This paper develops a model of external financing that jointly determines a firm’s capital structure, its voluntary disclosure policy, and its cost of capital. We study a setting in which investors– who provide financing to a firm in exchange for securities issued by the firm – sometimes incur trading losses when they subsequently trade their securities with a superiorly informed trader. Both the firm’s disclosure policy and the structure of the firm’s securities determine the informational advantage of the superiorly informed trader which in turn determines both the size of investors’ trading losses and the firm’s cost of capital.
    In this setting, among other things, we establish: there is a hierarchy of optimal securities that varies with the volatility of the firm’s cash flows, that an increase in the volatility of the firm’s cash flows is associated with: an increase in the amount of debt in the firm’s capital structure; a reduction in the firm’s voluntary disclosures; and an increase in the firm’s cost of capital. The model predicts a negative association between firms’ cost of capital and the extent of information they disclose voluntarily. This negative association does not imply, however, that more expansive voluntary disclosure causes firms’ cost of capital to decline. The paper also documents how imposing mandatory disclosure requirements can alter firms’ voluntary disclosure decisions, their capital structure choices, and their cost of capital.

In the (A) Case, Jason Phillips, Chief Financial Officer of a soup manufacturing business, is given the task of maximizing the value of the firm twelve months after the case is set. Although he does not want to break any legal rules, Jason is interested to see whether accounting and real action choices can be used to enhance the company’s financial position and increase its perceived value to investors. The case permits him to select from a menu of options, including decisions on product pricing, inventory levels, accounts receivables, leasing or purchasing a new machine and valuation or sale of securities. These choices are fed into an Excel spreadsheet which adjusts financial projections and accounting disclosures accordingly.

In the (B) Case, Ben Kerr, Chief Investment Officer at one of Dragon’s main competitors, considers the financial statements produced by Dragon to unravel any earnings management behavior and establish a true value for the company.
Although the case can be focused on the accounting consequences of real decisions, a richer discussion is obtained when considering the ethical angles of the decision process. In particular, how much ‘earnings management’ should be pursued and what types of behaviors are simply going to be unraveled by investors?

This paper investigates the effect of venture capitalist (VC) quality on earnings management in firms conducting initial public offerings of their equity stock, focusing on manipulation of both accruals and real activities. I develop a measure of VC quality based on a principal components factor analysis using data that are obtainable for virtually all VC firms. This metric is highly correlated with VC funds’ financial returns, and with the likelihood of successful exits through initial public offerings or trade sales. After going public, companies backed by higher quality VCs have lower abnormal accruals, lower earnings management through real activities manipulation, and a lower likelihood of financial restatement. Companies backed by top-quartile VCs do not appear to engage in real activities manipulation as a substitute for accruals manipulation. As for companies backed by lower-tier VCs, their earnings management behaviors are indistinguishable from those of non-VC-backed companies. The results continue to hold when controlling for endogeneity. Overall, the results suggest that higher quality VCs are better able to constrain opportunistic financial reporting by their portfolio companies going public.

Jimmy Fu is interviewing for a job at Moog, Inc., a worldwide designer, manufacturer, and integrator of precision motion and fluid controls and systems. He learns that a job offer from Moog typically includes stock options and restricted stock in the compensation package. The vesting and termination language for the stock plan leads Jimmy to investigate the Shareholders' Equity section of the Moog balance sheet, where he finds more activity than he expected. The case introduces students to the concepts of employee stock options, stock-splits and buybacks, multiple share classes, and the basics of equity investment and diversification. Students must complete a quantitative analysis of the financial transactions related to Shareholders' Equity. Primary Objective is to introduce students to the different components of the Shareholders' Equity section of the Balance Sheet, to understand employee stock options, multiple share classes, and certain basics of equity investment, risk, and diversification.

