. This study investigates firms subject to accounting enforcement actions by the Securities and Exchange Commission for alleged violations of Generally Accepted Accounting Principles. We investigate: (i) the extent to which the alleged earnings manipulations can be explained by extant earnings management hypotheses; (ii) the relation between earnings manipulations and weaknesses in firms' internal governance structures; and (iii) the capital market consequences experienced by firms when the alleged earnings manipulations are made public. We find that an important motivation for earnings manipulation is the desire to attract external financing at low cost. We show that this motivation remains significant after controlling for contracting motives proposed in the academic literature. We also find that firms manipulating earnings are: (i) more likely to have boards of directors dominated by management; (ii) more likely to have a Chief Executive Officer who simultaneously serves as Chairman of the Board; (iii) more likely to have a Chief Executive Officer who is also the firm's founder, (iv) less likely to have an audit committee; and (v) less likely to have an outside blockholder. Finally, we document that firms manipulating earnings experience significant increases in their costs of capital when the manipulations are made public.

Resume. Les auteurs analysent les entreprises assujetties aux mesures d'execution prises par la Securities and Exchange Commission dans les cas de presomption de transgression des principes comptables generalement reconnus. Ils s'interessent aux aspects suivants de la question: i) la mesure dans laquelle les presomptions de manipulations des benefices peuvent etre expliquees par les hypotheses existantes de gestion des benefices; ii) la relation entre les manipulations de benefices et les faiblesses des structures de regie interne des entreprises; et iii) la reaction du marche financier a l'endroit des entreprises au sujet desquelles les presomptions de manipulation des benefices sont rendues publiques. Les auteurs constatent qu'un incitatif majeur a la manipulation des benefices est le desir d'obtenir du financement externe a moindre cout. Ils demontrent que cet incitatif demeure important meme apres le controle des motifs contractuels que mettent de l'avant les travaux theoriques. Ils constatent egalement que les entreprises qui manipulent les benefices sont: i) davantage susceptibles d'avoir des conseils d'administration domines par la direction; ii) davantage susceptibles d'avoir un chef de la direction qui joue simultanement le role de president du conseil; iii) davantage susceptibles d'avoir un chef de la direction qui est egalement le fondateur de l'entreprise; iv) moins susceptibles d'avoir un comite de verification; et v) moins susceptibles d'avoir un bloc de titres detenus par un actionnaire exterieur. Enfin, les auteurs etablissent le fait que le cout du capital, pour les entreprises qui manipulent les benefices, enregistre des hausses appreciables lorsque ces manipulations sont rendues publiques.

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Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC*

The author systematically examines one of the important issues of information — establishing the market price. He introduces the concept of «search» — where a buyer wanting to get a better price, is forced to question sellers. The article deals with various aspects of finding the necessary information.

Economics of Information

National Institute of Standards and Technology における超伝導研究及び生活

Researchers have used various measures as indications of "earnings quality" including persistence, accruals, smoothness, timeliness, loss avoidance, investor responsiveness, and external indicators such as restatements and SEC enforcement releases. For each measure, we discuss causes of variation in the measure as well as consequences. We reach no single conclusion on what earnings quality is because "quality" is contingent on the decision context. We also point out that the "quality" of earnings is a function of the firm's fundamental performance. The contribution of a firm's fundamental performance to its earnings quality is suggested as one area for future work.

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Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences

Economics has much to do with incentives--not least, incentives to work hard, to produce quality products, to study, to invest, and to save. Although Adam Smith amply confirmed this more than two hundred years ago in his analysis of sharecropping contracts, only in recent decades has a theory begun to emerge to place the topic at the heart of economic thinking. In this book, Jean-Jacques Laffont and David Martimort present the most thorough yet accessible introduction to incentives theory to date. Central to this theory is a simple question as pivotal to modern-day management as it is to economics research: What makes people act in a particular way in an economic or business situation? In seeking an answer, the authors provide the methodological tools to design institutions that can ensure good incentives for economic agents. This book focuses on the principal-agent model, the "simple" situation where a principal, or company, delegates a task to a single agent through a contract--the essence of management and contract theory. How does the owner or manager of a firm align the objectives of its various members to maximize profits? Following a brief historical overview showing how the problem of incentives has come to the fore in the past two centuries, the authors devote the bulk of their work to exploring principal-agent models and various extensions thereof in light of three types of information problems: adverse selection, moral hazard, and non-verifiability. Offering an unprecedented look at a subject vital to industrial organization, labor economics, and behavioral economics, this book is set to become the definitive resource for students, researchers, and others who might find themselves pondering what contracts, and the incentives they embody, are really all about.

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The Theory of Incentives: The Principal-Agent Model

This article presents an economic model that determines the optimal amount to invest to protect a given set of information. The model takes into account the vulnerability of the information to a security breach and the potential loss should such a breach occur. It is shown that for a given potential loss, a firm should not necessarily focus its investments on information sets with the highest vulnerability. Since extremely vulnerable information sets may be inordinately expensive to protect, a firm may be better off concentrating its efforts on information sets with midrange vulnerabilities. The analysis further suggests that to maximize the expected benefit from investment to protect information, a firm should spend only a small fraction of the expected loss due to a security breach.

The economics of information security investment

The Economics of Information Security Investment.

This study examines the economic effect of information security breaches reported in newspapers or publicly traded US corporations. We find limited evidence of an overall negative stock market reaction to public announcements of information security breaches. However, further investigation reveals that the nature of the breach affects this result. We find a highly significant negative market reaction for information security breaches involving unauthorized access to confidential data, but no significant reaction when the breach does not involve confidential information. Thus, stock market participants appear to discriminate across types of breaches when assessing their economic impact on affected firms. These findings are consistent with the argument that the economic consequences of information security breaches vary according to the nature of the underlying assets affected by the breach.

The economic cost of publicly announced information security breaches: empirical evidence from the stock market

Enterprise risk management and firm performance: A contingency perspective

A new institutional arrangement for regulating utilities is suggested that minimizes the costs of natural monopolies. A mixture of regulation and franchising, the plan draws on the advantages of each and eliminates many of the problems. The proposal allows utilities to set their own price on the basis of demand and marginal-cost projections. Subsidies are provided by the regulatory agency if there is a consumer surplus. The system encourages the utility to select a competitive price and to produce only the amount of service needed. Operating efficiency is encouraged by rewarding cost reductions and discouraging cost overstatement at the rate review. The regulatory agency would not need to take action to bring price and marginal costs into equality. The franchise sale can be made by competitive bidding, in which the bidders would capitalize part or all of the subsidy or the regulatory agency could recover the subsidy in a lump-sum tax on the utility.

Martin P. Loeb

Papers

The economics of information security investment

The Economics of Information Security Investment.

The economic cost of publicly announced information security breaches: empirical evidence from the stock market

Enterprise risk management and firm performance: A contingency perspective

A Decentralized Method for Utility Regulation