[Regulatory bodies that oversee the provision of audit services have recently expressed concern about the common practice of pricing initial audits significantly below cost (lowballing). Specifically, it is feared that lowballing could weaken auditor independence and reduce audit quality, since lowballing could provide clients with a credible threat of terminating incumbent auditors should they refuse accounting concessions. However, Magee and Tseng (1990) have shown that when auditors possess all bargaining power and there is no disagreement among auditors on the proper interpretation of GAAP, clients have nothing to gain by threatening termination of incumbent auditors and there is no weakening of auditor independence. Therefore, the concern expressed by regulators must presuppose that clients (i) possess bargaining power superior to that of auditors, and (ii) are free to change auditors at any time. But, if these features are true, it is puzzling why lowballing would occur in the first place. Lowballing can only occur if there are rents to be earned by auditors (DeAngelo 1981a), but such rents seem to be inconsistent with clients possessing most of the bargaining power (Dye 1991; Magee and Tseng 1990). We construct and analyze an economic model of audit pricing which shows how equilibrium audit prices would sustain rents and lowballing even when clients have most or all of the bargaining power and are free to change auditors every period. Our analysis also throws light on the related phenomenon of auditor turnover, and shows that the efficient pricing of audit services by itself precipitates some turnover apart from any turnover due to other forces such as client-auditor disagreements (Dye 1991) and client-auditor matching (Gigler and Penno 1993). Given auditor turnover, we analyze how audit prices, lowballing, and turnover rates evolve over time.]

Budgeting, Participative budgets, Budgetary participation, Coordination role

Transfer Pricing, Risk sharing, Uncertainty

This paper examines the effect that imperfectly informed capital market agents have on the equilibrium paths of output, investment, and asset prices of value maximizing firms. Though information is imperfect, rational expectations is imposed as an equilibrium condition. It is found that both asset prices and corporate decisions are simultaneously affected in such a way that the efficiency-optimality relationship between them is pre- served. The effect of a fuller information structure is to move the economy from one efficient markets equilibrium to another. elaborated. Extant beliefs regarding accounting information are crystallized at two polar extremes. Policy-making bodies like the SEC and the FASB and most prac- titioners believe that investors are naive in processing information, and are principally concerned with the earnings per share figure as reported by accoun- tants. Investor decision rules are invariant to the rules for computing income, and therefore if the right or proper measure of income were not adopted, investors would be misled. In recent years stock price researchers have rapidly accumulated evidence against this naive investor hypothesis and in favor of the efficient markets hypothesis. For example, Kaplan and Roll (12) demonstrated that firms switching from the deferral method to the flow-through method for investment credit and firms switching from accelerated to straight-line deprecia- tion, in each case increasing their reported income, did not experience abnormal price increases. Sunder (23) found that firms switching from the FIFO to the LIFO method of inventory valuation, thereby decreasing their reported income, did not suffer in stock price performance. These findings raise a serious question. Do accounting statements have any informational impact on security prices at all? Several studies tested and rejected the null hypothesis that the periodic financial statements issued by corporations have no information content for capital market agents. Ball and Brown (1) tested for information content of the annual earnings report and found that foreknowledge of the earnings number could be used to generate excess returns. Brown and Kennelly (5) replicated the

Monitoring, Moral Hazard, Contracting, Stochastic monitoring policies

Disclosures, Investments, Periodic performance reports, Private information

Analyzes audit pricing, lowballing and auditor turnover services in accounting practices. Insight into audit pricing model; Effect of lowballing to auditor independence; Evolution of audit prices and auditor turnover; Empirical implications.

We examine how outsiders rationally interpret a reported loss on derivatives when the application of mark‐to‐market accounting to cash flow hedges creates a mixed attribute problem. We find that because of the mixed attribute problem, the information content of mark‐to‐market accounting is related to the information content of historical cost accounting in a very specific way. This relationship allows us to identify the circumstances under which mark‐to‐market accounting facilitates and when it detracts from the objective of providing an early warning of potential financial distress. We show that the reporting of an impending derivative loss by a distressed firm can actually lead outsiders to infer that the firm is in a better financial position than what they would have inferred under the silence associated with historical cost accounting. Without the mixed attribute problem, mark‐to‐market accounting would always yield more accurate assessments of the firm's financial position.