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Volume 05

Revisions in Disclosure Rules:
An Examination of Disclosure Costs for U. S. Banks

Terry Warfield

This research investigates proprietary disclosure costs associated with the mandated release of financial information by firm. These disclosure costs can arise if firms are required to release proprietary information which could be used by other firms to gain a competitive advantage relative to the releasing firm. While considerable accounting research has documented the informational usefulness of financial accounting data to investors and creditors, relatively little evidence exists on the costs of disclosing these data.

This research tests for proprietary disclosure costs in the banking industry. In 1983, U. S. banks were required by the SEC and bank regulators to provide substantial amounts of new detail concerning their foreign lending and investing activities. Since the new detailed information might be useful to competitors, this change presents an opportunity to test for proprietary disclosure effects for the U. S. banks. These effects are measured by using the security returns of affected U. S. banks as surrogates for the future cash flow effects (disclosure costs) of this regulatory disclosure change. The security return evidence documented at the time when the banks first released the new proprietary data supports the existence of disclosure costs for banks and provides evidence on factors beyond information content which may be relevant to disclosure policy deliberations. Volume 5, 1991, pgs. 3-30.

The SEC and the Globalization of Financial Markets

Sharokh M. Saudagaran

This paper examines the SEC's response to the increasing pressure to streamline its disclosure requirements in order to make foreign securities more accessible to U. S. investors as well as to make U. S. stock exchange more competitive in the global arena. It provides an overview of the steps taken by the SEC since the early 1980s that are aimed at reducing barriers to international capital formation and facilitating access to U. S. securities markets by foreign issuers. Included among these initiatives is the SEC's participation in multilateral organizations such as IOSCO. Further empirical research is needed to study the effects of these actions taken by the SEC. Volume 5, 1991, pgs. 31-53.

The Market Structure of Auditing in Australia:
The Role of Industry Specialization

Allen T. Craswell and Stephen L. Taylor

The perceived dominance of the accounting profession by the largest audit firms provides frequent focus for critics of the accounting profession in the United States, Australia, and elsewhere. Criticism of this type is often based on the presumption that concentration is associated with monopoly power, which can lead to exploitation by suppliers. The aim of this paper is to re-examine concentration in the Australian audit market by investigating the degree of client-industry variation in measures of concentration. Using comprehensive statutory disclosures for the Australian audit market, assessment of supplier concentration is shown to be sensitive to the basis upon which concentration is measured. More importantly, variations in individual audit firms' market shares across different client groups are found to be consistent with a derived demand for industry specialization by audit firms. Not only are simple measures of overall supplier concentration sensitive to the definition of activity base, but they also disguise considerable variation across client groups. Evidence from the Australian market calls into question the presumption of homogeneity among large audit firms as well as the usefulness of analysis directed toward the aggregate market share of these large firms. Such evidence is relevant in assessing criticisms of the market structure of auditing which typically focuses on aggregate market shares.

Regulatory agencies such as the United States Federal Trade Commission and the Australian Trade Practices Commission assume that industry concentration is positively associated with monopoly or market power which can be exploited to obtain above normal returns. However, such agencies frequently overlook the positive impact of higher concentration on costs and product quality. An increase in market concentration may be associated with lower costs resulting from scale economies and/or an increase in product quality resulting from specialization. In such circumstances, consumers as well as producers may benefit from higher levels of concentration.

The market for auditing is characterized by an increasing domination by the large international accounting firms. Whether this trend toward greater concentration is to be encouraged or discouraged depends upon whether expected benefits dominate potential collusive effects. Market power is typically assumed by regulators as an explanation for concentrated market structures [Lynk, 1984] even though explanations consistent with net consumer benefit can also be offered. In the market for audit services, a high degree of overall concentration among the largest suppliers may be representative of a market structure which accurately reflects consumer demand. However, acceptance of this proposition suggests recognition of a derived demand for auditing, in conjunction with evidence about the structure of the audit market.

More than 30 years ago, Mauts and Sharaf [1961] drew attention to increasing concentration among suppliers of audit services in the United States. More recently, evidence of increasing supplier concentration for audits of large, publicly listed corporations in the United States has been presented by Fried and Schiff [1981] and McConnel [1986]. Similar evidence has been reported for Australia by Craswell [1988] and for the United Kingdom by Moizer and Turley [1987].

