in the news and journals
How Word Choice Can Land a Company in Legal Hot Water
When a company discloses information to shareholders, it should watch its language. An overly optimistic tone can expose it to lawsuits from angry shareholders, according to a new paper by Jonathan Rogers, associate professor of accounting, Sarah Zechman, assistant professor of accounting, and a colleague at Ohio State University.
In their study, “Disclosure Tone and Shareholder Litigation,” which was published in the November 2011 issue of the Accounting Review, the researchers used a dictionary-based measure of optimism in order to gauge the tone of company statements. Sued companies used “measurably more optimistic” language in their disclosures as compared to peers who weren’t sued. “These results indicate a strong link between disclosure tone and litigation,” the authors concluded.
Further, said the researchers, the link between tone and litigation became even stronger when managers engaged in insider selling that contradicted the optimism of their statements. Therefore, according to Rogers and Zechman, in order to mitigate legal risk, managers should avoid overstating the company’s performance, particularly when selling off their own shares and assets. They stated, "insider selling is associated with litigation risk only when contemporaneous disclosures are unusually optimistic." (Photo of Rogers by Dan Dry; photo of Zechman by Chris Lake.) ■
IQ and Investing Prowess
By Erin O'Neill
Published: Summer 2012
Are smarter people instinctively better investors? For decades, economists have debated the root of the “participation puzzle,” in struggling to understand why such a small percentage of the population takes advantage of stock investments - which generally produce a higher rate of return than traditional savings.
Juhani Linnainmaa, associate professor of finance, and two colleagues tackled this question in two papers: “IQ, Trading Behavior, and Performance,” published in the May Journal of Financial Economics; and “IQ and Stock Market Participation,” published in the December 2011 issue of the Journal of Finance. The studies found evidence of a direct correlation between an investor’s IQ and decisions to invest in the stock market.
In the first paper, the researchers collected two decades-worth of scores from a mandatory army intelligence test administered to Finnish men who are required to enlist for nine months to a year. They analyzed this data along with records regarding equity return, trade, and limit-order book data. They found that higher IQ scores increased the likelihood of later stock ownership by 21 percent, even after being controlled for environmental factors such as wealth, income, age, and profession.
The subsequent research showed that high-IQ investors are less subject to the disposition effect, the tendency to sell winning investments but hold on to assets that have dropped in value. These investors are also “more aggressive about tax-loss trading, and more likely to supply liquidity when stocks experience a one-month high,” the research found. The study also found that investors with higher IQ scores “exhibit superior market timing, stock-picking skill, and trade execution.”
“It’s difficult to justify why someone wouldn’t have invested in the stock market, knowing what a good deal it has been,” Linnainmaa wrote. “It’s not just that it may be expensive to buy stocks and mutual funds, but people may not have enough knowledge about them.” (Photo by Beth Rooney.) ■
When Brand Loyalty Is Divided
By Erin O'Neill and Dan Kedmey
Published: Summer 2012
Why does a Budweiser-guzzling couch potato suddenly switch to Heineken when he’s at a cocktail party with friends? That’s just what Pradeep Chintagunta, Joseph T. and Bernice S. Lewis Distinguished Service Professor of Marketing, and his coauthor set out to answer in their paper, “Investigating Brand Preferences Across Social Groups and Consumption Contexts,” published in Quantitative Marketing & Economics.
Drinkers choose different brands depending on what they’re doing (for example, either bowling or sitting on a couch) and whom they’re with (alone or among friends). These shifts in consumption could provide valuable information to marketers, but the data for many of these scenarios tends to be scarce.
Chintagunta and his coauthor worked around this scarcity by developing a more parsimonious model of context-based consumption. The model reveals that context plays a powerful role in brand selection. Smaller companies could increase their market share by marketing to a highly-targeted “context or social group setting.” (Think the Corona on-the-beach ad campaign.) Ultimately, the study suggests “marketers should” indeed consider how consumers’ preferences can vary across social group and consumption context scenarios when designing their marketing programs.” (Photo by Chris Lake.) ■
The Consequences of Innovation
By Dan Kedmey
Published: Summer 2012
There are two sides to innovation. The bright side is that innovative firms are able to produce more, which in turn raises their output, consumption, and wages. The dark side is that less nimble competitors can be forced to slash pay and lay off older workers, who are less able to adapt to the innovation of the firms. This dark side, which is called “displacement risk,” is the subject of a new study by Stavros Panageas, assistant professor of finance, and two colleagues.
In their paper, “Displacement Risk and Asset Returns,” which is scheduled to be published in the Journal of Financial Economics, and which won the Best-Paper Award at the Utah Winter Finance Conference 2011, the authors measure the magnitude of displacement risk by looking at consumption data across generations. The authors find that, because “innovation benefits the young at the expense of the old,” growth firms - which derive a large part of their value from future inventions - are a good hedge against displacement risk, as opposed to less-innovative “value firms.” Finally, the authors “identify innovation shocks through their effect on the consumption of individual cohorts and show that inter-generational differences in consumption correlate with the return differences between value and growth stocks.” (Photo by Dan Dry.) ■
Finding Combinations That Satisfy
By Kalliope Dimitrakopoulos
Published: Summer 2012
In his paper, “The Combinatorial Assignment Problem: Approximate Competitive Equilibrium from Equal Incomes,” published in the Journal of Political Economy, Eric Budish, assistant professor of economics, tackled the problem of how to design a market-like resource allocation system in settings where there are legal or moral restrictions against using real money to figure out who gets what. He devised a new “Competitive Equilibrium from Equal Incomes” (CEEI) mechanism that could be applied, for instance, to course allocation at educational institutions: which students get to take the most popular professors’ courses at Booth? It also could be applied to shift allocation at companies: which employees have to work Thanksgiving or Christmas this year?
The CEEI system works as follows. First, the participants log their preferences to a computer program. For example, taking a particular professor’s class is worth 100 “utils.” Second, the program assigns each participant an equal amount of an artificial currency - say, 10,000 points, plus a small random amount extra. Third, a computer finds a “competitive equilibrium” - prices such that, when each participant “purchases” the set of goods she likes best at these prices, subject to not spending more than her budget of artificial currency, the market clears, so that supply equals demand. The reason for the random amount of extra budget in step two is to ensure that competitive equilibrium prices always exist in step three. Budish teamed up with computer scientists at Carnegie Mellon University to develop a computational procedure capable of finding these prices.
Budish showed that CEEI is attractive on three dimensions: efficiency, fairness, and incentives. Here, efficiency means that welfare-improving trades aren’t left on the table. Fairness means that the participants don’t envy each others’ allocations, or, if they do, their envy is small: I may envy you if you get one of the top professors and I don’t, but you won’t get two of the top professors while I get neither. Incentives mean that it is in each participant’s interest to report preferences truthfully to the computer in step one - that is, it is impossible to “game the system.” Budish argued that all other previously proposed systems for these kinds of problems, from both theory and practice, have fairness problems, incentives problems, or often both. (Photo by Dan Dry.) ■