Instrumental variable (IV) methods are increasingly being used in earnings management, corporate governance, executive compensation, and disclosure research where there is reason to believe that regressor variables are endogenous. While IV estimation is the standard textbook solution to mitigating the inconsistency in parameter estimates caused by endogeneity, the appropriateness of IV methods in typical accounting research settings is not obvious. Drawing on recent advances in statistics and econometrics, we provide conditions under which IV methods are likely to be preferred to traditional ordinary least squares (OLS). These results raise considerable doubt about the appropriateness of typical IV applications in accounting research. We illustrate these concerns by examining the association between corporate disclosure and the cost of capital. Our results indicate that the commonly used instruments are unlikely to provide estimates that are preferable to OLS.

Jimmy Fu is interviewing for a job at Moog, Inc., a worldwide designer, manufacturer, and integrator of precision motion and fluid controls and systems. He learns that a job offer from Moog typically includes stock options and restricted stock in the compensation package. The vesting and termination language for the stock plan leads Jimmy to investigate the Shareholders' Equity section of the Moog balance sheet, where he finds more activity than he expected. The case introduces students to the concepts of employee stock options, stock-splits and buybacks, multiple share classes, and the basics of equity investment and diversification. Students must complete a quantitative analysis of the financial transactions related to Shareholders' Equity. Primary Objective is to introduce students to the different components of the Shareholders' Equity section of the Balance Sheet, to understand employee stock options, multiple share classes, and certain basics of equity investment, risk, and diversification.

Biovail Corporation, a major Canadian pharmaceutical company listed on the New York Stock Exchange, announces that it will miss its quarterly earnings target by $25 to $45 million, blaming $10 to $15 million of the shortfall on a truck accident involving a shipment that left its facility on the last day of the quarter. The case was ultimately prosecuted by the U.S. Securities and Exchange Commission (SEC). The case is centered on the question of revenue recognition and how the company should have accounted for the sales (FOB company or FOB destination). However, it also provides a rich setting permitting exploration of peripheral topics around the ethics of earnings management. For example, the case discusses stock analysts' reactions to the announcement; questions how much product was actually in the truck; questions how aggressively the company responds against the analysts who downgrade the stock; and highlights the role of the SEC in enforcement. The primary objective is to explore the concepts of revenue recognition. Secondary points of interest include management of information flows to the capital markets, relationships with analysts and the enforcement role of the SEC

Biovail Corporation, a major Canadian pharmaceutical company listed on the New York Stock Exchange, announces that it will miss its quarterly earnings target by $25 to $45 million, blaming $10 to $15 million of the shortfall on a truck accident involving a shipment that left its facility on the last day of the quarter. The case was ultimately prosecuted by the U.S. Securities and Exchange Commission (SEC). The case is centered on the question of revenue recognition and how the company should have accounted for the sales (FOB company or FOB destination). However, it also provides a rich setting permitting exploration of peripheral topics around the ethics of earnings management. For example, the case discusses stock analysts' reactions to the announcement; questions how much product was actually in the truck; questions how aggressively the company responds against the analysts who downgrade the stock; and highlights the role of the SEC in enforcement. The primary objective is to explore the concepts of revenue recognition. Secondary points of interest include management of information flows to the capital markets, relationships with analysts and the enforcement role of the SEC

The study reported here is a comparison of the earnings-forecasting performance of analysts at a large buy-side firm with the performance of sell-side analysts in the 1997–2004 period. The tests show that the buy-side analysts made more optimistic and less accurate forecasts than their counterparts on the sell side. The performance differences appear to be partially explained by the buy-side firm’s greater retention of poorly performing analysts and by differences in the performance benchmarks used to evaluate buy-side and sell-side analysts.

Gu and Xue (this issue) study the disciplining effect of independent analysts on the accuracy and forecast relevance of the forecasts of non-independent analysts. One of the intriguing results is that while independent analysts issue inferior forecasts, their presence appears to reduce the forecast bias, improve the forecast accuracy and increase the forecast relevance of forecasts issued by non-independent analysts. We explore alternative explanations for the Gu-Xue results. Our evidence of endogenous entry and exit of independent analysts provides a more compelling explanation for the reported results.

