A Bayesian approach for predicting material accounting misstatements

Feng Xu^*a and Zinan Zhu^b
aSchool of Business Administration, Georgia Southwestern State University, U.S.A.
^bDepartment of Accounting, Business School, National University of Singapore, Singapore

Abstract
In this paper, we develop prediction models of material accounting misstatements in a Bayesian framework. Outputs of the Bayesian approach are probabilistic descriptions for the propensity of conducting an accounting misstatement and for a riskiness comparison across different companies. The models are applied to a comprehensive sample of firms that have been subject to enforcement actions by the SEC for allegedly misstating their financial statements between 1982 and 2005. The results suggest that while maintaining a comparable Type I error, out-of-sample predictions of the Bayesian models improve in terms of sensitivity and the Type II error. This study provides a useful tool to assess material accounting misstatement risks.

JEL classification: C11, C15, C53, M42

Keywords: accounting misstatements, prediction, Bayesian, MCMC

Connotative meaning and the challenges of international financial reporting/auditing standards convergence: the case of Taiwan’s Statement of Auditing Standards Number 33

Rong-Ruey Duh^*a, Hsiao-Lun Lin^b & Chee W. Chow^c
a Department of Accounting, National Taiwan University, Taiwan
^b Department of Accountancy, National Taipei University, Taiwan
^c La Jolla, CA, USA

Abstract
Translating international standards into local languages is a big obstacle to the global convergence of financial reporting and auditing practices. This study uses Taiwan’s promulgation of Statements on Auditing Standards No. 33 to examine an important component of this challenge: the need for local standard setters to anticipate how domestic constituents would interpret local words used to translate original English terms. Data collected from samples of Taiwanese auditors, public prosecutors, and investors revealed that as compared to the auditors, financial statement users ascribe different connotative meanings to a Chinese term that was originally proposed, and one that was chosen as its replacement after objections from the accounting profession. Further, the words’ connotative meanings significantly mediated the link between the local term and financial statement users’ judgments about auditor legal liability. Significantly, the connotative meaning that financial statement users ascribed to the replacement term was associated with a higher level of ascribed auditor liability, such that in successfully pushing for a wording change, members of Taiwan’s accounting profession may have increased, rather than reduced, their exposure to liability from audited financial statements. These findings have a number of implications for standard setters, the standard setting process, and accounting firms.

Keywords: international harmonization of accounting and auditing standards; translation; semantic differential; Taiwan’s auditing standard setting

Directors and officers liability insurance: an analysis of determinants of disclosure

Emeka Nwaeze^a & Rachana Kalelkar^*b
a Department of Accounting, College of Business, University of Texas at San Antonio, USA
^b Department of Accounting, School of Business Administration, University of Houston-Victoria, USA

Abstract
In this paper, we investigate factors that explain the disclosure of Directors and officers liability (D&O) insurance. D&O insurance is used extensively in top management compensation. Surprisingly, only a handful of firms listed in the US disclose their D&O insurance practices (based on our extensive search of publicly available databases on corporate disclosure). Using a sample of firms from 2004 to 2008, we focus on level of competition, threat of increase in lawsuit, and internal governance to examine the determinants of the disclosure practices. Consistent with the hypothesis, the results show that firms in competitive industries, firms with a high threat of lawsuits, big firms, and firms with weak internal governance are less likely to disclose D&O insurance. We further find that variations in the scope and nature of disclosure are associated with the firms’ litigation risk and governance structure.

Keywords: directors and officers liability insurance; disclosure; determinants

The effect of different levels of internal control over financial reporting regulation on the quality of accounting information: evidence from Korea

Kwangwuk Oh^a, Wooseok Choi^b, Seok Woo Jeong^*b & Jinhan Pae^b
a Korea University College of Business and Economics, Korea
^b Korea University Business School, Seoul, Korea

Abstract
This study investigates the effect of different levels of internal control over financial reporting (ICFR) regulations on accounting information quality. Stricter ICFR regulation restricts the opportunistic behavior of managers, leading to better accounting information quality. Strictly regulated firms tend to report lesser discretionary accruals. The results of this study indicate that the accounting information quality of less strictly regulated firms deteriorated, while there was no significant change in the accounting information quality of strictly regulated firms. This implies that the effect of ICFR regulation depends more on the enforcement rather than the adoption of the regulations.

Keywords: ICFR; accounting information quality; discretionary accruals; SOX 404

JEL classification: M40, M42, M48

Security analysts’ incentive and cognitive processing bias: evidence from analysts’ recommendations

Ruei-Shian Wu^*a & Hsiou-wei W. Lin^{b a} Accounting Discipline , College of Management, Yuan Ze University, Taiwan ^b Department of International Business , College of Management, National Taiwan University, Taiwan

Abstract
This study examines how incentive- and behavior-based variables affect analyst recommendation revisions. We use duration analysis to test analysts’ underreaction to information by isolating the effects of incentives and cognitive processing biases on the timing of recommendation revisions. By controlling for favorable (unfavorable) preceding recommendations, we find that analysts delay conveying bad (good) news, which is consistent with the predictions of both the incentives and cognitive dissonance hypotheses (only the cognitive dissonance hypothesis). We also find that analysts delay responses to favorable information for outperformers with lower representative information, suggesting that analysts’ underreaction to new favorable information is partially explained by the effect of psychological conservatism. Our results are robust after taking into account analyst affiliations, NASD Rule 2711 and SEC Rule 472, and market conditions.

Keywords: analyst recommendation; cognitive processing bias; cognitive dissonance; incentive;  psychological conservatism

JEL Classifications: G14, M41