Resource Allocation Decisions in Audit Engagements*

Abstract. We examine the empirical relationship between auditors' resource allocations and selected engagement characteristics. Our measure of resources is hours of grades of labor (partner, manager, etc.) “charged” to audit activities (planning, internal control evaluation, etc.). Engagement characteristics examined are client size, industry affiliation, client complexity, risk, auditor provision of management advisory services to the auditee, and degree of control reliance. The data were obtained from publicly available sources and a survey developed and administered by an international public accounting firm. We find the cross-sectional variation in the labor charged to various audit activities can be explained by engagement characteristics found to be important in prior studies on audit fees, total labor inputs, and the mix of labor inputs. Measures of client size, industry, complexity, risk, and services provided are associated with changes in the allocation of labor among audit activities. We find no substitution of internal control review/testing for substantive testing on reliance audits. Task assignments vary by rank. Measures of client size, complexity, risk, and services provided are associated with activity-specific changes in the labor mix.     

Context-Dependence of Auditors' Interpretations of the SFAS No. 5 Probability Expressions*

Abstract. Statement of Financial Accounting Standards (SFAS) No. 5 requires accrual of contingent losses which are deemed probable. This disclosure criterion is intended to be applied uniformly across a variety of contexts. We performed an experiment which examined whether audit managers' interpretations of the SFAS No. 5 probability expressions are influenced by one contextual feature, event base rate. Counter to the intention of the Financial Accounting Standards Board (FASB), interpretations of the expression probable were positively associated with event base rate. Résumé. Le SFAS n^o 5 exige l'imputation à l'exercice des pertes éventuelles qui sont jugées «probables». La règle ainsi établie veut que ce critère de présentation d'information soit appliqué uniformément dans des contextes très divers. Les auteurs procèdent à une expérience dans le cadre de laquelle ils examinent si la façon dont les responsables de mission interprètent la gamme de probabilités, au sens du SFAS n^o 5, est influencée par une caractéristique contextuelle, la fréquence relative de l'événement. Contrairement au résultat visé par le FASB, les interprétations du terme «probable» sont en relation positive avec la fréquence relative de l'événement.     

ON THE ANTICOMPETITIVE EFFECT OF EXCLUSIVE DEALING WHEN ENTRY BY MERGER IS POSSIBLE*

We extend the literature on exclusive dealing by allowing the incumbent and the potential entrant to merge. This uncovers new effects. First, exclusive dealing can be used to improve the incumbent's bargaining position in the merger negotiation. Second, the incumbent finds it easier to elicit the buyer's acceptance of exclusivity. Third, despite allowing the more efficient technology to find its way into the industry, exclusive dealing reduces welfare because (i) it may trigger entry through merger whereas independent entry would be socially optimal and (ii) it may deter entry altogether.     

Taxation and Tournaments

This paper analyzes the effects of progressive taxes on labor supply and income distribution in the context of the rank‐order tournament model originally developed by Lazear and Rosen (1981). We show conditions under which a more progressive tax schedule will cause so large general equilibrium effects that the inequality in disposable income will actually increase. We also show that a non‐zero redistributive tax is always optimal if society's welfare function displays inequality aversion; this result always holds, regardless of behavioral responses and general equilibrium effects.     

Hidden costs of consumption

Consumers often underestimate the costs resulting from their consumer decisions. This is especially the case when purchasing durable consumer goods, but also for recreational activities, for which e.g. athletic equipment is bought. A similar situation exists when pets are kept. This disregard for the costs of subsequent use connected with the purchase of household appliances is problematic for consumers. In a study on the usage life of consumer goods¹ in the household, it was recognized that many consumers do not pay attention to these subsequent costs. The decisive consumer problem was not the durability of consumer goods, nor their tendency to become defective, but the resulting costs of the purchase, the operating costs of household appliances. On one hand, the working expenses are not considered at the time of purchase and their effect is not included in the purchase decision. On the other, the operating costs vary greatly, depending on the chosen type and model of appliance and, of course, on the specific form of utilization. In this paper, the question of the durability of consumer goods is first discussed with the help of empirical work. Then the hidden resulting costs, i.e. operating costs or costs of usage of consumer goods, are described. The resulting costs of keeping pets are also discussed. In the final part, the question of objective help for the consumer making purchase decisions is discussed.     

It's SHO Time! Short-Sale Price Tests and Market Quality

We examine the effects of the Securities and Exchange Commission (SEC)-mandated temporary suspension of short-sale price tests for a set of Pilot securities. While short-selling activity increases both for NYSE- and Nasdaq-listed Pilot stocks, returns and volatility at the daily level are unaffected. NYSE-listed Pilot stocks experience more symmetric trading patterns and a slight increase in spreads and intraday volatility after the suspension while there is a smaller effect on market quality for Nasdaq-listed Pilot stocks. The results suggest that the effect of the price tests on market quality can largely be attributed to distortions in order flow created by the price tests themselves.     

Are Some Forecasters Really Better Than Others?

In any data set with individual forecasts of economic variables, some forecasters will perform better than others. However, it is possible that these ex post differences reflect sampling variation and thus overstate the ex ante differences between forecasters. In this paper, we present a simple test of the null hypothesis that all forecasters in the U.S. Survey of Professional Forecasters have equal ability. We construct a test statistic that reflects both the relative and absolute performance of the forecaster and use bootstrap techniques to compare the empirical results with the equivalents obtained under the null hypothesis of equal forecaster ability. Results suggest little support for the idea that the best forecasters are actually innately better than others, though there is evidence that a relatively small group of forecasters perform very poorly.     

On Price Caps Under Uncertainty

This paper shows how standard arguments supporting the imposition of price caps break down in the presence of demand uncertainty. In particular, though in the deterministic case the introduction or lowering of a price cap (above marginal cost) results in increased production, increased total welfare, decreased prices, and increased consumer welfare, we show that all of the above comparative statics predictions fail for generic uncertain demand functions. For example, for price caps sufficiently close to marginal cost, a decrease in the price cap always leads to a decrease in production and total welfare under certain mild conditions. Under stronger regularity assumptions, all of the monotone comparative statics predictions from the deterministic case also do not hold for a generic uncertain demand if we restrict attention to price caps in an arbitrary fixed interval (as long as the price caps are binding for some values in that interval).