This paper examines whether stock option grants explain missed earnings targets, including reported losses, earnings declines and missed analysts' forecasts. Anecdotal evidence and surveys suggest that managers believe that missing an earnings target can cause stock-price drops (Graham, et al. 2006). Empirical studies corroborate this notion (Skinner and Sloan 2002, Lopez and Rees 2002). Thus, a missed target could benefit an executive via lower strike price on subsequent option grants. Prior option-grant studies explore only general downward earnings management (Balsam et al. 2003, Baker et al. 2003) but our study is the first to explore whether option grants encourage missed earnings targets. Indeed, if missed targets drive the prior results, the literature has failed to document an important negative outcome of stock option incentives. We use quarterly and annual data for fixed-date options granted after firms announce they have missed earnings targets. We find that firms that miss earnings targets have larger and more valuable subsequent grants. Further, we find that the likelihood of missing earnings targets for firms that manage earnings downward increases with stock-option grants. To control for the possibility that firms miss earnings targets for operational reasons, we only include firms that likely managed earnings downward (Dechow et al. 1996, Phillips et al. 2003). Backdating or opportunistic timing of grants cannot explain our results because we include only fixed-date grants. While many studies explicitly consider whether and why managers meet or beat earnings targets, ours is the first study to find that some managers may seek to miss earnings targets (Burstahler and Dichev, 1997).

This paper examines the effect of transaction costs on the post-earnings-announcement drift (PEAD). Using standard market microstructure features we show that transaction costs constrain the informed trades that are necessary to incorporate earnings information into price. This leads to weaker return responses at the time of the earnings announcement and higher subsequent returns drift for firms with high transaction costs. Consistent with this prediction, we find that earnings response coefficients are lower for firms with higher transaction costs. Using portfolio analyses, we find that the profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. In addition, we show, using a combination of portfolio and regression analyses, that firms with higher transaction costs are the ones that provide the higher abnormal returns for the PEAD strategy. Our results indicate that transaction costs can provide an explanation not only for the persistence but also for the existence of PEAD.

We document that accrual-based earnings management increased steadily from 1987 until the passage of the Sarbanes-Oxley Act (SOX) in 2002, followed by a significant decline after the passage of SOX. Conversely, the level of real earnings management activities declined prior to SOX and increased significantly after the passage of SOX, suggesting that firms switched from accrual-based to real earnings management methods after the passage of SOX. We also document that the accrual-based earnings management activities were particularly high in the period immediately preceding SOX. Consistent with these results, we find that firms that just achieved important earnings benchmarks used less accruals and more real earnings management after SOX when compared to similar firms before SOX. In addition, our analysis provides evidence that the increases in accrual-based earnings management in the period preceding SOX were concurrent with increases in equity-based compensation. Our results suggest that stock-option components provide a differential set of incentives with regard to accrual-based earnings management. We document that while new options granted during the current period are negatively associated with income-increasing accrual-based earnings management, unexercised options are positively associated with income-increasing accrual-based earnings management.

In 2008 Merrimack Tractors and Mowers finds itself in a situation where product manufacturing costs are increasing faster than competitors’ costs, and as a result earnings are likely to fall below those reported in 2007. The company president and the company controller have discussed this problem, and the controller has mentioned the idea that if the company changed from LIFO to FIFO it might be possible to maintain earnings growth in 2008. He prepared a memo to the president explaining how inventory flow assumptions work and provides pro-forma income statements that show that for one product (reel mower units) adopting FIFO would allow Merrimack to report higher income in 2008 than it did in 2007, but higher income taxes would have to be paid.

The case is designed to be used in an introductory financial accounting course to explore the differential effects of LIFO and FIFO accounting on inventory valuation. Discussions can also explore the ethical questions which may arise as managers consider changes in accounting policies.

