Investor Overreaction to Earnings Surprises and Post‐Earnings‐Announcement Reversals

Prior literature suggests that the market underreacts to the positive correlation in a typical firm's seasonal earnings changes, which leads to a post‐earnings‐announcement drift (PEAD) in prices. We examine the market reaction for a distinct set of firms whose seasonal earnings changes are uncorrelated and show that the market incorrectly assumes that the earnings changes of these firms are positively correlated. We also document that positive (negative) seasonal earnings changes in the current quarter are associated with negative (positive) abnormal returns in the next quarter. Thus, we observe a reversal of abnormal returns, consistent with a systematic overreaction to earnings, rather than the previously documented PEAD. Additional analysis indicates that financial analysts similarly overestimate the autocorrelation of these firms, although to a lesser extent. We also find that the magnitude of overestimation and the subsequent price reversal are inversely related to the richness of the information environment. Our results challenge the notion that investors recognize but consistently underestimate earnings correlation and provide a new perspective on the inability of prices to fully reflect the implications of current earnings for future earnings. That is, we show that investors predictably overestimate correlation when it is lacking, but underestimate it when it is present.     

WIC Participation and Relative Quality of Household Food Purchases: Evidence from FoodAPS

We examine the effect of the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC) on the quality of household food purchases using the National Household Food Acquisition and Purchase Survey (FoodAPS) and propensity score matching. A healthy purchasing index (HPI) is used to measure nutritional quality of household food purchases. WIC foods explain the improvement in quality of food purchases, not self‐selection of more nutrition‐conscious households into the program. The improvement in purchase quality was driven entirely by WIC participating households who redeemed WIC foods during the interview week. There was no significant difference between WIC participants who did not redeem WIC foods and eligible nonparticipants. In this sample, there is no evidence that lack of access to clinics has adverse effects on participation nor is there evidence that HPI depends on supermarket access. A supervised machine learning process supports our main conclusion on the importance of WIC foods.     

The Law of 1/n Revisited: Distributive Politics,Legislature Size,and the Costs of Collective Action

The foundational model of distributive politics predicts a positive relationship between the number of legislative districts and the level of inefficiency of projects approved by the legislature—Weingast, Shepsle, and Johnsen's “Law of 1/n.” This relationship has been tested extensively in the empirical literature, with mixed results. This article presents a model wherein passing the omnibus legislation typical of distributive politics is a costly process. The model predicts a nonlinear relationship between legislature size and spending as increasing the size of the legislature also increases the costs of collective action. Results from an empirical exercise based on U.S. state legislatures (1962–2014) are consistent with the proposed model, showing a 1/n effect which diminishes at the margin as the legislature's size increases, especially in the lower chamber.     

Information effects of dividends: Evidence from the Hong Kong market

The literature has suggested that earnings and earnings forecasts provide stronger signals than dividends about future performance of a firm. We test the information effects of simultaneous announcement of earnings and dividends in the Hong Kong market, distinguished by three interesting features (concentrated family-shareholdings, low corporate transparency, and no tax on dividends). Our results show significant share price reactions to unexpected earnings and dividend changes, but dividends appear to play a dominant role over earnings in pricing, a result contrary to findings in the literature. The signaling hypothesis works primarily for firms with earning increases, while the maturity hypothesis works mainly for firms with earnings declines.

Disclosure and the cost of equity in international cross-listing

In this paper, we examine the relationship between disclosure level and the cost of equity capital for a sample of international firms cross-listing on the New York Stock Exchange. Increased disclosure has the potential to reduce information asymmetry, reduce the cost of financing and increase analyst following. Using an international asset pricing model, we find that listing firms experience a decrease in both disclosure risk and systematic risk while matching firms do not. Further, we find that the magnitude of the decrease is related to three types of disclosure: accounting standards; analyst following; and exchange/regulatory investor protection. Our results suggest that increased disclosure through accounting standards is beneficial to investors and that disclosure can be accomplished through information intermediaries, e.g., analyst following. For firms with the lowest levels of disclosure prior to cross-listing, all three types of disclosure appear to be valuable.

