Internal control material weakness, analysts’ accuracy and bias, and brokerage reputation

The main purpose of this paper is to examine the impact of internal control material weaknesses (ICMW hereafter) on sell side analysts. We find that ICMW reporting firms have less accurate analyst forecasts relative to non-reporting firms when the reported ICMWs belong to the Pervasive type. ICMW reporting firms have more optimistically biased analyst forecasts compared than non-reporting firms. The optimistic bias exists only in the forecasts issued by the analysts affiliated with less-highly-reputable brokerage houses. The differences in accuracy and bias between ICMW and non-ICMW firms disappear when ICMW disclosing firms stop disclosing ICMWs. Collectively, our results suggest that the weaknesses in internal control increases forecasting errors and upward bias for financial analysts. However, a good brokerage reputation can curb the optimistic bias.     

IPO Auctions: English,Dutch, … French,and Internet

Unseasoned shares are sold through the Book Building process in the United States and the United Kingdom, fixed price offerings in several countries, uniform price auctions in Israel or the new internet-based Open IPO mechanism, and an auction-like mechanism called the Mise en Vente in France. We analyze and compare the performance of these various IPO mechanisms within the context of a unified theoretical model. Fixed price offerings lead to inefficient pricing and winner's curse. Dutch auctions can also lead to inefficiencies, to the extent that they are conducive to tacit collusion by investors. The Book Building and Mise en Vente can lead to optimal information elicitation and price discovery. We document empirically the similarity between the Book Building and the Mise en Vente. We discuss the implications of our analysis for the design of optimal Internet IPO auctions. Journal of Economic Literature Classification Numbers: G24, G3, D82.     

Evaluating lotteries,risks, and risk‐mitigation programs

Two experiments were designed to explore the existence of systematic differences in risk perceptions and risk attitudes between Chinese and US participants. The first experiment involved ranking monetary lotteries using measures of perceived riskiness and willingness to pay (WTP). Several simple heuristics were evaluated to predict perceived riskiness and WTP. Using WTP responses, Cumulative Prospect Theory functions were determined for participants from both countries. The second experiment involved ranking multi‐attribute real‐world risks and associated risk‐mitigation programs using measures of concern and preference, respectively. Compared to their US counterparts, Chinese participants are found to be less risk averse, more concerned about risks with higher catastrophic potential, and more in favor of risk‐mitigation programs with greater scope of benefit. The results also reveal higher within‐group agreement by Chinese participants for all tasks. For both national groups, the within‐group agreement was highest when ranking risk‐mitigation programs, but lowest when ranking lotteries with negative expected value. The implications of cross‐cultural versus cross‐task variation are discussed.     

Accounting licensure,quality, and the “cadillac effect”

Empirical evidence from several professions suggests that licensing laws usually do not enhance the quality of service received by consumers, as alleged by licensing advocates. Moreover, licensing often reduces the availability of low-cost service to low-income consumers (the “Cadillac Effect”). This study applies these concerns to public accountancy. By comparing the malpractice coverage and fee structure of certified public accountants with their noncertified counterparts, the study finds that accounting licensure 1) is not related to service quality, and 2) may result in small businesses having to incur higher costs for accounting services.     

Predicting premiums for the market, size, value, and momentum factors

This paper investigates the out-of-sample predictability of monthly market as well as size, value, and momentum premiums. We use a sample from each of the US and the Swiss stock markets between 1989 and 2007. Using the Swiss sample provides an important new perspective as the repeated evaluation of the same (US) data set leads to data mining problems. To avoid data mining in our predictability study, we test both statistical significance and robustness in the two samples. Our key results are as follows. We find no robust indication that the market premium is predictable, which is also true for the momentum and value premiums. It cannot be excluded that the results from the US may be caused by data mining in light of the results from the Swiss sample. However, the size premium seems to be somewhat predictable, due to the credit spread. We theorize that there are three possible reasons for this rare evidence for predictability. First, predictability may have disappeared over the last decade, as academic research made the respective information public. Second, predictability seems, as we demonstrate, not to be robust to the choice of methodology. Third, robustness tests in the Swiss sample reveal that many of the supposedly statistically significant interrelations from the US sample may be attributed to randomness, which, in that case, would be data mining. Therefore, we think that future discussions of predictability should address the issue of data mining by applying robustness tests.

Corruption and the shadow economy: like oil and vinegar, like water and fire?

From a theoretical point of view, the relationship between corruption and the shadow economy is ambiguous: They can either be substitutes or complements. This paper contributes to this debate by using a structural equation model with two latent variables to extract information on various dimensions of corruption and the shadow economy. Analyzing a sample of 51 countries around the world over the period 2000 to 2005, we present empirical evidence for a complementary (positive) relationship of corruption and the shadow economy.     

