Jerold L. Zimmerman

Agency Problems, Auditing, and the Theory of the Firm: Some Evidence

This paper examines the history of auditing in the U.K. and the U.S. to test whether audits of companies arose as the consequence of governmental regulation or as a voluntary monitoring activity to reduce agency costs and increase firm value. The paper finds that audits existed early in the development of the modern corporation (as early as 1200) and evolved gradually into the type of audit required by the first English companies act (1844). The evidence suggests that the audits monitoring activity is important, if not crucial, to the formation of firms. The audits long survival suggests it is a part of the efficient technology for organizing firms. Differences in the timing of the evolution of professional auditors in the U.K. and U.S. prior to legally required auditing appear to reflect differences in the timing of capital market development in the two countries.

Financial performance surrounding CEO turnover

Abstract We document the behavior of a variety of financial variables surrounding CEO departures, and estimate the extent to which changes in potentially discretionary variables are explained by poor economic performance rather than direct managerial discretion. We conclude that turnover-related changes in R&D, advertising, capital expenditures, and accounting accruals are due mostly to poor performance. To the extent that outgoing or incoming managers exercise discretion over these variables, the discretion appears to be limited to firms where the CEOs departure is preceded by poor performance. We find no evidence of managerial discretion in strongly performing firms where the CEO retires as part of the normal succession process.

Conjectures Regarding Empirical Managerial Accounting Research

A blade-sharpening apparatus for knives and other cutting tools which uses a ceramic sharpening element. The sharpening element is a recycled aluminum oxide sodium vapor streetlight bulb. The vapor and heat expansion and contraction of the bulb during use as a light causes wear on the bulb and results in the ceramic element becoming more porous, thereby providing an abrasive surface suitable for blade sharpening. A first embodiment of the apparatus comprises a housing with a support substantially along a length of the sharpening element and a cover for enclosing the sharpening element when not in use. In the first embodiment, the sharpening element is supported on both ends. In a second embodiment, the sharpening element is supported on one end by a handle and a sleeve is provided to enclose the sharpening element when not in use. The sleeve may be attached to a portion of the handle opposite the sharpening element when in an operating position.

Changing incentives in a multitask environment: evidence from a top-tier business school

This study focuses on changes in incentives at the William E. Simon Graduate School of Business Administration in the early 1990s to redirect effort from academic research to classroom teaching. We find a substantial and almost immediate jump in teaching ratings following the changes in incentives. Longer-run learning and turnover effects are present. Evidence also suggests that research output fell. This case illustrates the power of organizational incentives to redirect effort in a multi-task environment, even in the presence of apparent human-capital constraints.

An Analysis of Competitive Bidding on BART Contracts

The purpose of this study is to analyze the competitive bidding on the heavy construction projects of the San Francisco Bay Area Rapid Transit (BART) District. We develop an analytic model that is appropriate to the study of the BART bidding experience and use it to derive a number of propositions concerning the bidding behavior of the participating contractors. Given that we have data pertaining to 77 BART construction projects, we are in the position of being able to test statistically many of the propositions we derive. There are at least two reasons which prompted us to undertake this study. First, because of a lack of data, the empirical study of bidding environments has lagged the development of theoretical bidding models. Not only will our study help to remedy this situation, but it also serves to isolate data requirements for future empirical studies. Second, the theoretical treatment of bidding problems has tended to focus on developing strategies to be followed by the individual bidders; little attention has been given to the problems faced by the procuring agency itself. Our study identifies certain variables that affect the outcome of the bidding process and in this regard provides the agency with information as to how to control the bidding environment. The paper is organized as follows: In Section II, the BART bidding environment is described. In Section III, an analytic model of bidding behavior relevant to the BART bidding experience is developed. Using this model, we derive a number of propositions concerning the contractors. In Section IV, we discuss the nature of the data base used in our empirical tests. Then in Section V, we describe the empirical model used and present the results of our tests. Finally, in Section VI we summarize the findings of our study.

Myth: External Financial Reporting Quality Has a First-Order Effect on Firm Value

I argue that external financial reporting quality has at best a 2nd order effect on firm value of U.S. publicly traded companies and that attempts to improve a firm’s external reporting quality has a 3rd order effect on these firms’ value. Recognizing that external financial reporting quality is at best a 2nd order effect on firm value imposes an important external validity test on accounting research. If the economic magnitude of the study’s proxy for quality on firm value is “too large,�? then the researcher should question the research design strategy and whether correlated omitted variables, endogeneity, or sample selection bias are corrupting the study’s inferences.

