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Volume 17

Shelf Registered Securities: Is it time to re-evaluate the process?

Stephen Moehrle
University of Missouri-Saint Louis

Jennifer Reynolds-Moehrle
University of Missouri-Saint Louis

Pamela S. Stuerke
University of Rhode Island

Firms that meet certain criteria can register debt or equity securities for issuance any time during the subsequent two years. This process is known as shelf registration. Key shelf registration qualification criteria include $75 million market capitalization held by outsiders, timely SEC filings, investment-grade ratings of debt, no defaults on debt payments, and listing on national stock exchanges. During the last few years, several visible companies have suffered quick financial collapses. Many of these companies had debt securities available for issuance from the shelf at the time of collapse. In this study, we examine shelf registrants to address whether shelf registrants of debt, on average, are riskier firms than those that do not have shelf registrations. Using various measures of risk, we assess the risk profiles of shelf registrants versus non-shelf registrants. We find that shelf registrant firms are more highly leveraged, slightly less profitable, and have greater bankruptcy probability than non-shelf registrant firms. Collectively, these findings raise concerns about the overall safety of shelf registrations, and suggest the need for regulators to reconsider the appropriate qualifications for shelf registration. The findings also suggest that investors and analysts should beware of the additional risk posed by the average firm that has shelf-registered debt securities.


Politically-Connected Firms: Are They Connected to Earnings Opacity?

Ahmed Riahi-Belkaoui
University of Illinois-Chicago

This paper is an investigation of the relationship between earnings opacity in 32 countries and elements of the political order. What the picture shows is a clear manifestation of earnings opacity internationally. What is interesting with this picture is the findings that earnings opacity is positively related to the percentage of politically connected listed firms and negatively related to the connected firms as a percentage of market capitalization and the degree of law enforcement. What is puzzling with this picture is the findings that the level of disclosure, the number of auditors per 100,000 inhabitants, and the adoption of International Accounting Standards (as elements of the accounting order) are not significantly related to earnings opacity internationally. It is the political climate rather than the technical accounting climate that is at the core of accounting quality in general and earnings opacity in particular.

The Effects of Accounting Regulation on Tax Credit Utilization Propensity

Thomas J. Linsmeier
Michigan State University

Thomas J. Carroll
University of Iowa

This research examines whether the anticipated imposition of the deferral method of accounting for the investment tax credit affected investors' perceptions about the propensity of firms to invest in ITC qualifying assets. We find significant negative (positive) abnormal returns associated with events increasing (decreasing) the probability of the mandated accounting change. Additionally, we find a significant association between these returns and variables measuring potential changes in future investment and proximity to debt covenant constraints. These results have implications for policymakers because they indicate that investors expected the proposed accounting regulation to mitigate the stimulative effects of the tax credit.

An Analysis of Restatements on Financial Reporting:
is the Loss of Investor Confidence Justified?

James H. Thompson
Oklahoma City University

Gregory M. Larson
Oklahoma City University

Public confidence in financial statements may be at an all-time low. The bankruptcy of Enron, the largest bankruptcy in United States history, brings into question whether the accounting profession, and the auditing process in particular, protects the users of financial statements. The shower of scandals and earnings restatements makes users skeptical of the financial reporting rules that are supposed to protect the public. In addition, a lack of transparency in reporting followed by restated financial restatements disclosing billions of dollars of omitted liabilities and losses exacerbate this problem.

This paper considers the frequency and nature of Form 8-K reports that are filed with the Securities and Exchange Commission (SEC) by Fortune 500 companies during 2001. This form is used to report the occurrence of any material events or corporate changes which are of importance to investors or security holders and previously have not been reported by the registrant. Information from Form 8-K is analyzed to identify which companies filed 8-K reports, the types of disclosures that are included, industry characteristics of companies that file 8-K reports, whether financial statements were restated as a result of those filings, the reasons that restatements, if any, were required, and the relationship between size of company and number of restatements.

