Second, another practical diculty involves the vagueness of GAAP. In the context of the opinion-shopping game, there is no uncertainly about whether the client's proposed accountingpolicy is dubious. Accounting issues in the real world are rarely so cut and dried. While one auditor might sincerely believe that a proposed accounting treatment, if allowed, would discredit the entire accounting profession, another might believe just as sincerely that this treat- ment is fully consistent with GAAP. For example, in response to Walter Schuetze's critical remarks cited earlier in this paper, the Advisory Panel on Auditor Independence (1994, p. 36) reviewed the facts of the four cases and concluded that ``the issues, at least in part, do not appear to be as black and white as Schuetze portrayed them''. To the extent that GAAP are vague, au- ditors apparently have less resolve to deny client accounting proposals. On the other hand, there are many controversial accounting issues for which reason- able but contradictory positions exist, so it may be impossible to completely remove the vagueness from GAAP.
In ``Economic Analysis of Accountants Õ Ethical Standards: The Case of Audit Opinion Shopping,'' Cushing (1999) examines the economic merits ofa laissez faire approach as opposed to formal ethical standards for auditors. Using a game-theoretic economic-modeling perspective, Cushing argues that stricter enforcement of standards is not necessarily the most ecient or eec- tive means to achieve desired ethical behavior. Instead, a less strict system might achieve the goals at lower cost. In lieu of strict enforcement of standards, Cushing suggests cultivation ofa strong moral climate and implementation of regulatory mechanisms such as auditor rotation, disclosure requirements, and formal procedures for obtaining rulings on accounting procedures. Coate (1999), among other issues, discusses the implications of Cushing Õ s paper for education and the socialization of accountants.
Freed and Swenson (1995, p. 881) found that observed PAC contributions varied widely by ®rm, and were only a small percent of tax bene®ts at stake. This ®nding was similar to all published non-tax empirical studies [see cites in Freed and Swenson (1995, pp. 893±894)]. As an indication of the magnitude of PAC contributions, Table 1 in Freed and Swenson (1995, p. 881) reported aggregate PAC contributions during 1980s, when a number of tax bills were enacted. The absolute and relative contributions were substantial; $5.3 million was given to tax writing members of Congress by corporate PACs prior to the enactment of TRA86, which was about 12% of PAC contributions to all po- litical candidates during this period (Freed and Swenson, 1995, p. 881). Freed and Swenson's (1995) analysis also found that prior to ERTA, which had very general provisions aecting virtually all ®rms, contributions were relatively small (Freed and Swenson, 1995, p. 881). In contrast, Freed and Swenson (1995, p. 881) found that equivalent per ®rm contributions just prior to the TRA86 were substantially higher. These observations agree with analytic propositions later in the paper.
In this research, I approached ®nancial analysis of the defense industry in a way dierent from approaches used in the past. First, I focused on defense- business segments instead of the whole company or speci®c defense contracts as was common in the past. Second, I used data envelopment analysis along with the more traditional ®nancial ratio analysis. The purpose behind using a dierent methodological approach (i.e., DEA) in this study was to take ad- vantage of the characteristics of the DEA methodology and illustrate its po- tential as an alternative and complementary tool for ®nancial analysis. In addition, when dealing with potential publicpolicy considerations as I am here, it is important that a question be reviewed from dierent perspectives so that policy makers can feel more comfortable in reaching a decision. DEA provides this dierent view. The DEA evaluations were buttressed by a variety of other assessments to include reviewing DEA virtual weight information and ratio analyses.
I ®rst began doing research on accounting ethics in 1969 (see, e.g., Loeb, 1970) when the topic was not a particularly fashionable area for academic research (see discussion in Previts and Merino, 1998, pp. 339±340). In the last decade there has been an increase in academic accounting ethics research. This increased interest in academic accounting ethics research may be due to a number of factors such as the Treadway Commission report (1987) and the activities of the American Accounting Association in the areas relating to ac- counting ethics (see, e.g., Loeb and Rockness, 1992, especially pp. 485±487; Ayres and Ghosh, 1996, p. 77).