A comprehensive pilot study was conducted to examine how remote senior monitoring of important vitals information and virtual nurse visits conducted remotely via videophone would improve seniors' adherence to care plan and enable them to remain in their homes longer. Recruitment of study individuals was conducted in the North Shore area of Chicago, ILL. Eleven seniors participated in this small scale study to keep scale issues controlled. Of the 11 participants, 8 were female. The average age was 80+ (64-89) with participants suffering from an average of 4.4 chronic conditions and requiring assistance in 3.4 activities of daily living.

We re-examine the existence of earnings announcement-day premia and find that they persist beyond the sample period used in prior studies (ending in 1988). The magnitude of the premia is lower for all sub-periods when we use the expected rather than actual announcement dates used in prior studies. Moreover, the premia are not present following earnings pre-announcements. Finally, we find that limits to arbitrage are a likely explanation for the continuing presence of the premia despite the fact that firms on earnings announcement dates have a significantly positive Jensen’s alpha and a higher Sharpe Ratio than on non-announcement dates.

This discussion reinforces and expands on some of the fundamental issues about endogeneity raised by Chenhall and Moers (European Accounting Review, 2007, pp. 173-195). We focus on the econometric problems researchers encounter when investigating the performance effects of some endogenous firm choice. Our points are illustrated using the classic research question about the relation between managerial equity ownership and firm value. We consider cases where ownership is treated as an exogenous, endogenous and 'partially' endogenous variable. We argue treating ownership as an exogenous variable is seriously flawed. Unfortunately, when ownership is at least partially endogenous, it is necessary for empirical researchers to identify exogenous variables that are the determinants of the ownership choice. This calls for better theory to guide the empirical work.

We examine the effects of analysts’ celebrity on investor reaction to earnings forecast revisions. We measure celebrity as the quantity of media coverage analysts receive in sources included in the Dow Jones Interactive database, and find that media coverage is positively related to investor reaction to forecast revisions. The effect of celebrity on the reaction to forecast revisions remains significant after controlling for forecast performance variables examined in prior studies (ex post forecast accuracy, ex ante accuracy, award status, and other variables shown to be related to forecast accuracy). While these results are consistent with the familiarity of the analyst’s name affecting the market reaction, we cannot rule out that our measure of celebrity is correlated with error in the performance measures we examine and/or correlated with other unexamined dimensions of forecast performance. A content analysis of a random subsample of the media coverage of our sample analysts suggests that our findings likely are not due to the increased availability of forecast revisions. Finally, an investigation of the excess returns around the quarterly earnings announcement date suggests that market participants react too strongly to forecast revisions issued by analysts with high levels of media coverage. Taken together, these findings suggest that an analyst’s level of media coverage can affect the initial market reaction to his forecast revisions.

The returns that institutional investors realize from private equity investments differ dramatically across institutions. Using detailed and hitherto unexplored records of fund investors and performance, we document large heterogeneity in the performance of different classes of limited partners. In particular, endowments’ annual returns are nearly 21% greater than average. Funds selected by banks lag sharply. Analysis of reinvestment decisions suggests that endowments (and to a lesser extent, public pension funds) are better than other investors at predicting whether a follow-on fund will have high returns. We find that the results are not primarily due to endowments’ greater access to established funds, since they also hold for young or under-subscribed funds. Our results suggest that limited partners vary in their level of sophistication and also their objectives.

