Pradyot K. Sen

The role of generally accepted reporting methods in the public sector: An empirical test

Abstract This study explores the role of standard or generally accepted accounting and reporting methods in the public sector. It differs from prior studies that address public sector accounting issues in that it considers more directly how the political process influences decisions to report financial information. The primary contention is that adopting standard reporting methods reduces costs to public officials that arise from factors that characterize political markets. Empirical evidence based on data from the state governments is consistent with this contention, but theoretical and methodological problems restrict our ability to ascertain which specific factors are relevant.

The political process and the use of debt financing by state governments

Empirical evidence offered in this study suggests that decisions by state government officials to effect debt-financed spending depend in part on the states gubernatorial election cycle. More specifically, the results reveal relative increases in state debt issues in anticipation of elections, and furthermore, they reveal that such increases are more significant for states characterized by high interparty political competition. While theoretical limitations preclude a definitive explanation for these results, the evidence is consistent with a view of state political markets where incumbent parties manipulate public policy so as to enhance the probability of success in pending elections. This insight is significant in that it suggests a relationship between public policy decisions and election cycles in a context heretofore unexplored.

Strategic alliances: a valuable way to manage intellectual capital?

Considers two forms of strategic alliances, technological and marketing, and examines how these alliances foster formation and maintenance of intellectual capital. Empirical evidence suggests that on average, strategic alliances do create value for shareholders that is consistent with the creation of intellectual capital. Between the two, technological alliances are potentially more beneficial than marketing alliances, and more likely to create intellectual capital. Empirical evidence is consistent with the notion that the gains from alliances are not shared equally by all the partners. When intellectual capital is created by the smaller or financially weaker partner, the return may be appropriately captured by the owner of such capital through strategic alliances. However, if the intellectual capital is created by the larger or financially stronger firm which moves first in an alliance relationship, the return on this intellectual capital may be subject to opportunistic exploitation by the late moving partner.

Relative Performance of Incentive Mechanisms: Computational Modeling and Simulation of Delegated Investment Decisions

This paper evaluates the relative performances of several well-known and widely-used incentive mechanisms under controlled experimental conditions. The scenario utilized is a delegated investment setting where effort and risk aversions contribute to moral hazard among fund managers. Analytical intractability of the problem requires a computational modeling approach to simulate comparative solutions for specific contracts under different parametric settings. Through a simulation exercise, we consider multiple agents who decide their investment strategy over several consecutive periods. Agents learn about estimation and market uncertainty through repeated realizations of investment returns. In each sequence of periods, a number of different incentive mechanisms based on the agents communication and/or outcome are considered. Results of the computational experiments are presented. Our results overwhelmingly show the efficacy of the incentive contracts in improving the welfare of the investors. In the presence of an estimation risk, when agents learn from their past performances, the market volatility interacts with the estimation risk that makes risk-sharing arrangements such as limited liability overly important. Paying the agent to assume the risk may no longer lead to the best performance incentives.

Another Specification of Ohlson's ‘Other Information’ Term for the Earnings/Returns Association: Theory and Some Evidence

:  Following Ohlson (2001) we characterize a variable that represents the ‘other information’ term in the Ohlson (1995 and 2001) framework using the security return specification. We interpret this variable as capturing the markets expectation that earnings change will persist into the future. This expectation can be measured using data that is readily available to capital markets researchers: future forecasts of earnings and realized accounting earnings. We show in a returns context that expectations for accelerating (decelerating) earnings growth are rewarded (discounted) by the market. While omitting other information may not be important in a reasonably long window such as a year, it becomes crucial in a shorter window. Even in the annual window, the inclusion of the earnings change persistence variable significantly improves explanatory power of the Ohlson model for returns. Finally, we offer evidence that the association of returns with earnings levels and changes observed in annual windows is robust to the quarterly time frame and we establish that the proper specification for quarterly earnings change is consecutive, not seasonal.

Reported Earnings Quality Under Conservative Accounting and Auditing

While conservatism may lead to a reduction of the current periods income, a consistent use of conservative accounting builds a hidden reserve that can inflate future earnings when investment growth slows down. For the same reason, reported earnings may be of a lower quality in terms of predictability of future cash flow when investments are growing. Managers of a growing firm, therefore, must choose to report a conservative but lower quality number or to undo the effects of conservatism by less conservative current-period cost estimates to improve the quality of reported earnings. Such departure from conservatism in the current period may lead to a conflict with the auditor, which may affect firm value as well as the managers own wealth. Managers of a steady-state investment firm, on the other hand, have an opportunity either to report conservative and high quality earnings or to slow down its investments and/or choose less conservative current period cost estimates to report higher earnings in order to effectively mimic the (high quality) report of the growing firm. In this environment, an increase in auditors conservatism may improve the informational efficiency of the market by reducing the incentives of the nongrowing firms to mimic a growing firms disclosure. An increase in incentives that are based on firm value tends to increase a growing firm managers propensity to report higher quality earnings while increasing the nongrowing firms managers propensity to cut back investment. Thus, we are faced with a situation where improving incentives for reporting higher quality earnings may be associated with an incentive to reduce investments by some firms.

Evidence of work related and incentive payments in gubernatorial pay

Concluding remarksThe usual caveat applicable to such exploratory study also applies to this one, i.e. the results should be viewed as mere association and does not imply causality. However, the results are interesting and consistent with a causal argument presented here. We find some support to the monitoring arguments presented in the paper and the ways such monitoring information may be produced. Our evidence is also consistent with the argument that in the high competition states, the executive power may be viewed as a necessary productive input, while in low competition states such powers could be viewed as alternative ways of allocating political dividends which could be traded with monitory compensation.