Bin Srinidhi

The Differential Effects of Auditors' Nonaudit and Audit Fees on Accrual Quality*

This paper examines linkages between the audit and non-audit fees and accrual quality. We measure accrual quality by the Francis et al. (2005) modification of Dechow and Dichev (2002) measure. We posit that in settings where audit quality is compromised by a loss of auditor independence, managers use accruals more opportunistically and thereby drive down the accrual quality. Conversely, higher audit effort and quality translate to a better accrual quality. Our dependent variables are the relative magnitude of non-audit fees to audit fees, the absolute magnitudes of audit, non-audit and total fees. Results show that accrual quality has a significant negative association with the magnitude of non-audit fees but a significant positive association with audit fees. This latter result is consistent with the proposition that higher audit fee reflects higher audit effort and better judgments about the propriety of accruals, but is not consistent with the proposition that audit fee is associated with economic bonding.

Strategic quality management

Notes that to be effectively implemented, quality management has to be aligned with strategy and properly co‐ordinated. Develops a systems framework entitled congruence management business architecture. Notes that under this architecture an activity is the core entity for change and that every quality or related initiative will change, eliminate or create activities. Considers various quality management mechanisms under this architecture and considers various barriers. Suggests that the congruence management framework can help make quality management more effective.

A Rationale for Fixed Charge Application

Much research effort has gone into the question of why service centers typically charge users a fixed amount that does not vary with the duration of service. One mode of imposing such charges is the allocation of fixed costs to the users. This has been studied by Zimmerman [6], Kaplan and Thompson [3], and Kaplan and Welam [4]. Another method of imposing such a charge is the use of a transfer price that is more than the marginal cost. Under conditions of known demand, Hirschleifer [2] found that marginal-cost transfer prices are optimal from the firms viewpoint. It is therefore not clear as to why there should be a component of transfer price that does not vary with service duration. This study provides a rationale for the application of positive fixed charges to the users of a service center using opportunity costs of delay. We do not address the problem of cost allocation in which the applied fixed charge is constrained to be equal to the incurred fixed cost. This study uses concepts from queuing theory when there is a single server; the arrivals are random with a Poisson distribution; and the service time per job is also a random variable with a general distribution. Traditionally, opportunity costs of congestion are said to be incurred only when the service center is operating at nearly full capacity. In this study, we show that under conditions of uncertainty in the arrivals and the service time, congestion can occur even when the service center is operating well below capacity. It is shown that in view of these opportunity costs of delay, a fixed charge needs to be applied to achieve an optimum utilization of the service center. We compute the amount of this fixed charge and show that under very general conditions it is in the interest of the firm to reduce the usage rate from its no-charge equilibrium value by applying a fixed charge. The difference between the no-charge equilibrium usage rate and the optimal usage rate is a measure of the need for such fixed charge application. Under reasonably realistic assumptions, this study deals with how the usage rates and their differences vary with the parameters used in the model. An important finding of the sensitivity analysis in this study is that the need for restricting the usage rate by imposing the fixed charge increases when there is greater uncertainty

Market Imperfections as the Cause of Accounting Income Smoothing—The Case of Differential Capital Access

We show income smoothing results as a rational equilibrium behavior in a setting where the manager has superior foresight about the firms prospects but faces inferior capital access relative to the owner. Under a legal structure that makes forecast-based compensation impractical and an accounting framework that requires reported income to be consistent, unbiased and cash-flow convergent, we show that the manager reports a composite of the underlying income and his foresight information. Moreover, the reported income will exhibit a lower inter-temporal variance than the underlying income. The extent of smoothing is shown to increase with the accuracy of foresight information.We argue that other market imperfections could also cause income smoothing if the manager is privately better informed about future prospects. As such, this paper supports the view that income smoothing is not always opportunistic but can be induced by the owner to satisfy his need to be informed about the future performance of the firm.

Strategic positioning and cost management along various quality dimensions

The traditional view of quality treats it as an economic good which can be developed by incurring costs. Proponents of total quality management have rejected the traditional view and stress the complementary nature of cost and quality. Reconciles these two views as different manifestations of the same underlying phenomenon within the same strategic framework. This requires precise definitions of quality concepts such as conformance and performance quality. The organization first examines its current position within this framework. The definitions of quality help sharpen the formulation of strategic objectives and the framework helps in mapping out a policy for moving the firm from the current position to the desired position. In addition, also determines the operating systems of quality management by how quality is defined in the organization. In conjunction with the strategic direction, the operational management procedures facilitate the process of cost management.