This paper studies the allocational effects associated with the precision of accounting estimates when the precision of estimates is a choice variable for firms. One part of the paper considers the effects of the observability of precision choices. We show that, generally, making precision choices private increases firms' equilibrium precision choices and also, as a by-product, their equilibrium investment choices. We further show that, when firms' precision choices are private, there may be a "disclosure trap," in which, unless investors conjecture the owner has chosen an estimate with the highest possible precision, the owner will respond to investors' conjecture by choosing an estimate whose precision is higher than investors' conjecture. In a multifirm version of the model with endogenous investment, we show that the equilibrium investment by the firm increases in the precision of the firm's own estimate and decreases in the precisions of other firms' estimates. Finally, we show that, in a setting where the firm's initial owner sells his stake in the firm over the course of two periods, with disclosures of estimates of the firm's value occurring prior to each sale of shares, if the precisions of the estimates are public, the equilibrium precisions of the estimates increase over time when the owner sells a sufficiently large fraction of the firm in the first period, and otherwise the equilibrium precisions of estimates remain constant over time.

While keeping up with customer value migration is important, it is perhaps only one of the multiple steps that an organization must take in order to achieve sustained superior performance.

Regulators’ interest in analyst reports stems from the belief that small investors are unaware of the conflicts sell-side analysts face and may, as a consequence, be misled into making suboptimal investment decisions. We examine who trades on security analyst stock recommendations by extending prior research to focus on investor-specific responses to revisions. We find that both large and small traders react to analyst reports; however, large investors appear to trade more than small traders in response to the information conveyed by the analyst’s recommendation and earnings forecast revision (proxied by the magnitudes of the recommendation change and the earnings forecast revision, respectively). We also find that small investors do not fully account for the effects of analysts’ incentives on the credibility of analyst reports, as captured by the type of recommendation (i.e., upgrade versus downgrade or buy versus sell). In particular, small investors not only trade more than large investors following upgrade and buy recommendations, but also trade more following upgrade and buy recommendations than they do following downgrade and hold/ sell recommendations. Furthermore, we observe that, on average, small traders are net purchasers following recommendation revisions regardless of the type of the recommendation; large traders tend to be net sellers following downgrades and sells. Consequently, large traders generate statistically positive returns from their trading, while small traders generate statistically negative returns from their trading. These findings are consistent with large investors being more sophisticated processors of information, and provide some support for regulators’ concerns that analysts may more easily mislead small investors.

We investigate incentives that led to the rash of restated financial statements at the end of the 1990s market bubble. We find the likelihood of a misstated financial statement increases greatly when the CEO has very sizable holdings of stock options "in-the-money" (i.e., stock price above exercise price). Misstatements are also more likely for firms that are constrained by an interest-coverage debt covenant, raise new debt or equity capital, or have a CEO who serves as board chair. Our results indicate that agency costs increased (Jensen 2005a) as substantially overvalued equity caused managers to take actions to support the stock price.

We investigate Gompers, Ishii, and Metrick's (2003) finding that firms with weak shareholder rights exhibit significant stock market underperformance. If the relation between poor governance and poor returns is causal, we expect that the market is negatively surprised by the poor operating performance of weak governance firms. We find that firms with weak shareholder rights exhibit significant operating underperformance. However, analysts' forecast errors and earnings announcement returns show no evidence that this underperformance surprises the market. Our results are robust to controls for takeover activity. Overall, our results do not support the hypothesis that weak governance causes poor stock returns.

This paper demonstrates the existence of two different kinds of externalities induced by an auditor servicing multiple clients at the same time. First, we show that the capital market price for a client can increase in the number of qualified reports that his auditor issues to his other clients, thus producing a stock price externality. Second when the audit firm has limited wealth, an additional client can actually decrease the audit quality and increase the average likelihood of audit failure relative to a single-client setting because of reporting externalities. Our analysis also demonstrates how requiring a more effective audit oversight mechanism can actually produce unintended consequences such as an increased likelihood of audit failures.

