Greg Trompeter

Corporate responses to political costs: an examination of the relation between environmental disclosure and earnings management

Abstract This study examines the relation between the level of pre-event environmental disclosure and the extent of earnings management in response to regulatory threat. This issue is examined within the context of the earnings management response by intra-industry firms following the December, 1984 chemical leak at Union Carbide’s Bhopal, India plant. The analysis finds that a sample of 40 US chemical firms exhibited significant negative discretionary accruals for 1984. Furthermore, companies with higher levels of pre-event environmental disclosures in their 10-K reports tended to take less negative discretionary accruals. These results are consistent with the argument that corporate management believes environmental disclosure is an effective tool for reducing exposure to potential regulatory costs and that decisions to manipulate earnings are tied to a larger corporate strategy for dealing with political pressures.

The value relevance of non-financial performance variables and accounting information: the case of the airline industry

Abstract This research examines the relative value relevance to investors of non-financial performance variables, traditional accounting variables (earnings and changes in abnormal earnings) and other financial statement information in the airline industry. Consistent with prior research, earnings and changes in abnormal earnings are employed to represent traditional accounting information. The findings suggest that accounting earnings, changes in abnormal earnings and non-financial performance variables are significantly associated with stock returns. When non-financial performance metrics, earnings and changes in abnormal accounting earnings are included in the same model, we find that non-financial performance variables exhibit incremental value relevance over traditional accounting metrics. We do not find the opposite to be true. That is, although we find the traditional accounting variables to be significantly associated with stock returns, we do not find evidence of incremental explanatory power beyond that provided by the non-financial variables. In addition, financial statement details such as revenues, gross profit, assets, etc., are examined as metrics to construct financial statement proxies that reflect value relevance similar to non-financial performance metrics. Findings suggest that such proxies for non-financial metrics, in combination with earnings and changes in abnormal earnings explain approximately as much of the variation in returns as the non-financial metrics.

Effects of Earnings Forecasts and Heightened Professional Skepticism on the Outcomes of Client-Auditor Negotiation

Ethics has been identified as an important factor that potentially affects auditors’ professional skepticism. For example, prior research finds that auditors who are more concerned with professional ethics exhibit greater professional skepticism. Further, the literature suggests that professional skepticism may lead the auditor to more vigilantly resist the client’s position in financial reporting disputes. These reporting disputes are generally resolved through negotiations between the auditor and client to arrive at the final reported amounts. To date, the role that professional skepticism potentially plays in the negotiation process has been relatively unexplored. The literature prior to the enactment of Sarbanes–Oxley (SOX) suggests that auditors are more likely to approve a client position when the matter in dispute is relatively ambiguous and when changing the client’s position will result in the client failing to meet analysts’ expectations. However, changes resulting from SOX have led auditors to be more vigilant and therefore results found in the pre-SOX environment may not hold in the current environment where auditors are held more accountable for their actions. Results from an experiment with experienced audit managers and partners suggest that in the post-SOX climate, auditors’ negotiations do not appear to be substantively influenced by management being able to meet or beat forecasts. Moreover, we find that when auditors exhibit heightened professional skepticism, they are more ethical by being conservative and they stand more resolute than when auditors do not exhibit heightened professional skepticism. Finally, although we do not find a main effect for the influence of earnings forecast, we do find a significant interaction between earnings forecast and heightened professional skepticism. Implications for practice and research are then presented.

The Impact of Group Audit Arrangements on Audit Quality and Pricing

Regulators have raised concerns about the quality of group audits, particularly where other component auditors are involved. These other component auditors may be affiliated (i.e. part of the principal auditor’s network) or unaffiliated with the principal auditor. Using Australian disclosures, we examine these arrangements and their impact on audit quality and fees. Although international auditing standards require the signing auditor to accept responsibility for the entire engagement, we find lower audit quality for group audits involving the principal auditor’s network compared to other arrangements, suggesting potential over reliance on the work of network members. Further, we find that fees are relatively higher when other auditors are involved, particularly network auditors. Collectively, our evidence supports the need for closer monitoring of group audits by audit firms and regulators when other auditors, especially network auditors, are involved.Regulators have raised concerns about the quality of group audits, particularly where other component auditors are involved. These other component auditors may be affiliated (i.e. part of the principal auditor’s network) or unaffiliated with the principal auditor. Using Australian disclosures, we examine these arrangements and their impact on audit quality and fees. Although international auditing standards require the signing auditor to accept responsibility for the entire engagement, we find lower audit quality for group audits involving the principal auditor’s network compared to other arrangements, suggesting potential over reliance on the work of network members. Further, we find that fees are relatively higher when other auditors are involved, particularly network auditors. Collectively, our evidence supports the need for closer monitoring of group audits by audit firms and regulators when other auditors, especially network auditors, are involved.

Quantifying intuitions about risk: Comparing public accounting firm partners perceived as risky and non-risky

The purpose of this study is to identify a psychological profile for public accounting firm partners who are likely to place the partnership and client shareholder at risk. Proprietary data from an executive counseling firm provided a unique opportunity to compare two groups of partners: those identified by their senior partners as placing the firm at risk (n=31) and those not so identified (n=64). The groups were compared using psychological measures, lifestyle measures, personal measures, and work history variables. Results found no significant measurable difference between the audit partners who were identified as posing a risk and those not so identified. This suggests that specific factors cannot lead a partner to engage in risky behaviors, but rather several, in combination, may be necessary. Implications for research include learning more about concepts such as resistance to temptation, motivation, and rationalization. Implications for practice are to focus on structuring business practices to provide early warning signs and minimize opportunities to engage in risky behavior. Continued and increased diligence in the client screening and client continuation and review process remain essential for best practices.