How to interact,when and with whom? SMEs and public procurement

Research consistently shows that small and medium enterprises (SMEs) struggle with public procurement processes. The aim of this paper is to extend the research agenda using the lens of supplier development. Dyadic mentoring theory is used to classify three role sets that buyers are willing to use in order to develop small firms. This paper's findings distinguish budget holders from traditional buyers in terms of how and what processes they are willing to use to develop SMEs. Role theory is used in the paper to explain the different mentor behaviours.     

Americanism and financial accounting theory – Part 3: Adam Smith,the rise and fall of socialism,and Irving Fisher's theory of accounting

A previous paper (Part 1) rejected the conventional wisdom that America was ‘born capitalist’ and the historians’ consensus that it had become capitalist by the early-19th century; another (Part 2) rejected Chandler's thesis that the ‘modern business enterprise’ brought a ‘new form of capitalism’ to America from the 1840s. The accounting evidence suggests that America began to make the transition to capitalism around 1900 in a period of intense conflict between ‘capital and labour’ generated by ‘big business’ from the 1880s, a process not completed until the 1920s. This paper (Part 3) examines the consequences for America's political ideology and financial accounting theory. America's exceptional transition, it argues, explains the history of its political ideology, and this history explains Irving Fisher's theory of accounting. Section A argues that America lagged behind Britain because it started from a society of simple commodity producers and semi-capitalists, which created an exceptional ideological problem for its ruling elite. Big business generated hostility from workers, farmers and small employers – expressed in labour movements, ‘populism’, socialism, and ‘progressivism’ – and created an ideological problem by contradicting the ‘independent producer’ ideology of workers and farmers, and the ‘individual liberalism’ of small manufacturers and merchants, both underwritten by Adam Smith's Wealth of Nations. The paper argues that Smith's theory of price articulates as semi-capitalist accounting, which explains his popularity in America until the appearance of big business in the 1880s. Socialism and progressivism became political forces in America from 1900 to around 1920. Progressivism produced ‘corporate liberalism’, the ideological counter to socialism that corporations could be made ‘socially responsible’ by government regulation and ‘publicity’ to ensure they earned only ‘fair’ returns, but this left two problems. First, socialists argued that no profit was ‘fair’, and second, fear of the ‘labour danger’ made American financial reports secretive and conservative. Section B argues that Irving Fisher responded to these problems with a theory of accounting, which he developed as a refutation of Marx and the American brand of socialism advocated by Eugene Debs, the threateningly successful presidential candidate of the Socialist Party of America. An important but neglected reason for socialism's abrupt collapse around 1920, it argues, was that the socialists lost the intellectual argument with the middle classes, and that Fisher's theory played an important role in this defeat. Fisher was a vigorous self-publicist, strongly influenced the teaching of economics and accounting in the universities and, the paper argues, changed the language of American accounting. Fisher claimed that accounting practice supported his theory of ‘capital’ and ‘income’, but the paper shows he did not understand double-entry bookkeeping or the accountants’ ‘cost theory of value’, and therefore divorced accounting from the reality of business transactions. As his theory underlies the FASB's framework, the paper concludes that Fisher's legacy to the world is a pathological theory of financial accounting.     

Exports,foreign direct investment,and the costs of corporate taxation

This paper develops a model of a monopolistically competitive industry with extensive and intensive investment and shows how these margins respond to changes in average and marginal corporate tax rates. Intensive investment refers to the size of a firm’s capital stock. Extensive investment refers to the firm’s production location and reflects the trade-off between exports and foreign direct investment as alternative modes of foreign market access. The paper derives comparative static effects of the corporate tax and shows how the cost of public funds depends on the measures of effective marginal and average tax rates and on the elasticities of extensive and intensive investment. The paper was presented in 2006 at the German public finance meeting in Giessen; the Institute for Advanced Studies in Vienna; the ESF/CEPR Workshop on Outsourcing, Migration and the European Economy in Rome; the University of St. Gallen; the Graduate Institute for International Studies in Geneva, and in 2007 at the International Monetary Fund in Washington, DC, the CESifo Area Conference in Public Sector Economics in Munich and the 63rd IIPF Congress in Warwick. I appreciate stimulating comments by Michael Devereux and seminar participants and, in particular, by the discussants Andreas Haufler and Nadine Riedl, an anonymous referee and the editor Richard Cornes.     

Insurance and Endogenous Bankruptcy Risk: When is it Rational to Choose Gambling,Insurance, and Potential Bankruptcy?

