The Effect of SOX Internal Control Deficiencies on Firm Risk and Cost of Equity

The Sarbanes-Oxley Act (SOX) mandates management evaluation and independent audits of internal control effectiveness. The mandate is costly to firms but may yield benefits through lower information risk that translates into lower cost of equity. We use unaudited pre–SOX 404 disclosures and SOX 404 audit opinions to assess how changes in internal control quality affect firm risk and cost of equity. After controlling for other risk factors, we find that firms with internal control deficiencies have significantly higher idiosyncratic risk, systematic risk, and cost of equity. Our change analyses document that auditor-confirmed changes in internal control effectiveness (including remediation of previously disclosed internal control deficiencies) are followed by significant changes in the cost of equity that range from 50 to 150 basis points. Overall, our cross-sectional and intertemporal change test results are consistent with internal control reports affecting investors' risk assessments and firms' cost of equity.     

Glued to the TV: Distracted Noise Traders and Stock Market Liquidity

In this paper, we study the impact of noise traders’ limited attention on financial markets. Specifically, we exploit episodes of sensational news (exogenous to the market) that distract noise traders. We find that on “distraction days,” trading activity, liquidity, and volatility decrease, and prices reverse less among stocks owned predominantly by noise traders. These outcomes contrast sharply with those due to the inattention of informed speculators and market makers, and are consistent with noise traders mitigating adverse selection risk. We discuss the evolution of these outcomes over time and the role of technological changes.     

The Local Aggregate Effects of Minimum Wage Increases

Using variation in minimum wages across cities and controlling for differences in business-cycle factors and long-run local economic trends, we find that following minimum wage increases, both, prices and nominal spending rise modestly. These gains are larger for certain subcategories of goods such as food away from home and in locations where low-wage workers account for a larger share of employment. Further, minimum wage increases are associated with reduced total debt among households with low credit scores, higher auto debt, and increased access to credit.     

Measuring Institutional Investors’ Skill at Making Private Equity Investments

Using a large sample of institutional investors’ investments in private equity funds raised between 1991 and 2011, we estimate the extent to which investors’ skill affects their returns. Bootstrap analyses show that the variance of actual performance is higher than would be expected by chance, suggesting that some investors consistently outperform. Extending the Bayesian approach of Korteweg and Sorensen, we estimate that a one‐standard‐deviation increase in skill leads to an increase in annual returns of between one and two percentage points. These results are stronger in the earlier part of the sample period and for venture funds.     

Employment in the Great Recession: How Important Were Household Credit Supply Shocks?

I pool data from all large multimarket lenders in the United States to estimate how many of the over 7 million jobs lost in the Great Recession can be explained by reductions in the supply of mortgage credit. I construct a mortgage credit supply instrument at the county level, the weighted average (by prerecession mortgage market shares) of liquidity-driven lender shocks during the recession. The reduction in mortgage supply explains about 15% of the employment decline. The job losses are concentrated in construction and finance.     

Are Analysts’ Recommendations Informative? Intraday Evidence on the Impact of Time Stamp Delays

We demonstrate that time stamps reported in I/B/E/S for analysts’ recommendations released during trading hours are systematically delayed. Using newswire‐reported time stamps, we find 30‐minute returns of 1.83% (?2.10%) for upgrades (downgrades), but for this subset of recommendations we find corresponding returns of ?0.07% (?0.09%) using I/B/E/S‐reported time stamps. We also examine the information content of recommendations relative to management guidance and earnings announcements. Our evidence suggests that analysts’ recommendations are the most important information disclosure channel examined.     

Global Security Policies against Terrorism and the Free Riding Problem: An Experimental Approach

The World Trade Center attack has shed light on the urgent need to implement preventing measures against terrorism and to enhance cooperation in the global security system for all countries. However, international coordination cannot be taken for granted. It is often ineffective and likely to fail for several reasons. Perhaps the more prominent reason to explain failure in coordination is that collective actions against terrorism may suffer from the well‐known free riding problem. In this paper we experimentally investigate cooperation dilemma in counterterrorism policies by measuring to what extent international deterrence policy may suffer from free riding. In our game, contributions to the group account do not aim to increase the production of the public good but instead seek to decrease the probability that a stochastic event destroys the good. A country could choose to free ride by investing nothing in the international deterrence policy and instead invest all its resources in its own national protection or even choose to ignore totally terrorism by investing on alternative projects. We also look at the effects of institutions that allow sanctioning and rewarding of other countries to facilitate coordination on deterrence policy. We find that, in absence of institutional incentives and after controlling for risk aversion, most of countries defect by investing very weakly in collective actions against terrorism while largely investing to protect themselves. In contrast, the introduction of punishment/reward incentive systems improves significantly the contribution level to the collective security account.     

THE NEED TO REFORM THE FEDERAL DEPOSIT INSURANCE SYSTEM

The biggest financial disaster in modern history struck the savings and loan industry during the 1980s. This paper argues that the unifying cause of this debacle was the way in which the federal deposit insurance system is structured. The fundamental cause was not fraud and deregulation, as is commonly argued. The government not only permitted reportedly insolvent institutions to continue to operate, it permitted many such institutions to grow by offering relatively high rates on their deposits. Unfortunately, the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 may not prevent a similar situation from ever recurring. Therefore, one must understand exactly what happened, what the FIRREA does and does not do, and the proposals for reforming the entire structure of the federal deposit insurance system.     

Partial Revelation of Information in Experimental Asset Markets

We develop a model of market efficiency assuming private information is partially revealed to uninformed traders via the behavior of those who are informed. This partial revelation of information (PRE) model is tested in fourteen computerized double auction laboratory markets. It explains the market value and allocation of purchased information, and asset allocations, better than either a fully revealing information model (FRE strong-form efficiency) or a nonrevealing expectations model; but it takes second place to FRE in explaining asset prices. We conjecture that refined versions of PRE may provide insight into “technical analysis” and minibubbles in securities markets.     

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.