Earnings Management to Minimize Superfund Clean‐up and Transaction Costs*

We investigate whether firms identified as potentially responsible parties (PRPs) under the Comprehensive Environmental Response, Compensation, and Liability Act (more commonly known as Superfund) appear to manipulate earnings to minimize their exposure to Superfund clean‐up and transaction costs. We analyze the discretionary accrual behavior of 612 PRPs from 1981 to 1995 and increase the power of our tests by identifying those PRPs with the most incentive to manage earnings during PRP identification years. The results provide robust evidence consistent with the hypothesis that these PRPs use income‐reducing discretionary accruals during PRP identification years in an attempt to minimize Superfund clean‐up and transaction costs. We also consider whether PRPs' incentives to manage earnings change in response to a change in the EPA regulatory regime and find modest evidence consistent with our conjecture.     

International Trade and R&D Investment: Evidence from Chinese Manufacturing Firms

A current concern for China's long‐term growth prospect is whether China can become an innovative economy and achieve industrial upgrading to compensate for the gradually declining competitiveness resulting from low‐cost labor. The present study examines this issue by exploring how trade participation impacts on the R&D investment of manufacturing firms through various channels. Merging China's Annual Manufacturing Survey Dataset and the Chinese Customs Dataset allows us to study such a relationship at the individual firm level. The empirical results suggest that channels such as geographical diversification of export markets, share of imports from high‐income countries, average unit value of imports, number of intermediate goods and capital goods imports, and the trade regime are significant factors that influence firm‐level R&D investment. The study discusses the policy implications of the empirical findings in relation to industrial and trade policies that may be potentially beneficial for China's transition towards an innovative economy.     

Gerschenkron Redux? Analysing New Evidence on Joint‐Stock Enterprise in Pre‐War Shanghai

Alexander Gerschenkron (1904–78) famously postulated that the more backward an economy was at the outset of industrialisation, the more reliant it would be on state‐backed banks as a means of directing investment. Gerschenkron thereby implied that impersonal equity markets were likely to play a less significant role in countries aiming to catch up with the West. This article is aimed at examining Gerschenkron's thesis primarily through an analysis of shareholding in 1930s Shanghai. Drawing on newly discovered archival material as well as on recent studies, the paper clarifies the magnitude of joint‐stock enterprise and the ubiquity of stock‐exchange trade in a city that was by far China's most important economic hub. The pattern of joint‐stock enterprise in pre‐war China is compared with that of Japan, the first non‐Western society to become fully industrialised. The argument advanced is that Gerschenkron's thesis incorrectly played down the significance of impersonal equity markets to pre‐war Japan's successful industrialisation and to the limited nature of pre‐war China's industrialisation. Japan could sustain its industrialisation thrust in the early 20th century on a nation‐wide scale partly because of the growing vitality of its equity markets in Tokyo and Osaka. By contrast, China's pre‐war industrialisation was much less extensive because its equity markets were more limited.     

Contingent capital and bank risk‐taking among British banks before the First World War1

The recent financial turmoil highlights the incentive of highly leveraged financial institutions to take excessive risk, given the protection of limited liability. During the nineteenth and early twentieth century, many banks operated under liability rules which obligated shareholders to bear larger costs of bank insolvency in the form of contingent, or even unlimited, liability. This article examines the empirical relationship between the size of banks' contingent liability and their risk‐taking behaviour using data on British banks from 1878 to 1912. We find that banks with more contingent liability appear to have taken less risk. We also find evidence that the risk‐reducing effects of contingent liability were larger for banks with higher leverage, suggesting that contingent capital mitigated the moral hazard problem at banks.     

Selection from Many Investments with Managerial Private Information*

We investigate capital investment problems when a manager knows the costs of a set of available projects, while the owner only holds probabilistic beliefs about these costs. With mutually exclusive projects, an optimal policy can be defined by a series of cost targets, one for each of the possible projects. The project with the lowest reported cost relative to the target is chosen, and funded as if the cost were equal to the target. The optimal investment policy can deviate from a traditional policy of selecting the project with the highest, positive net present value (NPV) in a number of ways. First, under-investment arises to limit the manager's ability to capture the economic rents. Second, when investment takes place, it is not always the project with the highest NPV that is implemented. Third, projects with lower cost variability can be favored. We extend the analysis to non-mutually exclusive projects. With two independent projects, batch processing is superior to individual appraisal whenever both optimal individual appraisal cost targets are interior. Individual appraisal ignores the impact of individual targets on incentives to report the costs of other potential projects. Batch processing can improve individual assessment by cost effective switching of investment away from the individual projects and into the batch as a whole. The results suggest that the common practice of analyzing batches of capital requests in an annual capital budgeting cycle provides advantages in the organization's attempt to deal with asymmetric information and incentive problems.     

