be decomposed. As a result, the optimal (second-best) contract always induces distortions in information acquisition and, for the case of the risk-averse manager, induces overinvestment in the risky project. Furthermore, communication of the search result is strictly valuable. The results suggest that optimal responses to information asymmetry among the members of the firm could result in practices that seem to disregard the value of information search and to use acquired information sub-optimally. The results also lend support to the use of accounting reports, such as budgets, in managerial performance evaluation.]

[Professional standards for analytical procedures call for auditors to hypothesize likely causes of unexpected patterns in financial statement balances and to develop plans to investigate (SAS 56). Therefore, audit efficiency and effectiveness depend on competency in recognizing patterns in financial data and in hypothesizing likely causes of those patterns to serve as a guide for further testing. Yet our knowledge of how well auditors accomplish these crucial steps has been limited by the difficulty of developing research tasks with criteria for evaluating auditor performance. The purpose of this study is to relate processes of pattern recognition and hypothesis generation to quality of performance in an analytical task. To accomplish this purpose, we conducted a laboratory study in which 21 auditors were asked to think aloud while performing an analytical procedures task. The case contained a seeded error that caused a fairly complex pattern of discrepancies between projected and unaudited financial ratios and balances. Think-aloud verbal protocols provided a trace of subjects' reasoning processes, and the seeded error provided an outcome criterion to evaluate the hypotheses they generated. This design supplies evidence needed to evaluate pattern recognition and hypothesis generation processes that lead to correct and incorrect outcomes. Results indicated that three auditors made acquisition errors and four failed to combine crucial cues into a pattern. Of the 14 auditors who recognized the pattern, six proposed a hypothesis consistent with the pattern. Thus, hypothesis generation was the stage at which process errors most frequently occurred, and the least experienced auditors had the most difficulty at that stage. Specific process problems that inhibited generation of a correct hypothesis included: addressing only part of a recognized pattern, and/or fixating on a certain error type. Thus, protocol analysis allowed insight into which stages in the process proved most difficult for the auditors and why, providing a focus for further research and decision aid development. This research responds to the call for inclusion of criterion outcomes in audit judgment research (e.g., Libby 1981; Ashton 1982; Biggs 1985; Davis and Solomon 1989). The importance of criterion outcomes can be seen in the advances made in decision research in medicine (e.g., Johnson et al. 1982; Patel and Groen 1986; Lesgold et al. 1988). and physics (e.g., Chi et al. 1982; Robertson 1990). In medicine especially, the ability to relate diagnostic processes to outcome quality has contributed to the theory and practice of medical decision making (Kassirer 1989) in ways that have been unavailable in auditing.]

[Prior research has investigated firms' success in the political process and its relation to firm size. For example, effective tax rates have been used to measure the extent to which firms are able to influence corporate income taxation. Effective tax rates, however, are a biased proxy of political success because they may contain a factor, net operating losses (NOLs), attributable to firms' operating results and experience rather than to success in the political process. Moreover, if firm size is also correlated with NOLs, then NOLs may affect the relationship between firm size and tax rates in a systematic manner. If such an effect is substantial, the association of firm size and effective tax rates will be a biased basis for drawing inferences about firm size and political success. The purpose of this article is to assess the extent of the effect of NOLs on the overall relationship of firm size and tax rates. Path analysis is employed to isolate the effect of firm size on effective tax rates that is attributable to NOLs (i.e., the indirect effect of NOLs). Determining the indirect effect of NOLs allows an assessment of the bias in the overall firm size/tax rate relation attributable to NOLs. To estimate the indirect effect of NOLs, a path model with two structural equations is built to identify the indirect links between firm size and effective tax rates mediated by NOLs, and the remaining direct link between firm size and effective tax rates. To correct errors-in-variables problems and to provide a consistent interpretation of the results, variables in the structural equations are modeled by a latent-variable approach (measurement model). The path model and the measurement model are estimated by LISREL. Based on the parameter estimates of the structural equations, the path analysis results indicate that the indirect effect of NOLs has a statistically significant impact on the overall relationship between firm size and effective tax rates. This indicates that NOLs constitute an important omitted variable in prior studies. While effective tax rates may measure some degree of firms' success in the political process, conclusions regarding the relation between firm size and firms' success in the political process is confounded by the serious omission of NOLs.]