[Accounting information plays an important role in a decentralized economy. It is a primary way for managers to make assertions about the past performance, current condition, and future prospects of their firms. The auditing of these accounting disclosures is purported to provide value to the economy for several reasons (Baiman 1979; Baiman et al. 1987; Blazenko and Scott 1986; Evans 1980; Scott 1984). Without accurate firm-specific information, investors may align their portfolios in a less-than-optimal fashion, resulting in an inefficient allocation of resources in the society. The public-good feature of auditing may prevent the less efficient private search for firm-specific information. Additionally, auditing is argued to assuage the divergent preferences of managers and investors. Included in these divergent preferences is managerial motivation to manipulate the accounting information to hide perquisite consumption or imply appropriate production, investment, or financing decisions. Investors anticipate these conflicting goals and price protect themselves, forcing managers to bear the residual loss (Jensen and Meckling 1976). Because of managers' motivation to avoid that loss, auditing can be purchased to provide credibility to managerial disclosures necessary to distinguish among firms of differing quality. With auditing in place, firm managers can reap the benefits of those actions expected to improve the firm's prospects. Research into managerial incentives to disclose and the effects of disclosures on other managerial actions is at an early stage. The analytical assertions of full disclosure when fraudulent disclosures are not possible are well known (Dye 1985; Grossman 1981; Grossman and Hart 1980; Milgrom 1981; Milgrom and Roberts 1986), and the body of experimental research is growing (Forsythe et al. 1989; King and Wallin 1990a, 1991). Only recently has either analytical or experimental research been conducted in environments permitting fraudulent disclosure (Dopuch and King 1991, 1992; Dopuch et al. 1989; Kachelmeier 1991; King and Wallin 1990a, 1990b; Wallin 1990). In particular, progress on the formulation of models of the demand for auditing has only recently been made. These models are argued to be at best embryonic (Baiman 1979; Scott 1984) and have typically ignored the possible effects of other mechanisms that may solve the problems that auditing addresses. An important aspect of this article is an investigation of the effect of legal recourse, which allows investors to sue when disclosures are believed to have been fraudulent. The analysis presented here concludes that the threat of lawsuit will cause less frequent fraudulent reports. Importantly, legal recourse also allows the manager to benefit from costly effort, such that the level of effort expended will be that which maximizes societal benefit. The central purpose of this study is to investigate the demand for auditing in environments both with and without legal recourse. Formal models are developed and tested that investigate the extent to which managers and investors can achieve a cooperative solution when no mechanism exists to aid that cooperation. The analysis and tests are performed in an environment in which the time horizon is not known. This extends the work of Dopuch et al. (1989) by constructing a base-line environment where the demand for auditing is not derived from the backward induction of a single-period equilibrium. Thirty-two experimental markets were conducted. The results show a demand for auditing, regardless of whether legal recourse was present. The availability of either auditing or legal recourse induced a higher level of managerial effort, the highest occurring when both options were available. Both auditing and legal recourse reduced a tendency for investor overbidding, but only legal recourse reduced the proportion of fraudulent disclosures.]

Investigates the demand for auditing in environments both with and without legal recourse. Important role of accounting information in a decentralized economy; Review of related literature; Results showing that there is a demand for disclosure in auditing regardless of whether legal recourse was present.

This paper presents the results of 32 experimental markets designed to test hypotheses based on Wagenhofer's (1990) disclosure model. The model predicts the existence of multiple disclosure equilibria in cases where a manager balances the effects that disclosures can have on two sets of external agents: investors and an opponent. The experimental results support the partial-disclosure equilibrium over the full-disclosure option. Additionally, a lower level of disclosure was observed in those markets in which the discloser repeatedly interacted with information receivers. Lower disclosure reduces the level of proprietary costs which is beneficial to the information sender.

