Knowledge that Transforms

Auctions allocate resources to their highest-valued uses. Yet bankruptcy does not use auctions. Instead judges determine a value and parcel out interests on the assumption that this valuation is correct. Errors inevitable in this process lead many persons to conclude that bankruptcy is inefficient. This essay argues that the conclusion does not follow. The costs of error in valuation may be less than the cost of conducting an auction. Legal rules endure because they are efficient or because they transfer wealth. Transfers are an implausible explanation of the current bankruptcy regime, leaving efficiency as the prevailing explanation.

Research suggests that leveraged buyouts create value through significant operating performance improvements. There is little evidence that buyouts lead to widespread employee layoffs, wage reductions, or wealth transfers from bondholders. LBOs continue to be controversial, however. Future research should focus on the effect of buyouts on firms' strategic investments, buyout firms' performance under difficult economic conditions, and the frequency and costs of financial distress associated with buyouts. Research can also focus on improving the performance of public corporations by examining the individual contributions of debt, management ownership, and corporate governance changes to podt-buyout performance.

This paper's results are consistent with the choice of accounting method in the oil and gas industry being dominated by measurable characteristics of firms and guided by the principles of efficient contracting. The results are inconsistent with an alternative hypothesis, opportunistic behavior by managers. The efficient contracting explanation is also consistent with the empirical findings from earlier studies; [e.g., Lilien and Pastena (1982) and Deakin 1979)].

We provide a positive analysis of a firm's decision to report the operations of a financial subsidiary on a consolidated versus an unconsolidated basis. Our evidence indicates that the firm is more likely to choose consolidated reporting the greater the operating, financial, and informational interdependencies between parent and subsidiary. Moreover, our evidence offers no support for the FASB hypothesis that firms use unconsolidated financial subsidíaries to understate the fixed claims on their balance sheets.

In this issue Duke and Hunt and Press and Weintrop show that leverage is significantly related to the existence of, and closeness to, accounting-based debt covenants. Alternative rationales for this relation are presented. The theory requires more rigorous specification to define closeness to covenants and determine which measure of leverage produces a more appropriate proxy for closeness to covenants. Then Healy and Palepu investigate a sample of firms close to their dividend restriction and find in general they are no more likely than other firms to change accounting methods. Their sample selection criteria reduces the generalizability of their results.

This paper demonstrates that the market reaction to announcements of seasoned stock offerings varies with the presence of outside agents - accounting firms, commercial banks, and underwriters - who monitor the firm. The stock price reaction is a positive function of the quantity of bank debt in a firm's financial structure, the quality of the firm's investment banker, and the quality of the public accounting firm that serves as its external auditor. The evidence supports theoretical models that imply external agents audit, monitor, and certify decisions to issue seasoned common stock.

This paper argues that audit firms achieve competitive advantages through specialization, and that clients purchase audit services from the least cost supplier. Client-auditor realignments thus represent efficient responses to changes in client operations and activities over time. Results obtained from analyzing the financial characteristics and share price performance of corporations that changed auditors between 1973 and 1982 support the view that realignments can generally be attributed to cross-temporal changes in client characteristics and differences in audit firm cost structures.

This paper presents a statistical procedure to identify effects of three potential structural changes on accounting earnings – temporary, short-run, and long-run. The procedure is applied to quarterly accounting earnings of 39 utility companies. Structural changes are found to be commonplace. Statistical forecasting models that explicitly incorporate structural change effects are found to generate more accurate forecasts than other statistical models in the literature. Although no statistical model significantly dominates Value Line, a firm-specific model with structural change adjustment forecasts as well as Value Line. Moreover, all statistical models examined have significant marginal forecasting power to complement Value Line forecasts.

Accounting-based dividend constraints in lending contracts are imperfect means of mitigating conflicts of interests between stockholders and bondholders since managers have flexibility to make accounting decisions to circumvent the covenants. This paper documents firms' accounting and dividend responses to an increase in the tightness of dividend constraints. Firms cut dividends and do not appear to make accounting changes to circumvent the dividend restriction. The magnitude of the dividend cut is proportional to the tightness of the dividend constraint. This suggests that accounting-based covenants are effective means for bondholders to restrict firmsś dividend policies.

In the preceding paper Christie provides three tests to facilitate formal inferences in survey papers that examine related empirical studies. Those tests reinforce the view that accounting technique choice is related to variables that may proxy for contracting and monitoring costs in the market and political processes. However, the contribution of the tests is limited because the fundamental question of the relation between the empirical regularities and the theory remains unexamined.