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Abstract:
We document post-event negative abnormal returns to the (implicit) sell recommendations of a group of fundamental analysts. We also find statistically significant deterioration in the financial performance of the identified firms in the year after the recommendations. Together the results are consistent with the claim of fundamental analysts that they are able to identify firms that are successfully masking operational problems with aggressive accounting. The results provide a strong rationale for future research to identify specific techniques of fundamental analysis that can be employed to detect operational problems masked by aggressive accounting practices.

Abstract:
We document post-event negative abnormal returns to the (implicit) sell recommendations of a group of fundamental analysts. We also find statistically significant deterioration in the financial performance of the identified firms in the year after the recommendations. Together the results are consistent with the claim of fundamental analysts that they are able to identify firms that are successfully masking operational problems with aggressive accounting. The sample in this study comprises 373 firms identified over a four-year period by the Center for Financial Research and Analysis (CFRA). The CFRA offers to subscribers a monthly report identifying approximately ten firms which CFRA claims are experiencing operational problems and particularly those that employ unusual or aggressive accounting practices to mask the problems. The CFRA analysts rely on traditional techniques of fundamental analysis, including mechanical screens and more time-consuming analyses of footnotes and other public disclosures. Their data sources include only publicly available information, primarily SEC filings. We conclude that CFRA's apparent success in identifying firms with deteriorating performance provides evidence about the usefulness of traditional financial statement analysis. The results also provide a strong rationale for future research to identify specific techniques of fundamental analysis that can be employed to detect operational problems masked by aggressive accounting practices.

Fundamental analysis, market efficiency, contextual analysis, off-financial-statement data

Abstract:
An important goal of accounting research is to provide evidence that improves the analysis of financial statements for predicting future profitability. Research (Sloan 1996; Xie 2001) has found that (1) the persistence of earnings performance depends on the proportions of the cash and accrual components and that (2) a market inefficiency results from the failure of investors to fully appreciate the implications of cash flows and accruals for future earnings performance. In this study we investigate whether these results with respect to accruals can be generalized to another form of growth in net operating assets. We find that growth in long-term net operating assets, like accruals, has a negative association with one-year-ahead return on assets. We also find that the negative associations of both forms of growth (accruals and growth in long-term net operating assets) to one-year-ahead return on assets are attributable to the effect of growth on the denominator of return on assets. Furthermore, we find that the apparent market mispricing of accruals applies to growth in long-term net operating assets and that the severity of the mispricing does not significantly differ between the components of growth. Thus, the results suggest that the accrual anomaly documented in Sloan (1996) is a subset of a larger anomaly with respect to a general market mispricing of growth in net operating assets.
Statement Analysis, Market Mispricing

Accrued Earnings, Growth, Earnings Quality, Financial

Abstract:
In this study, I investigate how financial details (e.g., footnotes to the financial statements and 10-K supplementary schedules) disclosed concurrently with financial statements are priced by market participants. I test, not only the value-relevance of footnotes and supplementary data, but also the hypothesis that such disclosures are used by investors to restate bottom-line (GAAP-based) summary measures reported in a financial statement (e.g., total assets or total liabilities). The data of interest are disclosures that describe financial statement representations (e.g., explanatory information on inventory accounting practices), offer information that has not met GAAP-based recognition criteria (e.g., operating lease disclosures), or provide disaggregated information on financial statement representations.

I use the pedagogy in financial statement analysis textbooks and these disclosures to adjust GAAP-based indicators of firms' resources and obligations. I produce adjustments to financial statements for firms in five industries. The adjustments to firms' disclosures of resources and obligations are related to intangible capital, contingent liabilities, as well as net values of property plant & equipment, pension obligations, other post-employment benefit obligations, and operating leases. In the first step, I estimate a cross-sectional valuation model with multiple covariates (i.e., GAAP-based measures of assets and liabilities and the six adjustment variables) and find evidence that all six adjustments are priced by investors.

In the second step, I aggregate each adjustment to its related financial statement measure of total assets or total liabilities to produce adjusted measures of firms' resources and obligations. The goal is to find which of two competing models (i.e., reported versus adjusted summary measures) better represents the data generating process in the market values of common equity. I find that adjusted summary measures are significantly more associated with market values than reported GAAP-based summary measures.

