The Market Perception of Corporate Claims
This paper examines the economic substance of a broad range of securities by investigating their association with systematic risk and prices. The analysis is motivated by continuing security innovation and its impact on hybrid security reporting. Based on a sample of 2,617 firms that reported minority interests or preferred stock during 1993-1997, the results indicate that redeemable preferred securities (including trust preferred stock) are not viewed by the market as either debt or equity, suggesting dichotomous security classification may lack representational faithfulness. Inconsistent with their treatment in the financial statements, non-redeemable preferred stock and minority interests are viewed as debt-like and equity-like respectively. Additional analyses document that the systematic risk and pricing results vary based on firm size, performance, and bond rating.
An Analysis of the Accounting Profession's Oligarchy: The Auditing Standards Board
John E. McEnroe
Marshall K. Pitman
The Auditing Standards Board (ASB), a committee of the American Institute of Certified Public Accountants (AICPA) has been granted the authority to promulgate auditing standards in the United States. Unlike the members of the Financial Accounting Standards Board (FASB), ASB members are all AICPA volunteers and are not required to sever ties with their employers. In its present mode of operation, the ASB brings in revenue for the exclusive benefit of members of the profession as well as creating a legal defense in the case of a lawsuit arising from an audit. Abbott (1988) refers to this as a jurisdictional claim. Over the past quarter of a century, there have been many critics of the ASB, but the accounting profession resisted making any significant changes in either the Board's composition or its operations. Given this background, this paper involves the following sections: a review of the auditing standard-setting process, criticisms and recommendations for a change in the ASB's operations, benefits to the profession of the current structure, and a call for a restructuring of the ASB in light of the recently signed Sarbanes-Oxley Act of 2002.
THE ORIGINS OF THE SEC'S POSITION ON AUDITOR INDEPENDENCE AND MANAGEMENT RESPONSIBILITY FOR FINANCIAL REPORTS
Contemporary legislation recently enacted by Congress seeks to reinforce the responsibility for financial statements with the financial officers and executives of SEC registrants. This paper reviews the development of SEC policy and case law regarding the established and traditional view of such responsibility as it affects auditors and financial officers and executives of these companies. The Cornucopia Gold Mines (1936) and Interstate Hosiery Mills (1939) actions reflect the origins of long standing views as to the role and responsibility of executives and auditors.
Auditor Liability: A Review of Recent Cases Involving
Generally Accepted Accounting Principles
Scot P. Gormley, Thomas M. Porcano, Wayne Staton
The Securities and Exchange Commission (SEC), the primary regulatory body that oversees the operations of the financial markets, requires that publicly-traded companies be subject to an annual audit¾a set of procedures designed to determine whether a firm's financial statements fairly comply with generally accepted accounting principles (GAAP). When performing audits, auditors use generally accepted auditing standards (GAAS) as guidelines in determining the amount of evidence to gather and to what degree the client's accounting system may be relied upon.
Since investors and their advisors rely on audited financial statements to make investment decisions, auditors have a significant impact on the financial community and capital markets. Accordingly, auditors must be diligent in the execution of their duties. However, notwithstanding the high level of care exercised by most auditors, sometimes misleading or erroneous information is released to the investing public, and this paper focuses on recent case law dealing with the auditor liability that attaches in such situations.
Professional Regulation and Labor Market
This study examines state regulations in the accounting profession and their impact on earnings and employment choices of accountants. It is based on U.S. Current Population Surveys from 1984 to 2000. The results of this study demonstrate that provisions for quality review, limited liability and continuing class of accountants appear to have induced entry of accountants into professional services. In addition, quality review and limited liability provisions appear to be positively associated with self-employment. Moreover, increased entry into the professional services sector appears to have exerted some competitive pressure on earnings.
