Showing papers in "The Accounting Review in 2000"

An Empirical Investigation of an Incentive Plan that Includes Nonfinancial Performance Measures

Abstract: Recent studies report an increasing use of nonfinancial measures such as product quality, customer satisfaction, and market share in performance measurement and compensation systems. A growing literature suggests that because current nonfinancial measures are better predictors of long‐term financial performance than current financial measures, they help refocus managers on the long‐term aspects of their actions. However, little empirical evidence is available on the relation between nonfinancial measures and financial performance, and even less is known about performance impacts of incorporating nonfinancial measures in incentive contracts. Using time‐series data for 72 months from 18 hotels managed by a hospitality firm, this study provides empirical evidence on the behavior of nonfinancial measures and their impact on firm performance. The results indicate that nonfinancial measures of customer satisfaction are significantly associated with future financial performance and contain additional information...

Audit Committee Composition and Auditor Reporting

Abstract: This study examines the relation between the composition of financially distressed firms' audit committees and the likelihood of receiving going‐concern reports For firms experiencing financial distress during 1994, we find that the greater the percentage of affiliated directors on the audit committee, the lower the probability the auditor will issue a going‐concern report These results support regulators' concern about financial‐reporting quality and the recent calls for more independent audit committees

The Balanced Scorecard: Judgmental Effects of Common and Unique Performance Measures

Abstract: The balanced scorecard is a new tool that complements traditional measures of business unit performance. The scorecard contains a diverse set of performance measures, including financial performance, customer relations, internal business processes, and learning and growth. Advocates of the balanced scorecard suggest that each unit in the organization should develop and use its own scorecard, choosing measures that capture the unit's business strategy. Our study examines judgmental effects of the balanced scorecard—specifically, how balanced scorecards that include some measures common to multiple units and other measures that are unique to a particular unit affect superiors' evaluations of that unit's performance. Our test shows that only the common measures affect the superiors' evaluations. We discuss the implications of this result for research and practice.

Investor Sophistication and Patterns in Stock Returns after Earnings Announcements

Abstract: This study tests whether the observed patterns in stock returns after quarterly earnings announcements are related to the proportion of firm shares held by institutional investors, a variable used by prior research to proxy for investor sophistication. Our findings show that the institutional holdings variable is negatively correlated with the observed post‐announcement abnormal returns. Our findings also show that traditional proxies for transaction costs (i.e., trading volume, stock price) as well as firm size have little incremental power to explain post‐announcement abnormal returns when institutional holdings is an explanatory variable. If institutional ownership is a valid proxy for investor sophistication, these findings suggest that the trading activity of unsophisticated investors underlies the predictability of stock returns after earnings announcements. However, tests evaluating the validity of institutional holdings as a proxy for investor sophistication yield only mixed results. This calls fo...

Effects of Comprehensive‐Income Characteristics on Nonprofessional Investors' Judgments: The Role of Financial‐Statement Presentation Format

Abstract: Statement of Financial Accounting Standards (SFAS) No. 130 requires companies to report comprehensive income in a primary financial statement, but allows its presentation in either a statement of comprehensive income or a statement of stockholders' equity (Financial Accounting Standards Board [FASB] 1997). In an experiment, we examine whether and how alternative presentation formats affect nonprofessional investors' processing of comprehensive‐income information, specifically, information disclosing the volatility of unrealized gains on available‐for‐sale marketable securities. The results show that nonprofessional investors' judgments of corporate and management performance reflect the volatility of comprehensive income only when it is presented in a statement of comprehensive income. We provide evidence consistent with our psychology‐based framework that these findings occur because format affects how nonprofessional investors weight comprehensive‐income information and not whether they acquire this inf...

Strategic Benchmarks in Earnings Announcements: The Selective Disclosure of Prior‐Period Earnings Components

Abstract: This paper provides evidence that managers strategically select the prior‐period earnings amount that is used as a benchmark to evaluate current‐period earnings in quarterly earnings announcements. Managers are more likely to separately announce a prior‐period gain from the sale of property, plant, and equipment (PPE) than a loss. This strategy provides the lowest possible benchmark for evaluating current earnings, thereby allowing the manager to highlight the most favorable change in earnings. This strategic disclosure behavior is more likely to occur when it prevents a negative earnings surprise. The observed strategic disclosure decisions are consistent with a conjecture by managers that the nonrecurring nature of the prior‐period gain/loss will be forgotten unless it is separately announced. Consistent with this conjecture, there is some evidence that equity investors, one potential target of strategic reporting, use the benchmark that managers provide in earnings announcements to evaluate current ear...