Abstract:
Prior research shows that a higher proportion of accrued relative to cash earnings is associated with lower earnings performance in the subsequent period (Sloan 1996). The result has been widely interpreted as indicative of higher levels of operating accruals relative to cash flows from operations signaling (opportunistic) earnings management. We note, however, that earnings performance in prior studies (e.g., Sloan 1996) is typically defined as one-year-ahead operating income divided by one-year-ahead average total assets. Consequently, and not unimportant to our study or prior studies, the deflation of operating income transforms operating income into return on assets (i.e., an income measure into a profitability measure).

We find that accruals have a greater impact than cash flows on one-year-ahead average total assets, the denominator of return on assets. We also find that, although accruals are less persistent than operating cash flows for one-year-ahead return on assets, accruals and cash flows have equivalent associations with one-year-ahead operating income. We conclude that the lower persistence of accruals relative to cash flows should not be interpreted as evidence of earnings management, but instead, as evidence that accruals are more highly correlated with one-year-ahead average total assets than are cash flows.

accrued earnings, growth, return on assets, earnings management, financial statement analysis

Abstract:
An increasing number of firms have restated previously issued financial statements in recent years. Legislators, regulators, and others speculate that restatements are associated with fees received by auditors for non-audit services (non-audit fees). The current study provides empirical evidence about the association between firms that restate financial statements and the non-audit service fees received by incumbent auditors during reporting periods that required restatement.

We identify a sample of 110 firms that restated financial statements previously filed with the SEC for fiscal years 2000 or 2001, and provided relevant audit and non-audit fee data. We compare the fees paid by the restatement sample with fee data for 3,481 firms that filed proxies with the SEC from February 5, 2001 to August 31, 2001 and develop benchmarks for expected non-audit fees, fee ratio, and total fees. Using these benchmarks, we calculate the unexpected values for these measures and investigate whether restatement firms differ from the control firms. Our findings of no significant differences between the restatement and control samples for unexpected non-audit fees, fee ratios, and total fees do not support concerns that either non-audit fees or total fees inappropriately influence the audit and lead to restatements.

audit pricing, non-audit pricing, joint provision of services, restatements

Abstract:
In this study I describe the population of auditor changes for companies subject to filing requirements with the Securities Exchange Commission over a five-year period 1992 to 1996. I use data obtained from Auditor Trak on the reasons why corporate managers change auditors. The description of the auditor changes over a five-year period and additional examination of factors leading to client-initiated changes, not only provide insights into client and auditor relations not documented in prior studies, but also offer evidence which financial reporting regulators can use to assess the need for increased or improved disclosures required when companies change auditors.

The study has two primary findings. First, I examine auditor changes over a five-year period and document differences in those auditor changes dependent on the party initiating of the auditor realignment decision. The data suggest that clients are three times as likely to initiate a change as compared to auditors. Clients most frequently initiate an auditor change (54 percent of the sample), and auditors resign or decline to stand for re-election in 16 percent of observations. The remaining 30 percent are due to factors that cannot be reliably categorized as either client or auditor initiated. Second, I use evidence from prior studies to classify managers' reasons for an auditor change into three groups that summarize the motivating factors surrounding auditor realignment decisions. These groups relate to structural changes of the company, audit fees, and auditor-client frictionss. The second primary result is obtained by grouping the reasons into similar motivating factors as shown in the literature (i.e., other than a simple classification by initiating party) for client-initiated changes. A structural change in the client or the auditor leads to the largest frequency of changes (38 percent) among client-initiated auditor switches. Another 25 percent of client-initiated changes report audit fees as being the reason for the change. Managers report that auditor-client frictionss led to the change for approximately 5 percent of the changes. The remaining 32 percent cannot be reliably classified along the lines suggested by prior literature.