Banking Industry Financial Statement Fraud and the Effects of
Regulation Enforcement and Increased Public Scrutiny

Brian Patrick Green, CPA, Ph.D.
University of Michigan-Dearborn

Alan Reinstein, CPA, D.B.A.
Wayne State University

In October 1987, the chairman of the SEC released his committee's Report of the National Commission on Fraudulent Financial Reporting, stating that "regulations and standards for auditing public companies must be adequate to safeguard … public trust (CFFR p. 5)." Using publicly owned banks and savings & loan institutions as a backdrop, we study the effects of regulation and increased public scrutiny on financial statement fraud. Specifically, we examine how the characteristics of bank fraud have changed over the past two decades. We hypothesize that increased public scrutiny through changes in regulation on banks and savings & loans, as well as general financial statement fraud detection standards have altered fraud strategies. The study further explores key characteristics of management fraud that occur in bank and savings & loan organizations. Results indicate that bank frauds have changed over time, and are now more likely to involve withholding real information than create fictitious information. While the frequency of frauds did not significantly change over time, the magnitude of each fraud event has declined. This may imply that public regulation and scrutiny may have little effect on the frequency of fraud, but does affect fraud strategies.

Corporate Governance Role in Financial Reporting

Zabihollah Rezaee,
Fogelman College of Business and Economics

Reported financial scandals have galvanized considerable interest in and discussion on the role of corporate governance in the financial reporting process. Many factors, including high-profile financial scandals, well-publicized restatements of financial reports, and concerns over auditors’ independence have resulted in loss of investor confidence in financial reports. The Sarbanes-Oxley Act of 2002 (the Act) was passed in response to these financial scandals to reinforce corporate accountability and professional responsibilities, and to rebuild investor confidence. The SEC has issued more than 20 rules to implement provisions of the Act. Other professional organizations (AICPA, NYSE, NASDAQ, AMEX, Conference Board) have issued standards and corporate governance guiding principles to restore public trust in corporations, the capital markets, and the financial reporting process. Mere compliance with these measures may not be adequate in rebuilding investor confidence and public companies should improve their corporate governance structure. This paper introduces a corporate governance structure consisting of seven interrelated mechanisms of oversight, managerial, compliance, audit, advisory, assurance, and monitoring functions. A well-balanced functioning of these seven interrelated functions can produce responsible corporate governance, reliable financial reports, and credible audit services.

Fair Value Capitalization of Mortgage Loan Servicing Rights

Robert J. Cochran
Longwood University

Edward N. Coffman
Virginia Commonwealth University

David W. Harless
Virginia Commonwealth University

This study examines whether the capitalization of mortgage loan servicing rights (MSRs) is consistent with FASB’s objective of fair value accounting. The FASB issued SFAS No. 122, “Accounting for Mortgage Servicing Rights, an amendment of FASB Statement No. 65” with the prescription that the MSRs be capitalized at their fair value. Fair value would imply that only servicing related firm characteristics influence the capitalization of MSRs. This study finds that several non-servicing related firm characteristics also exert a statistically significant influence on the capitalization of MSRs. As such, the evidence suggests that significant segments of the industry may have acted in a way that was at odds with the FASB’s stated objective of fair value capitalization.

Auditor’s Responsibility and Independence: Evidence from China

Z. Jun Lin
The Hong Kong Baptist University, Hong Kong

The auditor’s responsibility and independence are crucial issues underlying the independent auditing function and has significant implications on the development of auditing standards and practices. Through a questionnaire survey, this study investigated auditor’s responsibility and independence from the perspectives of audit beneficiaries and public practitioners in the People’s Republic of China. The results reveal that the role and benefits of public accounting (independent auditing) have been positively recognized by Chinese audit beneficiaries and auditors, and there are increasing demands for expanding the applicability of public accounting in China. However this study obtained substantial evidence on the emergence of the ‘expectation gap’ in China, with respect to audit objectives, auditor’s obligation to detect and report fraud, and third party liability of auditors. In addition, the study found that the majority of audit beneficiaries and auditors are supportive of improving auditor independence by reducing governmental control or intervention and moving towards ‘self-regulation’ of the profession. The causes and practical implications of the study findings are therefore analyzed contextual to the existing practices of public accounting in the changing Chinese social and economic conditions. This study should cast light on understanding of the institutional settings and updated development of independent audits in China and may also serve as an annotation to the recent accounting reform debates in the Western world.