The ®nding that there is a negative association between AC activity and dominant personalities on the board suggests that it may be worthwhile to pursue the impact of the presence of insiders on an AC on its activity. Certainly the literature, both theoretical and professional, seems to suggest that AC membership should not include insiders (executive directors). For example, Mace (1986, pp. 190±194) and Patton and Baker (1987, pp. 10±12) argue that management inherently dominate boards through control of the nomination and election of directors. This suggests that insiders on an AC might similarly dominate the AC and reduce monitoring activity. More pragmatically, Sommer (1991, p.91), Vicknair et al. (1993, p. 53) and the SEC (1980, p. 491) have highlighted this as an issue which may aect the independence of the AC. From a UK policy viewpoint, the Cadbury Committee clearly believed that the presence of insiders on the AC is likely to have a detrimental impact on AC activity and speci®cally state that membership ``should be con®ned to non-executive mem- bers of the company'' (1992, p. 69). To investigate whether the Cadbury Com- mittee have some grounds for their concerns, we have a ninth hypothesis to test:
Setting 1 serves as a base line for the experiment, giving the subjects an opportunity to learn the environment and providing control data for the ma- nipulations between groups and across a single group between Settings 2 and 3. Before the beginning of each cycle of four periods, Professor Shehata dis- tributed decision sheets to the subjects that provided them with information about the probability ofa good production environment for the current cycle (e.g., a 90% chance ofa good environment versus a 10% chance ofa bad one). Subjects were asked to decide which product, X or Y, should be produced to maximize the owner Õ s wealth and to record their decision on the record sheet that was provided. The record sheets were then collected from the subjects before the cycle began. In this way we know the subjects Õ beliefs before they are informed of their clients Õ decisions. This procedure permits us to identify vio- lations of audit independence. In practice independent auditors Õ beliefs are not known before they render their opinion on management Õ s reports.
mis-scored exams experiment forced students to realize the trade o between monetary gain, U x , and ethical actions, M a . In Dirsmith and Ketz's (1987, pp. 132, 133) mis-scored examination experiment a group of student exami- nation scores were intentionally mis-added. Some students received 10 points too many, while other students received 10 points too few (Dirsmith and Ketz, 1987, p. 132). Students with too few points returned their examinations; stu- dents with too many points did not (Dirsmith and Ketz, 1987, p. 132). When the experiment was revealed to the students, it appears that they understood the cost to the ethical play was 10 points on the examination (see the general discussion in Dirsmith and Ketz, 1987, p. 133). For a number of semesters, as a precursor to an ethics discussion, I have often posed on a hypothetical basis a dilemma somewhat similar to Dirsmith and Ketz's (1987) dilemma to my upper level accounting undergraduate students. Most students freely admit they would not (or probably would not) return the points; yet, ironically, students also generally agree that returning the points is the right thing to do. To explain this irony students rely on a number of rationalizations. A popular rational- ization is for students to note that, in K-12 and college, teachers rarely take back points when oered. Thus, student behavior has been socialized within the educational system ± a norm has been established. Interestingly, some students occasionally also remark that if they knew other students returned points, then they too would return points.