auditor switches, auditor quality

Abstract:
This study investigates the information content of FRR No. 31 reportable events (SEC 1988) communicated by auditors to clients in the two fiscal years and interim period preceding auditor changes. Reportable events identify weaknesses in internal control and problems related to the reliability of management representations and/or financial statement reliability. We examine 1,264 auditor changes (with available stock price data) over the period 1993 to 1996, including 118 companies with reportable events. Our findings suggest that reportable events, disclosed in Form 8-K filings of auditor changes are considered by investors to have information content. We find a -2.75 percent (-5.53 percent) cumulative abnormal return over a three-day (seven-day) announcement period surrounding the disclosure of reportable events in Form 8-K filings. The conclusion that reportable events offer useful information to investors is robust to alternative specifications of expected returns and to controls for other disclosures (resignations and disagreements) made when auditor changes occur. Further tests also highlight differential information content among the types of reportable events. Specifically, stock prices act as if investors find reportable events about reliability issues more informative than reportable events about internal control weaknesses.

reportable events, auditor changes, financial disclosure reliability

Abstract:
This study investigates the information content of FRR No. 31 reportable events (SEC 1988) that describe weaknesses in internal control and problems related to the reliability of management representations and/or financial statement reliability that were previously communicated to clients by their predecessor auditors. Our findings suggest that reportable events, disclosed in Form 8-K filings of auditor changes, convey negative information to investors. We find a -2.75% (-5.53%) cumulative abnormal return over a three-day (seven-day) announcement period surrounding the disclosure of reportable events in Form 8-K filings. The conclusion that reportable events offer information to investors is robust to alternative specifications of expected returns and to controls for other disclosures (resignations and disagreements) made when auditor changes occur. Further tests also highlight differential information content among the types of reportable events. Stock prices act as if investors find reportable events about reliability issues more informative than reportable events about internal control weaknesses.

Previous titles: "The Consequences and Information Content of the Types of FRR No. 31 Reportable Events", "The Information Content of Internal Control Related Matters Noted During an Audit in Form 8-K Filings of Auditor Realignments" and "Relation to Auditor Resignations; Auditor Changes and Reportable Events"

internal control, reportable events, auditor changes

Abstract:
In this study, we investigate whether the characteristics of clients, auditors, and the auditor-client relationship jointly determine audit and non-audit services. As done in prior studies, we maintain that fees proxy for the level of service provided and follow the physical flow of knowledge. Our results show that audit and non-audit fees are endogenous. More important, we find that inferences are different on the relation between audit and non-audit fees after we consider the simultaneity of audit and non-audit services compared with those inferences from single-equation estimations. Estimating the system of fee equations simultaneously, we find that provision of audit and non-audit services leads to no relation with audit fees, which suggests that single-equation estimations suffer from simultaneous-equations bias. Further, the finding suggests that there is either no knowledge spillover occur or equal knowledge spillover exist between audit and non-audit services.

audit pricing, non-audit pricing, economies of scope, joint provision of services

Abstract:
Drawing on competing theories in the audit pricing literature, we investigate whether initial audits are discounted by audit firms in periods in which audit fees are mandatory disclosures. Using data from 2,654 initial and 20,352 continuing audits in the first four years of required public disclosure of audit fees in the U.S., we do not find evidence consistent with the public disclosure argument in Dye (1991) that initial audits would not discounted if audit fees are publicly disclosed. Instead, we find evidence that initial audits of same-tier audit firm changes are discounted in each of the four fiscal year periods. Our findings of initial audit discounting for same-tier auditor changes is in contrast with empirical evidence from the Australian audit market where audit fees are publicly disclosed and initial audits of same-tier auditor changes are not discounted (Craswell and Francis 1999). The evidence suggests the pricing of initial audit engagements of clients in U.S. capital markets when audit fees are publicly disclosed is more consistent with initial audit engagement pricing theory offered by DeAngelo (1981) and Kanodia and Mukherji (1994) than with the public disclosure argument in Dye (1991).