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.

Avoiding integrity land mines

How does a large multinational keep thousands of employees, operating in hundreds of countries, honest in a high-pressure business environment? As the chief legal officer at General Electric for nearly 20 years, Ben Heineman was part of the senior management group that sought to do just that--to make sure its executives and employees are moved to do the right thing as strongly as they are motivated to make their numbers. Heineman describes a set of systems that combine the communication of clear expectations with oversight, deterrence, and incentives. Nowhere are the expectations higher--and the sanctions more powerful--than for top executives. Heineman recounts example after example of senior leaders terminated for ethical lapses even when the business consequences of doing so were painful--and even when they had no direct knowledge of the violations occurring on their watch. To make expectations clear throughout the company, GE has systematically sought to set uniform standards that stay well ahead of current legal developments and stakeholders' changing attitudes about corporate accountability. Responsibility for implementing those standards, which are embedded in GE's operating practices, rests with the business leaders in the field. Oversight is both methodical and multifaceted. A host of auditing and assessment systems enables GE to compare the performance of its various business units against one another and against industry benchmarks. Perhaps the most powerful is the company's ombudsman system, which doesn't just allow but requires employees to lodge concerns. Failures to report into the system or up the line, or retaliation in any form, are firing offenses. The current intense focus on board-level governance has missed the point, Heineman argues. It is time to shift the debate from board oversight of the CEO to how top company leaders can most effectively infuse integrity at all levels of the corporation.     

Financial statement effects of adopting international accounting standards: the case of Germany

Using a sample of German firms, we investigate the financial statement effects of adopting International Accounting Standards (IAS) during 1998 through 2002. We find that total assets and book value of equity, as well as variability of book value and income, are significantly higher under IAS than under German GAAP (HGB). In addition, book value and income are no more value relevant under IAS than under HGB, and HGB (IAS) income is highly persistent (transitory). Finally, we find weak evidence that IAS income exhibits greater conditional conservatism than HGB income. Our results are consistent with the fair-value (income smoothing) orientation of IAS (HGB).

Information in generalized method of moments estimation and entropy-based moment selection

In this paper, we make five contributions to the literature on information and entropy in generalized method of moments (GMM) estimation. First, we introduce the concept of the long run canonical correlations (LRCCs) between the true score vector and the moment function f(_vt,_θ0)$f(v_t,{\theta }_0)$ and show that they provide a metric for the information contained in the population moment condition E[f(_vt,_θ0)]=0$\mathrm{E}[f(v_t,{\theta }_0)]=0$. Second, we show that the entropy of the limiting distribution of the GMM estimator can be written in terms of these LRCCs. Third, motivated by the above results, we introduce an information criterion based on this entropy that can be used as a basis for moment selection. Fourth, we introduce the concept of nearly redundant moment conditions and use it to explore the connection between redundancy and weak identification. Fifth, we analyse the behaviour of the aforementioned entropy-based moment selection method in two scenarios of interest; these scenarios are: (i) nonlinear dynamic models where the parameter vector is identified by all the combinations of moment conditions considered; (ii) linear static models where the parameter vector may be weakly identified for some of the combinations considered. The first of these contributions rests on a generalized information equality that is proved in the paper, and may be of interest in its own right.     

Health care reform: universal access is feasible and necessary

While other industrial nations' health care systems have their own problems, they have more leeway to address those problems than does the United States, which spends twice as much on per capita health care as the average for other industrial capitalist democracies yet ranks average or below average in many comparative measures of health care quality. In fact, the authors of this article argue that international experience shows that assurance of universal access through expanded government involvement could provide savings while actually improving the quality of U.S. health care. In addition, universal access would recognize health care as a basic human right, not a commodity to be bartered in the marketplace and allocated based on class, race and social position.