Concentration among the largest suppliers of auditing has also received considerable political attention. Depot and Simunic [1982] note an increasing reliance on the "concentration doctrine" by critics of the accounting profession. By way of response, they argue that many of the criticisms, including an alleged lack of competition, can be answered in terms of product differentiation among suppliers. The primary focus of empirical tests of product differentiation among audit firms has been on the quality diminution with Big Eight auditors being regarded as a homogeneous high quality group and with quality differences between this group and other firms being used as an explanation for aggregate market shares. The aim in this paper is to provide additional evidence on the market structure of auditing by examining market share measures for individual audit firms across defined sets of clients grouped by industry. Variations in these market shares would be consistent with client-industry specialization which could be interpreted as an additional component of audit quality. The statutory disclosure of fee data for audit and non-audit services makes the Australian audit market ideal for this type of analysis. As observed by Pound and Francis [1981, p. 354], the accounting profession in Australia operates within a social and economic environment similar to that of the United States with auditing and ethical standards exhibiting a strong degree of overlap and Australian accounting firms having strong affiliations with U. S. firms. Moreover, Australian evidence of perceived audit quality differences has been shown to be consistent with that reported for the U. S. market [Francis and Stokes, 1986]. A comparison of evidence of Australian market structure with conventional wisdom is likely to be relevant when considering any proposed restrictions in other, similar markets.

In the following section of this paper, arguments and evidence about concentration among suppliers of auditing are reviewed. Although the Big Eight have a large share of the audit market for listed companies, variations in market share across different types of client groups are expected. Such variation would support the view that it is relatively naive to focus on the aggregate market share of the Big Eight when assessing the structure of the audit market. The second section offers an explanation of why variation in market share may exist across client groups. This evidence reflects the relationship between industry specialization by auditors and product differentiation. In the third section, evidence of audit firms' market shares across client-industry grouping is presented and interpreted. Conclusions and suggestions for extensions to the research are given in the final section. Volume 5, 1991, pgs. 55-77.

Victor Posner and the SEC:
The Raider and the Regulator

William E. Paxton

What the regulatory commissions are trying to do is difficult to discover; what effect these commission, actually have is, to a large extent, unknown; when it can be discovered, it is often absurd [McCraw, 1975]. Many see corporate "raiders" as vultures enriching themselves using fair means or foul at the expense of companies, their employees and society . Victor Posner is acknowledged to be one of the earliest, most creative and most feared of the raiders. He has been widely criticized in his career, which spans the era of modern takeovers.

As the primary regulatory body charged with promoting fair and efficient capital markets in the public interest, the SEC is caught between constituencies that feel the SEC should prevent harmful raider activity and the objectives of maintaining a free market system and property rights of all. The opening quotation confirms that regulatory commissions are not free from criticism either. This paper examines some of the major issues involved in regulation of the raider phenomenon by considering the interaction between Victor Posner, a prototypical raider, and the SEC. Volume 5, 1991, pgs. 79-98.

An Empirical Analysis of the Effects of
NCGA Statement 3 on Entity Reporting by Cities

James M. Patton, Robert W. Parry, Jr.,
James M. Lahey, and Kenneth R. Schermann

The Governmental Accounting Standards Board (GASB) is currently reconsidering the entity definition to be used in determining the scope of activities to include in state and local government financial reports. This is an important financial accounting issue because the content of governmental accounting reports can be significantly affected by the scope of activities included. It is also an important regulation and public policy issue because the entity scope definition can affect the public's perception of the activities for which officials should be held responsible. The purpose of this paper is to describe current entity reporting practices of cities and to analyze the impact of NCGA Statement 3 by comparing reports prepared before and after the issuance of Statement 3. The focus is on (1) Potential Component Units (PCUs) considered for inclusion, (2) the PCUs actually included in the financial statements, (3) the discussion of criteria employed to define the municipal entity, and (4) the relative importance of these criteria.

Our empirical results show that although about the same number of PCUs were considered in pre- and post-NCGA Statement 3 reports, more PCUs were actually included in post-NCGA 3 reports than in pre-NCGA 3 reports. Discussion of the entity issue was significantly expanded in post- vs. pre-reports and the criteria cited shifted to those specified in NCGA 3. Finally, financial criteria and oversight relationships were both frequently cited in the discussion explaining PCU inclusion and exclusion. We conclude that NCGA 3 has had a significant impact on the form and substance of municipal financial reports in the direction intended by the NCGA.

For many years, state and local government financial accounting standards provided little explicit guidance for determining the types of functions, organizations, and activities that should be included in governments' annual reports. The entity issue is an important financial accounting issue because the content of governmental accounting reports can be significantly affected by the scope of activities included. It is also an important regulation and public policy issue because the entity scope definition can affect the public's perceptions of the activities for which officials should be held responsible.

