William R. Baber

Client Security Price Reactions to the Laventhol and Horwath Bankruptcy

On November 21, 1990, Laventhol and Horwath (henceforth LH), then the nations seventh-largest public accounting firm, filed for protection under Chapter 11 of the U.S. Federal Bankruptcy Code. A portfolio of 75 LH client common stocks earned statistically significant risk-adjusted returns of -1.91% during the two-day trading period around the LH bankruptcy disclosure. We propose and investigate two explanations for these security price reactions. The insurance explanation presumes investor reliance on auditors to recover future investment losses (Kellogg [1984] and Stice [1991]). Recovery is conditioned on the auditors ability to pay; therefore, the LH

Consequences of GAAP Disclosure Regulation: Evidence from Municipal Debt Issues

We compare characteristics of municipal debt issues in states that mandate GAAP for municipalities with issues in states that impose no annual financial disclosure requirements. Cross-sectional comparisons indicate that the use of public (versus private) debt is greater, and municipal debt costs are 14 to 25 basis points lower, in states where GAAP is mandated. Moreover, municipalities in states that impose the GAAP requirement realize lower debt costs following the effective date of the regulation. These results suggest that GAAP requirements reduce municipal borrowing costs. More generally, the evidence indicates that financial reporting regulation reduces contracting costs between borrowers and lenders.

Accounting Restatements, Governance and Municipal Debt Financing

We find that mean municipal debt costs are greater following financial restatement disclosures. Comparisons of the relative use of municipal debt, and of the use of unsecured versus secured debt, corroborate that financial restatements increase the cost of municipal debt financing. Additional analyses indicate that adverse consequences of restatements are mitigated by strong audit oversight and by provisions that encourage direct voter participation in the governance process. The evidence supports the use of restatements as a summary measure of financial reporting quality in the municipal context and informs thinking about auditor and voter oversight in the municipal financial reporting process.

Estimates of economic rates of return for the U.S. pharmaceutical industry, 1976–1987☆

Abstract Estimation procedures are designed to consider features of publicly-available financial accounting information which allegedly compromise its use to estimate economic internal rates of return. These procedures, which focus on cashflows rather than conventional accounting income measures, are used to investigate the relative profitability of the U.S. pharamaceutical industry. Results indicate that pharmceutical returns exceed returns for comparable U.S. industrial firms during the period encompassed by the study. Differences for these comparisons are substantially less than what is implied by an uniformed use of accounting information, however. In particular, differences in implied internal rates of return of 2.1% to 3.8%, whereas differences in accounting rates of return are 4.0% to 5.6%. Results are robust for a wide variety of assumptions about industry growth rates and investment payout profiles, characteristics which potentially cause accounting-based return measures to differ from underlying internal rates of return.

External Corporate Governance and Misreporting

This study investigates how external corporate governance provisions, specifically statutory and corporate charter provisions that limit direct shareholder participation in the governance process, affect the likelihood of an accounting restatement. The analysis indicates that strong external governance (fewer restrictions on shareholder participation) is associated with a relatively low incidence of accounting restatements. The effect of external governance is incremental to that of internal governance, which is considered as provisions that foster effective board oversight of management. Such evidence supports the premise that shareholder participation improves financial reporting quality.