Cost containment in the office is becoming more important secondary to increasing overhead costs and lower reimbursement. In an attempt to limit these particular expenditures we analyzed and restructured our methods of ordering, storing and distributing office supply inventory. Materials and Methods: In a large academic practice with 11 urologists and approximately 20,000 annual patient visits an attempt was made to decrease overhead costs using the principle of just in time inventory popularized by large manufacturing companies. We initially issued a return of excess and/or unused supplies from our office inventory stock room. Our main supply room was then centralized to contain office supplies for up to 4 weeks. The 12 individual clinic rooms were stocked with appropriate supplies to last 1 week. Limited access to the main supply room was established and a supply manager was established to log all input and output. Results: The initial credit for the return of unused/overstocked supplies was $10,107 in January 2004. Annual office supply charges in calendar year 2004 were $87,444 compared to charges in calendar year 2003 of $175,340. No stock outs occurred during year 2004 and all standing delivery orders were terminated. The total number of patient visits in calendar year 2004 was 20,170 compared to 19,455 in calendar year 2003. Conclusions: Decreasing overall inventory through accurate demand forecasting, judicious accounting, office supply centralization and just in time ordering is a potential area for significant overhead cost savings in a clinical practice.

Bradshaw, Richardson, and Sloan (BRS, 2006) develop a comprehensive measure of corporate financing activities, rather than focusing on individual categories of external financing, and find a negative relation between this measure and future stock returns and profitability. The authors interpret their findings as consistent with a misvaluation hypothesis. However, we show that once controlling for total accruals, the documented relation between external financing activities and future stock returns is not statistically significant. Incidentally, these findings are consistent with Richardson and Sloan (2003).

Companies traditionally approach value creation through one of two ways--increasing revenues or decreasing costs. Organizations are primarily focused on one of these levers in order to create value at any given point in time. Creating a cost culture through the cost management maturity model provides a way to overcome this value creation paradox. Accelerating revenue growth while maintaining low costs is a matter of organizational and cost management maturity. Successful organizations have been able to create a pervasive culture in which cost management is perceived as a continuous process.

This paper investigates the relative informativeness of earnings and dividends for firms with dual class capital structures. In these firms, the two classes of common stock create a separation between cash flow rights and voting rights. Despite the concentrated ownership in the dual class firms, we find significantly lower informativeness of earnings, in the form of a weaker returns-earnings association, than for single class stocks. We attribute this finding to the reduced management accountability resulting from the separation of cash flow and voting rights. We also find, in general, greater dividend informativeness for the dual class stocks in the form of a significantly stronger returns-dividends relation, although these results are not consistent across all years.

Technology has made great strides in healthcare, but has been slow in reaching a Senior's home or residence. At 35 million and growing, the Senior population is making it known that home is where they want to stay. Technology advancements in devices, communications, and wireless capability are now making possible the delivery of customized telehealth solutions to provide Seniors with "enabled independence," allowing them to confidently "age in place" at home or residence for much longer, with improved health outcomes and quality of life. Combined with traditional ambulatory care services, integrating telehealth technology services now allows delivery of "virtual asisted living" services at home that can more efficiently meet Senior health requirements, and can simplify other aspects of a Senior's life that can play a role in extending time at home. To be successful, an integrated service must be able to usefully address a range of activities of daily living - instrumental activities of daily living, and enhanced activities of daily living - requirements. Already proven in other areas such as radiology, intensive care units, prisons, and rural communities, companies are working to develop practical telehealth service offerings designed for the home or residence. These services must be (a) packged to meet individual Senior needs and (b) reviewed and revised regularly to match changes in Senior requirements over time. A core element of this service is the use of regular "virtual visits" between healthcare professionals and a Senior at home or residence, which have been shown to both increase efficiency and Senior health out-comes. Another important element is centralizing key data from the telehealth technoloy into a single database to improve information delivered to a Senior's doctor, family, and other ambulatory care provides. North Shore eCare and other companies are conducting extensive market tests and pilot efforts to make sure service offerings meet Senior needs, and can be delivered cost-effectively.