In an effort to improve the comparability and comprehensiveness of financial reports and to help interested users identify operations for which government officials were responsible, the National Council on Governmental Accounting (NCGA) issued Statement 3: Defining the Governmental Reporting Entity in 1981, effective for all financial reports issued after December 31, 1982. The entity definition promulgated in Statement 3 was clarified in Statement 7 [NCGA, 1984] and in interpretation 7 [NCGA, 1983]. All three of these entity-related NCGA standards have been incorporated in Section 2100 of GASB Codification [GASB, 1990a].

The purpose of this paper is to describe present entity reporting practices and to analyze the impact of NCGA Statement 3 by comparing reports prepared before and after the issuance of Statement 3. The focus is on (1) the Potential Component Units (PCUs) considered for inclusion, (2) the PCUs actually included in the financial statements, (3) the discussion of criteria employed to define the municipal entity, and (4) the relative importance of these criteria. This empirical evidence should be useful to the Government Accounting Standards Board (GASB) in its current reconsideration of the entity issue because it can help focus attention on (a) particular types of PCUs that might be considered for inclusion by governments and (b) the actual effects of changing disclosure requirements. [GASB, 1990b]. Volume 5, 1991, pgs. 99-119.

Managerial Evaluation of the Internal Control Structure

Barbara Apostolou and Nicholas G. Apostolou

The Securities and Exchange Commission (SEC) recently proposed that managers of public companies prepare a Report Form 10-K [SEC, 1988]. Among other things, this proposal would require managers to report on their evaluation of the effectiveness of the internal control structure of their firm. The American Institute of the Certified Public Accountants (AICPA) initially challenged this requirement based on the presumption that managers cannot perform such an evaluation in the absence of the standard criteria. This paper reports the results of a study that examined how 52 managers ranked the importance of the elements of internal control structure using the Analytical Hierarchy Process. The extent of agreement among the managers was measured as well. The results offer strong support for the stance taken by the AICPA. Finally, in view of the finking that managers appear to need standard evaluation criteria for purposes of the SEC's proposed report, a model using the Analytical Hierarchy Process is suggested to assist managers in this task. Volume 5, 1991, pgs. 121-143.

New Evidence on Exploratory Aggressiveness
for Accounting Regulators in the Oil and Gas Industry

Marilyn Magee Greenstein and Roland Lipka

Since the mid-1950s, oil and gas firms have utilized two very different methods of accounting: the successful efforts (SE) method and the full cost (FC) method. Full cost firms have claimed in testimony before the SEC and U. S. Department of Energy that they are more aggressive in exploration than their successful efforts counterparts and, as a result, should be allowed to use different accounting techniques. The purpose of this study is to investigate whether they are indeed different. By using a combination of publicly available data and a questionnaire, we are able to develop three alternative measures of aggressiveness. The results reveal that no significant differences exist in two of our measures of exploratory aggressiveness: drilling depths and participation in farm-out agreements. In contrast to prior research on exploratory aggressiveness, highly significant differences are found, however, for a third measure: the proportion of found reserves to ending reserve balances.

The Financial Accounting Standards Board and the SEC have attempted to eliminate the full cost method of accounting for rediscovery exploration costs on the basis that it does not adequately report the underlying economic process. Apparently, these regulators are "user primacy" standard setters, who choose to satisfy the needs of users of the financial reports of oil and gas producers [Gaa, 1986]. In response to the regulators' actions, full cost companies incurred substantial lobbying costs to preserve the method. Consequently, although the regulators attempted to set user primacy based financial reporting standards, the full cost suppliers prevailed because they benefited from the fortuitous timing of distress in the industry and administration committed to energy independence. Oil prices by 1986 had fallen so precipitously that there was no undersell of anti-oil and gas movements in the Congress. The Reagan Administration was on record that it proposed to have the United States independent of foreign oil. Any government actions that might disturb the industry, therefore, would be unacceptable. But the SEC, perhaps unaware of the Administration's resolve, again proposed elimination of the full cost method in 1986. Fearful that the SEC's action might disturb output, the Reagan Administration (Departments of the Interior and Energy) quickly intervened and pressured the SEC to reverse itself within one week [Wall Street Journal, 1986].

In addition, resolution of the issue of uniformity or diversity of accounting methods eluded the regulators because the regulators themselves did not agree. For example, the U. S. Department of Justice adopted a contrarious position by arguing that: Uniformity as a goal can only claim superiority where like entities are being compared. If two entities or groups of entities were significantly dissimilar, attempts to draw simple accounting comparisons would only confuse the analysis. [United States Department of Justice, 1978, p. 18].

