Aggregate Earnings and Asset Prices

A principal-components analysis demonstrates that common earnings factors explain a substantial portion of firm-level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the systematic components of earnings and returns is stable over time. We also show that the earnings factors are priced, in the sense that the sensitivities of securities' returns to the earnings factors explain a significant portion of the cross-sectional variation in returns, even controlling for return risk. This suggests earnings performance is an underlying source of priced risk. Our evidence that the information sets of returns and earnings are jointly determined implies cash flow risk and return risk are not fully separable, and raises the possibility that it is the common variation of earnings and returns that is priced.     

COMPETING EXPLANATIONS OF U.S. DEFENSE INDUSTRY CONSOLIDATION IN THE 1990s AND THEIR POLICY IMPLICATIONS

Was the consolidation of defense industry in the 1990s driven by U.S. Department of Defense (DOD) directives, or was it driven instead by the same forces that drove consolidation in many other sectors of the U.S. economy in the 1990s? To better understand the roles of DOD policy and economy‐wide forces in shaping the U.S. defense industry, we test for structural breaks in defense industry and spending data and compare our findings to those relating to other sectors and the general economy. We identify structural breaks in the defense‐related data in the early 1980s and throughout the 1990s, roughly consistent with changes in the U.S. economy, including broader merger trends. Overall, our results are more consistent with the view that economy‐wide factors drove defense industry consolidation, largely independent of the DOD policy changes that occurred early in the 1990s. (JEL E0, C2, H0)     

Dissecting Earnings Recognition Timeliness

We dissect the portion of stock price change of the fiscal year that is recognized in reported accounting earnings of the year. We call this portion earnings recognition timeliness (ERT). The emphasis in our dissection is on empirical identification of two fundamental precepts of financial accounting: (1) the matching principle, which is manifested in the recognition of expenses in the same period as the related benefits (i.e., sales revenue) accrue; and (2) recognition of expenses in the current period due to changes in expectations regarding earnings of future periods (we refer to these expenses as the expectations element of expenses). Although the expectations element has implicitly been at the core of much of the recent empirical literature on asymmetry in the earnings/return relation, it has not been explicitly identified. This recent literature is based on the premise that bad news about the future leads to more recognition of expenses in the current period (such as write‐downs) whereas good news about the future tends to have a much lesser effect on expenses of the current period; asymmetry in the expenses/return relation is captured implicitly via the observation of asymmetry in the earnings/return relation (i.e., asymmetry in ERT). Since the ERT reflects the relation between sales revenue and returns, matched expenses and returns, as well as the relation between the expectations element of expenses and returns, a focus on the expectations element may lead to sharper inferences. Our straightforward empirical procedure permits a focus on this element.     

By What Criteria Do We Evaluate Accounting? Some Thoughts on Economic Welfare and the Archival Literature

The economic role of an accounting regime is to increase welfare through its effects—in conjunction with complementary institutions—on firm and household behavior. I review three major streams of the archival literature (real effects; price effects, including value relevance; and costly contracting), in terms of what they can and cannot reveal as proxies for welfare effects. One conclusion is that the partial correlations and average effects that predominate in this literature have provided valuable insights into the role of accounting in the economy, but provide limited and misleading proxies for welfare effects. A major concern is that teachers, students, and researchers—indeed, regulators and standard setters—raised on this literature could lose sight of, and underestimate, the fundamental contribution of accounting to aggregate welfare.     

Implied Equity Duration: A Measure of Pandemic Shutdown Risk

Implied equity duration was originally developed to analyze the sensitivity of equity prices to discount rate changes. We demonstrate that implied equity duration is also useful for analyzing the sensitivity of equity prices to pandemic shutdowns. Pandemic shutdowns primarily impact short‐term cash flows, thus they have a greater impact on low‐duration equities. We show that implied equity duration has a strong positive relation to U.S. equity returns and analyst forecast revisions during the onset of the 2020 COVID‐19 shutdown. Our analysis also demonstrates that the underperformance of “value” stocks during this period is a rational response to their lower durations.     

The Debt-Contracting Value of Accounting Information and Loan Syndicate Structure

We investigate how both the ownership structure and explicit contractual structure of syndicated loan deals are shaped by the debt‐contracting value (DCV) of borrowers' accounting information. DCV captures the inherent ability of firms' accounting numbers to capture credit quality deterioration in a timely fashion. We hypothesize and document that when a borrower's accounting information possesses higher DCV, information asymmetry between the lead arranger and other syndicate participants is lower, allowing lead arrangers to hold a smaller proportion of new loan deals. Further, we document that the influence of DCV on the proportion of the loan retained is conditional on the lead arranger's reputation, the existence of a credit rating, and the lead arranger's previous relationships with the same borrower. Finally, we find that when loans include performance pricing provisions, the likelihood that the single performance measure used is an accounting ratio, rather than a credit rating, is increasing in DCV.     

The Problems of the Development of the Service Sector in Czechoslovakia

This article exemplifies the principal-agent problem by reference to executive search consultancy The client company (principal) hires an executive search consultancy (agent) to recruit on its behalf Inherent in the relationship is the possibility of opportunistic behaviour: The effort expended by the agent on behalf of the principal cannot be monitored and the principal cannot judge whether sufficient effort has been expended. To overcome this, incentive systems based on outputs rather than behaviour would have been advocated. In the service sector; however, there is the added problem that often output itself’ is difficult to define and monitor: By taking a non-standard view this article considers the incentive systems that have evolved in executive search.     

Price Discovery without Trading: Evidence from Limit Orders

We analyze the contribution to price discovery of market and limit orders by high‐frequency traders (HFTs) and non‐HFTs. While market orders have a larger individual price impact, limit orders are far more numerous. This results in price discovery occurring predominantly through limit orders. HFTs submit the bulk of limit orders and these limit orders provide most of the price discovery. Submissions of limit orders and their contribution to price discovery fall with volatility due to changes in HFTs’ behavior. Consistent with adverse selection arising from faster reactions to public information, HFTs’ informational advantage is partially explained by public information.