Shredded Reputation: The Cost of Audit Failure

In this article we investigate the impact of the Enron audit failure on auditor reputation. Specifically, we examine Arthur Andersen's clients' stock market impact surrounding various dates on which Andersen's audit procedures and independence were under severe scrutiny. On the three days following Andersen's admission that a significant number of documents had been shredded, we find that Andersen's other clients experienced a statistically negative market reaction, suggesting that investors downgraded the quality of the audits performed by Andersen. We also find that audits performed by Andersen's Houston office suffered a more severe decline in abnormal returns on this date. We are not able to show that Andersen's independence was questioned by the amount of non–audit fees charged to its clients.     

The Willingness to Pay for Education for Daughters in Contrast to Sons: Evidence from Rural Peru

In most of the developing world the education of women lagsbehind that of men. This could come about from a lack of parentaldesire for educated daughters or from a perception by the parentsthat there is a lower net return to education for girls. Therelation between gender and education in rural Peru is exploredusing data from the 1985–86 Peru Living Standards Survey.A model of educational choice is developed. The estimated demandfunctions are used to assess the impact of user fees on demandand revenues. The empirical evidence indicates that parentsare more willing to pay for reduced travel time to secondaryschool for boys than for girls. However, parents are willingto pay increased fees for girls' schooling sufficient to generateteachers' salaries.     

Maximum likelihood estimation of stochastic volatility models

We develop and implement a method for maximum likelihood estimation in closed-form of stochastic volatility models. Using Monte Carlo simulations, we compare a full likelihood procedure, where an option price is inverted into the unobservable volatility state, to an approximate likelihood procedure where the volatility state is replaced by proxies based on the implied volatility of a short-dated at-the-money option. The approximation results in a small loss of accuracy relative to the standard errors due to sampling noise. We apply this method to market prices of index options for several stochastic volatility models, and compare the characteristics of the estimated models. The evidence for a general CEV model, which nests both the affine Heston model and a GARCH model, suggests that the elasticity of variance of volatility lies between that assumed by the two nested models.     

Acceptance of Accounting Standards

When financial statements are audited, a client and auditor may disagree about an accounting disclosure. While the disclosure of such a disagreement may increase the information content of a statement it may also be socially undesirable in that it signals a difference in views about the state of the reporting enterprise. This in turn may increase agency costs and introduce uncertainty about the state of the firm. In this paper we focus on public policy implications concerning auditor-client disagreements and examine the ex ante probability that such cases will occur. We find that accounting standards that allow two accounting options may be optimal in reducing frequency of disagreements among auditors and between standard-setters and their constituencies, and possibly also between clients and their auditors. The New Zealand model of compliance with accounting standards may be preferable to that practiced in the US.     

Regulatory Capital Arbitrage and the Potential Competitive Impact of Basel II in the Market for Residential Mortgages

U.S. banking regulators have proposed a bifurcated system of capital regulation where the largest, internationally active banking organizations would be subject to significantly more risk sensitive regulatory capital requirements than are currently in place, while most others would remain subject to the current rules. The proposed new capital regime has the potential to affect the competitive landscape among banking institutions, particularly in the area of residential mortgage lending. We analyze the potential competitive effects of the proposed, bifurcated regulatory capital system on competition in the residential mortgage market from the perspective of the theory of regulatory capital arbitrage. We then apply the theory and available evidence to perform some benchmark calculations that suggest a significant, potential shift of market share and income to the largest banking institutions in the mortgage market.

State takeover legislation and share values: The wealth effects of Pennsylvania's Act 36

Proponents of state antitakeover legislation argue that previous empirical tests by financial economists of the wealth effects of Pennsylvania's 1990 antitakeover law are biased. We show that the proponents are correct. In particular, firm size, event-time clustering, and non-synchronous trading effects account for the wealth decreases reported in earlier studies. We also show, however, that both proponents and critics of the Pennsylvania legislation have ignored the earliest press release about it. The wealth effect associated with this announcement is negative, large, and statistically significant. These results therefore are consistent with the hypothesis that the Pennsylvania law decreased company values and with the hypothesis that the initial market reaction is an unbiased estimate of the law's effect on firm values.     

Exotic Passport Options

The Vanilla Passport Option is an insurance against trading loss. In this paper, we add various exotic features to the Vanilla contract and price the resulting financial products. The assumptions that we make are the same as the Black-Scholes ones and the resulting pricing equations are Hamilton-Jacobi-Bellman type equations or parabolic free boundary PDE's which can be solved via finite difference methods.     

The impact of regulation on market risk

While it is crucial to understand the impact of regulatory changes on market risk, the literature does not show how risk responds to expected regulatory changes that are specifically designed to change risk. Our paper fills this gap by providing a detailed study of one such case. Using both a sample of privatized U.K. companies, and U.K. and U.S. control portfolios, between 1993 and 2000, we show (both for the single-factor market model and the three-factor Fama-French model) that the observed changes in market risk are significant and consistent with theory.     

Acquisitions: Private versus Public

Takeovers of privately held companies represent more than 80% of all takeovers. Despite their significance, studies of such takeovers and their impact on the wealth of shareholders are rare. Using a very large, near exhaustive, sample of listed and privately held UK targets we examine the impact of such takeovers on the risk adjusted return of listed UK acquirers over the period 1981 to 2001. Acquirers earn significant positive returns during the period surrounding the bid announcement although the gains are dependent on target status, mode of payment, and the relative size of those involved. The much quoted conclusion, derived from the experiences of listed firm bidders that the shareholders of acquiring firms fail to gain from takeovers, cannot be generalised. Acquiring a privately held company is an attractive option for maximising shareholder wealth.     

Forbearance: An empirical analysis

Several recent articles have analyzed conditions under which allowing capital-deficient banks to continue to operate may be optimal policy. This article examines the performance of banks admitted into the FDIC's Capital Forbearance Program between 1986 and 1989 and finds that, for the majority of these banks, there was no substantial improvement in their capital ratios. We use a logit regression analysis to attempt to identify those banks whose financial condition improved with forbearance and find that banks which did improve are not clearly identifiable from pre-forbearance financial data. Instead, the banks which improved did so due to infusions of new capital, extraordinary income, and improvements in the local economies, factors which are not easily identifiable ex ante by regulators. The conclusion is that, while some grants of forbearance may result in large saving to the FDIC, in the majority of cases granting forbearance to troubled banks is unlikely to reduce the expected loss to the deposit insurer.University of HoustonUniversity of HoustonCooperative Bank of Taiwan, Taipei, Taiwan