Board Monitoring and Earnings Management Pre- and Post-IFRS

In this paper, we address the question of whether the board of directors is more effective in constraining earnings management after the mandatory application of IFRS. Specifically, we explore how two board characteristics — board independence and (2) the existence of an audit committee impact earnings management. Our empirical results suggest that board independence and audit committees play an important and effective role in reducing earnings management after the introduction of IFRS and that the accounting regulatory framework significantly contributes to the effectiveness of the two corporate governance mechanisms. Our findings also confirm that a company's corporate governance characteristics remain an important determinant of earnings quality; therefore, an analysis of the effects of new regulations must consider firm-level determinants.     

Political uncertainty and risk premia

We develop a general equilibrium model of government policy choice in which stock prices respond to political news. The model implies that political uncertainty commands a risk premium whose magnitude is larger in weaker economic conditions. Political uncertainty reduces the value of the implicit put protection that the government provides to the market. It also makes stocks more volatile and more correlated, especially when the economy is weak. We find empirical evidence consistent with these predictions.     

The Influence of Country‐ and Firm‐level Governance on Financial Reporting Quality: Revisiting the Evidence

This paper examines how firm‐level governance and country‐level governance interplay in shaping financial reporting quality. Using IFRS adoption as a source of variation in firms’ reporting discretion, and a large sample of European firms that mandatorily switch to the new set of standards, we find that in countries with low enforcement and weak oversight over financial reporting, only firms with strong board‐level corporate governance mechanisms experience an increase in financial reporting quality, consistent with firm‐ and country‐level governance mechanisms being substitutes. However, in countries with high enforcement and strict oversight over financial reporting, firms with either strong or weak board‐level governance mechanisms experience an increase in financial reporting quality, even if the increase is larger for the former group. Overall, our findings indicate that in the debate about the effects of governance on the quality of financial reporting, it is important to consider both country‐ and firm‐level corporate governance mechanisms.     

Stock Valuation and Learning about Profitability

We develop a simple approach to valuing stocks in the presence of learning about average profitability. The market‐to‐book ratio (M/B) increases with uncertainty about average profitability, especially for firms that pay no dividends. M/B is predicted to decline over a firm's lifetime due to learning, with steeper decline when the firm is young. These predictions are confirmed empirically. Data also support the predictions that younger stocks and stocks that pay no dividends have more volatile returns. Firm profitability has become more volatile recently, helping explain the puzzling increase in average idiosyncratic return volatility observed over the past few decades.     

Going Public and the Sale of Shares with Heterogeneous Investors: Agent‐Based Computational Modelling and Computer Simulations

In this paper we use agent‐based computational modelling and computer simulations to examine the interrelationship between different selling strategies for going public. A great deal of recent empirical evidence suggests that to maximise the revenue raised from the shares sold in the public offering, it is fundamental to choose the appropriate design for the sale which, in turn, reflects the final ownership structure. This literature establishes that the market for shares is segmented and, particularly, that firms manage the sale of shares with the purpose of discriminating between relatively small and passive investors and applicants for large potentially controlling blocks. One of the key questions in this area, then, is: How and to what extent should this heterogeneity among potential investors influence the firm's strategy for selling shares? Here we attempt to address this question from the standpoint of using agent‐based computational modelling and computer simulations. Results show that the design of the sale is an important determinant of the performance of the negotiation process through which the firm is sold. A sequential sale beginning with an initial public offering of dispersed shares, followed by a negotiated sale of a controlling block is, in general, more effective than other alternative selling strategies. Changing the negotiation protocol itself can act as an effective way of impacting upon the revenue raised and the length of the process. The interrelationship between the method of sale and the performance may also depend on the degree of cognitive accuracy that characterises the negotiating agents' mental representations of their physical and social environment.     