A Study of the Economic Consequences of Regulation FD [Fair Disclosure]

Afshad J. Irani
University of New Hampshire

Irene Karamanou
University of Cyprus

In this paper we examine the market reaction to the events that led to the adoption of Regulation Fair Disclosure (FD). The new regulation requires that if and when a firm discloses material nonpublic information to select individuals like analysts and institutional investors, it must make public announcement of that information immediately if the disclosure was intentional and promptly if it was unintentional. The rule has triggered a tremendous amount of debate as opponents raise the concern that the rule will result in a reduction in the amount and quality of information disseminated to the market. The SEC maintains that the rule will result in fairer markets. The stock market reaction around significant FD events supports the SEC’s position. In particular, firms with poor information environments and greater propensity to selectively disclose information exhibit significantly positive abnormal returns on the first date that major provisions of the expected regulation are made public.

An Exploratory Study of Auditor Perceptions of Sanction Threats

William E. Shafer
Lingnan University

Roselyn E. Morris
Southwest Texas State University

The ongoing debate regarding the desirability of extending certain provisions of the Sarbanes-Oxley Act to auditors of nonpublic companies creates a need for a better understanding of the effectiveness of existing sanctioning mechanisms in the accounting profession. To provide input on this issue, the current paper reports the results of an exploratory study of perceived sanction threats among CPA/auditors employed by small public accounting firms. A survey of AICPA members in public practice was conducted to assess the perceived threat of sanctions for auditor acquiescence in a client earnings manipulation scheme. The results indicate that, prior to the passage of the Sarbanes-Oxley law, CPAs perceived a relatively high threat from many types of professional sanctions, and that most sanction threats appeared to act as a deterrent to fraud. However, the perceived likelihood of criminal conviction and CPA license revocation were relatively low. The findings also indicate that the materiality of the financial statement manipulation had a significant effect on all of the sanction threats examined, and the level of assurance on the financial statements affected perceptions of certain types of sanctions.

The Sarbanes-Oxley Act: Costs and Trade offs relating to International Application and Convergence

Erin Marks
Case Western Reserve University

Demand for international capital increased with widespread privatization efforts in the 1980s and 1990s stemming from the collapse of Communism in the former Soviet Union and Eastern Europe and from economic reform in China, Latin America, and Southeast Asia.

The Sarbanes-Oxley Act, perceived as the most important piece of legislation affecting public companies since the securities acts of the l930s, was enacted in the wake of several public companies and seeks to protect investors by improving corporate disclosures made pursuant to the securities laws. Unlike securities legislation and regulation in the recent past that accommodated or exempted foreign private issuers, the Act largely ignores the variations of foreign securities laws and extends the reach of U.S. law into many aspects of the internal affairs and governance regimes of foreign firms and their auditors. With the passage of the Act, fund sourcing cost-benefit analysis has therefore changed for foreign firms seeking access to U.S. capital markets. The costs associated with a U.S. listing may now seem disproportionate to the benefits. Aspects of this new cost benefit trade off and the implications for international standard setting and convergence are examined in this paper.

The Economic Role of the Audit in Free and Regulated Markets:
A Look Back and a Look Forward

Wanda A. Wallace
College of William and Mary

In 1980, The Economic Role of the Audit in Free and Regulated Markets described market evidence, how the demand for auditing services can be explained and predicted by agency, information, and insurance dimensions, by-products of the audit, the nature of the audit process, and the effects of regulation. In 1987, research since 1980 was described and discussed as to implications for future research. In 2004, the time has arrived to look back and look forward to reassess the body of evidence accumulated since 1987 regarding key sources of demand for the audit, supply issues, and regulatory activities, while offering a roadmap for future inquiry.

Lawyers as Whistle-blowers in a Post Enron World

Robert P. Lawry
Case Western Reserve University

A lawyers claim that the principle of client confidentiality overrides the public’s right to know in the wake of wide-spread and deep corporate malfeasance has raised new awareness and concern. The latest round of this debate began with the passage of the Sarbanes-Oxley Act of 2002. Section 307 of the Act required the Securities and Exchange Commission (SEC) to set forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission. The debate reached at least a temporary resolution in August, 2003, when the American Bar Association (ABA) amended key provisions of its Model Rules of Professional Conduct, conceding after a long and bitter battle, that its own rules had not been helpful in thwarting corporate greed - and that lawyers needed to play a more significant role when their clients defrauded the public out of countless millions of dollars. This review provides perspective on the issue and notes the various options and conditions involving the client confidentiality in financial markets and other legal settings.