We examine the coexistence of insurance and gambling in the context of limited liability. We develop a model where actuarially fair insurance is available to a risk-averse decision maker for a liability risk with non-bankrupting severity. The remaining wealth may be invested in a zero expected value risky project (i.e., gambled). The risk of bankruptcy is endogenous since either fully insuring or forgoing the project will guarantee solvency. We show that, for a range of parameters, it is optimal to both insure and gamble. The amounts insured and invested are chosen to create the potential for bankruptcy. Our results are robust to the cases where the risky project can cause bankruptcy without a liability loss and where the risky project’s expected return is nonzero.     

Government spending,interest rates,prices, and budget deficits in the United Kingdom, 1701–1918

The British data from the early 1700s through WWI provide an unmatched opportunity for studying temporary changes in government purchases. Temporary increases, which appeared mainly as wartime spending, raised long-term interest rates, but significantly increased the growth rates of money and prices only during suspensions of the gold standard (1797–1821 and 1914–1918). Temporary changes in military spending accounted for the bulk of budget deficits; over the sample of more than 200 years, I found only two major non-war deficits — one associated with compensation payments to slaveowners in 1835–1936 and the other with a dispute over the income tax in 1909–1910. Interest rates did not react much to these ‘exogenous’ deficits.     

Causality-in-mean and causality-in-variance among electricity prices,crude oil prices,and yen–US dollar exchange rates in Japan

In this study, we test the Granger-causality-in-mean and Granger-causality-in-variance among electricity prices, crude oil prices, and yen-to-US-dollar exchange rates in Japan using a cross-correlation function approach. We find Granger-causality-in-mean from neither the exchange market nor the oil market to the power market; the same was true of Granger-causality-in-variance, although both the exchange rates and oil prices greatly influence power generation costs in Japan. We suspect the efficiency of this market is at play.     

Climate Change, Agriculture, and Developing Countries: Does Adaptation Matter?

Because most developing countries depend heavily on agriculture,the effects of global warming on productive croplands are likelyto threaten both the welfare of the population and the economicdevelopment of the countries. Tropical regions in the developingworld are particularly vulnerable to potential damage from environmentalchanges because the poor soils that cover large areas of theseregions already have made much of the land unusable for agriculture. Although agronomic simulation models predict that higher temperatureswill reduce grain yields as the cool wheat-growing areas getwarmer, they have not examined the possibility that farmerswill adapt by making production decisions that are in theirown best interests. A recent set of models examines cross-sectionalevidence from India and Brazil and finds that even though theagricultural sector is sensitive to climate, individual farmersdo take local climates into account, and their ability to doso will help mitigate the impacts of global warming.      

Runs,panics and bubbles: Diamond–Dybvig and Morris–Shin reconsidered

The basic two-noncooperative-equilibrium-point model of Diamond and Dybvig is considered along with the work of Morris and Shin utilizing the possibility of outside noise to select a unique equilibrium point. Both of these approaches are essentially nondynamic. We add an explicit replicator dynamic from evolutionary game theory to provide for a sensitivity analysis that encompasses both models and contains the results of both depending on parameter settings.     

An Interview with Sylvie Voghel-Chair,Small and Medium Practices Committee,IFAC

How does IFAC support Small-and Medium-Sized Entitles(SMEs)and Small and Medium Practices(SMPs)? A thriving SME sector is a vital part of job creation, social cohesion, innovation and economic growth.     

Model uncertainty,recalibration, and the emergence of delta–vega hedging

We study option pricing and hedging with uncertainty about a Black–Scholes reference model which is dynamically recalibrated to the market price of a liquidly traded vanilla option. For dynamic trading in the underlying asset and this vanilla option, delta–vega hedging is asymptotically optimal in the limit for small uncertainty aversion. The corresponding indifference price corrections are determined by the disparity between the vegas, gammas, vannas and volgas of the non-traded and the liquidly traded options.     

Concavity of utility,concavity of welfare,and redistribution of income

The marginal social value of income redistribution is understood to depend on both the concavity of individuals’ utility functions and the concavity of the social welfare function. In the pertinent literatures, notably on optimal income taxation and on normative inequality measurement, it seems to be accepted that the role of these two sources of concavity is symmetric with regard to the social concern about inequality in the distribution of income. Direct examination of the question, however, reveals that this is not the case. Concavity of utility has a simple, direct effect on the marginal social value of redistribution, as might be expected, whereas concavity of the social welfare function has a more subtle influence, one that in some cases may not be very significant. The implications of this difference are examined for some standard forms of utility and welfare functions, including particular versions that appear in the optimal income taxation literature.