Is PIN priced risk?

Several recent papers assume that private information (PIN), proposed by Easley et al. [2002. Is information risk a determinant of asset returns? Journal of Finance 57, 2185–2221; 2004. Factoring information into returns. Working Paper, Cornell University], is a determinant of stock returns. We replicate Easley et al. (2002) and show that while PIN does predict future returns in the sample they analyze, the effect is not robust to alternative specifications and time periods. There is no evidence that PIN factor loadings predict returns or that PIN factor returns reflect future GDP growth. PIN exhibits no association with implied cost of capital derived from analysts’ earnings forecasts. Overall, our findings cast doubt on whether PIN reflects information risk systematically priced by investors.     

A Theory of Noise Trading in Securities Markets

In a recent article, Black 1 introduces a type of trading that he terms noise trading. He asserts that noise trading, which he defines as trading on noise as if it were information, must be a significant factor in securities markets. However, he does not provide an explanation of why any investors would rationally want to engage in noise trading. The goal of this paper is to provide such an explanation for one type of investor, managers of investment funds. As shown here, the incentive for a manager to engage in noise trading arises because of the positive signal that the level of the manager's trading provides about his or her ability to collect private information concerning current and potential investments. If the manager's compensation is directly related to investors' perceptions of his or her ability, the manager will then trade more frequently than is justified on the basis of his or her private information. In addition to providing this explanation for noise trading, the results of this analysis may also be useful for further empirical exploration of the relation between investment fund portfolio turnover and subsequent performance.     

Information Control, Career Concerns, and Corporate Governance

We examine corporate governance effectiveness when the CEO generates project ideas and the board of directors screens these ideas for approval. However, the precision of the board's screening information is controlled by the CEO. Moreover, both the CEO and the board have career concerns that interact. The board's career concerns cause it to distort its investment recommendation procyclically, whereas the CEO's career concerns cause her to sometimes reduce the precision of the board's information. Moreover, the CEO sometimes prefers a less able board, and this happens only during economic upturns, suggesting that corporate governance will be weaker during economic upturns.     

Adverse selection, contract design, and investment distortion

We examine the design of compensation contracts and determination of investment policies when a manager has private information regarding the effect of investment on both the firm's cash flows and the private benefits she is able to extract from employment. We show that, in general, the optimal mechanism is characterized by a menu of salary and option contracts. When the manager's private information relates only to the firm's cash flows, the firm overinvests relative to the Pareto optimal level. On the other hand, if the private information relates only to private benefits, the firm will underinvest.     

The Value of Mandatory Certification: A Real Effects Perspective

We study the real effects of certification to demonstrate the value of mandatory certification over and above mandatory disclosure in enhancing investment efficiency. In our model, a firm's manager selects a project to maximize the firm's short-term stock price, which is a function of her certification and disclosure decisions about the outcome of the project. Although the manager might be either forthcoming or strategic with regard to the disclosure of her private information, she can strategically choose whether to incur a cost or not to certify her disclosure, unless mandated. The manager always selects the first-best project when both certification and disclosure are mandatory. However, when certification is voluntary, project selection is inefficient. In addition, mandating disclosure without mandating certification can lead to lower investment efficiency than mandating neither. In justifying why mandatory certification is beneficial for public firms, our results offer a note of caution regarding the contemplated regulatory moves for increased disclosures by public firms without corresponding certification requirements, for example, the recent SEC proposal requiring extensive climate-related disclosure.     

Cost Uncertainty and Taxpayer Compliance

The existence of a private cost borne by audited taxpayers affects the tax enforcement policy. This is so because tax auditors will face now two sources of uncertainty, namely, the typical one associated with taxpayers’ income and that associated with the taxpayers’ idiosyncratic attitude towards tax compliance. Moreover, the inspection policy can be exposed to some randomness from the taxpayers’ viewpoint due to the uncertainty about the audit cost borne by the tax authority. In this paper we provide an unified framework to analyze the effects of all these sources of uncertainty in a model of tax compliance with strategic interaction between auditors and taxpayers. We show that more variance in the distribution of the taxpayers’ private cost of evading raises both tax compliance and the ex-ante welfare of taxpayers. The effects of the uncertainty about the audit cost faced by the tax authority are generally ambiguous. We also discuss the implications of our model for the regressive (or progressive) bias of the effective tax system.     