An Analysis of the Economic Consequences of the Proportionate Liability Rule*

Major accounting firms in the United States have singled out elimination of joint and several liability as one of the most needed legal reforms in the country. The recent legislation of the Private Securities Litigation Reform Act of 1995 replaced joint and several liability with proportionate liability. This paper develops a simple model to analyze the economic consequences of such a change in the legal environment facing public accountants. In particular, we examine the incentive effects induced by the proportionate liability rule on the auditor's effort and financial statement users' litigation decisions. Our analysis demonstrates that replacing joint and several liability with proportionate liability can decrease the equilibrium audit effort, lawsuit probability, market price of the firm, and audit fee. More important, even though the proportionate liability rule reduces the equilibrium audit effort, we show that it can actually increase social welfare.     

China＇s Economic Prospects and Sino-US Economic Relations

A better comprehension of the mixed sentiment in the rest of world towards the rapid rise of the Chinese economy will depend on the understanding of some key features of the Chinese economy, such as those associated with its size, structure and institution. To further sustain its high growth, China is facing more challenges than it has encountered in the past 2 decades, including a gamut of material constraints. Although polices and technological progress might alleviate many of these constraints, the ultimate solution will still lie in continued institutional reform. China's recent move towards a more flexible exchange rate regime is in line with its broad reform and in accordance with the progress of its development. However, such a move will have limited immediate effects on the prodigious US trade deficit, which itself is a problem rooted in the flawed international reserve system, far beyond a Sino‐US trade issue. Edited by Xiaoming Feng     

The Social Welfare Impact of Indonesian Dairy Policies

The Indonesian dairy sector remains highly regulated, in spite of trade and investment policy reforms elsewhere in the economy. The regulations, aimed mainly at fostering development of local industry, include an import ratio requirement (BUSEP), import tariffs; an import licensing scheme, and restrictions on investment in milk processing The paper shows that the current policy mix has resulted in a significant increase in numbers of dairy cattle and dairy farmers, and in fresh milk and end-product output. However, this policy mix imposes costs. The analysis indicates that the economy, and in particular domestic consumers, would gain if dairy trade and investment restrictions were lessened. The gradual movement towards a more deregulated dairy sector is a necessary condition for improved efficiency and a strengthening of Indonesia's competitive position in the world dairy market.     

Monetary Policy and Corporate Investment： Evidence from Chinese Micro Data

This paper investigates how a firm's characteristics restrict the influence of monetary policy changes on its investment behavior. Focusing on China's listed companies for a sample period from the first quarter of 2002 to the first quarter of 2011, we find that quantity‐oriented and price‐based monetary policies have heterogeneous impacts on corporate investment behavior, but the influence of monetary policies is constrained by the liquidity, inventory, size and asset–liability ratio of a firm. Firms with higher liquidity, lower inventory level and lower asset–liability ratios are less sensitive to the impact from two kinds of monetary policies. The larger the size of the firm, the less it is subject to influence from quantity‐oriented monetary policy; it responds more to price‐based monetary policy. The policy implication is that the monetary authorities should pay attention to the importance of policy‐making based on the monetary demand of microeconomic entities.     

Does “skin in the game” reduce risk taking? Leverage,liability and the long-run consequences of new deal banking reforms

This essay examines how the Banking Acts of the 1933 and 1935 and related New Deal legislation influenced risk taking in the financial sector of the U.S. economy. The analysis focuses on contingent liability of bank owners for losses incurred by their firms and how the elimination of this liability influenced leverage and lending by commercial banks. Using a new panel data set, we find contingent liability reduced risk taking. In states with contingent liability, banks used less leverage and converted each dollar of capital into fewer loans, and thus could survive larger loan losses (as a fraction of their portfolio) than banks in limited liability states. In states with limited liability, banks took on more leverage and risk, particularly in states that required banks with limited liability to join the Federal Deposit Insurance Corporation. In the long run, the New Deal replaced a regime of contingent liability with deposit insurance, stricter balance sheet regulation, and increased capital requirements, shifting the onus of risk management from bankers to state and federal regulators.     

