Retail Financial Advice: Does One Size Fit All?

Using unique data on Canadian households, we show that financial advisors exert substantial influence over their clients' asset allocation, but provide limited customization. Advisor fixed effects explain considerably more variation in portfolio risk and home bias than a broad set of investor attributes that includes risk tolerance, age, investment horizon, and financial sophistication. Advisor effects remain important even when controlling flexibly for unobserved heterogeneity through investor fixed effects. An advisor's own asset allocation strongly predicts the allocations chosen on clients' behalf. This one‐size‐fits‐all advice does not come cheap: advised portfolios cost 2.5% per year, or 1.5% more than life cycle funds.     

How Do Crises Spread? Evidence from Accessible and Inaccessible Stock Indices

We provide empirical evidence that stock market crises are spread globally through asset holdings of international investors. By separating emerging market stocks into two categories, namely, those that are eligible for purchase by foreigners (accessible) and those that are not (inaccessible), we estimate and compare the degree to which accessible and inaccessible stock index returns co‐move with crisis country index returns. Our results show greater co‐movement during high volatility periods, especially for accessible stock index returns, suggesting that crises spread through the asset holdings of international investors rather than through changes in fundamentals.     

Information Transparency and Coordination Failure: Theory and Experiment

We examine the effect of higher order beliefs on the ability of decentralized decision makers to coordinate and take advantage of improvements in information transparency that can increase welfare. Theories that address this question have not been empirically explored. We study coordination in a laboratory experiment with privately informed decision makers. Economic outcomes in the setting depend both on agents' rational beliefs regarding economic fundamentals and on their rational beliefs regarding the beliefs of other agents. Increasing information transparency mitigates uncertainty about economic fundamentals but may increase strategic uncertainty, precipitating multiple equilibria and less efficient group outcomes. We provide evidence that sometimes the equilibrium attained by creditors is inferior from a welfare perspective to other available equilibria. Risk dominance appears to determine equilibrium selection in our setting.     

Underwater Options and the Dynamics of Executive Pay-to-Performance Sensitivities

We empirically analyze the dynamics of executives' pay‐to‐performance sensitivities. Option pay‐to‐performance sensitivities become weaker as options fall underwater, often leading to pressures to reprice options or restore pay‐to‐performance sensitivity in other ways. Building a detailed data set on executives' portfolios of stock and options, we find that the responsiveness of pay‐to‐performance sensitivities (created by all executive holdings of stock and options) to changes in stock price is large. The elasticity of pay‐to‐performance sensitivities with respect to stock price decreases is about 0.7 and is larger for high‐option executives and for executives with high percentages of options already underwater. The dominant mechanism through which companies offset declines in option pay‐to‐performance sensitivities is larger option grants following stock price declines; on average, these larger grants restore approximately 40% of the stock‐price‐induced pay‐to‐performance sensitivity declines. Option repricings are inconsequential in this regard, despite the attention they have attracted. In looking at positive returns, we find the reverse: higher returns both directly increase pay‐to‐performance sensitivities and lead to larger option grants, which raise pay‐to‐performance sensitivities further. Thus, option grants to executives tend to be largest following large stock price increases or large stock price decreases.     

Fiscal Illusion at the Local Level: An Empirical Test Using Australian Municipal Data

This paper seeks to extend the literature on the empirical analysis of fiscal illusion in two ways. First, it provides a simultaneous test of four specific hypotheses subsumed under fiscal illusion, namely the revenue-complexity, renter illusion, debt illusion and flypaper models. and second, it adds evidence drawn from the Australian institutional milieu to existing empirical work which has an overwhelming North American focus. Using 1991 data from 46 local government authorities in Tasmania, the results suggest significant support for revenue-complexity, debt illusion, and the degree of indirectness of the revenue system.     

Linguistic Complexity in Firm Disclosures: Obfuscation or Information?

Prior research generally interprets complex language in firms’ disclosures as indicative of managerial obfuscation. However, complex language can also reflect the provision of complex information; for example, informative technical disclosure. As a consequence, linguistic complexity commingles two latent components—obfuscation and information—that are related to information asymmetry in opposite directions. We develop a novel empirical approach to estimate these two latent components within the context of quarterly earnings conference calls. We validate our estimates of these two latent components by examining their relation to information asymmetry. Consistent with our predictions, we find that our estimate of the information component is negatively associated with information asymmetry while our estimate of the obfuscation component is positively associated with information asymmetry. Our findings suggest that future research on linguistic complexity can construct more powerful tests by separately examining these two latent components of linguistic complexity.     

SEIGNORAGE AND EUROPEAN MONETARY UNION

Inflation differentials in Europe have narrowed substantially since the inception of the European Monetary System in 1979. However, their persistence after more than a decade raises the question of why these differentials are so difficult to eliminate. Some European Community countries systematically use seignorage—financing government expenditures with money creation—while others do not. This increases the difficulty of achieving the convergence of monetary policies and inflation rates required for irrevocably fixed exchange rates in Europe. This paper, utilizing a model of government finance that minimizes the social cost of financing government expenditures, examines monetary finance in the European Community. It rejects soundly the social cost minimization model of seignorage collection.     

Internal Audit Quality and Financial Reporting Quality: The Joint Importance of Independence and Competence

In light of the growing importance of internal audit functions (IAF) and the limited archival evidence on internal audit quality, we examine an interactive model of IAF quality (comprised of competence and independence) to better understand the determinants of IAF effectiveness as a financial reporting monitor. Our tests support the hypothesis that the joint presence of competence and independence is a necessary antecedent to effective IAF financial reporting monitoring. In sum, our results show that, the answer to “what is the effect of internal audit competence (independence) on financial reporting quality?” is “it depends on the independence (competence) of the internal auditor.” Our study extends the understanding of IAF quality determinants in the realm of financial reporting as it relates to ongoing discussions by researchers, standard setters, regulators, and practitioners.