James R. Frederickson

The effect of information asymmetry on negotiated budgets: an empirical investigation

Abstract This study examines three issues: (1) the effect of information asymmetry on the budget negotiation process, (2) the effect of information asymmetry on budgetary slack when budgets are set through a negotiation process, and (3) whether subordinates consider superiors imposing a budget following a failed negotiation as being low in procedural justice, which in turn causes low subordinate performance. The results suggest that smaller differences in initial negotiation positions do not indicate a higher likelihood of agreement when initial differences are due to differential information symmetry. Further, information asymmetry affects the relationship between negotiation agreement and budgetary slack. Last, inconsistent with a pure economic perspective, having superiors impose a budget after a failed negotiation causes justice or fairness considerations to demotivate subordinates.

Carrot or Stick? Contract Frame and Use of Decision-Influencing Information in a Principal-Agent Setting

A fundamental management accounting issue is how to incorporate decision-influencing information (e.g., an ex post state signal) into employment contracts. Our experiment examines the effects of contract framing on such information use in a principal-agent setting. In each of 40 rounds, participants (as employer and worker) negotiate a contract that specifies pay depending on an ex post state signal. State-signal pay is framed as either a bonus or a penalty over two groups. The results show that the bonus frame facilitates information use, because of worker loss aversion. Although both groups initially underweigh the state signal, the bonus group quickly converges toward the optimal weight, whereas the penalty group persistently underweighs the state signal.

Independent auditor litigation: Recent events and related research

Abstract The public accounting professions difficulties with litigation have been widely asserted (e.g., Hill and Metzger, 1992, pp. 263–265; Mednick and Peck, 1994. pp. 897–898; Miller and Young, 1997, pp. 1990–1991, 2027). Public accountants have recently won several major victories in their efforts to reduce litigation based on allegedly negligent auditing. We discuss three of the more important of these recent victories for public accountants and their implications for auditor litigation. We conclude that, despite recent events, the debate over independent auditor litigation is far from over and long-term trends are uncertain. We also briefly examine some of the recent research in response to the public accounting professions call in the early 1990s for academic research related to independent auditor litigation. In doing so, we briefly comment on some of the articles in this and the Winter 1997 issue of the Journal of Accounting and Public Policy which was dedicated to independent auditor litigation issues. We conclude that research to date in response to this call is providing useful evidence on litigation issues involving the profession, but that additional research is needed to shed light on unresolved issues. Suggestions are made for research that might address some of these questions.

Earnings Management: The Role of Economics and Ethics on Managers' Decision Making

A significant amount of earnings management (EM) research has treated managers’ EM decision processes as a “black box”. The objective of this study is to begin to open the black box though examining the relative importance of economic factors as well as ethical considerations in managers’ EM decisions. We performed a survey of 225 CFOs and CEOs of listed companies. They were provided with a case study where the firm’s earnings were projected to be below market expectations and they were asked whether their firm in the same situation would manage earnings via accounting adjustments versus real operational adjustments and then they were asked about a number of economic factors and ethical considerations related to this decision. We find the predominant factors in the initial decision to manage earnings is whether the EM is ethically questionable and the economic consequences to stakeholders – rather than manager self-interest. We also find ethics is substantially more important in the choice of EM method than the relative economic costs of the two methods. The stronger the CFOs’ and CEOs’ belief that the use of accounting (real operational) adjustments is ethically questionable the more likely their firms would use real operational (accounting) to manage earnings. Finally, we find a significant portion of the explanatory power of ethics in EM decisions is due to CFOs’ and CEOs’ perceiving the decision to be lying for both the initial decision to manage earnings and also for the choice of method to manage earnings.

Earnings Announcements, Aggregate Earnings, and Individual-Firm Stock Returns: A Signal Extraction Perspective

There is an extensive stream of research that documents a positive association between earnings surprises and stock returns at the individual firm level. We posit that individual firms’ earnings surprises have systematic and firm-specific components that differ in their persistence, implying that the market reaction to individual firms’ earnings surprises should depend upon the relative magnitudes of the underlying systematic and firm-specific earnings surprise components. We further posit that investors behave as if they solve a signal extraction problem that allows them to estimate from aggregate (e.g., market) earnings the systematic earnings surprise component. Our signal extraction framework implies that the market reaction to individual firms’ earnings surprises is increasing in the cross-sectional mean earnings surprise and that the magnitude of the mean effect is inversely related to the cross-sectional dispersion of the earnings surprises. Our results are consistent with these predictions. Also consistent with signal extraction, we find that the effect of the crosssectional mean earnings surprise is significantly larger for firms that announce their earnings early in the quarter. We also find that signal extraction occurs for firms with a large percentage of individual investors, but not a large percentage of institutional investors, consistent with institutional investors having private information that allows them to partition a firm’s earnings surprise into its systematic and firm-specific components. Overall, our results suggest that to understand the market reaction to individual firms’ earnings announcements, one must consider aggregate earnings.