The Economic Theory of Regulation and
The economic theory of regulation (ETR) holds that various groups will attempt to influence the regulatory process to promote their self-interest, and that politicians respond most favorably to those groups that can assist them in their careers. Prior research has used ETR to explain the variation in accounting regulations across states. This paper extends that work by examining, in depth, a recently completed sunset review process in one state. Various parties, including government officials, the State Board of Accountancy, the State Society of CPAs, and educators, were involved in this process. We conclude, as indicated by ETR, that the positions of these groups appear to be consistent with their respective self-interests. Also consistent with ETR, several factors suggest that the regulated profession (CPAs) has successfully captured the first level regulators (the State Board). In addition, we conclude that the political ideology of the governor was an important determinant of the sunset review's outcome.
The Impact of Statement of Financial Accounting Standard Number 123 on
Stock options have become a significant component of compensation for top executives. However, the appropriate method of accounting for stock options has been the subject of much debate. We document the history and current status of accounting for stock options including the issuance of Statement of Financial Accounting Standard No. 123, Accounting for Stock Based Compensation (SFAS 123). We then examine the stock market reaction to six events leading to the adoption of SFAS 123. The results from this test show that the market reacted negatively to the possibility that a standard would be adopted requiring stock options to be expensed. We also document that the magnitude of the market reaction is affected by debt contracting costs and political costs. These results suggest that the market reduces the value of firms who might violate their debt covenants and that firms with higher income are more subject to regulation by political entities. These results can add to the debate about accounting for stock options that has been revived in light of the Enron, WorldCom, and Tyco accounting scandals.
GAAP: A Regulatory Tool to Manage Healthcare
How effectively can government use accounting measures in a privatization scenario, where public duties are entrusted to non-government organizations? Texas Senate Bill 427 establishes minimal levels of charity care, using accounting measures, that Texas not-for-profit hospitals must provide. We test how this legislation influenced (1) not-for-profit hospitals' charity care spending, and (2) the distribution of charity care among not-for-profit hospitals. We provide evidence suggesting that the legislation led to improved tracking of charity care but only nominally increased spending on charity care. Furthermore, we find that the burden of charity care may have shifted from the hospitals which were spending the most on charity to those that were spending less, so that, in response to the legislation, some hospitals apparently reduced their charity care spending. Finally, we document anecdotal evidence indicating that, when creating and enforcing accounting-based standards, unfamiliarity with accounting techniques may encumber legislators' efforts.
Improving Auditor Independence - The Principles vs. Standards Debate:
In response to reported corporate irregularities, in 2002 Congress and the General Accounting Office (GAO) addressed the issue of auditor independence in ways which continue to contrast the approaches identified as "principles vs. standards." Non-audit services are included in the revisions because of concerns that auditor independence, in fact or appearance, could be impaired when the auditor also provides their client with non-audit services and that even a perceived lack of independence could cause investors to be less likely to invest in a company's securities. This paper discusses differences in the revised regulations and reports the results of an experiment examining the impact of non-audit services on professional investors' judgments with implications for the regulations' relative effectiveness. The results indicate that the participants' stock recommendations did not vary between outsourced internal audit and mergers and acquisitions non-audit services. Both were considered to impair independence, supporting the GAO's principles-based approach to auditor independence. Further, the participants issued about twice as many "sell" stock recommendations when the non-audit services were provided by an associated entity than by either the accounting firm itself or an unrelated firm, supporting the GAO's standard for, and the SEC's expected administrative treatment of, associated entities.
The Association Between Auditor Industry
The purpose of this paper is to investigate if clients of industry-specialist auditors are less likely to manage earnings relative to clients of non-specialist auditors. This paper focuses on two specific contexts: (1) when firms are highly leveraged, and (2) when the accrual generating ability of the firm is substantial. Using discretionary accruals as a proxy for earnings management, this study found that there is less earnings management for specialist clients, consistent with industry-specialists constraining earnings management when the accrual generating ability of the firm is substantial. Such an association was not apparent for highly leveraged firms, however. Prior research indicates that the quality of an audit is a function of the size of the auditor. The results of this paper indicate that quality of the audit is partly a function of auditor industry expertise as well. Such an association is, however, context-specific.
Concurring Partner Review: Does Involvement in
Robert J. Ramsay
This study examines the effect of prior involvement in audit planning on concurring partners' willingness to agree with an engagement team's conclusion. Thirty-six audit partners from eight CPA firms in the U.S. participated in the study. Some of these partners played a role in audit planning for bad debt allowance, while others did not.