Merchant and Rockness (1994, pp. 87±90) provide initial evidence on the ethical assessments of earnings management among various organizational members (e.g., general managers, corporate sta, operating-unit controllers, and internal auditors). In this study I focus on assessments of those outside the organization ± users of ®nancial statements. Managers, companies, andpolicy makers should be interested in the extent to which external parties view earnings management activities as unethical. If earnings management is con- sidered unethical by ®nancial statement users, then managers' and companies' reputations may suer and companies' credibility in the ®nancial markets may be damaged. Beneish (1997, pp. 288±292) found, for example, that ®rms ac- tually violating GAAP earn negative returns for two years following the dis- closure of the GAAP violation. Similarly, Dechow et al. (1996, pp. 22±25) found that the stock market responds negatively to allegations of earnings management by the ®nancial press or the Securities and Exchange Commis- sion. Alternatively, the cost of capital may be higher among ®rms perceived as employing a management of questionable ethical standards. 1
including rerunning the analysis using 2SLS rather than 3SLS, replacing the dependent variable in Eq. (1), cost per patient in revenue departments, with cost per patient in all departments, and replacing the total weighted procedures per patient with the corresponding raw total procedures in Eqs. (1) and (2). Our results are generally robust to these changes except that in the case of the last change, LOS and OCCUP are no longer statistically signi®cant, consistent with our overall result that the reduction in LOS did not produce a reduction in cost. We also reran the Section 4 analysis using a reduced form estimation to avoid the loss of degrees of freedom associated with the simultaneous equation approach. Again, the ordinary least squares (OLS) regression results are consistent with the pro®ling policy having no statistically signi®cant eect on the cost per patient day. Finally, to check the simultaneity speci®cation, we ran the Hausman test (1978, pp. 1264± 1269) of the null hypothesis that all of the variables are exogenous and that the coecients obtained by using OLS and 2SLS are equal. The Hausman test results for Eqs. (1)±(3) indicate rejection of the null hypothesis that the variables of concern are exogenous for Eqs. (2) and (3).
An important response to this controversy, which goes back many decades (Hotelling, 1925), was to introduce a cash-based rate of return which is cal- culated from a ®rm's cash recovery rate (Ijiri, 1978). The intuition behind Ijiri's approach is that if decision-makers use cash-¯ow forecasts to evaluate possible investments and acquisitions, 3 then cash ¯ows rather than earnings should be used for performance evaluation. Ijiri's cash-based rate of return, which has been modi®ed and re®ned by Salamon (1982) and Shinnar et al. (1989), is the internal rate of return under the assumptions of particular reinvestment models. 4 When applied to an actual ®rm's set of ®nancial statements, the cash- based rate of return formulas are, of course, only approximations or estimates of the ®rm's internal rate of return.
Steven E. Kaplan, Professor of Accountancy and Information Management, received his Ph.D. in Accountancy from the University of Illinois. His research interests are in auditor judgement and ethical decision-making. He has published in a variety of academic journals, including the JournalofAccounting Research, The Accounting Review, Accounting, Organizations & Society, Auditing: AJournalof Practice & Theory andJournalofAccountingandPublicPolicy.
Given the resource stress under which manygovernments operate, the study of resource scarcity's impact on use of ®nancial and non®nancial information is particularlyrelevent. The results indicated that the presence of scarcity(®scal stress) had little impact on the principals' decisions. In the one instance where ®scal stress mayhave impacted the use of ®nancial measures the result was contraryto expectations, and case research (DeMarco and Holley, 1984, p. 179). The presence of ®scal stress actually decreased the use of ®nancial mea- sures. These results support Berg's (1984, p. 78) argument that the presence of scarcityimpedes rational behavior. Berg (1984, p. 79) argues that scarcity creates a zero-sum environment. That is, while agents mayhave engaged in cooperative strategies in hopes of future gains under a no scarcityenvironment, there is zero to be gained byengaging in such strategies in a scarcityenvi- ronment. Budget ocers, realizing that cooperation among agencies will de- crease during scarcitymayimplement across-the-board adjustments to limit con¯ict, thus reducing time spent and reputation costs incurred in arriving at a budget. Based on the argument byBerg (1984, p. 79) and the results of this article, a government contemplating incorporation of costlyeciency /eec- tiveness measures into reports may®nd the measures will gain greater accep- tance and cooperation if implementation does not occur during periods of ®scal stress. This observation is also supported bya comment (Poister and McGowan, 1984, p. 392) that managers of stressed cities indicated that the importance of performance indicators would be greater if stress were not such an important factor.
