Dynamic Stock Markets with Multiple Assets: An Experimental Analysis

We study the performance of the rational expectations hypothesis in multiperiod experimental markets with multiple assets. We find that the markets are generally inefficient from the point of view of full information aggregation. However, arbitrage relationships hold, and it is not possible to detect the informational inefficiency by using some standard tests of market efficiency. These findings suggest that the lack of arbitrage opportunities and the failure of common tests to reject inefficiency are not sufficient to conclude that a market is informationally efficient.     

The Effects of Cross-Sectional Scale Differences on Regression Results in Empirical Accounting Research*

Abstract. This study investigates coefficient bias and heteroscedasticity resulting from scale differences in accounting levels-based research designs analytically and using simulations based on accounting data. Findings indicate that including a scale proxy as an independent variable is more effective than deflation at mitigating coefficient bias, even if the proxy is 95 percent correlated with the true scale factor. In fact, deflation can worsen coefficient bias. Also, deflation often does not noticeably reduce heteroscedasticity and can decrease estimation efficiency. White (1980) standard errors are close to the true ones in regressions using undeflated variables. Replications of specifications in three recent accounting studies confirm the simulation findings. The findings suggest that when scale differences are of concern, accounting researchers should include a scale proxy as an independent variable and report inferences based on White standard errors. Résumé. Les auteurs examinent, tant sur le plan analytique qu'au moyen de simulations basées sur les données comptables, la distorsion des coefficients et l'hétéroscédasticité résultant des différences d'échelle dans les plans de recherche comptable basés sur les niveaux. Leurs constatations révèlent que l'inclusion d'un substitut d'échelle à titre de variable indépendante est plus efficace que la déflation pour atténuer la distorsion relative au coefficient, même si le substitut présente une corrélation de 95 pour cent avec le véritable facteur d'échelle. En fait, la déflation peut accentuer la distorsion relative au coefficient. Aussi, il arrive souvent que la déflation, sans réduire de façon appréciable l'hétéroscédasticité, puisse diminuer l'efficience de l'estimation. Les erreurs-types de White (1980) se rapprochent des erreurs véritables dans les régressions faisant appel à des variables non déflatées. La répétition des mêmes caractéristiques dans trois études comptables récentes confirme les résultats de la simulation. Les conclusions de l'étude donnent à penser que lorsque les différences d'échelle sont sujet de préoccupation, les chercheurs en comptabilité devraient faire intervenir un substitut d'échelle à titre de variable indépendante et formuler les inférences à partir des erreurs-types de White.     

OPTIMAL ENFORCEMENT AND ANTI‐COPYING STRATEGIES TO COUNTER COPYRIGHT INFRINGEMENT*

In this paper we study the mix of anti‐copying investment strategies by an incumbent firm and the enforcement policies of a government that consists of monitoring and penalizing the copier to address the issue of commercial piracy. If monitoring is socially optimal then the subgame perfect equilibrium anti‐copying investment does not guarantee the prevention of copying. If not monitoring is socially optimal then the subgame perfect equilibrium anti‐copying investment may guarantee the prevention of copying.     

Attracting Attention: Cheap Managerial Talk and Costly Market Monitoring

We provide a theory of informal communication—cheap talk—between firms and capital markets that incorporates the role of agency conflicts between managers and shareholders. The analysis suggests that a policy of discretionary disclosure that encourages managers to attract the market's attention when the firm is substantially undervalued can create shareholder value. The theory also relates the credibility of managerial announcements to the use of stock-based compensation, the presence of informed trading, and the liquidity of the stock. Our results are consistent with the existence of positive announcement effects produced by apparently innocuous corporate events (e.g., stock dividends, name changes).     

Information Complementarities and the Dynamics of Transparency Shock Spillovers

We show that information complementarities play an important role in the spillover of transparency shocks. We exploit the revelation of financial misconduct by S&P 500 firms, and in a “Stacked Difference-in-Differences” design, find that the implied cost of capital increases for “close” industry peers of the fraudulent firms relative to “distant” industry peers. The spillover effect is particularly strong when the close peers and the fraudulent firm share common analyst coverage and common institutional ownership, which have been shown to be powerful proxies for fundamental linkages and information complementarities. We provide evidence that increase in the cost of capital of peer firms is due, at least in part, to “beta shocks.” Disclosure by close peers—especially those with co-coverage and co-ownership links—also increases following fraud revelation. Although disclosure remains high in the following years, the cost of equity starts to decrease.     

Public Information Precision and Coordination Failure: An Experiment

More precise public disclosure reduces uncertainty about economic fundamentals, but it can increase uncertainty about other agents' actions, leading to coordination failure. We conducted a laboratory experiment to study the effects of public information precision and strategic complementarity on coordination failure. Information precision is operationalized in terms of “granularity” (level of detail). We found that (1) granular public disclosure, which is disaggregated and precise, increases the likelihood of coordination failure and decreases coordination efficiency when public information is pessimistic about future economic prospects; (2) the deleterious effect of granular disclosure is stronger when strategic complementarity is high; and (3) higher levels of strategic complementarity decrease coordination efficiency. Overall, the observed likelihood of coordination failure is higher and coordination efficiency is lower than predicted by theory. Our findings have implications for the Federal Reserve's decision to publicly disclose detailed stress test results for distressed banks, and the debate on whether the Public Company Accounting Oversight Board should publicly release reports on firm‐specific quality‐control deficiencies of audit firms.     

Buyer–Supplier Relationships and the Stakeholder Theory of Capital Structure

Firms in bilateral relationships are likely to produce or procure unique products—especially when they are in durable goods industries. Consistent with the arguments of Titman and Titman and Wessels, such firms are likely to maintain lower leverage. We compile a database of firms' principal customers (those that account for at least 10% of sales or are otherwise considered important for business) from the Business Information File of Compustat and find results consistent with the predictions of this theory.     

Choosing to Disagree: Endogenous Dismissiveness and Overconfidence in Financial Markets

The psychology literature documents that individuals derive current utility from their beliefs about future events. We show that, as a result, investors in financial markets choose to disagree about both private information and price information. When objective price informativeness is low, each investor dismisses the private signals of others and ignores price information. In contrast, when prices are sufficiently informative, heterogeneous interpretations arise endogenously: most investors ignore prices, while the rest condition on it. Our analysis demonstrates how observed deviations from rational expectations (e.g., dismissiveness, overconfidence) arise endogenously, interact with each other, and vary with economic conditions.     

Risk Aversion and Arbitrage

This paper characterizes conditions under which asset returns and consumption are consistent with risk-averse preferences. It is shown that risk aversion is equivalent to “zero arbitrage” on a transformation of the payoff space. The implicit state prices which are dual to this no-arbitrage condition can be interpreted as prices of “pure consumption hedges.” This zero-arbitrage restriction implies the usual restrictions associated with nonsatiation. The analysis holds in both complete and incomplete market settings.     

Disclosing to Informed Traders

We develop a model in which a firm's manager can voluntarily disclose to privately informed investors. In equilibrium, the manager only discloses sufficiently favorable news. If the manager is known to be informed but disclosure is costly, the probability of disclosure increases with market liquidity and the stock trades at a discount relative to expected cash flows. However, when investors are uncertain about whether the manager is informed, disclosure can decrease with market liquidity and the stock can trade at a premium relative to expected cash flows. Moreover, contrary to common intuition, public information can crowd in more voluntary disclosure.