David Shields

Corporate director liability and monitoring preferences

Abstract An important issue in the regulation of corporate behavior is its impact on the monitoring configuration selected by top management. In this article, we provide evidence consistent with the notion that the recent trend toward audit committee formation, and the movement toward Big-Eight auditors, are responses to increased legal exposure of the board of directors, notably stemming from the passage of the Foreign Corrupt Practices Act of 1977. The costs associated with changes in monitoring configurations are also considered. In particular, it is argued that auditor assistance can substantially reduce the cost of audit committee formation. Because external auditors may have differential incentives to support audit committee formation, a hypothesis linking auditor identity and audit committee formation is offered. Recent auditor changes and audit committee formations of American Stock Exchange companies are examined to provide positive evidence for the theory. The data reveal a clear trend to form audit committees, and a movement to Big-Eight auditors. Underscoring the importance of auditor involvement, it is shown that audit committees were more likely to be formed given recent selection of a new Big-Eight auditor.

Managerial moral hazard and auditor changes

Abstract In many situations, an auditor change is in the best interests of both shareholders and managers. However, management may also initiate an audit firm change in an attempt to suppress or delay the release of unfavourable information. In this paper, we present the results of three separate tests of “Over the Counter” companies, which relate to managerial attempts to withhold information from the market. In the first who tests, we show that companies that change auditors shortly before bankruptcy appear to have done so because they were unable to suppress unfavourable information. The first of the tests shows a significantly better bankcruptcy prediction model for auditor changers than for non-changers. The second test rules out the major competing rationale for the results observed in the first test: that the auditor change firms had an early warning, or longer lead-time, before bankcruptcy. The remaining explanation, that managers were attempting to switch to more cooperative auditors, is thus indirectly supported. In the third test we show that the market takes the possibility of managerial moral hazard into account. Abnormal returns in the month of auditor change announcement are significantly negative in all cases except for changes from non-Big Eight to Big Eight auditors. Furthermore, abnormal returns were significantly more-negative when managers held more than 50 percent of the companys common stock, thus removing any effective method of managerial discipline by outside shareholders. Taken together, the results indicate that in periods of financial distress, managers seem to attempt to suppress unfavourable information from the market. This suppression cannot be accounted for as the result of a longer lead-time between distress and bankcrupty for firms that change auditors than for firms that do not. Finally, the market seems to be aware of the potential for managerial moral hazard, in that the share price response is unambigously negative, except in likely “good news” situations.

Accounting controls and bureaucratic strategies in municipal government

Abstract We investigate the degree to which accounting and auditing characteristics in municipal governments lead to effective control systems, i.e., systems which result in the production of services desired by the electorate at minimum costs. Such control systems are subject to strategic manipulation by the bureaucracy. The study examines the effects of accounting disclosure and auditing controls on the level of governmental expenditures. We adopt the Gonzalez-Mehay model (GM 1985) from the public choice literature, which relates governmental expenditures to a number of structural and control variables. The GM model assumes that bureaucrats have a monopoly over information, disseminating little financial information outside the bureaucracy (GM 1985, p. 90). In reality, bureaucrats are subject to auditing, budgeting, and public reporting controls. We found that budget control (as measured by surplus/deficit variables) generally supported a strategic manipulation interpretation, as did total debt (for capital outlays). However, a public accountants audit opinion appears to be an effective control device when an unqualified opinion is obtained. The city manager form of government, especially when combined with a Certificate of Achievement, also supports a control interpretation. The results suggest that, as with commercial organizations, appropriate monitoring methods can lead to superior governmental performance, but that such monitoring methods are subject to capture by agents.

Cost uncertainty and budget overspending: A safety-first perspective

Abstract In this study we model a cost center managers decision about how to achieve a required level of output. The spending plan that the manager adopts is expected to result in successful performance, but at an uncertain cost. The uncertainty associated with the spending plan is inversely related to the expected cost. The analysis presented in this article suggests that a manager who exhibits Safety-First behavior and wishes to avoid large budget deviations is more likely to exceed what he or she perceives to be the overspending limit rather than the underspending limit. That manager will tend to incur costs in excess of the budget. This mathematical result has an intuitive appeal; a manager is willing to pay a certain “risk premium” to avoid the risk of large budget deviations and accompanying adverse consequences. This result has implications for both performance evaluation and budget setting, particularly in the public sector. Under the circumstances that we describe, using budgets in evaluating managerial performance may be misleading. Another application of our study relates to the “budget creep” phenomenon and how, under particular circumstances, its size can be reduced.

Small CPA firm product differentiation in the small business market

Abstract This study investigates the product differentiation factors that major referees use in referring CPAs to small business. Two methodological approaches are developed. The first is a systematic method of cue determination. The second examines the convergence of different judgments to test the external validity of single-system lens model results. The results show that the referees most value good working relationships and technical competence.