Auditor independence, self-interested behavior and ethics: some experimental evidence

Haim Falk, Bernadette Lynn, Stuart Mestelman, Mohamed Shehata 

Journal of Accounting and Public Policy 18 (1999) 395-428

Abstract

Our paper presents the results obtained in a laboratory environment in which subjects revealed their beliefs about an uncertain state of the world and then participated in a simple task which required them to report on whether the report of a second party is consistent with the subjects’ beliefs. Because maintaining prior judgements (audit independence) which were in disagreement with the second party’s decision (a potential

for a qualified audit opinion) were costly to the subject, a situation was created in which the subject might compromise her beliefs at a price. The results suggest that amoral, selfinterested profit-maximizing behavior does not generally characterize the subjects in this experiment. Furthermore, subjects compromise their beliefs less often, i.e., breach independence, the higher their scores on a Defining Issues Test, but more often, the greater the cost of adhering to their beliefs. © 1999 Elsevier Science Inc. All rights reserved.

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A model of corporate rent-seeking through tax legislation

Journal of Accounting and Public Policy 18 (1999) 375-394

Michael G. Williams a, Charles W. Swenson

Abstract

An analytic model is developed to examine the role of rent-seeking expenses on tax legislation. Rent-seeking expenses are found to be only a fraction of the tax benefits at stake. Rent-seeking expenses increase when firms cannot cooperate, when very general tax legislation is proposed, and when there is legislative support for tax cuts. © 1999 Elsevier Science Inc. All rights reserved.

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Discussion of ``economic analysis of accountants’ ethical standards: the case of audit opinion shopping''

Comment

Journal of Accounting and Public Policy 18 (1999) 365-373

Charles J. Coate

Abstract

In his paper, Cushing (Cushing, B.E., (1999). Economics analysis of accountants’ ethical standards: The case of audit opinion shopping. Journal of Accounting and Public Policy 18 (4/5)) argues for an increasing role of ``laissez-faire'' approaches to professional accounting ethics. To formally present his argument, Cushing (1999) employs a classic auditor±client dispute over a financial reporting issue; the dispute’s resolution is framed within a prisoner’s dilemma game. Three increasingly sophisticated models are used to examine both strict (explicit rules and monitoring) and laissez-faire (moral training and leadership) approaches to induce ethical auditor play within the prisoner’s dilemma game. My comments are an effort to consider if Cushing's (1999) arguments for a laissezfaire approach are practicable. To do this I first relate Cushing's (1999) arguments to the theoretical attributes of a profession. Second, I extend his arguments to include ethical disposition. Two bases of ethical disposition are discussed, moral reasoning theory and the persona of individuals. I conclude that a movement toward a laissez-faire approach to ethics is a strategy the profession should not ignore. © 1999 Elsevier Science Inc. All rights reserved.

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Economic analysis of accountants' ethical standards: The case of audit opinion shopping

Journal of Accounting and Public Policy 18 (1999) 339±363

Barry E. Cushing

Abstract

The public accounting profession presently employs a strict system of ethical standards that relies upon explicit rules plus monitoring and enforcement procedures that penalize violations of the rules. An alternative approach to ethical standards that the public accounting profession may wish to consider is a laissez faire approach. Instead of rules and penalties to enforce desired behaviors, the laissez faire approach utilizes moral training and leadership to motivate professional accountants to act in the public interest, for the sake of the profession as a whole. The theoretical basis for the laissez faire approach is a growing body of evidence in economics and related disciplines that people often take actions to further the collective welfare of a group despite a detrimental effect on their own selfish interests. This paper offers a framework for examining the relative economic merits of the strict and laissez faire approaches to ethical standards within the accounting profession. The framework is based on game theory, and the setting employed in the paper involves opinion shopping by audit clients. The paper finds that the effectiveness of a laissez faire approach to ethical standards, at least in the opinion shopping scenario, is related to (a) the ethical climate, which refers to the likelihood a given independent auditor will choose the ethical action, (b) the frequency of independent auditor rotation, which reduces the economic advantage of being the incumbent auditor, (c) the explicitness of Generally Accepted Accounting Principles (GAAP), which reduces uncertainty over whether or not a particular act is ethical, (d) the availability of opportunities to discuss ethical choices with rival auditors, and (e) disclosure requirements associated with auditor±client disputes over material accounting issues.©1999 Elsevier Science Inc. All rights reserved.

