Loss Contingencies Research Articles

Early Evidence on Critical Audit Matters regarding Environmental, Social, and Governance Sustainability: Trends in ESG Reporting

ABSTRACT This study investigates the contents and trends of critical audit matters (CAMs) as they relate to ESG matters (ECAMs). Our examination of the description of ESG matters in ECAMs suggests that the majority of ECAMs fall under measurement issues from environmental liabilities and loss contingencies. To address ECAMs, auditing procedures must assess managerial assumptions by making frequent use of an environmental specialist. Our descriptive analysis suggests that firms that receive ECAMs are more profitable, more likely to have a Big 4 auditor, and have higher litigation risk. Our cross-country comparison suggests a similar trend between ECAMs and their equivalent reports in Europe, as both focus mainly on environmental matters rather than social or governance matters. Overall, our analysis suggests that the issuance of ECAMs represents an important source for discerning a portion of firms’ ESG standings. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M4.

A Novel Bus-Ranking-Algorithm-Based Heuristic Optimization Scheme for PMU Placement

This article presents a scheme for cost-optimized phasor measurement unit (PMU) placement and associated communication infrastructure (CI) design. For this purpose, a bus ranking algorithm is proposed, which ranks the buses in terms of connectivity, associated branch lengths, and supplementary network coverage ability that incentivizes better redundancy and lesser CI requirement. Next, a genetic algorithm (GA) is employed to search for minimum-cost optimal PMU placement solutions within the search space defined by the ranked-bus order. The search space is expanded by adding buses in the ranked order till GA finds a suitable solution satisfying the requisite constraints. The proposed scheme's performance is validated through comparison with existing state-of-the-art algorithms for IEEE 14-, 30-, and 118-bus networks under normal, <inline-formula xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink"><tex-math notation="LaTeX">$N-1$</tex-math></inline-formula> PMU contingency, branch loss contingency, and <inline-formula xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink"><tex-math notation="LaTeX">$N-1$</tex-math></inline-formula> PMU/branch loss contingency conditions. In addition, considering real-world applications, the performance of the proposed scheme under channel-limit conditions is reported in this article.

Probabilistic Modeling of Maritime Accident Scenarios Leveraging Bayesian Network Techniques

This paper introduces a scenario evolution model for maritime accidents, wherein Bayesian networks (BNs) were employed to predict the most probable causes of distinct types of maritime incidents. The BN nodes encompass factors such as accident type, life loss contingency, accident severity, quarter and time period of the accident, and type and gross tonnage of the involved ships. An analysis of 5660 global maritime accidents spanning the years 2005 to 2020 was conducted. Using Netica software, a tree augmented network (TAN) model was constructed, thus accounting for interdependencies among risk-influencing factors. To confirm these results, a validation process involving sensitivity analysis and historical accident records was performed. Following this, both forward causal inference and reverse diagnostic inference were carried out on each node variable to scrutinize the accident development trend and evolution process under preset conditions. The findings suggest that the model was competent in effectively predicting the likelihood of various accident scenarios under specific conditions, as well as extrapolating accident consequences. Forward causal reasoning unveiled that general cargo ships with a gross tonnage of 1–18,500 t were most prone to experiencing collision and stranding/grounding accidents in the first quarter. Reverse diagnostic reasoning indicated that, in the early morning hours, container ships, general cargo ships, and chemical ships with a tonnage of 1–18,500 t were less likely to involve life loss in the event of collision accidents.

Development of the equivalent Great Britain 36-zone power system for frequency control studies

