JENNIFER J. GAVER, University of Georgia - J. M. Tull School of Accounting, Terry College of Business
Email: jgaver@terry.uga.edu
JEFFREY S. PATERSON, Florida State University
Email: jpaters@cob.fsu.edu
CARL PACINI, Florida Gulf Coast University - Department of Accounting, Finance & Business Law
Email: cpacini@fgcu.edu

We hypothesize that when auditors face greater legal liability they will have less tolerance for loss reserve understatements by their insurance clients. To test this hypothesis, we analyze a sample of 6,033 loss reserve observations from 1993 through 2001. Consistent with Petroni (1992), we find that financially struggling insurers tend to under-reserve. This behavior is attenuated when the insurer is domiciled, headquartered, or licensed in a state which uses either the Restatement of Torts or the reasonable foreseeability standard to determine the auditor’s liability to third parties. Compared to the case where the auditor’s liability is defined by the legal concept of privity, these standards impose greater legal costs on auditors for ordinary negligence. The results suggest that auditors demand more conservative reporting when they face higher legal costs.

LIN CHENG, The Ohio State University - Fisher College of Business
Email: cheng_301@fisher.osu.edu
SCOTT LIAO, University of Toronto - Joseph L. Rotman School of Management
HAIWEN (HELEN) ZHANG, Ohio State University - Department of Accounting & Management Information Systems
Email: zhang.614@osu.edu

In this paper, we examine the economic consequences of disclosure deregulation by exploring a recent regulatory change that allows smaller reporting companies to voluntarily provide certain information in their SEC filings. Compared with voluntary disclosure, mandatory disclosure imposes additional financial reporting cost but potentially provides a credible commitment mechanism and reduces managers’ opportunistic disclosure behavior. Consistent with this argument, we find that smaller firms that have entrenched managers and face less information demand are more likely to reduce their disclosure level. We find that firms that choose to scale their disclosure face decreased market liquidity. In addition, we find decreased liquidity even for firms that are eligible to scale their disclosure but choose to maintain their disclosure level, which suggests that loss of commitment is costly in absence of loss of information. Finally, our findings of positive stock market returns when the Advisory Committee on Small Public Companies made progress on the recommendation of scaled disclosure practice for small public companies suggest that the new rule is overall beneficial to smaller reporting companies despite of decreased liquidity.

M. MARTIN BOYER, HEC Montreal - Department of Finance, Center for Interuniversity Research and Analysis on Organization (CIRANO), University of Montreal - HEC Montréal
Email: martin.boyer@hec.ca
HANON AMANDINE, Procter and Gamble
Email: amandine.hanon@hec.ca

A lingering topic in corporate governance is whether corporate directors should be protected against shareholder lawsuits and whether such protection reduces the incentives of directors to monitor appropriately the behaviour of corporate officers. To achieve this goal, we examine whether corporations whose corporate managers’ wealth is protected under a directors’ and officers’ liability insurance policy (D&O insurance hereafter) are more to report accounting results aggressively. Using discretionary accruals as our measure of accounting aggressiveness, the results in our paper suggest that the magnitude of discretionary accruals has no real impact on the demand for D&O insurance, be it on the decision to purchase insurance or on the amount of limit chosen. The positivity of discretionary accruals appears, however, to have an impact on the decision to purchase insurance. Surprisingly, although these insurance policies protect directors and officers in the event they make a “mistake� in their role as representatives of the company, directors do not seem to see this as an invitation to be a little less careful when overseeing the firm’s accounting practices.

TAO MA, Washington University, St. Louis
Email: taoma@wustl.edu

Prior studies show that CEOs view earnings as an important performance metric and under great pressure to meet or beat earnings benchmarks. Accounting conservatism requires firms to accelerate the recognition of future economic losses but delay the recognition of economic gains. This paper argues that the asymmetrical recognition standard for gains and losses can incentivize CEOs to forego positive NPV projects if undertaking these NPV projects cause an understatement of near-term accounting performance due to accelerated recognition of future expenses. Further, the underinvestment becomes more pronounced when CEOs face strong market pressure to meet earnings benchmarks. Empirical results show that accounting conservatism and underinvestment are positively correlated, and this positive correlation becomes more pronounced when firms are followed by analysts and is mitigated by CEOs’ equity ownership, consistent with the notion that equity ownership mitigates agency conflicts (Jensen and Meckling, 1976). The results are robust to alternative empirical identification strategies, variable specifications, and sample selection criteria.

MARIANNE OJO, Center For European Law and Politics
Email: marianneojo@hotmail.com

From the responses received from the European Commission’s consultation on control structures in audit firms and their consequences on the audit market, a consultation which was launched in November 2008, and whose deadline was scheduled for the end of February 2009, the role played by the facilitation of greater access to external financial capital as a means of increasing access to the audit market, hence opening up the market for the audit of international companies to more suppliers, and encouraging new market players, was acknowledged. However, this factor on its own, coupled with the need to amend current rules on the control of audit firms, namely through a relaxation of the rules – beyond that which is currently permitted under Article 3 of the 2006 Statutory Audit Directive, was not considered to be the most important source of impediment to the emergence of new players. Other further possible catalysts, both on the supply side (namely auditors) and the demand side (companies), were also considered vital to efforts aimed at encouraging more players in gaining access to the international audit market. This paper will focus on greater access to external financial capital - as a means of lowering barriers to the international audit market. In arriving at the conclusion that the benefits associated with the external investor model outweigh the possible risks it generates, the paper not only considers theories on managerial behaviour and ownership structure, but also gives attention to the safeguards for audit independence as listed under the 2002 Statutory Auditors’ Independence in the EU: A Set of Fundamental Principles, and the 2006 Statutory Audit Directive. It will also consider why, in view of the limitations and restrictions placed on audit firms, with particular reference to the Sarbanes Oxley Act of 2002, actions aimed at encouraging new market players at EU level, whilst ensuring that auditors’ independence and audit quality are not compromised, would also require a consideration of an international dimension of issues involved in lowering barriers to entry.