The Effect of Limited Liability on the Market Response to Disclosure*

Abstract. We formalize the effects of an earnings disclosure on security prices under an assumption of limited liability. We derive various nonlinear relations between equity prices and earnings under a variety of capital structure assumptions and. if possible, we tie the relations attained to results from the existing empirical literature. We also characterize how debt prices respond to earnings when holders of debt have limited liability. Finally, we analyze how changes in the degree of leverage and conversion features of debt affect the relation between price and earnings.     

China＇s Pattern of Growth： Moving to Sustainability and Reducing Inequality

I. Introduction China’s gross domestic product (GDP) growth has averaged 9.4 percent per annum since1978. As a result of this impressive growth, millions of people were lifted out of poverty. Economic reforms implemented over the last 25 years have certainly been instrumental in the remarkable growth performance, leading to higher productivity growth than in the pre- reform period. Nevertheless, it is widely agreed that China’s growth during this period has been resource intensive, drawing…     

Auditor Liability and Business Investment*

We model a firm's investment decision, an auditor's effort‐rendering behavior, audit fees, and prices of the firms under two auditor liability rules: strict liability and negligence liability. We show that an auditor's effort level is socially optimal under strict liability, while it is not generally so under negligence liability. Furthermore, both the firm owner's expected benefit and the audit fee are higher under strict liability than under negligence liability. We define the legal error under negligence liability as the difference between the assessed audit effort (that is, the estimate of audit effort made by the court) and the actual audit effort and prove that the greater the variance of the legal error, the more incentive an auditor has to exert effort under negligence liability compared with strict liability. Finally, the number of investments being undertaken could be higher under strict liability because more firm owners are willing to hire auditors to go public.     

Individual investors and social ownership structures in the UK before the 1930s: Joint holdings and trustee investment

After the introduction of limited liability, a growing number of individuals in Britain from a widening social spectrum, including the less affluent, began to own stocks and shares. Drawing upon a unique and large dataset of 35 848 investors between 1870 and 1935, this study analyses joint holdings which have been a neglected aspect of investor behaviour. Our findings reveal that joint holdings were quite common and that about one in five UK investors were involved in a joint investment. Men were more likely to be joint holders than women for reasons related to institutions of social ownership such as trusts and executorships.     

Disclosure Policy and Market Liquidity: Impact of Depth Quotes and Order Sizes*

This paper investigates the relation between disclosure policy and market liquidity. Our tests examine two key aspects of market liquidity, the effective bid‐ask spread and quoted depth, and how they relate to financial analysts' ratings of firms' disclosure policies. We introduce a method of combining order sizes and depth quotes to yield more precise estimates of effective spreads on trades likely constrained by quoted depth. We find that while firms with higher rated disclosures are charged lower effective spreads, they are also quoted lower depth, consistent with the notion that better disclosures reduce information asymmetry but also cause some liquidity suppliers to exit the market. Therefore, a simple examination of spreads and depths yields ambiguous inferences on the relation between disclosure policy and market liquidity. We resolve this ambiguity by estimating depth‐adjusted effective spreads, and find that firms with higher rated disclosures have lower depth‐adjusted effective spreads across all trade sizes. Consequently, our results reveal a robust inverse relation between disclosure ratings and effective trading costs. This implies that a policy of enhanced financial disclosure is related to improved market liquidity.     

Home Country Investor Protection,Ownership Structure and Cross‐Listed Firms' Compliance with SOX‐Mandated Internal Control Deficiency Disclosures