This paper presents a dynamic model of the equivalent Great Britain (GB) 36-zone power system, which can be used for reliable and realistic assessment of emerging load frequency control mechanisms. Flexible architecture of the presented dynamic test system permits a broad range of security of supply and small-signal stability studies for design of future power grids. It can be particularly useful for academic research, but also for undertaking feasibility studies in power industries. The proposed dynamic test system, which is obtained through network reduction of the original full-scale GB transmission power system developed by National Grid Electricity System Operator (NGESO) Company, provides detailed information about the GB power system. In this regard, the required data and modelling approaches to develop the 36-zone system are provided in detail. The presented dynamic test system represents the system topology, impedance characteristics and electromechanical oscillations of the original GB power system however, it is not an exact equivalent of the master GB system. Illustrative dynamic models of the key system components, including synchronous generators, automatic voltage regulators, power system stabilizers, hydro and steam turbines models along with speed governing systems are presented. Dynamic behavior of 36-zone test system in response to infeed loss contingencies is investigated. Particularly, the impact of changes in the system inertia on the system electromechanical modes is examined using the modal analysis approach. In this context, the mode shape concept is employed to determine dominant generators and contribution of different zones in the low frequency oscillations. Moreover, time-domain simulations are undertaken to validate the modal analysis results. Additionally, the condition of different zones from the viewpoint of frequency nadir and maximum rate of change of frequency for various contingencies and extreme cases are examined.

A Multiobjective Intelligent Decision-Making Method for Multistage Placement of PMU in Power Grid Enterprises

The wide area measurement system (WAMS) based on synchronous phasor measurement technology plays an increasingly important role in dynamic monitoring and wide area protection of modern power systems. If the phasor measurement unit (PMU) is placed on all buses of the power system, the voltage and branch current of all buses can be directly observed. However, due to the high placement cost of PMU and its ability to measure the voltage phasor of the installed bus and the current of the associated branch, it is unrealistic and unnecessary to install PMU on all buses of the system. This paper discusses the incomplete observability under single PMU loss (N-1) contingencies and its effect on PMUs placement. An improved two-archive algorithm is proposed to solve the five-objective placement optimization model. In addition, a fuzzy decision-making method combining subjective and objective is proposed to help power grid enterprises select the most appropriate solution. The proposed method is tested on several IEEE bus systems and Polish 2383-bus system, and the test results verify its effectiveness.

Optimal Placement of Phasor Measurement Unit in Smart Grids Considering Multiple Constraints

The distribution of measurement noise is usually assumed to be Gaussian in the optimal phasor measurement unit (PMU) placement (OPP) problem. However, this is not always accurate in practice. This paper proposes a new OPP method for smart grids in which the effects of conventional measurements, limited channels of PMUs, zero-injection buses (ZIBs), single PMU loss contingency, state estimation error (SEE), and the maximum SEE variance (MSEEV) are considered. The SEE and MSEEV are both obtained using a robust <tex xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink">$t$</tex> -distribution maximum likelihood estimator (MLE) because <tex xmlns:mml="http://www.w3.org/1998/Math/MathML" xmlns:xlink="http://www.w3.org/1999/xlink">$t$</tex> -distribution is more flexible for modeling both Gaussian and non-Gaussian noises. The A- and G-optimal experimental criteria are utilized to form the SEE and MSEEV constraints. This allows the optimization problem to be converted into a linear objective function subject to linear matrix inequality observability constraints. The performance of the proposed OPP method is verified by the simulations of the IEEE 14-bus, 30-bus, and 118-bus systems as well as the 188-bus practical distribution system in China.

Evaluating Performance of a Linear Hybrid State Estimator Utilizing Measurements From RTUs and Optimally Placed PMUs

Synchro-phasor technology, using Phasor Measurement Unit (PMU), has improved the way power system data is collected for monitoring through state estimation. The placement of PMUs in a power system presents technical benefits, but it comes with high infrastructural costs. It is, therefore, necessary to install the minimum number of PMUs at optimal locations subject to power system observability, creating the Optimal PMU Placement Problem (OPPP). Some factors may be considered constraints in the OPPP, such as PMU outage. The main challenge with incorporating such constraints in the PMU placement problem is that the minimum number of PMUs required for system observation increases, contributing to the high infrastructural costs. This paper, therefore, proposes using a Linear Hybrid State Estimator (LHSE) that considers existing Remote Terminal Unit (RTU) measurements randomly distributed within the system and optimally placed Phasor Measurement Unit (PMU) measurements. The proposed LHSE addresses challenges associated with nonlinearity in state estimation. The LHSE is also based on the Weighted Least Absolute Value (WLAV) criterion, considered robust and able to detect and discard bad data during the estimation process. The proposed LHSE can address state estimation reliability and resiliency, specifically the PMU outage contingency, by employing existing RTU measurements and optimally placed PMU measurements based on the Artificial Bee Colony (ABC) optimization technique. The proposed approach also leverages RTU and PMU measurements to address PMU loss contingency instead of utilizing PMU measurements only as in existing studies. Three test cases (IEEE 14 Bus, IEEE 30 Bus, and IEEE 57 Bus) are considered, with the simulations performed in MATLAB using MATPOWER data. The performance of LHSE is evaluated considering PMU/RTU measurements and PMU measurements only scenarios. Both RTU/PMU measurements present a lower Normalized Cumulative Error (NCE) performance index than PMU measurements only. In case of a single PMU outage, the proposed LHSE can estimate all states based on RTU/PMU measurements instead of only PMU measurements that fail.