This paper presents the results of 16 laboratory markets designed to test the theoretical assertion that, when disclosures are credible, managers/sellers will fully disclose private information to potential investors/buyers. Sellers are predicted to disclose all information so as not to be classified as having the worst possible information. This experiment manipulated two treatments: the number of disclosure options available to the seller and the buyers' knowledge of those disclosure options. The results show that, after repeated dealings between sellers and buyers, the sellers moved toward full disclosure. Buyers adjusted their bidding strategies in response to the seller's disclosure strategy in all markets except those that had both (1) a large number of disclosure options and (2) no knowledge by buyers of the disclosure options. These results may provide some perspective on the market‐based results that show that investors do not react in a fully skeptical fashion with respect to managerial disclosures. Our results suggest that knowledge of the menu of disclosure options may increase the speed of markets adjusting to disclosures, particularly when the menu of disclosure options is large. Résumé. Les auteurs présentent les résultats de l'étude en laboratoire de seize marchés à partir desquels ils ont voulu vérifier l'affirmation théorique selon laquelle, lorsque l'information communiquée est vraisemblable, les gestionnaires‐vendeurs présentent intégralement l'information privilégiée aux investissieurs‐acheteurs potentiels. La décision des vendeurs de communiquer intégralement l'information serait motivée par leur désir de ne pas laisser supposer que l'information qu'ils possèdent est extrêmement négative. Dans le cadre de cette expérience, les auteurs ont abordé la question sous deux angles: le nombre d'options dont dispose le vendeur en matière de présentation de l'information et la connaissance de ces différentes options chez l'acheteur. Les résultats démontrent qu'après plusieurs séances de négociation entre vendeurs et acheteurs, les vendeurs consentaient à la présentation intégrale de l'information. Les acheteurs adaptaient leur stratégie d'offre en réponse à la stratégie de présentation de l'information du vendeur dans tous les marchés, à l'exception des marchés caractérisés à la fois par 1) un nombre important d'options de présentation de l'information et 2) aucune connaissance, chez les acheteurs, des options de présentation de l'information. Ces résultats pourraient ouvrir certaines perspectives en ce qui a trait aux résultats, fondés sur le marché, qui démontrent que les investisseurs ne mettent pas systématiquement en doute l'information présentée par les gestionnaires. Les résultats de l'étude laissent supposer que la connaissance des différentes options de présentation de l'information peut accélérer l'adaptation des marchés à la présentation de l'information, en particulier lorsque les options de présentation sont nombreuses.

Both theoretical and experimental research has shown that full disclosure of private information will be observed when disclosures are credible. Disclosures are generally considered to be credible when they either are subject to an antifraud rule, are ex post verifiable, or are both. However, little consideration has been given to the individual and interactive effects of these conditions. This paper presents arguments concerning the effects of antifraud rules and ex post verifiability on disclosures of private information and the reaction to those disclosures. It predicts an equilibrium of full disclosure only when an antifraud rule is in effect, independent of the presence or absence of ex post verification. Further, one adverse selection problem is posited to disappear after repeated observations, regardless of antifraud rules or ex post verifiability. These assertions are tested by 20 laboratory experiments, which, in addition, provide insight into the effect of a legal system on disclosures. The results generally support the analytical assertions. Résumé. Les recherches théoriques aussi bien qu'expérimentales ont démontré que la présentation intégrale de l'information à caractère privé est observée lorsque les renseignements fournis sont crédibles. Ces renseignements sont généralement jugés crédibles lorsqu'ils sont assujettis à une règle anti‐fraude, lorsqu'ils peuvent être verifiés ex post ou lorsqu'ils présentent ces deux caractéristiques. Jusqu'à maintenant, cependant, on s'est peu intéressé aux conséquences particulières et interactives de ces caractéristiques. Les auteurs présentent ici leur argumentation au sujet des conséquences des règles anti‐fraude et de la vérifiabilité ex post sur la présentation d'information privée et sur la réaction à la présentation de cette information. Selon eux, l'équilibre de présentation intégrale de l'information n'est atteint que dans le cas où s'applique une règle anti‐fraude, indédependamment de l'existence d'une vérification ex post. Plus encore, ils concluent à la disparition d'un problème de sélection préjudiciable après des observations répétées, peu importe les règles anti‐fraude ou la vérifiabilité ex post. La véracité de ces affirmations est mise à l'épreuve dans le cadre de 20 expériences en laboratoire qui livrent en outre certaines indications relatives à l'incidence d'un système juridique sur la présentation d'information. Les résultats viennent généralement appuyer les hypothèses d'analyse.

In this paper we report the results of experimental markets designed to test a disclosure model based on the models of Dye [1985] and Jung and Kwon [1988]. These authors show that when receivers of information do not know whether senders possess private information, the senders will not fully disclose their private information. Their models were motivated by the discrepancy between the theoretical predictions for voluntary disclosures and empirical results. In the theoretical area, Grossman [1981] and Milgrom [1981] predicted that private information will be fully disclosed when disclosures are credible and receivers know the holder has private information; agents disclose to identify themselves as not possessing the worst possible information. Watts [1977] argued that voluntary disclosure will occur because of market pressures and the threat of regulatory intervention. Beaver [1977; 1988] described how auditing and legal liability may induce full disclosure. Nevertheless, empirical research indicates full disclosure is not always observed (e.g., Penman [1980] and Seligman [1986]).