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Research in ethics and economic behavior in accounting

Guest Editorial

Journal of Accounting and Public Policy 18 (1999) 335-338 

Frances L. Ayres, Dipankar Ghosh

Important in recent years. To promote ethical behavior organizations have used techniques such as ethics hotlines, code of ethics, appointed ethics officers, and undertaken other ways of encouraging ethical behavior (Morf et al., 1999, especially pp. 265, 269).

Professional norms in tax practice also have significant ethical dimensions. The widely accepted view among accountants is that, while tax evasion is unethical, tax avoidance is expected and is considered a building block of sound tax planning. The problem lies in determining where one ends and the other begins. For example, we have heard comments that suggest that officials of large corporations view their tax return as a first offer, and spend years negotiating with the Internal Revenue Service to reach final settlements on their tax returns.

Despite the increasing interest in ethics among the business community, and the significant cost to shareholders of lapses in ethics, ethics-related academic research in accounting has been limited. In large part, we feel this stems from a research paradigm focusing on descriptive as opposed to prescriptive research, in addition to a belief that ethical issues are not conducive to economic modeling or empirical research. A notable exception is a paper by Eric Noreen (1988, pp. 363-364) in which he argues that ethical behavior can coincide with maximization of economic welfare. He (1988, pp. 363-364) focuses on ethical behavior as a utilitarian concept, and argues that efficient economic exchange is facilitated by voluntary compliance with a set of mutually agreed upon rules of behavior. Compliance is encouraged by cultural expectations that are expressed as a part of religion, behavior norms (conscience), and even biological survival (see Noreen, 1988, pp. 364-369). Codes of ethics also serve as a means of encouraging and describing ethical behavior (Loeb 1971, p. 4; 1984, p. 53).

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Accounting ethics research

Editorial

Journal of Accounting and Public Policy 18 (1999) 333-334

I first began doing research on accounting ethics in 1969 (see, e.g., Loeb, 1970) when the topic was not a particularly fashionable area for academic research (see discussion in Previts and Merino, 1998, pp. 339-340). In the last decade there has been an increase in academic accounting ethics research. This increased interest in academic accounting ethics research may be due to a number of factors such as the Tread way Commission report (1987) and the activities of the American Accounting Association in the areas relating to accounting ethics (see, e.g., Loeb and Rockness, 1992, especially pp. 485-487; Ayres and Ghosh, 1996, p. 77). The three main articles and comment that follow are drawn from a conference entitled ``Ethics and Economic Behavior in Accounting and Taxation'' that was held at the University of Oklahoma in April of 1997 (see Ayres and Ghosh, 1996, 1999). The conference coordinators, Professors Frances L. Ayres and Dipankar Ghosh, are also Special Associate Editors for this partial special theme issue that relates to ``economic behavior'' and accounting ethics (Ayres and Ghosh, 1996, 1999). An important issue relating to accounting ethics research is defining what is accounting ethics research. I view the conference directed by Professors Ayres and Ghosh and this partial special theme issue as part of an ongoing effort to better define the young and hopefully growing field of academic accounting ethics research.

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Audit committee activity and agency costs