Opportunistic Avoidance of Litigation Loss Accruals and the Mitigating Effects of Auditors

We find that firms with preliminary earnings that are expected to just meet analyst forecasts are more likely to only disclose (i.e., not accrue) litigation loss contingencies, claiming that the litigation event falls below the qualitative thresholds necessitating accrual. We also find that this opportunistic treatment of a subjective estimate is reduced when firms’ auditors have expertise in the defendant’s industry or have experience auditing litigation contingencies. Furthermore, we find that opportunistic disclosure usage increases when firms are more economically important to auditors’ client portfolios. Our results are robust to a series of additional tests. We provide evidence to support the Public Company Accounting Oversight Board’s (PCAOB) call for increased auditor professional skepticism toward management bias and opportunism when evaluating subjective estimates.

The scale and scope of corporate litigation exposure and the factors that explain contingent loss disclosures

We collect a sample of 75,421 lawsuits filed against 90,255 public company defendants from 2006 through 2016 using federal district court docket information. These lawsuits involve an array of allegations, including product liability, civil rights discrimination, improper compensation and labor practices, antitrust violations, pollution, trademark and copyright violations, and patent infringement. The vast majority of these lawsuits likely do not make it onto the radar of investors: only 3% of lawsuit-defendants disclose the pending litigation at any point, with disclosure by plaintiffs and fellow defendants increasing the overall rate of disclosure to 6%. If disclosed, the decision to do so typically occurs early in the legal process, suggesting that the type of claim and the circumstances surrounding its filing—as opposed to how the lawsuit unfolds over time—drive the decision to disclose. Prior SEC scrutiny, the desire to hide potential losses that may make existing debt look particularly risky, and incentives to shape the narrative relative to other available lawsuit information factor into firms’ disclosure decisions. We also find that increased contingency-related concerns expressed in SEC comment letters coincided with the FASB’s consideration of loss contingencies in the 2008 to 2012 timeframe. Yet, the rate of disclosure (particularly of losses) declined over our sample period. Overall, our findings inform the debate about contingency disclosure standards and enforcement. In so doing, our study offers researchers a measure of overarching legal exposure that allows for the study of litigation risk, as well as firm risk more broadly, from new and increasingly relevant perspectives.

The Effects of Ambiguity on Loss Contingency Evaluation by Auditors and Investors

The objective of this study is to provide additional evidence regarding the effect of ambiguity on auditors’ and investors’ judgments when they evaluate managers’ disclosures about loss contingencies. Inspired by Nelson and Kinney (1997), we conducted an experiment where auditors and investors evaluate managements’ loss disclosures. We manipulate the probability of loss at three levels and the uncertainty about the ambiguity at two levels. Our results show that both auditors and investors appear to be aggressive towards financial reporting choices, and are less willing to recommend a loss contingency disclosure when there is ambiguity. Our results extend prior accounting literature and highlight the importance of understanding imprecise estimates in financial reporting. We found that auditors and investors reacted very similarly towards ambiguity in loss disclosures. This result may reflect a narrowing of the expectations gap around reporting accounting estimates and highlight the potential improvements in users’ confidence in accountants.

