James Jiambalvo

Debt covenant violation and manipulation of accruals

Abstract This paper examines the abnormal accruals of a sample of 94 firms that reported debt covenant violations in annual reports. We expect debt covenant restrictions to influence accounting choices in the year preceding and the year of violation. Time-series and cross-sectional models are used to estimate ‘normal’ accruals. In the year prior to violation, both models indicate that ‘abnormal’ total and working capital accruals are significantly positive. In the year of violation, there is evidence of positive abnormal working capital accruals after controlling for management changes and auditor going concern qualifications.

Institutional Ownership and the Extent to which Stock Prices Reflect Future Earnings

Articles in the financial press suggest that institutional investors are overly focused on current profitability, which suggests that as institutional ownership increases, stock prices reflect less current period information that is predictive of future period earnings. On the other hand, institutional investors are often characterized in academic research as sophisticated investors and sophisticated investors should be better able to use current-period information to predict future earnings compared with other owners. According to this characterization, as institutional ownership increases, stock prices should reflect more current-period information that is predictive of future period earnings. Consistent with this latter view, we find that the extent to which stock prices lead earnings is positively related to the percentage of institutional ownership. This result holds after controlling for various factors that affect the relation between price and earnings. It also holds when we control for endogenous portfolio choices of institutions (e.g., institutional investors may be attracted to firms in richer information environments where stock prices tend to lead earnings). Further, a regression of stock returns on order backlog, conditional on the percentage of institutional ownership, indicates that institutional owners place more weight on order backlog compared with other owners. This result is consistent with institutional owners using non-earnings information to predict future earnings. It also explains, in part, why prices lead earnings to a greater extent when there is a higher concentration of institutional owners.

Do Stock Prices Fully Reflect the Implications of Special Items for Future Earnings

Previous research (Rendleman, Jones, and Latane [1987]; Freeman and Tse [1989]; Bernard and Thomas [1990]; and Ball and Bartov [1996]) indicates that security prices do not fully reflect predictable elements of the relation between current and future quarterly earnings. We investigate whether this finding also holds for the special items component of earnings. Given that special items are prominent in financial analysis and are assumed to have relatively straightforward implications for future earnings (special items are assumed to be largely transitory), one might expect that prices would fully impound the implications of special items for future earnings. Based on the “two-equation” approach used in Ball and Bartov [1996] and other studies (e.g., Abarbanell and Bernard [1992]; Sloan [1996]; Rangan and Sloan [1998]; and Soffer and Lys [1999]), we find that while prices reflect relatively more of the effects of special items compared to other earnings components, we still reject the null hypothesis that prices fully impound the implications of special items for future earnings. The “two-equation” approach assesses the consistency of coefficients in a pair of prediction and pricing equations, and thus depends on an assumed functional form. However, a less structured abnormal returns methodology like that used in Bernard and Thomas [1990] also supports the conclusion that the implications of special items are not fully impounded in prices. Specifically, a trading strategy based only on the sign of special items earns small but statistically significant abnormal returns during a 3-day window four quarters subsequent to the original announcement of special items.

Changes in the probability of bankruptcy and equity value

Abstract Work in finance suggests that changes in the probability of bankruptcy likely affect firm value by affecting perceptions of the cost of transacting with the firm. In this paper, accounting information from the balance sheet as well as the income statement is used in conjunction with Ohlsons (1980) bankruptcy prediction model to calculate unexpected changes in the probability of bankruptcy. For a sample of firms with a large estimated probability of bankruptcy sometime during the ten-year study period, unexpected changes in the probability of bankruptcy are useful in explaining security returns even after controlling for unexpected earnings.

Relationships between leader behaviors and audit team performance

Abstract This study considers the nature and importance of leadership in the audit process. The relationships between audit team performance and leader behaviors, which are practised by in-charge auditors to supervise staff assistants, are examined in a field experiment. The results identify a number of leader behaviors which relate, either directly or through some intermediary factors, to audit team performance. For example, high performing audit teams tended to be supervised by in-charge auditors who allowed staff innovation, were considerate to the staffs personal needs, administered frequent positive reinforcement, relied heavily on time budgets, assigned a small number of tasks per staff member and administered negative reinforcement infrequently. These and other results appear to have implications for practicing auditors as well as future research in the area.

An examination of performance evaluation decisions in CPA firm subunits

Abstract This study examined performance evaluation decisions made by members of the audit, tax, and management services subunits of a large CPA firm. Utilizing a methodology developed in the clinical judgement area of psychology, it was found that individuals differ significantly in terms of what they believe to be proper overall evaluations of performance. These differences appear to be due to evaluation policy differences rather than inconsistent application of individual evaluation policies. It was hypothesized that the evaluation processes in the three subunits would differ significantly. This follows from the unique task environment faced by each subunit. In comparing the members of the audit, tax, and management services subunits, no differences in terms of consistency or self-insight were found. However, there were differences in terms of agreement on overall evaluations and in terms of the importance attached to various performance evaluation categories.

Measures of Accuracy and Congruence in the Performance Evaluation of CPA Personnel: Replication and Extensions

A major problem in all organizations is to motivate subordinates properly to engage in actions desired by superiors. For years, performance evaluation of subordinates has been a major procedure followed in organizations to achieve motivation. While the need for performance evaluation is well recognized, the process is not without problems. Numerous cases in which performance evaluation has contributed to poor performance have been documented (e.g., Hopwood [1973], Ridgway [1956]). This should not be too surprising, since we do not completely understand the interaction between performance evaluation and human behavior. Indeed, this lack of knowledge provides the motivation for the extensive literature in psychology which examines performance evaluation issues.1 Recently, this issue has been studied within CPA firms by Jiambalvo [1979] and Maher, Ramanathan, and Peterson [1979]. In the latter study it was found that accuracy in assessing the importance of evaluation criteria and congruence between the perceived and desired importance of evaluation criteria are related to the overall performance of CPA firm employees. The purpose of this paper is to provide further evidence on the importance of accuracy and congruence in CPA firms. Almost every behavioral accounting study ends with the caveat that

Determinants of leader behavior in an audit environment

Abstract Although leader or supervisory behaviors are generally thought to have a significant effect on subordinate performance, motivation and job satisfaction, the variables which affect an auditors approach to supervision have not been investigated. In this paper we examine two categories of variables (situational variables and leader-person variables) which determine an auditors use of key leader behavior. The determinants of leader behavior are examined in the context of an audit team composed of an accountant in charge (leader) and one or more staff assistants (subordinate). The results of our empirical tests provide some evidence that leader behavior is related to three variables: (1) the match between the accountant in charges perception of the complexity of the task assigned to the staff assistant and the staff assistants job experience, (2) the staff assistants intolerance of ambiguity and (3) the accountant in charges personality dominance.