We then investigate the cross-sectional variance in initial audit discounting. We find that an audit cost efficiency advantage is the main determinant of initial audit discounting. However, changes in financial condition, differences in audit firm classifications (based on size), disclosures of auditor-client frictions with predecessor auditors, and the length of tenure of the predecessor auditor tenure are also associated with the level of initial audit discounting. We find no evidence the investors perceive earnings quality is affected by initial audit discounting. Further, the evidence is not consistent with concerns expressed by regulators in U.S. capital markets that contend initial audit discounting erodes audit quality.

audit pricing, non-audit pricing, lowballing, quasi-rents, audit quality, earnings quality

Abstract:
In this study, I investigate whether restating financial statement data for other types of financial disclosures (e.g., footnotes to those statements and supplementary schedules in Form 10-K filings) produces differences in financial ratios as well as summary measures of economic resources and obligations. I provide evidence from univariate t-tests and Wilcoxon sign-ranked tests to test whether, even in the presence of high correlations, empirical evidence suggests that different financial ratios emerge after restating financial statement data for alternative and non-GAAPs.

The restatements to financial statement data utilize alternative GAAPs (i.e., inventory cost flow and depreciation choices) and non-GAAPs (i.e., related to intangible capital, pension plans, OPEB plans, loss contingencies, and operating leases). The 10 adjustments of interest to this study are to the income statement (3 adjustments) and to balance sheet (7 adjustments) data. The results support the prediction that the restatements to income statement and balance sheet data lead to different financial ratios and summary measures than would otherwise be obtained from use of reported financial statement data.

For example, Return on Assets, Return on Equity, Profit Margin, and Net Income are reliably different when income statement data are restated for alternative GAAPs (adjustments to as-if current cost-flow for COGS and as-if accelerated depreciation) and a non-GAAP (nonsmoothed pension cost). Thus, the evidence on signals of profitability and activity (Asset Turnover) suggest that restating income statement data for alternative and non-GAAPs may be informative for some decision-making contexts. Similar results exist from the restatements to balance sheet data. Signals of profitability, liquidity, activity, and solvency are reliably different even in the presence of high correlations between those signals that use reported versus restated financial data.

The evidence suggests that users of financial statement data will likely find balance sheet restatements, in addition to income statement restatements to be useful in decision-making contexts. The evidence on the differences between financial ratios that use reported versus restated financial statement data suggests the most pronounced differences occur when the financial ratios utilize restated income statement and balance sheet data.

Abstract:
In this study we investigate relations between the quality levels of successor and predecessor auditors for a sample of client-initiated auditor switches. We use reasons reported by managers for changing auditors to investigate whether those reasons are differentially related to changes in the quality levels of successor and predecessor auditors. Based on prior evidence on auditor realignments, we classify the reasons from managers into three categories that appear to summarize the motivating factors surrounding client-initiated changes. The three categories relate to structural changes of the company, audit fees, and accounting disagreements. In this study we introduce a three-level auditor quality proxy that suggests and allows future researchers, to consider auditor quality as other than a binary variable (i.e., Big 6 versus non-Big 6). We find that the quality level of the successor auditor is related to the quality level of the predecessor auditor irrespective of the reason for the change. Our results suggest that auditor quality levels are, on average, unchanged following a client-initiated change. However, an investigation of any changes in auditor quality subsequent to our classification of client-initiated changes into the three categories suggests that managers' reasons are differentially related to the change in quality of the auditor. Managers who cite structure reasons move up in quality, confirming prior literature. Managers who cite fees as a reason tend to move down in quality, which is different from findings in prior papers. Finally, we find that clients who cite accounting disagreement as the reason for changing also move down in quality, which is consistent with managers searching for less conservative auditors. Our evidence offers additional insights into possible reasons that managers change auditors and may suggest the need for financial reporting regulators to consider increased or improved disclosures related to the reasons for changing auditors ? particularly in the case of client-initiated changes.

Key Words: Auditor switches, auditor quality

Abstract:
The motivation for this study can be found in a 1977 Securities and Exchange Commission (SEC) proposal to amend the reporting requirements when publicly-traded companies experience an auditor realignment. In 1977 the SEC proposed amendments to Form 8-K filing requirements for reporting of changes in a registrant?s independent accountants to require disclosure of the reason(s) for such changes. Although the SEC decided against mandating the disclosure of the reason(s) for changing auditors, the SEC did encourage disclosure of these reasons on a voluntary basis. We describe and document over a reasonably long sample period these voluntary disclosures made by managers.