The Effects of Ambiguity on Loss Contingency Evaluation by Auditors and Investors

ABSTRACTThe objective of this study is to provide additional evidence regarding the effect of ambiguity on auditors' and investors' judgments when they evaluate managers' disclosures about loss contingencies. Inspired by Nelson and Kinney (1997), we conducted an experiment where auditors and investors evaluate management's loss disclosures. We manipulate the probability of loss at three levels and the uncertainty about the ambiguity at two levels. Our results show that both auditors and investors appear to be aggressive toward financial reporting choices, and are less willing to recommend a loss contingency disclosure when there is ambiguity. Our results extend prior accounting literature and highlight the importance of understanding imprecise estimates in financial reporting. We found that auditors and investors reacted very similarly toward ambiguity in loss disclosures. This result may reflect a narrowing of the expectations gap around reporting accounting estimates and highlight the potential improvements in users' confidence in accountants.

Auditor Experience and the Timeliness of Litigation Loss Contingency Disclosures*

ABSTRACTThis paper hypothesizes and finds that firms audited by city‐industry specialists have more timely disclosures of contingent losses from litigation when there is no news coverage relating to the legal case prior to management disclosures. A closer examination reveals that this result is explained by the specialist auditors’ prior experience auditing clients in the same office and industry who are involved with litigation. In our setting, disclosures of litigation‐related contingent losses, we identify two kinds of knowledge generated from experience: industry knowledge and litigation knowledge. Industry knowledge helps auditors detect and correct poor implementation of guidance for litigation loss contingency disclosures. Auditors gain litigation knowledge from auditing clients in a given office and industry with previous involvement as defendants. Thus, the two types of knowledge interact in their effects on reporting outcomes.

Using Linguistics to Mine Unstructured Data from FASB Exposure Drafts

ABSTRACTAccounting standard setting is a high-stakes, political, and market process influenced by constituents through a public commenting mechanism. Comment letters are widely studied by researchers and the Financial Accounting Standards Board (FASB), typically manually because the letters contain unstructured data. Our study employs a topic modeling method, latent Dirichlet allocation (LDA), to overcome the difficulties posed by the unstructured data. We analyze comment letters on two exposure drafts proposed by the FASB in 2008 and 2010 regarding loss contingencies. Results show that LDA is effective in compiling information from unstructured data. LDA also enables us to identify topics and detect shift in focus of the letters responding to the two exposure drafts. The findings have practical implications for standard setters, regulators, and researchers while also contributing to the digital reporting, data analysis, economic theory of democracy, and coalition and influence theory literatures.

Strategic Disclosures of Litigation Loss Contingencies When Customer-Supplier Relationships Are at Risk

ABSTRACT In the presence of litigation-facing suppliers, the supply chain relationship is at risk. Suppliers with principal customers (dependent suppliers) have a higher concentration of sales to customers, and they are more at risk relative to suppliers without principal customers (non-dependent suppliers). As a result, we predict and find that litigation disclosure patterns differ for the two supplier types: dependent suppliers are more likely to delay bad news and accelerate good news related to litigation outcomes, compared to non-dependent suppliers. Such strategic disclosure patterns in our end-game setting are opposite to those documented in the existing supply chain literature for the repeated-game setting (for example, Hui, Klasa, and Yeung 2012). JEL Classifications: M41; M48; K22.

Gunslingers, poker players, and chickens 3: Decision making under mental performance pressure in junior elite athletes.

