REVISION: Corporate Governance and Innovation: Theory and Evidence
Date Posted: Feb 28, 2013
We develop a theory to show how external and internal corporate governance mechanisms affect innovation. We show that there is a U-shaped relation between innovation and external takeover pressure, which arises from the interaction between expected takeover premia and private benefits of control. We show strong empirical support for the predicted relation using ex ante and ex post innovation measures. We exploit the variation in takeover pressure created by the passage of anti-takeover laws acro
REVISION: How Frequent Financial Reporting Causes Managerial Short-Termism: An Analysis of the Costs and Benef
Date Posted: Jan 05, 2013
We investigate the costs and benefits associated with the frequency of financial reporting. We show that more frequent reporting results in price pressures that cause managerial short-termism. On the other hand, more frequent reporting provides increased discipline on the incentive to undertake negative net present value projects. We develop condition under which greater frequency of reporting is dysfunctional even though such reporting provides incremental information to the capital market.
REVISION: Corporate Governance and Innovation: Theory and Evidence
Date Posted: Jul 08, 2012
We develop a theory to show how external corporate governance mechanisms, such as the market for corporate control, and internal governance mechanisms interact to affect innovation by
firms. Our model generates the novel testable implication that there is a non-monotonic U-shaped relation between the degree of innovation undertaken by
firms and the external takeover pressure they face. The U-shaped relation arises from the incentive effects of the interaction between expected takeover premia
New: Agency Conflicts, Prudential Regulation, and Marking to Market
Date Posted: Jan 13, 2011
We develop a theory of how agency conflicts between the shareholders and debt holders of a financial institution, accounting measurement rules, and prudential capital regulation interact to affect the institution’s capital structure and project choices. We show that, relative to a benchmark historical cost regime in which assets and liabilities on the institution’s balance sheet are measured at their origination values, fair value or mark-to-market accounting could mitigate asset substitution, b
REVISION: The Economic Trade-Offs in the Fair Value Debate
Date Posted: Mar 27, 2010
In this paper, I provide two general insights that are useful in evaluating the economic trade-offs of alternative accounting measurement rules. First, when there are multiple imperfections in the world, restricting a strict subset of it need not always improve welfare. Second, a firm is not a black box that operates independently of the measurement environment. Measuring a firm’s operations affects the firm’s actions which, in turn, affect the underlying distribution of cash flows that is being
Should Intangibles be Measured: What are the Economic Trade-Offs?
Date Posted: May 26, 2009
We investigate whether a firm's intangible investments should be measured and separated from operating expenses. We find that the information extracted from accounting reports of investments and earnings is different when intangibles are measured and identified separately from operating expenses than when intangibles are left commingled with operating expenses. This difference in the market's information causes a change in the behavior of market prices, inducing changes in the firm's investments
New: Accounting Conservatism and the Efficiency of Debt Contracts
Date Posted: May 06, 2009
In this paper we examine whether accounting conservatism facilitates or detracts from the efficiency of debt contracting. We consider both “unconditional” and “conditional” conservatism as discussed in the literature. In both cases, our analysis does not support the positive relationship between accounting conservatism and the efficiency of debt contracting, as suggested by Watts [2003], and as hypothesized in numerous empirical studies.1 In fact, we find the opposite can be true. Under very pla
REVISION: Auditor Conservatism and Investment Efficiency
Date Posted: Feb 13, 2009
We develop a theoretical framework to investigate (i) both the determinants and the consequences of auditor conservatism in a capital market setting and (ii) the implications of the Sarbanes-Oxley Act for auditor conservatism and investment efficiency. We derive the following results. First, by varying the mix of audit and nonaudit fees, companies with high business risk induce auditor conservatism while companies with low business risk induce auditor aggressiveness. Second, if auditor conserva
REVISION: Accounting Conservatism and the Efficiency of Debt Contracts
Date Posted: Feb 10, 2009
In this paper we examine how accounting conservatism affects the efficiency of debt contracting. We develop the statistical and informational properties of accounting reports under varying degrees of conditional and unconditional accounting conservatism, consistent with Basu's [1987] description of differential verifiability standards. Optimal debt covenants and interest rates on debt are derived from a natural tension between debt holders and equity claimants. We show how optimal covenants vary
REVISION: Market Pressure, Control Rights, and Innovation
Date Posted: Feb 10, 2009
There has been significant controversy over the desirability of anti-takeover protection devices, such as poison pills and golden parachutes. These devices are usually viewed negatively because they are associated with entrenchment and insider rent extraction. This position, however, is subject to debate. Insider protection, for instance, has the advantage of transferring control to better-informed insiders. In fact, in this paper we show that insider protection can arise endogenously as an
New: Fair Value Accounting and Financial Stability
Date Posted: Sep 30, 2008
Accounting is sometimes seen just as a veil leaving the economic fundamentals unaffected. Indeed, in the context of completely frictionless markets, where assets trade in fully liquid markets and there are no problems of perverse incentives, accounting would be irrelevant since reliable market prices would be readily available to all. Just as accounting is irrelevant in such a world, so would any talk of establishing and enforcing accounting standards. To state the proposition the other way roun
REVISION: Marking to Market: Panacea or Pandora's Box?