Utilizing those voluntary disclosures as sample evidence, we investigate whether voluntarily-supplied reasons as well as other mandated disclosures in actual Form 8-K filings provide useful information toward understanding auditor-client frictions that lead to realignments. We evaluate the usefulness of the voluntarily-supplied reasons by examining relations of those reasons to either changes in auditor quality or size within an auditor quality level. The results suggest that the voluntary disclosures provide insights into auditor-client frictions and also show that the disclosures are not "boiler-plate" disclosures as opponents to the mandatory disclosure of the reasons argued in response to the 1977 proposed changes. Additionally, we document extremely low compliance rates to two important required disclosures related to the auditor-client relationship in Form 8-K filings.

Another contribution of this study is a unification of the literature on auditor changes. We implement few data restrictions over a four-year sample period of 2,637 auditor realignments. In this attempt to unify the literature, we re-examine several research questions addressed in prior studies where inconsistent or inconclusive results exist. We confirm results from prior studies that document when companies grow (shrink) they tend to move to higher (lower) quality audit firms.

Our research design offers increased power of tests and hence supports hypotheses postulated but not borne out in the data of prior studies. For example, we show that a reason for changing auditors cited as merger or consolidation issues is positively related to changes in auditor quality. We also document that when corporate managers report either an accounting disagreement or reportable event in Form 8-K filings they tend to align with a successor auditor of lower quality. We also find that firms citing the need for better service do not have a discernable change in quality of auditors.

Key Words: Auditor switches, Auditor quality, Audit size, Lateral-quality changes, SEC compliance rates

Abstract:
In this paper we investigate whether voluntarily disclosed reasons for auditor-client realignments (as encouraged by the SEC) have information content for investors. After classifying realignment reasons into two types - verifiable and non-verifiable, with the latter representing disclosures about the auditor-client relationship not evident from alternative sources, we find that, as predicted by the "good news" precept of theoretical signaling models, non-verifiable realignment reasons are positively associated at the time of their announcement with abnormal returns. We also investigate whether voluntarily disclosed realignment reasons are associated with the relative size of the predecessor or successor auditor. We find that clients are more likely to cite service-related (non-verifiable) reasons when dismissing large predecessor auditors, and are more likely to cite fee-related (non-verifiable) reasons when choosing small successor auditors. These findings are consistent with auditors competing for the clients of large auditors by offering better or broader services, and with smaller auditors competing based upon price. All of our findings are robust to controlling for mandatory auditor change disclosures (auditor client disagreements, reportable events, and going-concern opinions), and operating, financing and investing activities found in prior research to be associated with auditor changes.

audit markets, auditor realignments, disclosure regulations

Abstract:
In this paper we investigate whether voluntarily disclosed reasons for auditor-client realignments (as encouraged by the SEC) have information content for investors. After classifying realignment reasons into two types - verifiable and non-verifiable, with the latter representing disclosures about the auditor-client relationship not evident from alternative sources, we find that, as predicted by the "good news" precept of theoretical signaling models, non-verifiable realignment reasons are positively associated at the time of their announcement with abnormal returns. We also investigate whether voluntarily disclosed realignment reasons are associated with the relative size of the predecessor or successor auditor. We find that clients are more likely to cite service-related (non-verifiable) reasons when dismissing large predecessor auditors, and are more likely to cite fee-related (non-verifiable) reasons when choosing small successor auditors. These findings are consistent with auditors competing for the clients of large auditors by offering better or broader services, and with smaller auditors competing based upon price. All of our findings are robust to controlling for mandatory auditor change disclosures (auditor client disagreements, reportable events, and going-concern opinions), and operating, financing and investing activities found in prior research to be associated with auditor changes.

audit markets, auditor realignments, disclosure regulations

Abstract:
In this study, we investigate whether the variation in the expected costs of technical default provides insights into whether managers manipulate earnings in periods prior to technical default as well as in the fiscal year in which avoidance of technical default is unlikely. We argue that managers have private information about the expected costs and consequences of default, and that, prior to default, managers condition their decisions about accounting choice and accounting (accrual) discretion on these expectations. We provide evidence on the endogeneity of two forms of discretion in accounting choices (i.e., choice of accounting methods and discretion in accounting accruals) in the context of testing the debt covenant hypothesis. Controlling for the endogeneity of the two forms or earnings management, we document that both forms of earnings management are associated with a lower cost of technical default and the use of either form of earnings management tends to reduce the use of the other. Our findings also suggest that earnings management is less likely when the expected cost of technical default is low, and that, managers appear to benefit from earnings management as such decisions are associated with a lower default cost for firms that enter technical default.