The Value Relevance of Nonfinancial Measures of Air Pollution in the Electric Utility Industry

Abstract: This study examines the relation between the market value of equity and nonfinancial pollution measures (sulfur dioxide emissions) that capture firms' exposure to future environmental liabilities. ...

The Effects of Audit Quality and Consequence Severity on Juror Evaluations of Auditor Responsibility for Plaintiff Losses

Abstract: This study investigates whether providing higher quality audits increases auditors' chances of avoiding legal liability. Negligence rules hold auditors responsible for plaintiff losses only when the quality of the audit provided fails to meet standards of care. The results of my experiment suggest that the ex post observed consequences of audit failure can affect the standards of care to which jurors hold auditors. Specifically, participants serving in the role of jurors assessed higher standards of care for auditors when the consequences of audit failure were more severe. Furthermore, when the consequences of audit failure were more severe, participants' evaluations of the auditor did not depend on the quality of the audit provided—auditors who provided higher quality audits were evaluated just as negatively as those who provided lower quality audits. In contrast, when audit failure led to only moderately negative consequences, auditors who provided higher quality audits received more favorable evaluatio...

Does Mandated Audit Communication Reduce Opportunistic Corrections to Manage Earnings to Forecasts

Abstract: This paper reports two experiments in which Big 5 audit managers estimate reported (audited) earnings conditional on analysts' consensus forecast, auditing standards, and auditor discovery of a quantitatively immaterial earnings overstatement. We find that auditors judge overstatement correction less likely if it would cause a missed forecast, even for objectively measured misstatements. This behavior is consistent with SEC Chairman Levitt's concerns about opportunistic corrections to manage earnings to forecasts. Also, SAS No. 89's mandated representations and communications do not increase corrections that would cause a missed forecast, indicating that the Auditing Standards Board has limited ability to reduce opportunistic corrections through such regulations.

The Effect of Incentive Contracts on Learning and Performance

Abstract: This paper reports the results of an experiment that examines how incentive‐based compensation contracts compare to flat‐wage compensation contracts in motivating individual learning and performance. I use a multiperiod cognitive task where the accounting system generates information (feedback) that has both a contracting role and a belief‐revision role. The results suggest that incentives enhance performance and the rate of improvement in performance by increasing both: (1) the amount of time participants devoted to the task, and (2) participants' analysis and use of information. Further, I find evidence that incentives improve performance only after considerable feedback and experience, which may help explain why many prior one‐shot decision‐making experiments show no incentive effects. Collectively, the results suggest that incentives induce individuals to work longer and smarter, thereby increasing the likelihood that they will develop and use the innovative strategies frequently required to perform w...

Budgeting: An Experimental Investigation of the Effects of Negotiation

Abstract: Despite the common use of negotiations to set budgets in practice, accounting research has focused primarily on budgets set unilaterally by subordinates, while goal‐setting research in management has focused primarily on budgets set unilaterally by superiors. In addition, budgeting research in accounting has focused almost exclusively on the planning aspects of budgets to the exclusion of their motivational aspects. This study complements prior research in two ways. First, the study examines how budgets and the economic consequences of the budget‐setting process differ when budgets are set through a negotiation process vs. when set unilaterally. The study also considers factors associated with negotiation agreement and the relation between agreement and the economic consequences of negotiated budgets. Second, the economic consequences examined are budgetary slack and subordinate performance, allowing us to address the trade‐offs between the planning and motivational aspects of budgets. Negotiated budgets ...

Disclosure Effects in the Laboratory: Liquidity, Depth, and the Cost of Capital

Abstract: Greater disclosure quality leads to higher prices and greater liquidity in a laboratory financial market, and these effects are stronger when investors face the risk of unpredictable demand shocks. These results are consistent with a broad class of theoretical and empirical studies. Disclosure has larger effects on prices and liquidity at greater market depths. We conclude that archival studies looking only at quoted transaction prices and spreads (which typically pertain to small transactions) may underestimate the potential importance of disclosure on larger transactions that occur at greater market depths.