Analytical and Empirical Evidence of the Impact of Tax Rates on the Trade-off between Debt and Managerial Ownership

We show that, for a firm facing a high marginal tax rate, the benefit of using debt relative to managerial ownership to control agency costs increases at a decreasing rate. Debt and managerial stock ownership represent alternative mechanisms for reducing agency costs of the relationship between owner-investors and managers in firms. However, although debt and managerial ownership provide overlapping benefits, only debt can provide the differential benefit of reducing the firms tax liability. While the tax benefit from using debt relative to managerial ownership to control agency conflicts is an increasing function of the firms marginal tax rate, the decreased managerial ownership results in external investors bearing a larger part of the cost of debt that accrues to the firm. Effectively, for external investors, the relative cost of debt decreases at a decreasing rate when the marginal tax rate increases. Therefore, the trade-off between debt and managerial ownership predicted by the agency literature is expected to be strong at low marginal tax rates, but get progressively weaker at higher marginal tax rates. In this paper, we build an analytical model of this hypothesis and provide strong empirical evidence in its support. Our study contributes to a further understanding of how tax rates might affect the interaction of capital structure decisions with the incentive compatibility issues and corporate governance. The study also provides a basis for future studies to examine factors other than tax rates that differentially affect debt and managerial ownership costs.

Leases with purchase options and double moral hazard

The purpose of this paper is to explain why leases have a purchase option and how the exercise price of this option is determined. We follow Demski and Sappingtons (1991) approach by using a double moral hazard setting. One limitation of their model is that the agent has unlimited liability. The agent has to have enough wealth and the obligation to buy the firm when the principal decides to exercise the put option. In our paper, this problem is resolved by using a call option, which is a feature of many lease contracts. We show that leases with a purchase option can completely resolve the double moral hazard problem even if all the variables in the model are unverifiable. It is the threat of being the residual claimant that induces the lessor to provide an efficient level of effort. On the other hand, it is the opportunity of being the residual claimant that induces the lessee to maintain the asset efficiently. Finally, the model predicts that certain leased assets are not properly accounted for under the current accounting standards for leasing.

Just in time or just in case? An explanatory model with informational and incentive effects

There is extensive literature on the benefits of manufacturing control arising from minimal inventory policies of just in time (JIT). Operations management literature has focused on controlling set‐up, lead and changeover times to streamline the operations and achieve low optimal inventory levels. Our paper first expands these models to include information and incentive effects. We then develop a model in which JIT focuses attention on process imbalances and derive the compensation contract that induces managers to be more creative in managing the process. We show that the loss of controllability decreases the benefits of JIT and increase the benefits of traditional buffer inventory. If, as on 11 September 2001, the loss or gain of controllability occurs quickly and unexpectedly, organizations need to develop the agility to switch between minimal inventory and buffer inventory systems.

Auditor Tenure and Audit Quality: The Role of the Demand for Unique Client Specific Knowledge

Using a sample of US firms from 1988 to 2000, we find a strong positive (weak or no) association between auditor tenure and earnings quality in client firms whose demand for unique client-specific knowledge is higher (lower). These results are consistent with the idea that learning the unique client-specific knowledge is best accomplished by long tenure. Firms requiring higher unique client-specific knowledge are identified in two ways: those with operating characteristics that diverge significantly from industry norms and those with high audit complexity as measured by volatility and audit fees. Our findings are robust to alternative specifications of earnings quality.

Target Analysis : Cost, Quality or Both?

In the increasingly competitive environment of the nineties, considerable attention has been paid to cost and quality issues. Though, traditionally, improvement in quality meant increased costs and was associated with reduced productivity, more recent research treats them as complementary characteristics. In this article, K R Balachandran and Bin Srinidhi argue that the target analysis approach which combines cost and quality issues in a complementary manner can help achieve the strategic objectives of the firm. Data from NMMC, a subsidiary of Nissan Motor Corporation located in the US, have been used to describe the process of implementation of this approach.