Our results indicated that the degree of concurring partners' agreement with an engagement team's conclusion was unaffected by prior involvement in audit planning. We also obtained data that revealed general characteristics regarding the activities performed as part of concurring partner reviews.
LOCAL GOVERNMENT AUDIT PROCUREMENT REQUIREMENTS,
Laurence E. Johnson
Robert J. Freeman
Stephen P. Davies
For several years, Florida local governments have been subject to laws intended to enhance audit quality. Hackenbrack et al . (2000) report that the fiscal 1992 audit fees of Florida local governments exceed those of local governments in surrounding states and conclude that Florida's audit procurement requirements created an "audit market climate" that promotes audit quality. We extend Hackenbrack et al .'s research by comparing the audit effort (hours) and audit fees associated with selected Florida local governments with the audit effort and fees associated with a nationwide sample of local governments in states other than Florida for fiscal 1996. We find that both audit hours and audit fees are higher in Florida vis-a-vis those of other local governments. Our results provide further empirical support for the premise that Florida=s local government audit procurement laws represent sound public policy.
An Experimental Examination of the Peer Review Process
Jeff L. Payne
The recent financial failure of several multi-billion dollar publicly traded companies has dramatically increased financial statement users concerns about the quality of financial reporting. In response, President Bush recently signed the Sarbanes-Oxley Act, which significantly increases regulatory oversight of the financial reporting and auditing processes. A section of the Act creates an inspection process for firms that provide audits to publicly traded companies. This research provides an examination of the timing of the current peer review and recently enacted inspection processes. The stated goal of these review processes is to increase the value of accounting services by improving quality. Utilizing the laboratory markets methodology, this paper examines the influence of a peer review type process on the provision of audit quality, specifically examining the periodicity of review process. The results indicate a timely review process increases audit quality.
Deregulation of the Private Corporation Audit in Canada:
Morina Rennie, David Senkow, and Richard Rennie,
Jonathan Wong, C.A., Vancouver
We examine the deregulation of an audit requirement for a group of private Canadian companies. In particular, we study the circumstances surrounding this deregulation and the impact of the change in legislation on the subsequent purchase of audit services. The study was done through the examination of archival documents relating to the change to the legislation, together with a survey of Chief Financial Officers of companies that were affected by this change in legislation.
We found that the federal government justified the change as a response to a perceived threat to the viability of the federal incorporation legislation, and that the government pursued this course in spite of the lobbying efforts of representatives from the accounting profession. Approximately one-quarter of the companies whose audit requirement was deregulated, purchased lesser levels of assurance services or no assurance services after the change in legislation.
SFAS 95 Cash Flow Information and Securities Valuation
Sulaiman A. Alaraini
Joanne P. Healy
Ray G. Stephens
Recipient - The Braden Award 200l-2
This presentation delivered by Donald J. Kirk on November 27, 2001 is one of the few public addresses made by a member of the Public Oversight Board prior to the disclosures and subsequent public debate which preceded action by the members of the Board to discontinue its operations. In his remarks Mr. Kirk addresses three issues which continue to be central to the debate and the concerns affecting the role of auditors in the contemporary capital market: 1. independence and scope of services of the auditing firms; 2. the recommendations of the Panel on Audit Effectiveness; and 3. fraudulent financial reporting.
The "Information Right" and the CPA Profession
Gary J. Previts
CASE WESTERN RESERVE UNIVERSITY
A profession is a skilled association of individuals who profess to serve the public interest above their own self-interest. In the market driven, versus mandate driven accountancy world of the l980s and l990s where competition was unleashed at the direction of an AICPA-FTC accord, the orientation was top line - expand the use of skill sets to meet market demands for the knowledge services related thereto. As the Y2K bubble burst and 2001-2 events unfolded, much as the survivors of a shipwreck, individual CPAs, their leadership and practice units are picking through the philosophical flotsam and jetsam strewn about their environment. Serving the public's information right is identified as the proper orientation for our profession's domain.