Hedging, hedge accounting, and speculation in a rational expectations equilibrium

This paper explains corporate hedging and speculation in a two period rational expectations model. A risk averse manager represents a firm that is priced in a risk neutral market. The manager enters into a cash flow hedge of a forecast transaction by taking a short position in the futures market. When the futures position is chosen, the manager possesses private information regarding the firm’s production capacity. Mandatory disclosure of the futures position in the financial statements allows the market to draw inferences over the manager’s information. These inferences affect the market’s pricing decision and in turn the manager’s hedging decision. The futures position taken is chosen not only to reduce price risk exposure but to signal some capacity level. In equilibrium, however, the market anticipates the manager’s strategy and is not fooled.Considering varying managerial preferences, we analyze three settings. In the basic setting speculation occurs whenever the manager prefers high market values in both periods. In the second setting we add transaction costs and find that speculation is less likely. Finally, we introduce uncertainty regarding the manager’s preferences. If the market needs to determine prices based on expected preferences, incentives to speculate are mitigated in equilibrium but still present.     

Reporting Discretion and Private Information Communication through Earnings

We model a two-period pure exchange economy where a risk averse manager, who has private information regarding future earnings, is required to issue an earnings report to investors at the end of each period. While the manager is prohibited from directly disclosing her private information, she is allowed to bias reported earnings in the first period, subject to GAAP rules that require that a specified proportion of the bias be reversed subsequently. We show there is a minimum threshold of reversal, such that, when the proportion of required reversal is above this threshold, the manager smooths income and communicates her private information through reported earnings. Consequently, the market attaches greater weight to reported earnings than under a regime that allows no discretion. When the required reversal is below the minimum threshold, the manager increases reported earnings without limit and the equilibrium degenerates. When the manager is not endowed with any private information, the market unravels the "true" earnings and price is unaffected by earnings management. Our results underscore the importance of both allowing and restricting reporting discretion through formal mechanisms.     

Mediating instruments and making markets: Capital budgeting, science and the economy

We examine in this paper how certain instruments link science and the economy through acting on capital budgeting decisions, and in doing so how they contribute to the process of making markets. We use the term “mediating instruments” to refer to those practices that frame the capital spending decisions of individual firms and agencies, and that help to align them with investments made by other firms and agencies in the same or related industries. Our substantive focus is on the microprocessor industry, and the roles of “Moore’s Law” and “technology roadmaps”. We examine the ways in which these instruments envision a future, and how they link a multitude of actors and domains in such a way that the making of future markets for microprocessors and related devices can continue. The paper begins with a discussion of existing literatures on capital budgeting, science studies, and recent economic sociology, together with the reasoning behind the notion of “mediating instruments”. We then address the substantive issues in three stages. Firstly, we consider the role of “Moore’s Law” in shaping the fundamental expectations of an entire set of industries about rates of increase in the power and complexity of semiconductor devices, and the timing of those increases. Secondly, we examine the roles of “technology roadmaps” in translating the simplified imperatives of Moore’s Law into a framework that can guide and encourage the myriad of highly uncertain and confidential investment decisions of firms and other agencies. Thirdly, we explore one particular and recent example of major capital investment, that of post-optical lithography. The paper seeks to help remedy the empirical deficit in studies of capital budgeting practices, and to demonstrate that investment is much more than a matter of valuation techniques. We argue, through the case of the microprocessor industry, for greater attention to investment as an inter-firm and inter-agency process, thus lessening the fixation in studies of capital budgeting on the traditional hierarchical and bounded organization. In addition, we seek to extend and illustrate empirically the richness of the notion of “mediating instruments” for researchers in accounting, science studies, and economic sociology.     

Motivating managers to make investment decisions

Owners of capital frequently lack knowledge about investment opportunities. One alternative is to turn to a manager for assistance. The owner's problem of contracting for the services of a manager is treated as a problem in buying information. The surprising result is that it is sometimes possible to trade information even when the owner is unable to form his own assessment of the information's value. Under some conditions it is possible to write a managerial compensation contract which will induce the manager to act in the best interests of the owner. These conditions require owner knowledge of the manager's employment and investment alternatives and risk preferences as well as some, but not all, of the characteristics of the investment opportunities.     

