Knowledge that Transforms

Multi-bank holding companies file detailed financial statements on their subsidiary banks. The availability of these data allows for an empirical examination of the relation between accounting-based performance and personnel decision for lower-level managers. For our sample of Texas banks, we find that turnover of subsidiary bank managers is negatively related to subsidiary performance, while promotions are positively related to performance. Holding own-bank performance constant, turnover increases with holding-company performance, which is consistent with the view that turnover decisions are based on performance relative to a firm-specification benchmark.

This paper tests the demand-side prediction of Datar, Feltham, and Hughes (1991) that new issuers of securities are more likely to choose a high-quality auditor and retain a lower level of ownership as the firm-specific riskiness of future cash flows increases. Previous tests of this hypothesis using U.S. data have generally been inconclusive, perhaps because an increase in the riskiness of client cash flows simultaneously increases an auditor's litigation risk and supply price. Our results using data from a significantly different legal environment (Canada) are consistent with the predictions of Datar, Feltham, and Hughes.

Union Carbide's chemical leak in Bhopal, India during December 1984 resulted in approximately 4,000 deaths and 200,000 injuries. This study examines the market reaction of chemical firms other than Union Carbide to this catastrophe. Evidence indicates that a significant negative intra-industry reaction occurred. However, firms with more extensive environmental disclosures in their financial report prior to the chemical leak experienced a less negative reaction than firms with less extensive disclosures. This result suggests that investors interpreted such disclosures as a positive sign of the firm managing its exposure to future regulatory costs.

This paper examines the abnormal accruals of a sample of 94 firms that reported debt covenant violations in annual reports. We expect debt covenant restrictions to influence accounting choices in the year preceding and the year of violation. Time-series and cross-sectional models are used to estimate ‘normal’ accruals. In the year prior to violation, both models indicate that ‘abnormal’ total and working capital accruals are significantly positive. In the year of violation, there is evidence of positive abnormal working capital accruals after controlling for management changes and auditor going concern qualifications.

Using cross-sectional data from hospitals in Washington State, we test whether overhead costs are proportional to overhead activities. This assumption is at the heart of nearly all cost accounting systems, which implicitly assume that marginal cost is equal to average cost. Empirically, the proportionality hypothesis can be rejected for most of the overhead accounts. On average across the accounts, the average cost per unit of activity overstates marginal costs by about 40% and in some departments by over 100%. Thus, the average cost per activity should be used with a great deal of caution in decisions.

There are frequent expressions of concern in the accounting, economics, and legal literature about managers' conflicting duties and incentives in management buyouts. This study is motivated by a concern about the managerial incentive to reduce reported earnings prior to the announcement of the buyout proposal. Our analysis of a sample of 175 management buyouts during 1981-88 provides evidence of manipulation of discretionary accruals in the predicted direction in the year preceding the public announcement of management's intention to bid for control of the company.

This study reports a preliminary empirical investigation into the relation between the choice of investment accounting method used by colleges and universities and factors such as type of institution, endowment size and returns, and debt. Because these institutions use fund accounting, the effects of the choice of investment accounting method can reasonably be isolated from other accounting decisions. The results indicate that the selection of investment accounting method is influenced by type of institution, endowment size and returns, but not by debt covenants.

This paper examines the valuation of employee stock options (ESOs). Because ESOs are inalienable, the employee's optimal exercise policy differs from the policy a naive reading of the finance literature would suggest. The employee prefers to exercise options before maturity under certain conditions on risk aversion, investment opportunities, and wealth. Since the ESOs' cost to the employer depends on the employee's exercise policy, this finding has implications for changes to the accounting treatment of ESOs under this finding has implications for changes to the accounting treatment of ESOs under consideration by the Financial Accounting Standards Board. Numerical examples suggest the employer's cost is much less than the options' Black-Scholes value.

This paper analyzes the repricing of employee stock options after market-wide crash. The model identifies sufficient conditions for renegotiation to be optimal and for optimal compensation to be a fixed salary plus stock options. Empirical results support the renegotiation prediction. Stock opition grants increase in both number and value after the 1987 crash. Firms with underwater options grant significantly more options post-crash than pre-crash, whereas firm with in-the-money options don't. Furthermore, firms suffering the largest impact from the crash are the most likely to increase grants after the crash.

This study shows real estate investment trusts' (REITs) characteristics and compensation incentives vary with compensation method. Formula-based compensation encourages advisors to generate cash from their assets, whereas discretion-based compensation encourages cash conservation. Consequently, dividend yields are 82 percent of formula REITs' total returns, but only 33 percent of discretion REITs'. Partly due to REITs switching from formula-based to discretion-based compensation, the number of discretion REITs has grown while the number of formula REITs has declined. Average formula REIT return performance is inferior and switches tend to follow a period of poor financial performance; performance improves after such changeovers.