Benjamin P. Foster

An Analysis of the Usefulness of Debt Defaults and Going Concern Opinions in Bankruptcy Risk Assessment

This study extends the research of Hopwood et al. (1994) and Mutchler et al. (1997) by empirically investigating the relationships between loan defaults, violation of loan covenants, going-concern opinions, and bankruptcy in bankruptcy prediction models. One objective of this study is to empirically test the ability of loan defaults/accommodations and loan covenant violations to assess the risk of bankruptcy. Another objective of this study is to investigate the impact of failing to control for these two distress events on results from tests of the usefulness of going-concern opinions in assessing bankruptcy risk. Results suggest that loan default/accommodation and loan covenant violation are both significant explanatory variables of bankruptcy at the time of the last annual report before the event. While a going-concern opinion variable appears to significantly explain bankruptcy, it is not significant when included in a model with loan default/accommodation and covenant violation variables. Consequently, our results suggest that researchers should include both loan default/accommodation and covenant violation as control variables when using bankruptcy to test the usefulness of going-concern opinions.

A note on selecting a response measure for financial distress

Since 1966, researchers have examined financial distress prediction models to determine the usefulness of accounting information to lenders. These researchers primarily used legal bankruptcy as the response variable for economic financial distress, or included legal bankruptcy with other events in dichotomous prediction models. However, theoretical models of financial distress normally define financial distress as an economic event, the inability to pay debts when due (insolvency). This study uses a loan default/accommodation response variable as a proxy for the inability to pay debts when due. The purpose of this note is to empirically test whether or not using the inability of a firm to pay debts when due, loan default/accommodation, as a response measure produces different results than using legal bankruptcy as the response measure. The studys empirical results show that legal bankruptcy and loan default/accommodation financial distress prediction models produce different statistical results, thus suggesting that the responses measure different constructs. A loan default/accommodation model also fits the data better than a bankrupt model. Our results suggest that a loan default/accommodation response may be a more appropriate measure to determine which accounting information is most useful to lenders in evaluating a firms credit risk. Copyright Blackwell Publishers Ltd 1997.

Audit costs, material weaknesses under SOX Section 404

Purpose - Section 404 of the Sarbanes-Oxley Act (SOX) of 2002 required companies to report on the effectiveness of their internal controls over financial reporting. Auditors also must attest to, and report on, the assessment of the effectiveness of internal control over financial reporting made by the management of the company being audited. The purpose of this paper is to provide analyses of audit fee costs and material weaknesses reported for companies of different sizes after the effective date of Section 404 and suggest approaches to reduce SOX 404 compliance costs. Design/methodology/approach - Quantitative analysis and deductive reasoning are used to evaluate audit costs associated with Section 404. Findings - Audit fees have been increased substantially, particularly during the first year a company complied with Section 404, and have not been dropped substantially after the first year of compliance. Companies with sales of less than

Investigation of Artificial Neural Networks for Classifying Levels of Financial Distress of Firms: The Case of an Unbalanced Training Sample

1 billion reported significantly more material weaknesses than larger companies. Originality/value - This paper documents audit costs after the SOX Section 404 effective date, the typical types of material weaknesses reported, the proportion of companies of different sizes reporting material weaknesses, and describes approaches to reduce compliance costs.

A comparison of the ability of neural networks and logit regression models to predict levels of financial distress

Accurateprediction of financial distress of firms is crucial to bank lending officers, financial analysts, and stockholders as all of them have a vested interest in monitoring the firms’ financial performance. Most of the previous studies concerning predicting financial distress were performed for a dichotomous state such as nonbankrupt versus bankrupt or no going concern opinion versus going concern opinion. Many studies used well-balanced samples. Much less than one-half of firms become distressed and firms generally progress through different levels of financial distress before bankruptcy. Therefore, this study investigates the usefulness of artificial neural networks in classifying several levels of distress for unbalanced but somewhat realistic training samples. The chapter also compares the classification ability of neural networks and logistic regression through extensive computer simulation of several experiments. Results from these experiments indicate that analysis with two cascaded neural networks produce the best classification results. One network separates healthy from distressed firms only, the other network classifies those firms identified as distressed into one of three distressed states.