We examine whether home country investor protection and ownership structure affect cross‐listed firms' compliance with SOX‐mandated internal control deficiency (ICD) disclosures. We develop a proxy for the likelihood of cross‐listed firms' ICD misreporting during the Section 302 reporting regime. For cross‐listed firms domiciled in weak investor protection countries, we have three main findings. First, firms whose managers control their firms and have voting rights in excess of cash flow rights are more likely to misreport ICD than other firms during the Section 302 reporting regime. Second, there is a positive association between the likelihood of ICD misreporting and voluntary deregistration from the SEC prior to the Section 404 effective date. Third, for firms that chose not to deregister, there is a positive association between the likelihood of ICD misreporting and the reporting of previously undisclosed ICDs during the Section 404 reporting regime. We do not find similar evidence for cross‐listed firms domiciled in strong investor protection countries. Our findings are consistent with the hypothesis that, for cross‐listed firms domiciled in weak investor protection countries, managers who have the ability and incentive to expropriate outside minority shareholders are reluctant to disclose ICDs in order to protect their private control benefits. The results of our study should be of interest to regulators who wish to identify noncompliant firms for closer supervision, investors who wish to identify ex ante red flags for poor financial disclosure quality, and researchers who wish to understand the economic forces governing cross‐listed firms' financial disclosure behavior.     

Growth Slowdown in China since 2008: Will There Be a Hard Landing in the Near Future?

China has witnessed an unprecedented great leap forward in investment since the 2008 global financial crisis, and at the same time real GDP growth has undergone a significant slowdown. This paper examines China's growth slowdown since 2008 up to 2013 using a growth accounting model in a systematic way. It is found that China's growth slowdown since 2008 almost completely comes from a sharp slowdown in total factor productivity growth. During this period, the positive effect on growth from expanding investment has been completely offset by the negative effect of the slowdown in total factor productivity growth. Currently, China's economy has slid into the Solow downward path. Under these circumstances, a soft landing is completely infeasible. Unless the Chinese Government implements substantial rebalancing and comprehensive and in‐depth market‐oriented reform, accompanied by large‐scale de‐investment (decreasing in the ratio of investment in GDP) and massive employment adjustment, China will be unable to avoid the Solow downward path, and a hard landing in investment will be inevitable in the near future.     

‘Armament in depth’ or ‘armament in breadth’? German investment pattern and rearmament during the Nazi period1

Today, most scholars agree that Nazi Germany did not follow a premeditated Blitzkrieg strategy in the late 1930s and at the beginning of the Second World War. However, the question of the extent to which Germany's economy had been prepared for a longer war is still debated because statistical information on Germany's investment pattern is fragmentary and data on the structure of prewar German military expenditure are not available. Relying on newly discovered sources, this article closes these gaps. The Nazi regime clearly shifted its investment towards preparation for war from the mid‐1930s on, and though armaments purchases stagnated during the period from 1937 to 1939, investment in munitions industries grew considerably. Consequently, during the late 1930s the Nazis pursued a ‘sustainable’ rearmament strategy necessary for fighting a longer war. Yet, despite massive capacity enlargements in the munitions industries, total German investment was not unusually high by today's definition because contemporary figures included a significant amount of armaments purchases.     

The Mercantile Laws Commission of 1854 and the Political Economy of Limited Liability

It is widely agreed that the coming of limited liability in the Joint-Stock Companies Act of 1855 marked a revolutionary change. However, this change is hard to explain because it appeared to serve no particular interest. This article supports the lone alternative view of Jeffreys that limited liability was introduced in the interests of wealthy potential investors. It argues that the commission's report was introduced in the interests of wealthy potential investors. It argues that the commission's report presented parliament with competing analyses of limited liability from the perspectives of two very different theories of political economy: one which followed Adam Smith in arguing that unlimited liability was necessary to sustain a world fit for individual capitalists; and another which, anticipating Marx's critique of Adam Smith, argued for limited liability to create a world fit for social capital.     

Imported Capital Goods and Manufacturing Productivity: Evidence from Botswana's Manufacturing Sector

This article examines the effects of imported capital goods on manufacturing productivity growth in Botswana. Despite consistent efforts aimed at diversification, Botswana's economy has remained heavily dependent on diamond exports, and the country's productivity remains a point of concern. The ability to apply foreign technologies to increase productivity and spur diversification is limited by the foreign exchange gap. This study uses an imported input growth model to analyse how the importation of capital goods contributes to enabling productivity growth and export diversification. With a panel of 340 manufacturing firms, the study also analyses the effects of imported capital goods on firm productivity growth and skills development. The results show that imported machines and equipment have increase manufacturing productivity after 1‐2 years following the investment. Additionally, foreign‐owned firms were found to enjoy more productivity growth than their domestic counterparts.