The Pricing of Italian Equity Returns

In this paper, we investigate the relationship between common risk factors and average returns for Italian stocks. Our research has identified the Italian stock market's economic variables by using the results from factor analyses and time series regressions. We study several multi‐factor models combining the relevant macroeconomic variables with the mimicking equity portfolios SMB (small minus big) and HML (high minus low) proposed by Fama and French (1993). The key question we want to ask ourselves, is whether the influential role of the size and book‐to‐market equity factors in explaining average stock returns can stand up well when competing with some macroeconomic factors. In other words, do stock returns carry some risk premium that is independent of either the market return or the economic forces that underlie the common variation in returns? Our empirical work estimates risk premiums using both traditional two‐pass procedures and one‐pass (full information) methodologies. We show that only the market index and variables linked to interest rate shifts are consistently priced in the Italian stock returns. The role of other factors, and in particular both the size and the price‐to book ratio, are crucially dependent on the estimation procedure. (J.E.L.: G11, G12).     

Technological Change, Market Rivalry, and the Evolution of the Capitalist Engine of Growth

In the early stages of Western industrialization, innovation was the domain of individuals who devoted their entrepreneurial talents to the development of a new product or process, typically setting up a new firm in order to take the innovation to the market. Today, commercial R&;D is almost exclusively carried out by corporate laboratories affiliated with manufacturing firms. The corporate R&;D lab, however, did not exist in its modern form until the late nineteenth century. The history of Western industrialization, thus, suggests that a fundamental change in the structure of incentives, and consequently in the nature and the organization of the R&;D process, occurred around the turn of the century. Three questions arise. What is the nature of this change? What economic forces caused it? What are its implications? To answer these questions, I construct a model where this change is endogenous to the evolution of the economy toward industrial maturity. The change in the locus of innovation—from R&;D undertaken by intventor-entrepreneurs, to R&;D undertaken within established firms in close proximity to the production line—results from the interaction of market structure and technological change. This interaction captures the essence of the evolution of the capitalist engine of growth and provides an economic explanation of a “stylized fact” that has received no attention in the theoretical literature. The endogenous market structure generates dynamic feedbacks that shape the growth path of the economy and determine the structural change it undergoes, including the endogenous formation of corporate R&;D labs. The evolution of market rivalry explains when and how established firms become the major locus of R&;D activity.     

AN OBTRUSIVE REMARK ON CAPITAL AND COMPARATIVE STATICS

We present a simple comparative statics analysis of steady‐state equilibria in overlapping generations economies with capital accumulation. We regard comparative statics as paradoxical whenever an exogenous increase in saving propensity induces a decrease (an increase) in consumption at the steady state when interest rate is positive (negative). It is shown that there is an exact relation between paradoxical comparative statics and a perverse intersection of properly identified curves of demand for and supply of capital in value. The demand curve for capital in value coincides with that of neo‐Ricardian analysis. We relate our conclusions to some old and recent issues in capital theory.     

Earnings Quality Measures and Excess Returns

This paper examines how commonly used earnings quality measures fulfill a key objective of financial reporting, i.e., improving decision usefulness for investors. We propose a stock‐price‐based measure for assessing the quality of earnings quality measures. We predict that firms with higher earnings quality will be less mispriced than other firms. Mispricing is measured by the difference of the mean absolute excess returns of portfolios formed on high and low values of a measure. We examine persistence, predictability, two measures of smoothness, abnormal accruals, accruals quality, earnings response coefficient and value relevance. For a large sample of US non‐financial firms over the period 1988–2007, we show that all measures except for smoothness are negatively associated with absolute excess returns, suggesting that smoothness is generally a favorable attribute of earnings. Accruals measures generate the largest spread in absolute excess returns, followed by smoothness and market‐based measures. These results lend support to the widespread use of accruals measures as overall measures of earnings quality in the literature.     

Low-Income Countries and an SDR-based International Monetary System

The global financial crisis, the weakening role of the dollar and the increasing international importance of China are calling for a reform of the international monetary system in the direction of greater multilateralism. To this end, we advance a proposal based on a greater role of the Special Drawing Rights (SDRs) and focus on the potential benefits that these could bring to Low-Income Countries (LICs). SDRs would be created exogenously - with a disproportionate allocation to LICs -, but also endogenously, through a substitution account and an overdraft facility. Finally, the paper discusses the superiority of this proposal in the context of the current foreign assistance framework.