Accounting choice, discretionary accounting, earnings management, accounting, debt, technical default, positive accounting

Abstract:
Financial Reporting Release (FRR) No. 31 (SEC 1988) changed the disclosure requirements about auditor-client frictions (i.e., disagreements and reportable events) in auditor change announcements. The first goal of the study is to document factors associated with an auditor change sample disclosing auditor-client frictions compared with an auditor change sample not making such disclosures in auditor change announcements.

We use 5,128 observations of auditor changes obtained from a sample period following enactment of FRR No. 31. In the fiscal periods in which the frictions are reported to have occurred, firms disclosing auditor-client frictions tend to have (1) higher levels of audit risk, (2) deteriorating financial condition, (3) higher levels of growth, (4) higher incidence of new going-concern audit opinion, (5) more auditor resignations, (6) greater incidence of Big 5/6 predecessor auditors, and (6) lower incidence of Big 5/6 successor auditors. We also find that auditor change firms with disclosures of auditor-client frictions tend to be (7) younger firms, (8) exhibit higher audit risk, and interestingly, occur in (9) larger firms with (10) increasing levels of institutional ownership.

The second goal of the study is motivated by a growing body of empirical evidence from a variety of contexts that indicates market participants under-react to certain disclosures. Also, the SEC (1988) suggests that both types of auditor-client frictions may be potential early warning signs of trouble. We find that firms disclosing auditor-client frictions exhibit long-run drift in stock prices in the same direction as the initial price reaction. Stock prices indicate that investors under-react to disclosures about auditor-client frictions in auditor change announcements. The evidence of under-reaction to the auditor change sample disclosing auditor-client frictions is robust to alternative asset pricing models and tests suggested by the literature documenting appropriate research design choices for long-run stock price tests.

Auditor changes, reportable events, auditor-client disagreements, information content of client-auditor disclosures, long-run stock price tests

Abstract:
We identify, solely on the basis of public grant and stock price data, a sample of companies that are highly likely to have committed backdating. Two-thirds of this sample have not disclosed evidence of backdating, allowing the first study of the economic consequences and characteristics of undisclosed backdaters. Undisclosed backdaters show negative abnormal stock price performance, negative ROA, and abnormal rates of unfavorable stock market delisting events that are as bad as or worse than disclosed backdaters. This suggests that disclosure does not drive the destruction of shareholder wealth, and may mitigate losses, due to backdating. We find that over 500 backdaters remain undisclosed.

Backdating, Corporate governance, Executive stock option grants

Abstract:
An increasing number of firms have restated previously issued financial statements in recent years. Legislators, regulators, and others speculate that restatements are associated with fees received by auditors for non-audit services (non-audit fees). The current study provides empirical evidence about the association between firms that restate financial statements and the non-audit service fees received by incumbent auditors during reporting periods that required restatement.

We identify a sample of 110 firms that restated financial statements previously filed with the SEC for fiscal years 2000 or 2001, and provided relevant audit and non-audit fee data. We compare the fees paid by the restatement sample with fee data for 3,481 firms that filed proxies with the SEC from February 5, 2001 to August 31, 2001 and develop benchmarks for expected non-audit fees, fee ratio, and total fees. Using these benchmarks, we calculate the unexpected values for these measures and investigate whether restatement firms differ from the control firms. Our findings of no significant differences between the restatement and control samples for unexpected non-audit fees, fee ratios, and total fees do not support concerns that either non-audit fees or total fees inappropriately influence the audit and lead to restatements.

restatements, audit fees, independence

Abstract:
Prior research provides evidence that a higher proportion of accrued relative to cash earnings is associated with lower earnings performance in the subsequent fiscal year. The result has been widely interpreted as indicative of higher levels of operating accruals relative to cash flows foreshadowing a subsequent earnings reversal, and thus signaling earnings management. We note, however, that earnings performance in prior studies is typically defined as one-year-ahead operating income divided by one-year-ahead invested capital, or a measure of profitability.

