Knowledge that Transforms

Decisions are typically made by drawing on multiple sources of information, yet the correlation among these sources is often hard to assess. We study robustly optimal strategies—those that maximize the worst-case payoff guarantee across all correlation structures. With two states and two actions, the robustly optimal strategy is strikingly simple: use only the best information source and ignore the rest. With more actions, a robustly optimal strategy decomposes the problem into local comparisons and assigns each comparison to the source that is best at that comparison. With more states, the same specialization logic survives through a concavification characterization: the decision problem is decomposed into payoff-relevant components, and each component is assigned to its best source. These results offer a new rationale for why ignoring information can be optimal and highlight the benefit of using specialized information sources when correlations are ambiguous.

Disclosure rules in many countries require public companies to report fees paid to the principal audit firm and its affiliates, but not to unaffiliated component auditors (UCAs). Reported fees thus depend on component auditor affiliation. We show that UCA involvement is significant in many countries. Using Italian private companies’ public filings, we find that UCA involvement is a statistically and economically significant source of bias in audit fee models. This bias is particularly relevant around principal auditor changes, when some subsidiaries temporarily retain UCAs before switching to auditors affiliated with the new principal auditor. The exclusion of fees paid to temporary UCAs explains the initial-year audit fee discount (lowballing) previously documented, which disappears once these omitted fees are accounted for. Our results suggest that lowballing reflects measurement bias rather than systematic strategic pricing. Because UCAs are common internationally and disclosure rules similarly exclude these fees, this bias extends beyond Italy.

We demonstrate how private equity (PE) promotes nonbank lending by substituting for bank monitoring. Relative to non-PE-backed loans, PE-backed loans exhibit lower bank monitoring, smaller loan shares retained by lead banks, and larger shares held by nonbanks. The substitution is strongest when sponsors have greater incentives to engage with portfolio firms, is not associated with weaker loan performance, and persists during borrower distress. Our findings suggest that PE sponsors’ active engagement—through monitoring and support in distress—reduces banks’ need for monitoring and information production, enabling them to retain less skin in the game and sell loans to nonbanks.

Using US Supreme Court’s narrow-decision on Shelby v. Holder as a shock that diluted voting rights of Black Americans in covered counties, we document the relationship between political voice and economic decision-making. We show fewer Black Americans buy homes after their de-facto disenfranchisement, reflected through lower mortgage applications. Among those who apply for mortgages, there is a flight to Black lenders. Leveraging individual-level survey data, we show confidence in government and financial institutions plays a significant role in driving these effects. Our findings demonstrate that the effects of disenfranchisement extend beyond the ballot box to fundamental economic decisions like homeownership.

Organizational learning (OL) is a critical organizational capability. Yet designing management control (MC) that effectively supports OL is challenging, as learning outcomes are often intangible and unfold over extended time horizons. Employing situational strength theory, we examine combinations of MC practices that affect OL contingent on environmental uncertainty. Drawing on a survey of 210 senior business unit controllers, we use fuzzy-set Qualitative Comparative Analysis (fsQCA) to identify multiple combinations of MC practices that achieve high OL in different uncertainty contexts. In a subsequent step, we examine whether the situational strength of certain combinations of MC practices is associated with OL. Results show that in a low-uncertainty environment, the combined use of diverse performance measures and social controls, as well as performance pay and a mechanistic administrative structure, have a synergetic effect on OL. In a high-uncertainty context, the combined use of measure diversity and deliberate formal strategic planning is beneficial for achieving OL. Our results suggest that the effectiveness of MC practices for OL depends on aligning MC practices with the internal as well as the external context.

Once a good idea comes to mind, it is hard to avoid wondering why no one else has already taken advantage of it. Is it because the idea is not as good as it initially appears? This concern gives rise to a dilemma over whether to pursue the idea or abandon it despite its apparent promise, a dilemma we call “the good idea dilemma”. Paradoxically, the more compelling an idea appears, the more puzzling it becomes that others have not exploited it, thereby deepening the dilemma. We study this dilemma in a continuous-time game with multiple players, analyzing idea adoption dynamics and their economic implications. The dilemma yields both under-implementation of good ideas and over-implementation of bad ideas. Its adverse consequences equally affect trivial ideas that arise frequently and creative ideas that rarely do, but intensify for ideas accessible to larger audiences or with riskier outcomes, even under risk neutrality.

Based on a comprehensive visual deception score constructed from China’s mandatorily disclosed IPO roadshow videos using computer vision and machine learning, we find that visual cues embedded in these videos predict IPO financial fraud. The predictive power is incremental to financial, textual, and audio indicators. Further analyses show that these cues are well grounded in psychology research and focusing on the psychology-based deception-cue-area features improves fraud predicting performance. Furthermore, decomposing each video into five topics, we find that only the deception score of the topic on financial performance is positively associated with financial fraud. We further show that insiders of firms with higher visual deception scores are more likely to sell shares shortly after lock-up periods expire, and these firms experience significantly lower subsequent stock returns. Our study demonstrates the feasibility and potential value of using video information for fraud detection in accounting and finance.

We show that leading investor disagreement proxies have near-zero cross-correlation – making disagreement pricing inferences challenging. We develop a frictionless model that generates overpricing from latent disagreement, jointly rationalizes major proxies, and generates new testable predictions. Equilibrium interrelationships motivate a new disagreement measure, DIS, which is more predictive of returns cross-sectionally than major proxies and more consistently predictive across macroeconomic regimes. We provide evidence that the friction-based channel of Miller (1977) and a frictionless mechanism coexist and are empirically separable. DIS also provides a micro-founded, disagreement-based account of the IVOL puzzle, absorbing IVOL’s predictability while revealing its regime and friction dependence.

We develop a model to study the efficiency of socially responsible investing (SRI) as a mechanism to control firms' externalities. When SRI is not too popular, responsible investors favor strategies that lead to a concentration of SRI in a subset of firms in the economy. This concentration can mitigate coordination issues in adopting green technologies, but it can also crowd out the green investments of excluded firms and increase the price of green products. In equilibrium, responsible investors continue to favor concentration even as SRI becomes more popular, and concentrate the most when concentration is least desirable.

Litigation risk is an important source of motivation for auditors to conduct high‐quality audits, but theory suggests that certain lawsuits will have a more salient disciplining effect on auditor behavior. To this end, we identify lawsuits naming an individual partner as a co‐defendant along with the audit firm. We then examine how these lawsuits affect subsequent behavior of other auditors in the office of the sued partner. Relative to lawsuits naming only the firm, our results indicate that lawsuits naming individual partners as co‐defendants are significant office‐level events that motivate a meaningful response from non‐sued audit partners in the form of higher quality and fees on existing clients and more careful client portfolio management. These results have practical implications about how auditor litigation incentivizes individual auditors to fulfill their professional duties. For regulators and audit firms seeking to promote audit quality, these findings highlight the disciplining effect of auditors' concern for their personal reputation and litigation exposure. Furthermore, audit committees, clients, and investors may observe elevated audit quality, effort, and fees following partner‐level litigation in the local office.