Having investigated the decision making of world class elite and subelite athletes (see Parkin and Walsh, 2017; Parkin et al., 2017), here the abilities of those at the earliest stage of entry to elite sport are examined. Junior elite athletes have undergone initial national selection and are younger than athletes examined previously (mean age 13 years). Decision making under mental pressure is explored in this sample. During performance an athlete encounters a wide array of mental pressures; these include the psychological impact of errors, negative feedback, and requirements for sustained attention in a dynamic environment (Anshel and Wells, 2000; Mellalieu et al., 2009). Such factors increase the cognitive demands of the athletes, inducing distracting anxiety-related thoughts known as rumination (Beilock and Gray, 2007). Mental pressure has been shown to reduce performance of decision-making tasks where reward and loss contingencies are explicit, with a shift toward increased risk taking (Pabst et al., 2013; Starcke et al., 2011). Mental pressure has been shown to be detrimental to decision-making speed in comparison to physical stress, highlighting the importance of considering a range of different pressures encountered by athletes (Hepler, 2015). To investigate the influence of mental pressure on key indicators of decision making in junior elite athletes. This chapter concludes a wider project examining decision making across developmental stages in elite sport. The work further explores how psychological insights can be applied in an elite sporting environment and in particular tailored to the requirements of junior athletes. Seventeen junior elite athletes (10 males, mean age: 13.80 years) enrolled on a national youth athletic development program participated in the study. Performance across three categories of decision making was assessed under conditions of low and high mental pressure. Decision making under risk was measured via the Cambridge Gambling Task (CGT; Rogers et al., 1999), decision making under uncertainty via the Balloon Analogue Risk Task (BART; Lejuez et al., 2002), and fast reactive responses to perceptual stimuli via the Visual Search Task (Treisman, 1982). Mental pressure was induced with the addition of a concurrent verbal memory task, used to increase cognitive load and mimic the distracting effects of anxiety-related rumination. In junior elite athletes, fast reactive responses to perceptual stimuli (on the Visual Search Task) were slower under conditions of mental pressure. For decision making under risk there was an interaction of mental pressure and gender on the amount of points gambled, under pressure there was a higher level of risk taking in male athletes compared to females. There was no influence of mental pressure on decision making under uncertainity. There were no significant correlations in the degree to which individual's responses changed under pressure across the three measures of decision making. When assessing the applicability of results based on group averages there were no junior elite athletes who showed an "average" response (within 1SD of the mean) to mental pressure across all the three decision-making tasks. Mental pressure affects decision making in a sample of junior elite athletes, with a slowing of response times, and modulations to performance of decision making under risk that have a high requirement for working memory. In relation to sport, these findings suggest that novel situations that place high cognitive demands on the athlete may be particularly influenced by mental pressure. The application of this work in junior elite athletes included the feedback of individual results and the implementation of a decision-making taxonomy.

Gunslingers, poker players, and chickens 2: Decision-making under physical performance pressure in subelite athletes.

Having investigated the influence of acute physical exhaustion on decision-making in world-class elite athletes in Parkin et al. (2017), here a similar method is applied to subelite athletes. These subelite athletes were enrolled on a Team GB talent development program and were undergoing training for possible Olympic competition in 4-8 years. They differ from elite athletes examined previously according to expertise and age. While considered elite (Swann et al., 2015), the subelite athletes had approximately 8 years fewer sporting experience and were yet to obtain sustained success on the international stage. Additionally, the average age of the subelite sample is 20 years; thus, they are still undergoing the behavioral, cognitive, and neuronal changes that occur during the transition from late adolescence to young adulthood (Blakemore and Robbins, 2012). Previous work has used broad definitions of elite status in sport, and as such overlooked different categories within the spectrum of elite athletes (Swann et al., 2015). Therefore it is important to consider subelite athletes as a discrete point on the developmental trajectory of elite sporting expertise. This work aims to investigate the influence of physical pressure on key indicators of decision-making in subelite athletes. It forms part of a wider project examining decision-making across different stages of the developmental trajectory in elite sport. In doing so, it aims to examine how to apply and develop psychological insights useful to an elite sporting environment. 32 subelite athletes (18 males, mean age: 20 years) participated in the study. Performance across three categories of decision-making was assessed under conditions of low and high physical pressure. Decision-making under risk was measured with performance of the Cambridge Gambling Task (CGT; Rogers et al., 1999), decision-making under uncertainty with the Balloon Analogue Risk Task (BART; Lejuez et al., 2002), and fast reactive responses and inhibition via the Stop Signal Reaction Time Task (SSRT; Logan, 1994). Physical exhaustion was induced via intervals of maximal exertion exercise on a wattbike. Under pressure subelite athletes showed increased risk taking for both decisions where probability outcomes were explicit (on the CGT), and those where probability outcomes were unknown (on the BART). Despite making quicker decisions under pressure, with fewer errors, on the CGT, subelite athletes showed a reduced ability to optimally adjust betting behavior according to reward and loss contingencies. Fast reactive responses to perceptual stimuli and response inhibition did not change as a result of physical pressure. Individual responses to pressure showed a negative correlation in that a decrease in reaction times on the SSRT Task under pressure was associated with an increase in risk taking on the BART. When assessing the applicability of results based on group averages to individual athletes, 17% of the sample showed an "average" response (within 1 SD of the mean) to pressure across all three decision-making tasks. Indicators of decision-making in a sample of subelite athletes are influenced by physical pressure, with a shift toward increased indiscriminate risk taking. The influence that physical pressure has on decision-making was different to that observed in world-class elite athletes; this highlights the importance of distinguishing between athletes at the elite level (Swann et al., 2015). The application of this work to a novel subgroup of elite athletes, including the implementation of a decision-making taxonomy, is discussed.