The Disclose or Abstain Incentive to Issue Management Guidance

Prior research generally argues that managers issue management earnings forecasts (MFs) to secure capital market benefits (that is, to reduce information asymmetry between managers and investors to lower a firm’s cost of capital), to reduce the firm’s litigation costs, or to allow managers to trade opportunistically in their firm’s stock. We discuss and test whether some MFs are issued because managers have an affirmative duty under Rule 10b-5 of the Securities Acts to disclose all material information or to abstain from trading in their firm’s securities. Four sets of tests support our conjecture that managers issue some MFs to comply with their duty under Rule 10b-5. Since prior MF studies have typically ignored the alternative explanation that managers issue some MFs to comply with disclose or abstain obligations, the inferences drawn from such studies about managerial incentives to issue MFs likely overstate the economic significance of the variables used to capture capital market or opportunistic incentives for MF disclosure.

The role of accounting in the twenty-first century firm

I explore the evolving role of accounting information in allocating capital. Accounting arose to control conflicts of interest in organizations (stewardship role). The industrial revolution spawned capital-intensive firms and public capital markets with dispersed shareholders to finance these firms. The regulation of these public capital markets shifted the role of accounting toward providing investors with information for making informed investment decisions (valuation role). With the advent of the semiconductor and global competition, emerging and public firms today differ from their predecessors in fundamental ways. Exploiting the information technologies created by the semiconductor, twenty-first century firms are now more knowledge based, have more intangible assets, are more reliant on their employees’ human capital, confront increased competition, and face diverse conflicts of interests and hence different challenges accessing capital than their forerunners. Responding to the demands of twenty-first century firms, private-equity (PE) markets provide a bundled service – capital and governance. To supply this bundle, PE firms require accounting information to control the conflicts of interest both within the PE firm (between the general and limited partners) and within their investees. Controlling these conflicts shifts the role of accounting back toward its original stewardship roots. The valuation role remains important, but there is little to value unless the conflicts of interest are first mitigated.

Using Organizational Architecture to Lead Change

Effective leadership involves more than developing and communicating the right strategic vision for the company. To encourage employees to carry out the corporate vision, companies must ensure consistency among the following three main components of their “organizational architecture:” • the allocation of decision‐making authority (that is, who in the organization gets to make what decisions); • performance measurement systems (for evaluating the performance of individuals as well as business units); and • reward systems (the rewards for success, both financial and otherwise, and the consequences of failure). The authors illustrate the application of this framework with the case of Xeroxs (eventually) successful attempt to create a customer‐oriented workforce in the 1980s. But a more effective demonstration of the importance of these principles, as the authors go on to suggest, might well be the same companys well‐known failure to realize the commercial promise of the many inventions by its research group in Palo Alto. This organizational framework is especially useful for evaluating the likely effects of major corporate initiatives such as “Six Sigma” or the “Balanced Scorecard.” For example, it could be used to help top management determine whether, and under what circumstances, decentralization is likely to improve decision‐making and performance, as well as the changes in the firms performance management and incentive systems that would be required to make decentralization work. Finally, the authors apply the framework to another important leadership issue: corporate ethics. In response to the scandals of the past decade and the passage of Sarbanes‐Oxley, many U.S. companies have issued formal codes of conduct, appointed ethics officers, and instituted training programs in ethics. But a key question for top management is whether the incentives established by the firms organizational architecture reinforce or undermine the code of conduct. In this sense, ensuring consistency in organizational design is an important leadership function—one that is critical to encouraging ethical behavior as well as the pursuit of shareholder value.

The Role of Accounting in the 21st Century Firm

I explore the evolving role of accounting information in allocating capital. Accounting arose to control conflicts of interest in organizations (stewardship role). The industrial revolution spawned capital-intensive firms and public capital markets with dispersed shareholders to finance these firms. The regulation of these public capital markets shifted the role of accounting towards providing investors information for making informed investment decisions (valuation role). With the advent of the semiconductor and global competition, emerging and public firms today differ from their predecessors in fundamental ways. Exploiting the information technologies created by the semiconductor, 21st century firms are now more knowledge based, have more intangible assets, are more reliant on their employees’ human capital, confront increased competition, and face diverse conflicts of interests and hence different challenges accessing capital than their forerunners. Responding to the demands of 21st century firms, private-equity markets provide a bundled service – capital and governance. To supply this bundle, private equity firms require accounting information to control the conflicts of interest both within the private-equity firm (between the general and limited partners) and within their investees. Controlling these conflicts shifts the role of accounting back towards its original stewardship roots. The valuation role remains important, but there is little to value unless the conflicts of interest are first mitigated.