Research Note

Journal of Accounting and Public Policy 18 (1999) 311-332

Paul Collier, Alan Gregory 

Abstract

Menon and Williams indicate that many United States (US) over-the-counter (OTC) firms which form audit committees appear not to rely on them (cf. Menon, K., Williams, J.D. 1994. Journal of Accounting and Public Policy, 13(2), 121-139). Reliance on audit committees appears to depend upon board composition, while audit committee activity is associated with firm size. In this paper, we compare the US experience and evidence on audit committees and monitoring with the position in the United Kingdom (UK), where there has been a steady growth in the number of major companies voluntarily forming audit committees over the last 15 years (Collier, P.A. 1996. Accounting, Business and Financial History 6(2), 121-140). We contend that the dataset is best analyzed using the Heckman procedure (cf. Heckman, J.A. 1979. Econometrica 47(1), 153-161) which captures the two stages of the decision on audit committee activity. Our results show little support from the UK data for the findings of Menon and Williams (cf. Menon and Williams, 1994. Journal of Accounting and Public Policy 13(2), 121-139). However, consistent with their agency theoretic perspective of monitoring, we found that high quality (Big Six) auditors, and to some degree leverage have akan positive relationship with audit committee activity. Contrary to an agency theoretic expectation, we found that audit committee activity is reduced in firms that combine the role of chairman and chief executive. On the basis of this result we explored the impact of insiders (executive directors) and found that their presence on an audit committee had a significant negative impact on audit committee activity. This result suggests that the emphasis placed by the US Securities and Exchange Commission (SEC) (Staff Report on Corporate Accountability, US Government Printing Office, Washington, DC, 1980, p. 491) and the Cadbury Committee (Committee on the Financial Aspects of Corporate Governance. 1992. Report of the Committee on the Financial Aspects of Corporate Governance. Gee, London) on the independence of audit committee members may be well founded. The reduction in audit committee activity that arises from the combination of the role of chairman and chief executive officer, and the presence of insiders on the audit committee, has important policy implications. Indeed, in the UK, both practices are the subject of recommendations in the Hampel Committee report Hampel Committee 1998. Committee on Corporate Governance. Gee, London. ©1999 Elsevier Science Inc. All rights reserved.

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An analysis of the financial performance of defense business segments using data envelopment analysis

Journal of Accounting and Public Policy 18 (1999) 287-310

William F. Bowlin

Abstract

This research examines the financial performance of defense-oriented business segments compared to non-defense-business segments for the years 1983±1992. A financial performance measure developed from data envelopment analysis is evaluated both cross-sectionally and longitudinally. The data envelopment analysis is supplemented by, and compared to, traditional financial ratio analysis which provides additional insight into the financial performance of defense-business segments. Generally, the research findings are that the defense-business segments financially outperformed non-defensebusiness segments for most of the years covered by this study. However, defense segments did deteriorate financially relative to the non-defense-business segments during the time period 1983±1989. Then, beginning in 1990 there are indications that the defense segments reversed this trend and are gaining financial strength and making greater contributions to the financial health of their firms. © 1999 Elsevier Science Inc. All rights reserved

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Supplier selection, monitoring practices, and firm performance

Journal of Accounting and Public Policy 18 (1999) 253-281

Christopher D. Ittner, David F. Larcker, Venkatesh Nagar, Madhav V. Rajan

Abstract

Our paper examines whether supplier selection and monitoring practices affect the association between supplier strategies and organizational performance. Management accounting researchers (Atkinson, A., Waterhouse, J., 1996. Strategic Performance Measurement: Scope and Implementation Issues; Gietzmann, M.B., 1996. Accounting, Organizations and Society, 21 (6), 611±626, p. 613) argue that supplier partnerships can enhance cost management efforts by improving product quality, accelerating the product development process, and increasing process effciency through supplier-originated ideas and technologies. However, the development of effective supplier partnerships may also require different selection and monitoring practices than arms-length supplier transactions. Empirical tests using data from the automotive and computer industries indicated that the performance gains from supplier partnerships practices are contingent on extensive use of non-price selection criteria, frequent meetings and interactions with suppliers, and supplier certification. In contrast, these selection and monitoring practices appeared to have little effect on the performance of organizations following arms-length supplier relations. © 1999 Elsevier Science Inc. All rights reserved.

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Stock market reactions to activity-based costing adoptions

Journal of Accounting and Public Policy 18 (1999) 229-251

Lawrence A. Gordon, Katherine J. Silvester

Abstract

The use of activity-based costing (ABC) has been steadily, if not rapidly, spreading on an international level. This fact notwithstanding, the economic benefit associated with adopting ABC is suspect, at best. In an effort to shed additional light on this apparent dilemma, this paper empirically investigates the stock market effects of announcing the adoption of an ABC system. The research methodology includes both parametric and non-parametric tests for excess market returns from a seemingly unrelated regressions model with a matched pairs sample of firms. The analysis indicates that the installation of an ABC system in the United States is not associated with a significant (either positive or negative) stock market reaction. ©1999 Elsevier Science Inc. All rights reserved.