Bailey's (1995) model looks more speci®cally at the accounting change process in the transitional economies of central and eastern Europe. Bailey (1995, p. 603) identi®es three stages of development: ``state directed'', ``state regulated'', and ``market driven''. Bailey (1995, p. 605) summarizes these phases as periods when accounting information is ``a legally required historical record'', ``a tool of administrative control'', and ``a tool with relevance to entrepreneurial endeavour'', respectively. In the ``state directed'' former com- mand-economies accounting amounted to no more than formalized book- keeping and compliance with the letter of the law (Bailey, 1995, p. 599). In the transition economies, however, state regulation is seen as having a positive role to play in transforming politically driven accounting information into market driven, economically useful accounting information upon which transaction decisions can be based (Bailey, 1995, pp. 604, 605). Thus ``state regulated'' is characterized by an imposed normative accounting model, which is rather static and unresponsive to pressures brought to bear by market forces and economic development. Bailey's (1995, p. 605) ``market driven'' state, on the other hand, is one in which changes in the economy and competitive pressures will lead accounting legislation which, in turn, will be responsive to, and re¯ect, such developments. Implicit in Bailey's (1995, p. 605) model is linear devel- opment from ``state directed'' through ``state regulated'' to the ultimate goal of ``market driven''. In line with my view that transition in central and eastern Europe has no ®xed starting point nor ultimate destination, this character- ization of the change process is unduly restricting. However, building on the insight from Streeck and Schmitter (1985), these three stages of economic transition can be considered limiting and ideal cases which de®ne a set of feasible combinations within which economies in transition can be located.
Figure 2 depicts a unitary monopoly state that includes a peripheral region. The latter is situated at the border, but it does not need to be the case in general, particularly as distance in the space of preference becomes much more pregnant than physical distances. One may wonder why state j does not take such a break into account. This very lack of consideration explains the isolation of the periphery. Consciously or not, capital j acts as if the whole population could be controlled by using a constant functional form, g, throughout the territory. Similarly, function f would accurately describe the willingness to belong to the state whatever the location on the territory. Reference to the surplus-maximizing solution would not solve the problem at all. In the case of Figure 2, the peripheral region would simply no longer be a border region. The problem may be even more pronounced: The capital may not grasp the fact that regions not very distant from the center may be so specific as to require different functions of cost and willingness. The impossibility for state j to take this heterogeneity into account may rest on a normative principle according to which a unitary state cannot acknowl- edge peripheral behaviors without endangering its very unity. The economic translation of this principle is that the government keeps itself from using price discrimination. In other words, it does not allow itself to propose t j,p , t j to i [ [i p ,i * f ]. This policy would,
In contrast to the above studies, Beneish (1997) develops a model based on several speci®c accruals, focusing on ®rms from a number of industries. He uses a sample of ®rms identi®ed by the SEC as generally accepted accounting principle violators to calibrate alternative measures of earnings management. Beneish (1997, pp. 282±288) develops a model to identify earnings management which is based on a number of ®nancial statement ratios, several of which relate to spe- ci®c accruals such as receivables, inventory and accounts payable. What is dis- tinctive about his approach is that a richer information set is utilized to identify variation in the levels of these speci®c accruals. Although he focuses on several accruals, the modeling of each accrual's behavior is done separately, rather than for the aggregate. In addition, the ability of the various accruals to identify GAAP violations is assessed account by account, allowing for variation in the exercise of discretion across accruals. There seems to be great potential to apply this approach further, with more extensive modeling of the behavior of speci®c accruals. One could also focus on a speci®c accrual or set of accruals by focusing on industry settings where those accruals are most material.
Economic consequences of regulatory accounting in the nuclear power in- dustry: market reaction to plant abandonments, The, 161±187. Eects of changes in cost allocations on the assessment of cost containment regulation in hospitals, The, 97±112. Eect of relative performance evalua- tion on earnings management: a game- theoretic approach, The, 377±397. Empirical analysis of auditor report timing by large municipalities, An, 263±281.