In an agency setting where the agent must be compensated both to exert effort to produce a new project and to announce honestly when the new project has been produced, we show that Holmstrom's (1979) well-known "informativeness criterion" does not, by itself determine whether a variable is optimally incorporated into the agent's contract. What also matters is how "severe" the control problem is between the principal and the agent. We further show that the severity of the moral hazard problem also determines whether it is desirable for the principal to have the agent implement the project more often than warranted by first-best implementation considerations.

Abarbanell and Lehavy provide evidence that analysts' forecast errors are not normally distributed exhibiting a high occurrence of extreme negative forecast errors (left-tail asymmetry) and a high occurrence of small positive forecast errors (middle asymmetry). This is important for researchers who rely on techniques that are sensitive to the distributional assumptions of analysts' forecast errors. Many of the conclusions drawn by Abarbanell and Lehavy, however, are based on visual impressions (as opposed to formal empirical tests) or based on methods that are very sensitive to the empirical methods used (e.g., whether the serial correlation of forecast errors is caused by the left-tail asymmetry).

We investigate if sell-side security analysts exhibit relative persistence in their stock picking ability. We find that analysts whose recommendation revisions earned the most (least) positive excess returns in the past continue to outperform (underperform) other analysts in the future. Further, we find that the market recognizes these performance differences in the five-day period surrounding the recommendation revision. This market reaction, however, is incomplete. Excess returns measured over the one and three trading months following the revision are significantly different from zero and positively associated with the analysts’ prior performance. A trading strategy taking long (short) positions in recommendation upgrades (downgrades) conditional on an analyst’s prior performance generates excess returns, but these returns are insufficient to cover transaction costs.

Controlling for other determinants of the cost of capital, we find that firms with repeated large earnings surprises experience a higher cost of equity capital. This finding holds regardless of the sign of the earnings surprises, but firms that consistently report negative surprises have relatively higher cost of equity capital. Although firms that frequently surprise the market experience a decrease in analyst following relative to no surprise firms, this reduction in monitoring cannot account for the higher cost of equity capital. Overall, these findings document that repeated earnings surprises are costly, and provide evidence that managers have incentives to avoid missing earnings targets.

This paper studies how an accountant's method of aggregating information in a financial report is affected by differences in the reliability and relevance of components of the report. We study a firm that hires an accountant to produce a report that reveals information to investors regarding the returns to the firms past investments. In constructing the report, the accountant must combine information elicited from the firm's manager with other information directly observable to the accountant. The manager's information is assumed to be directly observable only by the manager and to be of superior quality to the other information available to the accountant. Reliability-relevance trade-offs arise because as the accountant places more weight on the manager's report, potentially more useful information gets included in the report, at the cost of encouraging the manager to distort his or her information to a greater extent. Capital market participants anticipate this behavior and price the firm accordingly. We show how the market's price response to the release of the firm's aggregate report, the efficiency of the firm's investment decisions, and the manager's incentives to manipulate the soft information under his or her control are all affected by - and affect - the aggregation procedure the accountant adopts. In addition, we identify a broad range of circumstances under which aggregated reports are strictly more efficient than disaggregated reports because aggregation tempers the manager's misreporting incentives. We also demonstrate that, as any given component of the aggregated accounting report becomes softer, the equilibrium level of the firm's investment diminishes and the market places greater weight on the remaining components of the report.

This paper studies a manager's attempt to maximize his firm's discounted expected profits by choosing what strategic actions to select and what performance measurement system to employ in a setting where the manager is uncertain about what variables "drive" the firm's profits, the firm's profit drivers remain stationary over time, and strategic actions differ in the amount of information they produce about the firm's profit drivers. For each available performance measurement system, this paper identifies necessary and sufficient conditions for experimentation - that is, deviating from the firm's short-run expected profit-maximizing action - to be optimal. In addition, the paper determines what factors influence a firm's preferred performance measurement system, and it explains why the preferred performance measurement system is likely to change over time.

ABC/M Software with basic activity-based functions is commonly used to obtain, process, and generate predifined reports, but system designers often fail to consider how the software will work with the system databases.