This study addresses the relationship between the supply of auditing in the public sector and political competition expected in future elections. Empirical tests that use cross-sectional data from state governments reveal positive correlations between state audit budgets and measures of political competition. These results are consistent with an argument that public officials' incentives to supply auditing arise from contracting between the officials and their supporting interests.

Internal control system, Decision making, Parallel-processing control decisions

[Budget-based compensation arrangements often are used in decentralized organizations to motivate manager decision-makers toward achieving organizational objectives. The use of budgets for this purpose can influence managers' decisions to make discretionary expenditures that yield future benefits. This study analyzes how budget-based compensation influences these decisions. The primary insight is that, if a lump-sum bonus is paid for meeting budgets, then managers prefer more discretionary expenditures when budgets are set at levels relatively difficult to achieve than when budgets are at levels easily attained.]

Budget-based compensation arrangements often are used in decentralized organizations to motivate manager decision-makers toward achieving organizational objectives. The use of budgets for this purpose can influence managers' decisions to make discretionary expenditures that yield future benefits. This study analyzes how budget-based compensation influences these decisions. The primary insight is that, if a lump-sum bonus is paid for meeting budgets, then managers prefer more discretionary expenditures when budgets are set at levels relatively difficult to achieve than when budgets are at levels easily attained.

Investigates whether concern about reporting favorable trend in accounting net income influence decisions to invest in research and development (R&D). Case study of 438 American industrial firms during 1977 to 1987; R&D as a discretionary investment; Analysis of increases and decreases in relative spending for R&D; Factors which influence R&D investments.

Auditing, Bankruptcy, Market reaction, Audit quality

William R. Baber, Eugene H. Brooks, William E. Ricks, An Empirical Investigation of the Market for Audit Services in the Public Sector, Journal of Accounting Research, Vol. 25, No. 2 (Autumn, 1987), pp. 293-305

We condition security price reactions to quarterly earnings announcements on whether firms disclose supplementary balance sheet and/or cashflow information that can be used to estimate the consequences of earnings management. Disclosure of supplementary information is voluntary, and thus, we consider the possibility that firms that disclose balance sheet and/or cashflow information differ systematically from firms that do not disclose. Results indicate that investors discount evidence of earnings management at the disclosure date when supplementary information is disclosed. Such results indicate more informed earnings interpretations of quarterly earnings when firms provide balance sheet and/or cashflow information concurrently.

[This study investigates whether concern about reporting favorable trends in accounting net income influences decisions to invest in research and development (R&D). Using data for 438 U.S. industrial firms during the period 1977-1987, the analysis indicates that relative R&D spending is significantly less when spending jeopardizes the ability to report positive or increasing income in the current period. Unlike related studies that consider choices among alternative accounting practices (DeAngelo 1986; Healy 1985; Liberty and Zimmerman 1986; McNichols and Wilson 1989; Moses 1987), this study focuses on investment decisions as instruments for achieving income objectives. In most instances, choices among accounting practices have no direct cash flow consequences, but changes in R&D spending to satisfy current-period income objectives do alter cash flows. The evidence is consistent with assertions that U.S. manufacturing firms are not competitive internationally in part because U.S. managers are overly concerned about how their R&D investment decisions affect current-period earnings (see, e.g., Markoff 1990). We analyze capital spending to determine whether these R&D reductions reflect differences in investment opportunities or incentives rather than differences in accounting treatment. Unlike the results for R&D, differences in capitalized costs among firms in the sample are not statistically significant. We also consider whether the results can be attributed to accounting-based compensation arrangements. For this purpose, we examine a sample of firms with no accounting-based management compensation contracts in effect during the test period. Results are comparable to those obtained for the entire sample, which is inconsistent with an explanation that the observed differences in R&D spending are attributable only to explicit compensation arrangements. Our results are consistent with conclusions that compliance with SFAS No. 2 (FASB 1974) discouraged investment in R&D (Elliott et. al. 1984; Horwitz and Kolodny 1980). That is, the evidence suggests that managers are more likely to consider current-period income effects when making R&D decisions than when making capital-spending decisions, whose costs are amortized over a number of accounting periods.]

A cross-sectional analysis of cash compensation paid to CEOs of 713 US firms reveals that the sensitivity of compensation to earnings varies directly with earnings persistence. Additional analysis indicates that this sensitivity is greater for cases where executives are approaching retirement. Such evidence suggests the use of earnings persistence to counterbalance adverse consequences of earnings-based contracting with managers who face finite decision horizons.