EVALUATING THE EXPECTED WELFARE GAIN FROM INSURANCE

ABSTRACTEconomic theory tells us how to evaluate the expected welfare gain from insurance products on offer to individuals. If we know the risk preferences of the individual, and subjective beliefs about loss contingencies and likelihood of payout, there is a certainty equivalent of the risky insurance policy that can be compared to the certain insurance premium. This simple logic extends to nonstandard models of risk preferences, such as those in which individuals exhibit “optimism” or “pessimism” about loss contingencies in their evaluation of the risky insurance policy. We illustrate the application of these basic ideas about the welfare evaluation of insurance policies in a controlled laboratory experiment. We estimate the risk preferences of individuals from one task, and separately present the individual with a number of insurance policies in which loss contingencies are objective. We then estimate the expected consumer surplus gained or foregone from observed take‐up decisions. There is striking evidence of foregone expected consumer surplus from incorrect take‐up decisions. Indeed, the metric of take‐up itself, widely used in welfare evaluations of insurance products, provides a qualitatively incorrect guide to the expected welfare effects of insurance.

A Multi-objective Placement of Phasor Measurement Units Considering Observability and Measurement Redundancy using Firefly Algorithm

This paper proposes a multi-objective optimal placement method of Phasor Measurement Units (PMUs) in large electric transmission systems. It is proposed for minimizing the number of PMUs for complete system observability and maximizing measurement redundancy of the buses, simultaneously. The measurement redundancy of the bus indicates that number of times a bus is able to monitor more than once by PMUs set. A high level of measurement redundancy can maximize the system observability and it is required for a reliable power system state estimation. Therefore, simultaneous optimizations of the two conflicting objectives are performed using a binary coded firefly algorithm. The complete observability of the power system is first prepared and then, single line loss contingency condition is added to the main model. The practical measurement limitation of PMUs is also considered. The efficiency of the proposed method is validated on IEEE 14, 30, 57 and 118 bus test systems and a real and large- scale Polish 2383 bus system. The valuable approach of firefly algorithm is demonstrated in finding the optimal number of PMUs and their locations by comparing its performance with earlier works.

Effects of and preference for conditions of token earn versus token loss.

The effects of earning and losing tokens on the disruptive behavior of 12 first-grade students were evaluated under symmetrical contingencies of earn and loss. Both contingencies produced decreases in disruptive behavior. For some participants, more consistent decreases were observed during the loss contingency. In addition, participants generally earned or kept more tokens during the loss contingency. When offered a choice of contingencies, most participants preferred the loss contingency. The results showed some consistency with behavioral economic principles of loss aversion and the endowment effect.

Disclosure of contingent legal liabilities

There has long been user dissatisfaction with firm’s disclosure of contingent legal liabilities, and the FASB, IASB, and SEC have all considered compliance issues and standard amendments on this topic in recent years. This study uses a sample of employment discrimination cases to provide evidence on the extent to which current contingent legal liability disclosures provide useful contingency evaluations. Consistent with legal concerns influencing reporting decisions, I find that current disclosure practices provide limited quantitative detail regarding the magnitude of the expected loss. However, the text of the disclosures does provide qualitative indicators of the probability of loss. I find evidence that statements about the inestimable nature of the loss and statements about the firm’s willingness to consider a settlement are related to higher probabilities of loss and higher loss amounts. I also find evidence that statements regarding an existing accrual for losses and warnings about materiality reflect a higher likelihood of a nontrivial loss. These results emphasize firms’ strong resistance to quantitative disclosures of legal contingencies but suggest that existing SFAS 5 disclosures do contain qualitative information useful for evaluating the loss contingency.