Martin P. Loeb
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Deloitte & Touche Faculty Fellow
Van Munching Hall 3351
Robert H. Smith School of Business
The University of Maryland
College Park, MD 20742, USA
Phone: (301) 405-2209

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Book

Managing Cybersecurity Resources: A Cost-Benefit Analysis

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AUDITING, IPOs, EARNINGS MANAGEMENT,

LOW-BALLING AND THE WINNER¡¦S CURSE

This paper investigates whether entrepreneurs manipulate earnings in the periods prior to taking their firms public through the choice of accounting conventions. The preponderance of evidence, using powerful accrual tests that were able to detect earnings management in other contexts, indicates little, if any, manipulation. To the extent that there is earnings management, the results suggest that this phenomenon is more pronounced among small firms and among firms with large financial leverage and is to a lesser degree related to the quality of the underwriters and auditors employed when going public.

The note tries to determine whether the results of Myers, Gordon, and Hamer (1991) would hold up when firm performance is evaluated with various accounting rate of return. Myers et al, using a market-based measure of performance, Tobin's q, shows that, among firms having a q value less than one, the initiation of a sophisticated postauditing system for the evaluation of capital assets significantly improved the q value. This study shows that, using the same sample of firms as used in the Myers et al study, the same time period, and the same statistical procedures, such significant positive effect still holds up when using several different accounting rate of return to measure firm performance.

  • Coate, Charles J. and Martin P. Loeb, ¡§Audit Pricing, Auditor Changes, and the Winner¡¦s Curse,¡¨ The British Accounting Review, December 1997, pp. 315-335.

This paper presents a two-period model of the audit market. In the first period, all auditors have symmetric information and adopt identical bidding strategies. In the process of performing the audit, the incumbent auditor learns the actual costs, thereby becoming informationally advantaged in the second period. In the model presented, unlike earlier ones found in the literature, audit costs include both a component common to all potential auditors and a private component that varies across auditors. The common component of auditor costs gives rise to a ¡¥winner's curse¡¦ scenario. A winner's curse is said to exist because a non-incumbent bidder who does not take into account the superior information of the incumbent would be expected to generate a loss from winning the audit engagement. The adjustment of bids by sophisticated auditors to compensate for the winner's curse is shown to play a significant role in determining the degree of low-balling (first-period price cuts) and auditor turnover. In the model, low-balling is not associated with loss of audit quality. Additionally, it is shown that it is in the interest of the client to structure audit selection in a manner that gives rise to low-balling.

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