The Difference between Earnings and Operating Cash Flow as an Indicator of Financial Reporting Fraud*

This paper examines the relation between earnings and operating cash flow to derive and test an indicator of financial statement fraud. Accrual measurement concepts indicate that financial statement fraud should be associated with high levels of earnings relative to operating cash flow. We demonstrate that the excess of earnings over operating cash flow is extreme in most fraud cases in years immediately prior to the fraud discovery based on a sample of 56 fraud cases from 1978 to 1991. We compare the distribution of the earnings minus operating cash flow variable for fraud firms with that for a sample of 60,453 firm-years for firms listed on COMPUSTAT. We test a logistic regression model in which the discovery/nondiscovery of fraud is the dependent variable, and earnings minus operating cash flow is the explanatory variable. Other control variables are included in the model based on prior studies. Results are consistent with expectations derived from accrual measurement theory. We then examine the predictive ability of the model using our sample of fraud firms and a sample of nonfraud firms in the same four-digit SIC code industries. Observations for the fraud firms are for the fiscal year prior to the discovery of fraud. Observations for the nonfraud firms are for the same fiscal years as the fraud firms in the same industries. The predictive ability of the model, including the excess of earnings over operating cash flow, is substantially higher than the predictive ability of the model omitting this variable. We conclude that the earnings-operating cash flow relation provides important information for those interested in identifying financial statement fraud, especially when considered in conjunction with other factors associated with fraud risk.     

The Impact of Open Data on Public Procurement

We examine how open procurement data affect the competitiveness of award procedures and the execution of government contracts. The European Union recently made its historical procurement notices available for bulk download in a cohesive and user-friendly database. Comparing government contracts above and below EU procurement size thresholds, we find that, after the open data initiative, procurement officials are more likely to award treated contracts through open bidding. In cross-sectional analyses, we document variation in the open bidding effect consistent with two underlying mechanisms: (1) increased scrutiny by NGOs and investigative journalists and (2) learning by national procurement regulators. However, treated contracts are also more likely to experience costly modifications because the shift to open bidding introduces rigidity that limits officials’ discretion in selecting suppliers based on private information. Overall, our evidence indicates that open procurement data promote competitive bidding but lead to contracts with weaker execution performance. These inferences also hold in an alternative open data setting.     

Securitization and Bank Performance

Using predominantly precrisis U.S. commercial bank data, this paper employs a propensity score matching approach to analyze whether individual banks did improve their performance through securitization. On average, our results show that securitizing banks tend to be more profitable institutions, with higher credit risk exposure. Despite a more diversified funding structure, they face higher funding costs. We also find that securitizing banks tend to hold larger and less diversified loan portfolios, have less liquidity, and hold less capital. However, our analysis does not provide evidence to suggest that securitization had an impact upon bank performance.     

Factors Related to Employees’ Desire to Join and Leave Unions

Regression analyses based on a sample of 3372 nonunionized and unionized employees showed that, while the desire to join a union is associated with a wide range of work attitudes, perceived company performance, and facets of satisfaction, one's desire to leave one's union is associated with a narrow range of economic concerns. Implications of the findings are discussed in light of the declining unionization rate in the United States.     

Efficient Recapitalization

We analyze government interventions to recapitalize a banking sector that restricts lending to firms because of debt overhang. We find that the efficient recapitalization program injects capital against preferred stock plus warrants and conditions implementation on sufficient bank participation. Preferred stock plus warrants reduces opportunistic participation by banks that do not require recapitalization, although conditional implementation limits free riding by banks that benefit from lower credit risk because of other banks’ participation. Efficient recapitalization is profitable if the benefits of lower aggregate credit risk exceed the cost of implicit transfers to bank debt holders.     

Deep Habits in the New Keynesian Phillips Curve

We derive and estimate a New Keynesian Phillips Curve (NKPC) in a model with deep habits. Habits are deep in that they apply to individual consumption goods instead of aggregate consumption. This alters the NKPC in a fundamental manner since it introduces consumption growth and future demand terms into the NKPC equation. We construct the driving process in the deep habits NKPC by using the model's optimality conditions to impute time series for unobservable variables. The resulting series is considerably more volatile than unit labor cost. Generalized methods of moments estimation shows an improved fit and a much lower degree of indexation compared to the standard NKPC.     

CO‐MOVEMENT OF AUSTRALIAN STATE BUSINESS CYCLES*

We use a variety of techniques to examine the nature and degree of co‐movement among Australian state business cycles. Consistent with the results of Dixon and Shepherd (2001 ), we find that these cycles move quite closely together, with particularly strong links between the cycles of the larger states. We then seek to understand the causes of this co‐movement by using an unobserved components model to distinguish between various shocks and their transmission. Our model implies that the major source of this co‐movement in state activity is the commonality of shocks affecting state cycles. In contrast, spillovers of region‐specific shocks appear to play only a minor role in creating co‐movement, though region‐specific shocks themselves have a moderate influence on cyclical fluctuations. These findings are consistent with the results of recent studies for the United States, Canada and Europe, where common shocks have also been found to dominate regional cyclical activity.     

A STATISTICAL THEORY OF EQUILIBRIUM IN GAMES*

This paper describes a statistical model of equiliobrium behaviour in games, which we call Quantal Response Equilibrium (QRE). The key feature of the equilibrium is that individuals do not always play responses to the strategies of their opponents, but play better strategies with higher probability than worse strategies. we illustrate several different applications of this approach, and establish a number of theoretical properties of this equilibrium concept. We also demonstrate an equililance between this equilibrium notion and Bayesian games derived from games of complete information with perturbed payoffs     

TRENDS IN AMERICAN LIVING STANDARDS AND INEQUALITY, 1959–2007

We analyze the trends from 1959 to 2007 using an expanded measure of income called the Levy Institute Measure of Economic Well‐Being (LIMEW). LIMEW is different in scope from the official U.S. Census Bureau measure of gross money income (MI) in that our measure includes non‐cash transfers, public consumption, imputed income from wealth, and household production and nets out personal taxes. While the annual growth rates of median LIMEW and MI are very close over the whole period (0.67 and 0.63 percent), median LIMEW grew much faster than median MI after 1982 and much slower before. The Gini coefficient of MI is uniformly higher than that of LIMEW but both show about the same change from 1959 to 2007. Decomposition analysis shows that changes in inequality are driven to a large extent by non‐home wealth in LIMEW and earnings in MI. While the racial gap in MI declined somewhat over the 1990s and 2000s, the racial gap in LIMEW actually widened a bit. Over the same years, while there was little change in the gap in MI between the elderly and non‐elderly, the LIMEW of the elderly actually overtook that of the non‐elderly.     

Product Liability in the European Community: The Legislative History

This article analyzes the complex history of the important new product liability directive of the European Community. The member countries must amend their laws and meet the directive's proconsumer standards and spirit. The lengthy political evolution of this policy involved many aggressive constituencies, including nations, parts of the European Community governance structure, business federations, consumer organizations, and other functional interest groups.