Hence, the issue that the regulators must solve is whether there are fundamental differences and whether the differences justify different accounting methods. If differences do not exist, we can reject the full cost arguments for diversity. However, if differences do exist, diversity does not necessarily follow. Thus, before they act, conclusive evidence is needed.

While previous research has examined the issue of differences in aggressiveness, the results are inconclusive, partly due to the fact that it is difficult for publicly reported measures to avoid confounding of various market forces on the data. Hence, this study explores for differences by using alternative measures of aggressiveness that use more controlled data for tests of the assertion that full Costers are more aggressive. Therefore, the tests may help to resolve whether the full costers' assertion is true.

Thus, the purpose of this study is to extend existing research by examining three: (1) the decision to start-up or to continue exploration; (2) the willingness to engage in farm-out agreements; and (3) the degree of reliance on purchased reserves and discovered reserves. Data for the first two measures are obtained through a survey instrument. The source for the third measure is the annual report (or 10-K). Hence, our principal contributions are: the use of industry experts for the development of multiple surrogates to measure exploratory aggressiveness, and the use of alternative sources of data (survey and financial reports). Since aggressiveness is an unobservable construct rather than a physically measurable phenomenon, analyses that employ different data sources and different proxies are more reliable when convergence of results is observed. Similarities or differences may provide regulators with better information upon which to set future reporting standards. Our findings are surprising: we observe that, consistent with their assertion, full cost companies in fact do rely more heavily on found (discovered) reserves than do successful efforts firms.

Prior research that has been conducted in this area is presented in the next section. The third section describes the methodology, including the formulation of the hypotheses, the sample selection and the size, the definition and measurement of the variables, and the data collection procedures. In the fourth section, the statistical tools utilized are presented, and the results of the research are analyzed. The final section contains a discussion of the scope and limitations of the study and suggestions for future research. Volume 5, 1991, pgs. 145-164.


The Challenge of "Elsewhere"

Richard L. Measelle

   …Information is needed to cope within the environment. Not since the universe's Big Bang has an environment just "happened." Our environment is constantly changing and the discernible patterns point toward:

·        more large enterprises than small

·          more complex enterprises with global interests rather simple regional or national interests

·         more interdependent enterprises than independent

·          more reliance on intellect than experience developed repetition

All of these characteristics, if they continue to develop, prescribe a need for current information and not historical data. Because society does not need to rationalize why something has happened as much as society needs to know what is happening.

The "mind of business" grows dormant without current information. The "product" of the accounting profession is information. The power of the profession can only be derived from the power of its “product.” Feeding the mind of business enhances the power of the profession. Thus, information is power both to the profession and to society … power to understand what is happening and what could happen … power to decide…   Volume 5, 1991, pgs. 167-173.

The CPA as Tax Adviser

Harry F. Immerman

To briefly explore three aspects of the tax practice today:

 ·               how the role of the CPA as a tax advisor is consistent with our professional responsibilities

 ·               the tax services that have evolved to meet the needs of our clients; and

 ·               the challenges of the educational community: to produce quality graduates to serve in our profession- and who will serve our clients well. Volume 5, 1991, pgs. 175-180.

A Perspective on the Sociology of Accounting Schisms

Arthur R. Wyatt

…The research emphasizes in the academic community over the past quarter century have, in my view, exacerbated the schism in the sense that it has become easy for practitioners to point to the articles publishes as evidence that academics are not in tune with the problems in the “real world.” It is interesting that academics have had a significant influence n the development of concepts and the board’s conceptual framework but have had very little influence on the development of specific accounting standards. Maybe the future will see an increased role for academics in this area… Volume 5, 1991, pgs. 181-187.

Crisis and Opportunity in Financial Institutions and the Accountancy Profession

William V. Roth, Jr.

 … In an attempt to strike a balance ( of an effective audit ), I (William Roth) proposed a bill (S-3050) last year that is designed to improve the quantity and quality of information that the regulators can use to determine the state and needs of insured depository institutions. This is important, because we rely on the regulators- that is, the appropriate Federal banking agencies- to oversee some 16,000 banks and savings institutions with combined insured deposits totaling more than $2 trillion. … Volume 5, 1991, pgs. 189-194.

Identifying Resources for SEC Education

Jimmy W. Martin

 Accountants must understand the environments in which they work. The attainment of this understanding had been cited as a primary objective of educational courses at the university level [Accounting Education Change Commission, 1990]. The Securities and Exchange Commission (SEC) comprises an important part of the regulatory environment. Both public and corporate accountants are affected by the SEC’s policies and procedures. While not all companies come under the SEC’s jurisdiction, thousands of publicly held firms must adhere to the agency’s registration and periodic reporting requirements. Volume 5, 1991, pgs. 195-206.