We find that accruals are more highly associated than cash flows with invested capital in the denominator of the profitability measure. In contrast, accruals and cash flows have no differential relation to one-year-ahead operating income. The evidence is not consistent with accruals having a reversal effect on earnings. This suggests that the lower persistence of accruals versus cash flows may not be due to earnings management but may rather be due to the effect of growth on future profitability.

accrued earnings, growth, return on assets, earnings management, financial statement analysis

Abstract:
In this study, we investigate whether the characteristics of clients, auditors, and the auditor-client relationship simultaneously determine audit and non-audit fees. As done in prior studies, we maintain that fees proxy for the level of service provided and follow the physical flow of knowledge. Estimating single-equation models of audit and non-audit fee models, we confirm prior findings of an association between audit and non-audit fees. Studies have concluded such evidence is consistent with knowledge spillovers between the two services. However, we document empirically that audit and non-audit fees are simultaneously determined. Since the data indicate audit and non-audit fees are jointly determined, we then investigate whether previously documented associations between audit and non-audit fees are the result of biased estimation induced by using endogenous variables in single-equation models. In contrast to results from single-equation estimations, we find no association between audit and non-audit fees using a simultaneous specification of the fee system, suggesting that single-equation estimations suffer from simultaneous-equations bias. In sum, the findings are not consistent with the existence of economies of scope from the joint performance of audit and non-audit services after controlling for the joint behavior of audit and non-audit fees. Given the ongoing debate over the level of allowed non-audit services by auditors, the argument for the joint provision of audit and non-audit services is less justified than if joint-supply benefits had been documented.

audit pricing, non-audit pricing, economies of scope, joint provision of services

Abstract:
Prior research reveals that the accrual component of profitability is less persistent than the cash flow component, and that investors fail to fully appreciate their differing implications for future profitability (Sloan 1996). However, accruals are a component of growth in net operating assets as well as a component of profitability. Just as we can disaggregate profitability into accruals and cash flows from operations, we can disaggregate growth in net operating assets into accruals and growth in long-term net operating assets. We find, after controlling for current profitability, that both components of growth in net operating assets - accruals and growth in long-term net operating assets - have equivalent negative associations with one-year-ahead return on assets. This result is consistent with conservative accounting and diminishing marginal returns on investments. We also find, after controlling for current profitability, that the market appears to equivalently overvalue accruals and growth in long-term net operating assets relative to their association with one-year-ahead ROA. Our evidence suggests that the accrual anomaly documented in Sloan (1996) is a special case of what could be viewed as a more general growth anomaly.

accrued earnings, growth, earnings quality, financial statement analysis, market mispricing

Abstract:
This study examines the change in investors' private search activities after being provided SFAS No. 95 disclosures compared with their behavior when provided a set of financial reporting disclosures with APBO No. 19 disclosures. Consistent with the theoretical analysis in McNichols and Trueman (1994), we find that market participants private search behavior changes when provided SFAS No. 95 disclosures. We identify this change as the precision effect associated with SFAS No. 95 disclosures of cash flow from operations. Our research design is similar to that employed in Ball and Brown (1968), yet differs by examining the abnormal returns (i.e., CAR realizations) to good/bad news portfolios formed using earnings and cash flow signals (independently and jointly). We compare the returns across the two reporting enviroments of interest to the study. Also, this study provides initial empirical evidence on price changes associated with unexpected CFO before and after SFAS No. 95 disclosures was mandated and offers a CFO model that closely approximates SFAS No. 95 disclosures for use in periods prior to the implementation of SFAS No. 95. In support of the statements made by financial reporting regualtors, we find that market participants use the information in SFAS No. 95 disclosures with earnings to price securities. However, consistent with the result in Dechow (1994), we find that unexpected earnings dominates unexpected CFO (as measured by association with abnormal returns) when both signals are use to form portfolios.