Overconfidence,CEO Selection,and Corporate Governance

We develop a model that shows that an overconfident manager, who sometimes makes value‐destroying investments, has a higher likelihood than a rational manager of being deliberately promoted to CEO under value‐maximizing corporate governance. Moreover, a risk‐averse CEO's overconfidence enhances firm value up to a point, but the effect is nonmonotonic and differs from that of lower risk aversion. Overconfident CEOs also underinvest in information production. The board fires both excessively diffident and excessively overconfident CEOs. Finally, Sarbanes‐Oxley is predicted to improve the precision of information provided to investors, but to reduce project investment.     

The case of the downsizing decision

New CEO Charles Rampart's decision to make deep across-the-board cuts at Universal Products Company, Ltd. presents division manager Andrew Jordan with a thorny problem. Plagued by slow growth, a declining stock price, and an increasingly skeptical investment community, UPC needs to control costs and control them fast. But Jordan's division is the most profitable in the company, and the 11% cut proposed by Rampart could destroy already shaky morale and seriously threaten the division's ability to compete. "There comes a time in every manager's career when he has to fight a bad decision made by his boss," argues Sam Godwyn, Jordan's vice president for marketing and sales. "To cut across the board is to take a blunt axe to the company when a surgeon's scalpel is called for." He suggests it is better to line up support for an alternative plan that links cuts to a long-term strategy and that differentiates between successful and unsuccessful divisions. "It would be a terrible mistake for us to focus only on the narrow needs of the division when the future of the whole company is at stake," counters Mary Wyatt, Jordan's vice president for finance. Yes, the downsizing will hurt the division in the short term, but the real issue is getting behind the new CEO. Supporting the downsizing decision is a necessary investment in this future credibility and effectiveness--whatever the short-term costs. Four commentators debate Jordan's dilemma and how he should resolve it.     

Syndicated Loans

This paper analyzes the market for syndicated loans, a hybrid of private and public debt, which has grown at well over a 20% rate annually over the past decade and which totaled over $1 trillion in 1997. We identify empirically the factors that influence a bank or nonbank's decision to syndicate a loan and the determinants of the proportion of the loan sold in the event of syndication. The evidence reveals a loan is more likely to be syndicated as information about the borrower becomes more transparent, as the syndicate's managing agent becomes more “reputable”, and as the loan's maturity increases. The lead manager holds larger proportions of information-problematic loans in its own portfolio. Loan syndications, like loan sales, appear to be motivated, in part, by capital regulations, and the liquidity position of the agent bank influences the likelihood of syndication, but not the extent. Our results confirm that information and agency problems affect the salability of debt claims and the extent to which a loan is “transaction oriented” rather than “relationship oriented” in the sense of A. Boot and A. Thakor (2000, J. Finance54, 679–713). Journal of Economic Literature Classification Numbers: D82, G20, G21, G24.     

Celebrity CEOs and corporate investment: A psychological contract perspective

Drawing on the psychological contract theory, we examine how the celebrity status of chief executive officers (CEO) influences corporate investment behavior. Using a sample of Chinese listed companies from 2002 to 2019, we find that celebrity CEOs increase corporate investment levels, leading to lower investment efficiency. In addition, they employ more impression management tactics to signal their superior managerial ability, and dodge possible rejections of their investment decisions by having fewer board meetings. Furthermore, since the perceived psychological contract is dynamic, we provide evidence that the association between the celebrity CEO and corporate investment is more pronounced when a firm faces environmental uncertainty, and pressures from intensive industry competition and peers' performance. Our study contributes to corporate finance literature and results indicate that CEOs with celebrity status are pressured to maintain a psychological contract, which in turn, reduce the efficiency of corporate resource allocation.     

