Knowledge that Transforms

Public audit oversight bodies have become ubiquitous following the establishment of the U.S. PCAOB in 2002. However, despite their cost and prominence, little is known of their economic implications, if any. We examine the relation between establishment of public audit oversight bodies (POBs) and cross-border investment. Using a difference-in-differences design, we find that after a country establishes a POB, the country attracts more foreign capital. Our results suggest that total foreign portfolio investment (FPI) increases by approximately $11 billion for the average country that establishes a POB. The impact of POBs on foreign investment is dependent on the effectiveness of the POB in improving audit quality and the strength of a country’s existing institutional environment. Our study provides evidence of real economic effects of public audit oversight around the world, which adds to the literature on auditor oversight and to the broader literature on economic consequences of regulation. Data Availability: Data are available from the public sources cited in the text.

A growing literature has examined the benefits and costs of implementing new disclosure regulations. However, little is known about the consequences when regulators fail to take action. Using IFRS adoption in 2005 as the setting, we examine the costs of regulatory inactions among non-adopting countries. We find that firms located in non-adopting countries with a higher overlap of common investors with firms in IFRS-adopting countries experience a significant decline in liquidity. Employing a within-firm-time design, we further demonstrate that analysts and institutional investors shift their attention from non-IFRS firms when other firms in their portfolios adopt IFRS. Moreover, the decline in liquidity and the associated reduction in information production by analysts and institutional investors are particularly pronounced in non-adopting countries with weak reporting enforcement actions and increasing accounting distance from IFRS standards. Overall, our findings highlight the potential costs of regulatory inaction. Valuable information production resources are diverted to the new regime, resulting in a worsened information environment for companies in the old regime.

Using regression discontinuity and difference-in-differences designs to compare prices of California homes across a new wildfire risk zone boundary, I identify null effects in the immediate vicinity of the new risk zone boundary. In contrast, prices of homes newly assigned to a riskier zone drop by 5.7% further away from the new risk zone boundary. These findings suggest that households do not respond to the risk salience triggered by the new risk zone assignment. Instead, they update their risk beliefs in response to rezoning in a way that is consistent with the actual wildfire risk.

We estimate the supply-side effects of climate change on firm sales by exploiting variation in local average temperature across suppliers of the same client. A 1°C increase in temperature leads to a 2.5% decline in annual sales. This effect is nonlinear, with stronger effects among suppliers in regions with the largest temperature increases and in cooler regions. Manufacturing and heat-sensitive industries are more affected, consistent with a reduction in labor productivity and labor supply when local temperatures rise. Nondiversified and financially constrained firms are also more affected, supporting the importance of operational and financial flexibility in adapting to climate change.

We show that investors extrapolate from recent stock returns of locally headquartered firms when forming beliefs about aggregate stock market outcomes. While it may be optimal to rely on local information, these effects are unrelated to how informative local returns are on predictions of aggregate outcomes. Evidence from a sample of retail investors suggests this belief extrapolation is driven by investors’ own holdings of local firms. Our findings suggest that beliefs about information contained in public signals vary systematically with geography, and are an important component of local biases in equity markets.

We decompose cross-sectional differences in the level of price-earnings ratios using professional forecasts. High price-earnings ratios are accounted for by both low expected returns and overly high expected earnings growth. The magnitudes and timing of the comovements between prices, earnings growth, and returns are consistent with gradual learning rather than expectations being highly sensitive to recent realizations. Earnings growth surprises do not translate 1-1 into one-period returns but instead are gradually reflected in returns over time. A structural risk-premium model incorporating constant-gain learning about mean earnings growth replicates our findings and generates realistic dispersion and persistence in price-earnings ratios.

We measure investors’ short- and long-term stock-return expectations using both options and survey data. These expectations at different horizons reveal what investors think their own short-term expectations will be in the future, or forward return expectations. Across data sources, investors’ forward return expectations are countercyclical, especially when measured as forward risk premiums. This countercyclical variation is, however, excessive, as changes in forward return expectations are too large relative to subsequent realized short-term expectations. The excess variation in forward return expectations can help account for a meaningful share of the stock-price declines during the global financial crisis and the COVID-19 crisis.