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Choice of an information structure versus a production environment: A managerial control perspective

Sri S. Sridhar, Bala V. Balachandran

Abstract

Modern manufacturing systems often require standardization of tasks and training of employees with the intent of creating flexible and interchangeable production schedules. Designing of such a production environment must invariably rely on employees' superior information about the task characteristics. Recognizing employees' incentives in their participation of budgeting for such tasks leads to a better understanding of the eciency implications of different information structures in the context of advanced manufacturing systems. This paper examines the principal's ability and willingness to substitute an information structure for a given specificity of a production environment and vice versa, where production environment is classified either as person-specific (PS) or task-specific (TS). In a TS environment, provision of greater predecision information to multiple managers is always desirable. However, under certain conditions, the principal will prefer managers to have less information but operate in a TS environment to providing greater information to them in a PS environment. Thus, under specified conditions, the specificity effect of the production environment dominates the information effect. Moreover, for a given information structure, we identify sucient conditions under which the principal will prefer the PS environment to a TS one and vice versa. Finally, ceteris paribus, managerial control problems are less severe when the production environment is TS than when it is PS. © 1999 Elsevier Science Inc. All rights reserved.

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Foreword to Theme Issue on Cost Management Concepts, Firm Performance, and Industrial Competitiveness

Guest Editorial

Journal of Accounting and Public Policy 18 (1999) 189-1

Given the increase in global competition over the last several decades, one would expect economic policy makers to have increased their attention on their respective nation’s industrial competitiveness. Similarly, over the same period and driven by the same forces, one would also expect managers and academic researchers to have had a renewed interest in examining cost management systems as a means of enhancing firm performance and gaining strategic advantage in world markets. In the cost management literature, evidence of such renewed interest can be seen from the publication and reaction to Johnson and Kaplan (1987). A great deal of this recent cost management literature has centered around activity-based costing (e.g., Banker and Hughes, 1994; Cooper and Kaplan, 1992; Datar and Gupta, 1994). However, other modern cost management tools such as benchmarking (e.g., Elnathan and Kim, 1995), and just-in-time inventory systems (e.g., Alles et al., 1995) have also recently been examined. The articles by Balachandran and Sridhar (1999), Gordon and Sylvester (1999), and Ittner et al. (1999), which make up this special theme issue, individually and together, provide insightful and stimulating contributions to the interface between industrial competitiveness and cost management systems.

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Taxpayer behavior in response to taxation:comment and new experimental evidence

Journal of Accounting and Public Policy 18 (1999) 165-177

M.A. Sillamaa

Abstract

This experiment replicates an experiment previously published in C.W. Swenson [Taxpayer behavior in response to taxation, an experimental analysis, Journal of Accounting and Public Policy 7 (1) (1988) 1±28] on how people adjust their work effort in response to a linear tax where the amount taken away by the marginal tax rate is returned to the individual as a lump-sum grant, i.e., where the net tax revenue is zero.

The prediction is that work effort should decrease as the marginal tax rate rises. Swenson obtained a result partially in contradiction to this theory. The experiment in this paper introduces some changes to his experimental design, and in contrast, supports the theory. © 1999 Elsevier Science Inc. All rights reserved.

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Systematic differences in employee stock ownership plan contributions: some evidence

Journal of Accounting and Public Policy 18 (1999) 141-163

Elaine G. Mauldin

Abstract

Under current federal law, ESOPs are intended to provide an employee benefit and also meet corporate financial objectives. These dual purposes may not always be compatible. This study examines total retirement plan contributions, using data from Department of Labor Form 5500s, and demonstrates systematic differences in those contributions between companies establishing the ESOP for different reasons. A signi- ficant increase in benefits after the ESOP is implemented is found in those firms using the ESOP primarily as an employee benefit with no apparent finance objectives, while akan significant decrease in benefits is found in those firms using the ESOP primarily for corporate finance reasons. The difference in benefits suggests that the reason an ESOP is adopted may make a difference to the employees of the firm. Further analysis links total retirement contributions to a measure of firm productivity. ESOPs with positive increases in total retirement benefits are associated with increases in sales per employee. © 1999 Elsevier Science Inc. All rights reserved.

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