Independent accountant’s reports: signaling and early-stage venture funding

In this study we compared the classification accuracy rates of neural networks to those from ordinal logit models for a multi-state response variable. The results indicate that with the multi-state response variable, neural networks produce higher overall classification rates than ordinal logit models, but do not more accurately classify distressed firms. As a result, we can not clearly state that neural networks are superior to regression when predicting more than one level of financial distress.

Analysis of Domestic Violence Costs in West Virginia and the Potential Cost of False or Unnecessary Claims

Purpose - This paper aims to examine whether the ability of early-stage ventures to obtain external funding and the amount of additional information provided to potential investors are affected by the level of assurance (audit, review or compilation) received from independent accountants on the ventures’ historical financial statements. The assurance level provided should differently impact potential investors’ willingness to invest in a new venture and need for additional information during due diligence evaluation of the organization and entrepreneur. Design/methodology/approach - To examine the relative effects of the signal provided by these levels of assurance on investment decisions, a survey is administered to collect data regarding an investment-related decision scenario. The three levels of assurance in independent accountant’s reports (audit, review or compilation) is manipulated when eliciting participants’ responses. Findings - Results indicate that respondents perceive the signal provided by compilation reports, review reports and audit reports as increasing in reliability and are more likely to invest in a venture providing reports with that increasing reliability. Audited financial statements are viewed as the most reliable and provide a positive signal to potential investors and lenders. Consequently, potential investors may require less additional information from entrepreneurs with audited financial statements when conducting due diligence investigations. Research limitations/implications - Subjects used (Master of Business Administration students, with an average work experience of over six years, including some with investing experience) may not be the best proxies for early-stage investors. Originality/value - This is the first study to examine the relative effectiveness of signals provided by the independent accountant’s audit, review and compilation reports in assisting early-stage business ventures and entrepreneurs raising funds, and dealing with due diligence requests for additional information. Results indicate that engaging an auditor for independent assurance on financial statements can benefit entrepreneurs by increasing the likelihood of obtaining necessary funds and decreasing the amount of additional information needed by potential investors.

Artificial Neural Networks in Predicting a Dichotomous Level of Financial Distress for Uneven Training and Testing Samples

Government entities around the country (if not the world) expend large dollar amounts related to domestic violence. This study attempted to determine the cost of false or unnecessary domestic violence cases to West Virginia taxpayers. The costs are incurred by West Virginia state, county, and city governments, by many different departments within those governments, and members of the West Virginia Coalition Against Domestic Violence (WVCADV) that receive public funding. Many joint costs related to government programs that provide services not exclusively to domestic violence victims must be reasonably allocated to domestic violence cases. As many costs as possible were identified from publicly available documents and reasonable estimates were calculated for costs related to domestic violence cases. This report includes domestic violence related costs from law enforcement agencies, the court system, public defenders, and the WVCADV. Other substantial costs related to domestic violence (particularly costs associated with the West Virginia Department of Health and Human Resources), were not estimated because no reasonable basis could be determined with which to derive an estimate. The total annual cost of reasonably estimated items related to domestic violence was over

Impact on pre-and post-sarbanes oxley users’ perceptions by incorporating the auditor’s fraud detection responsibility into the auditor’s internal control report

22.6 million. Information on court decisions related to domestic violence petitions filed led to an estimate that 80.6% of domestic violence petitions are false or unnecessary. Consequently, the total identifiable cost for false or unnecessary domestic violence cases annually in West Virginia is estimated at over

The Impact Of Mentoring On Career Plateau And Turnover Intentions Of Management Accountants

18.2 million per year.