Date Posted: Aug 06, 2008
Financial institutions have been at the forefront of the debate on the controversial shift in international standards from historical cost accounting to mark-to-market accounting. We show that the trade-offs at stake in this debate are far from one-sided. While the historical cost regime leads to some inefficiencies, marking to market may lead to other types of inefficiencies by injecting artificial risk that degrades the information value of prices, and induces sub-optimal real decisions. We
REVISION: Do Accounting Measurement Regimes Matter? A Discussion of Mark-to-Market Accounting and Liquidity Pr
Date Posted: Aug 06, 2008
Using a model with banking and insurance sectors, Allen and Carletti show that marking-to-market interacts with liquidity pricing to exacerbate the likelihood of financial contagion between the two sectors. In this discussion, I lay out the main ingredients of their model and explain how they interact with liquidity pricing to generate financial contagion. I then discuss some limitations of their model and propose an interesting extension.
New: Information Management and Valuation: An Experimental Investigation
Date Posted: Jul 30, 2008
We explore the management of information and the response of market prices to such information. Sellers may be uncertain of dividends. We examine whether sellers anticipate buyers' pricing behavior and whether buyers' prices reflect correct inferences of the disclosure strategy of sellers. Buyers' inferences and sellers' anticipation require implicit Bayesian updating in solving for the equilibrium decision strategies of sellers and pricing behavior of buyers. Because of traditional problems in
New: Marking to Market, Liquidity and Financial Stability
Date Posted: Jul 30, 2008
This paper explores the financial stability implications of mark-to-market accounting, in particular its tendency to amplify financial cycles and the "reach for yield". Market prices play a dual role. Not only do they serve as a signal of the underlying fundamentals and the actions taken by market participants, they also serve a certification role and thereby influence these actions. When actions affect prices, and prices affect actions, the loop thus created can generate amplified responses - b
New: Hedge Disclosures, Futures Prices, and Production Distortions
Date Posted: Jul 30, 2008
In this paper, we identify social benefits to hedge accounting disclosures that have not previously been examined. We show that from the perspective of price efficiency in the futures market the key information that is provided by hedge accounting is information about firms' underlying risk exposures. Without this information, the futures price confounds information regarding firms' hedge-motivated trades with their speculative trades, making the futures price inefficient. Our model shows tha
New: Do Mandatory Hedge Disclosures Discourage or Encourage Excessive Speculation?
Date Posted: Jul 30, 2008
In order to shed some light on the desirability of hedge disclosures, I investigate the consequences of hedge disclosures on a firm's risk management strategy. Several major results emerge from this analysis. First, greater transparency about a firm's derivative activities is not necessarily a panacea for imprudent risk management strategies. I show that such transparency actually induces the firm to take excessive speculative positions in the derivative market. Second, I show that the firm may
New: Do Derivatives Disclosures Impede Sound Risk Management?
Date Posted: Jul 17, 2008
We model an environment in which firms disclose only one side of a hedging transaction, namely the gain or loss on the forward. However, the firm cannot credibly disclose the other side of the hedging transaction, namely the underlying exposure that is being hedged. We show that because the firm cannot credibly communicate that the exposure from its underlying project is hedgeable, greater transparency in the firm's derivative activities distorts firms' hedging decisions.
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