Understanding the Positive Announcement Effects of Private Equity Placements: New Insights from Hong Kong Data

The literature has documented positive announcement effects for privately placed seasoned equity issues. This study shows positive announcement effects not only for private but also for public placements in Hong Kong. Our unique data offer new insights not obtainable from U.S. data as we examine the cross-sections of the announcement effects. Most importantly, we find that the announcement effect is more likely to be positive for smaller issuers, such as private placing firms and some public issuers where asymmetric information arises more from growth than from assets in place. This finding is consistent with the generalized Myers-Majluf model.★The authors wish to thank Jack Cooney, Espen Eckbo, Ned Elton, Cliff Holderness, Rene Stulz, Piet Sercu, Tom Vinaimont, John Wei, and participants at the 2003 Financial Management Association Annual Conference in Denver and at seminars at the Guanghua School of Management of Peking University and the Department of Finance of National Taiwan University for their helpful discussions and comments. Special thanks go to Marco Pagano (the editor) and an anonymous referee for advice and suggestions that have significantly improved the quality of this paper. Wu gratefully acknowledges financial support from the Research Grants Council of the Hong Kong SAR (Project No. CityU 1244/04H) and from the City University of Hong Kong (DAG project No. 7100183).     

The Coffee Pot: A management control exercise

Managers use management control systems to actively steer their organizations towards strategic success. The Coffee Pot is a short, in-class exercise that provides a hands-on opportunity for students to diagnose and solve an organization’s management control issues using Simons’ Levers of Control Framework. The exercise features a chain of coffee shops, a business most students should be familiar with, and asks students to discuss why the new CEO is having trouble improving her firm’s performance, even after she has introduced a winning strategy.     

Boards,CEO entrenchment,and the cost of capital

Existing research on chief executive officer (CEO) turnover focuses on CEO ability. This paper argues that board ability is also important. Corporate boards are reluctant to replace CEOs, as this makes financing expensive by sending a negative signal about board ability. Entrenchment in this model does not result from CEO power, or from agency problems. Entrenchment is mitigated when there are more assets-in-place relative to investment opportunities. The paper also compares public and private equity. Private ownership eliminates CEO entrenchment, but market signals improve investment decisions. Finally, the model implies that board choice in publicly listed firms will be conservative.     

In the mirror of the market: The disciplinary effects of company/fund manager meetings

This paper draws upon empirical qualitative research with Finance Directors and Investor Relations managers to examine the disciplinary consequences of their meetings with institutional investors. These ‘private’ meetings have increased both in frequency and importance in the last decade, but, when compared to public disclosure, they are relatively under researched. Existing studies have focussed on the role that the meetings play either in the market for information, or as a mechanism for corporate governance. By contrast, in this paper we draw upon Foucault’s analysis of power/knowledge to explore how the meetings shape executive subjectivity. The meetings take place in the context of a proliferation of techniques through which corporate performance is disclosed, modelled, compared and ranked. Such visibility makes possible processes of executive subjection which the paper traces firstly in the anticipatory self-discipline of executive’s extensive rehearsals for the meetings, and secondly in the rituals of face-to-face scrutiny of the meetings themselves where the body of the executive is understood to represent the company. The paper then explores the ways in which subjection to investors enables executives to speak on behalf of the investor within the business and effect its restructuring in the name of shareholder value. We suggest that these neglected disciplinary effects of company/fund manager meetings have been all too potent in recent years.     

Earnings quality at initial public offerings

We show that, contrary to popular belief, initial public offering (IPO) firms report more conservatively. We attribute this to the higher quality reporting demanded of public firms by financial statement users and consequentially higher monitoring by auditors, boards, analysts, rating agencies, press, and litigants, and to greater regulatory scrutiny [Ball, R., Shivakumar, L., 2005. Earnings quality in UK private firms: comparative loss recognition timeliness. Journal of Accounting and Economics 39, 83–128]. We also question the evidence of Teoh et al. [1998b. Earnings management and the subsequent market performance of initial public offerings. Journal of Finance 53, 1935–1974] supporting the alternative hypothesis that managers opportunistically inflate earnings to influence IPO pricing. We conjecture that upward-biased estimates of “discretionary” accruals occur in a broad genre of studies on earnings management around similar large transactions and events.     

Last resort gambles, risky debt and liquidation policy

This paper develops a real option model in which the interaction between debt, liquidation policy and risky investments is studied. We consider a manager who owns the firm and faces the opportunity to invest in risky projects which may boost current profits at the cost of bankruptcy if they turn out to be unsuccessful. These investments are “last resort gambles” in the sense that, if successful, they save the company from insolvency, while, if unsuccessful, they make liquidation unavoidable. It is shown that last resort gambles delay liquidation. We study how the liquidation trigger and the last resort investment decisions are affected by the firm's capital structure.