John D. Lyon

We analyze tests for long‐run abnormal returns and document that two approaches yield well‐specified test statistics in random samples. The first uses a traditional event study framework and buy‐and‐hold abnormal returns calculated using carefully constructed reference portfolios. Inference is based on either a skewness‐adjusted t ‐statistic or the empirically generated distribution of long‐run abnormal returns. The second approach is based on calculation of mean monthly abnormal returns using calendar‐time portfolios and a time‐series t ‐statistic. Though both approaches perform well in random samples, misspecification in nonrandom samples is pervasive. Thus, analysis of long‐run abnormal returns is treacherous.

ABSTRACT Fama and French (1992) document a significant relation between firm size, book‐to‐market ratios, and security returns for nonfinancial firms. Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results. We document that the relation between firm size, book‐to‐market ratios, and security returns is similar for financial and nonfinancial firms. In addition, we present evidence that survivorship bias does not significantly affect the estimated size or book‐to‐market premiums in returns. Our results indicate data‐snooping and selection biases do not explain the size and book‐to‐market patterns in returns.

ABSTRACT Previous research provides evidence that, for the clients of a large audit firm, audit clients with higher perceived business risk bear the expected costs of this risk with higher audit fees. We extend the literature, which focuses on the relation between litigation risk and audit fees, by examining alleged client misconduct that is not illegal but possibly increases business risk. In particular, we examine the relation between audit fees and business risk for audit clients doing business in developing countries where bribery of top government officials has been an accepted business practice. We hypothesize that bribery‐paying clients are riskier because of both client business risk and audit business risk. Using data collected from Securities and Exchange Commission filings and audit fee data in the 1970s, before the passage of the Foreign Corrupt Practices Act, we provide evidence that audit fees were higher for clients that disclosed paying bribes. This evidence is consistent with an audit market where auditors assess business risk at the client level, then pass their expected costs to the client in the form of higher audit fees.