Purchase, Pooling, and Equity Analysts' Valuation Judgments

Abstract: We provide evidence that analysts' stock‐price judgments depend on (1) the method of accounting for a business combination and (2) the number of years that have elapsed since the business combinati...

Capital Gains and Dividend Taxes in Firm Valuation: Evidence of Triple Taxation

Abstract: Although firms account for entity‐level taxes, they do not account for shareholder‐level capital gains and dividend taxes. To account for these proprietary‐level taxes, we add them to a residual‐income equity valuation model. Empirical analysis supports the model's predictions. First, both capital gains and dividend taxes reduce investors' implicit valuation of the reinvested portion of earnings. Second, dividend taxes reduce the valuation of the portion of earnings distributed as dividends, but capital gains taxes do not. Third, dividend taxes reduce the valuation of retained earnings equity, but again, capital gains taxes do not. These findings suggest that investors implicitly extend entity‐level accounting to the proprietary level when they value the firm. The findings also suggest that when fully accounting for the effects of implicit dividend taxes, reinvested earnings appear to be subject to three levels of taxation—corporate, dividend, and capital gains taxes. Paying earnings out as dividends elim...

Valuation of the Firm in the Presence of Temporary Book‐Tax Differences: The Role of Deferred Tax Assets and Liabilities

Abstract: This study uses an analytical model to investigate the value of the firm when there are temporary differences between when revenue and expense items are recognized for tax‐ and financial‐reporting purposes. The model shows that deferred tax assets and liabilities transform book values of underlying liabilities and assets into estimates of the after‐tax cash flows on which the firm's market value is based. The analysis shows that if tax deductions are taken on a cash basis, and if the underlying assets and liabilities are recorded at the present value of their associated future cash flows, then the value of deferred tax assets and deferred tax liabilities is their recorded amount, regardless of when the asset will be realized or when the liability will reverse. If tax deductions are not taken when the expenditure is made (e.g., depreciation) or if underlying assets and liabilities are recorded at more than the present value of their associated future cash flows (e.g., warranty liabilities), then the market...

Tax holidays and tax noncompliance : an empirical study of corporate tax audits in China's developing economy

Abstract: Many developing economies use tax holidays to attract foreign investment by providing a limited period of tax exemptions and reductions for qualified investors. This paper investigates the effect of tax holidays on foreign investors' tax noncompliance behavior in China's developing economy. We measure noncompliance in terms of tax audit adjustments the Chinese tax authorities require in response to avoidance and evasion. The results indicate that a company's tax‐holiday position affects noncompliance. Companies are least compliant before entering a tax holiday, and most compliant while in a tax‐exemption period. In addition, domestic market‐oriented companies, service‐oriented companies, and joint ventures are less compliant than export‐oriented companies, manufacturing‐oriented companies, and wholly foreign‐owned enterprises, respectively. Our evidence is relevant to policymakers designing tax incentives to attract foreign investors. Our evidence on noncompliance should also help tax authorities and fiel...

Rate Regulation, Competition, and Loss Reserve Discounting by Property-Casualty Insurers

Abstract: This study examines whether the reported loss reserves of property‐casualty insurers contain an implicit discount for the time value of money Reporting the present value of loss reserves enables insurers to justify the competitive level of insurance premiums to regulators The evidence indicates that there is a positive and significant discount rate implicit in the relation between reported loss reserves and expected future claim payments Moreover, insurers subject to relatively stringent rate regulation discount to a greater extent than do other insurers The results also suggest that implicit discounting is distinct from solvency and tax motives to exercise discretion over the loss reserve

An Experimental Investigation of Auditors' Liability: Implications for Social Welfare and Exploration of Deviations from Theoretical Predictions

Abstract: This paper reports the results of an experiment designed to investigate how legal regimes affect social welfare. We investigate four legal regimes, each consisting of a liability rule (strict or negligence) and a damage measure (out‐of‐pocket or independent‐of‐investment). The results of the experiment are for the most part consistent with the qualitative predictions of Schwartz's (1997) model; however, subjects' actual choices deviate from the point predictions of the model. We explore whether these deviations arise because: (1) subjects form faulty anticipations of their counterparts' actions and/or (2) subjects do not choose the optimal responses given their anticipations. We find that subjects behave differently under the four regimes in terms of anticipation errors and departures from best responses. For example, subjects playing the role of auditors anticipate investments most accurately under the regime with strict liability combined with out‐of‐pocket damages, but are least likely to choose the op...