Financial Reporting and Credit Ratings: On the Effects of Competition in the Rating Industry and Rating Agencies' Gatekeeper Role

This paper studies firms' financial reporting incentives in the presence of strategic credit rating agencies and how these incentives are affected by the level of competition in the rating industry and by rating agencies' role as gatekeepers to debt markets. We develop a model featuring an entrepreneur who seeks project financing from a perfectly competitive debt market. After publicly disclosing a financial report, the entrepreneur can purchase credit ratings from rating agencies that strategically choose their rating fees and rating inflation. We derive the following core results: (1) More rating industry competition leads to stronger corporate misreporting incentives if ratings are sufficiently precise or if rating agencies assume a gatekeeper role. Under imperfect rating industry competition, (2) agencies' gatekeeper role primarily weakens firms' misreporting incentives, which then influences rating agencies' strategies, and (3) firms' misreporting and rating agencies' rating inflation can be strategic complements when agencies assume a gatekeeper role. (4) Regulatory initiatives aimed at increasing rating industry competition or at weakening rating agencies' gatekeeper role improve investment efficiency as long as corporate misreporting incentives are not significantly strengthened.     

Spaces of Difference: Reflections from Toronto on Multiculturalism,Bourgeois Urbanism and the Possibility of Radical Urban Politics

What explains the lack of what Mike Davis famously called ‘magical urbanism’— referring to the increasingly influential and potentially radical role played by Latino immigrants in US politics — in such diverse Canadian cities as Toronto, Montreal and Vancouver? This article points out how the Canadian legacy of multiculturalism constitutes one key cause of the failure of left urban politics in Canada to produce yet anything approaching the promise of ‘magical urbanism’ south of the border, especially by underlining how this bulwark of liberal ideology lends itself so readily to some resilient variations of bourgeois urbanism — including the commodification of difference, most recently under the auspices of Richard Florida's ‘creative class’. Against the pluralism of the food court and the shopping mall, both in its official multicultural and seemingly oppositional ‘hybrid’ forms, are radical approaches to difference in the city still possible — in Canada or elsewhere? The authors argue that the concepts of ‘maximal’ and ‘produced’ (vis‐à‐vis ‘minimal’ and ‘induced’) difference and the politics of ‘the right to the city’ elaborated by Henri Lefebvre — in conjunction with the reflections on subaltern experiences of difference by critics such as Himani Bannerji and Ambalavanar Sivanandan — indeed provide a starting point for radical urban politics. Comment expliquer, dans des villes canadiennes aussi différentes que Toronto, Montréal ou Vancouver, l’absence de ce que Mike Davis a appelé‘l’urbanisme magique’ en parlant du rôle de plus en plus influent, voire radical, des immigrants latinoaméricain dans la politique des États‐unis? L’héritage canadien du multiculturalisme explique d’abord pourquoi la politique urbaine de gauche n’a encore rien pu produire au Canada qui s’approcherait de la promesse d’un ‘urbanisme magique’ comme au sud de la frontière. L’article souligne notamment comment ce rempart d’idéologie libérale se prête si facilement à quelques variantes résistantes d’urbanisme bourgeois, dont la banalisation de la différence, tout récemment sous les auspices de la ‘classe créative’ de Richard Florida. Face au pluralisme de l’aire de restauration et du centre commercial, tous deux sous des formes ‘hybrides’ multiculturelles et aparemment contradictoires, des approches radicales de la différence dans la ville sont‐elles encore possibles, au Canada ou ailleurs? Les concepts de différence ‘maximale’ et ‘produite’ (par opposition à‘minimale’ et ‘induite’) et la politique du ‘droit à la ville’ conçue par Henri Lefebvre — alliés aux réflexions sur des expériences de différence subalternes émanant de critiques tels que Himani Bannerji et Ambalavanar Sivanandan — offrent indubitablement un point de départ pour une politique urbaine radicale.     

External and Internal Pricing in Multidivisional Firms

Multidivisional firms frequently rely on external market prices in order to value internal transactions across profit centers. This paper examines market‐based transfer pricing when an upstream division has monopoly power in selling a proprietary component both to a downstream division within the same firm and to external customers. When internal transfers are valued at the prevailing market price, the resulting transactions are distorted by double marginalization. The imposition of intracompany discounts will always improve overall firm profits provided the supplying division is capacity constrained. Under certain conditions it is then possible to design discount rules so that the resulting prices and sales quantities are efficient from the corporate perspective. In contrast, the impact of intracompany discounts remains ambiguous when the capacity of the selling division is essentially unlimited. It is then generally impossible to achieve fully efficient outcomes by means of market‐based transfer pricing unless the external market for the component is sufficiently large relative to the internal market.     

Hedge Funds and the Technology Bubble

This paper documents that hedge funds did not exert a correcting force on stock prices during the technology bubble. Instead, they were heavily invested in technology stocks. This does not seem to be the result of unawareness of the bubble: Hedge funds captured the upturn, but, by reducing their positions in stocks that were about to decline, avoided much of the downturn. Our findings question the efficient markets notion that rational speculators always stabilize prices. They are consistent with models in which rational investors may prefer to ride bubbles because of predictable investor sentiment and limits to arbitrage.     

Sizing Up Repo

To understand which short‐term debt markets experienced “runs” during the financial crisis, we analyze a novel data set of repurchase agreements (repo), that is, loans between nonbank cash lenders and dealer banks collateralized with securities. Consistent with a run, repo volume backed by private asset‐backed securities falls to near zero in the crisis. However, the reduction is only $182 billion, which is small relative to the stock of private asset‐backed securities as well as the contraction in asset‐backed commercial paper. While the repo contraction is small in aggregate, it disproportionately affected a few dealer banks.     

Integrating Factor Models

This paper develops a comprehensive framework to address uncertainty about the correct factor model. Asset pricing inferences draw on a composite model that integrates over competing factor models weighted by posterior probabilities. Evidence shows that unconditional models record near-zero probabilities, while postearnings announcement drift, quality-minus-junk, and intermediary capital are potent factors in conditional asset pricing. Out-of-sample, the integrated model performs well, tilting away from subsequently underperforming factors. Model uncertainty makes equities appear considerably riskier, while model disagreement about expected returns spikes during crash episodes. Disagreement spans all return components involving mispricing, factor loadings, and risk premia.