Instrumental variable (IV) methods are commonly used in accounting research (e.g., earnings management, corporate governance, executive compensation, and disclosure research) when the regressor variables are endogenous. While IV estimation is the standard textbook solution to mitigating endogeneity problems, the appropriateness of IV methods in typical accounting research settings is not obvious. Drawing on recent advances in statistics and econometrics, we identify conditions under which IV methods are preferred to OLS estimates and propose a series of tests for research studies employing IV methods. We illustrate these ideas by examining the relation between corporate disclosure and the cost of capital.

ABSTRACT We investigate Gompers, Ishii, and Metrick's (2003) finding that firms with weak shareholder rights exhibit significant stock market underperformance. If the relation between poor governance and poor returns is causal, we expect that the market is negatively surprised by the poor operating performance of weak governance firms. We find that firms with weak shareholder rights exhibit significant operating underperformance. However, analysts' forecast errors and earnings announcement returns show no evidence that this underperformance surprises the market. Our results are robust to controls for takeover activity. Overall, our results do not support the hypothesis that weak governance causes poor stock returns.

ABSTRACT This paper examines the effect of transaction costs on the post–earnings announcement drift (PEAD). Using standard market microstructure features we show that transaction costs constrain the informed trades that are necessary to incorporate earnings information into price. This implies weaker return responses at the time of the earnings announcement and higher subsequent returns drift for firms with higher transaction costs. Consistent with this prediction, we find that earnings response coefficients are lower for firms with higher transaction costs. Using portfolio analyses, we find that the profits of implementing the PEAD trading strategy are significantly reduced by transaction costs. In addition, we show, using a combination of portfolio and regression analyses, that firms with higher transaction costs are the ones that provide the higher abnormal returns for the PEAD strategy. Our results indicate that transaction costs can provide an explanation not only for the persistence but also for the existence of PEAD.

We examine the link between bank competition and financial stability using the recent financial crisis as the setting. We utilize variation in banking competition at the state level and find that banks facing less competition are more likely to engage in risky activities, more likely to face regulatory intervention, and more likely to fail. Focusing on the real estate market, we find that states with less competition had higher rates of mortgage approval, experienced greater inflation in housing prices before the crisis, and experienced a steeper decline in housing prices during the crisis. Overall, our study is consistent with greater competition increasing financial stability.

ABSTRACT We examine the causal effect of expected private litigation costs on voluntary disclosure using a natural experiment, the Supreme Court ruling in Morrison v. National Australia Bank. Even though this ruling had no effect on what constituted fraudulent conduct for the purpose of securities litigation, it significantly reduced the expected private litigation costs for foreign cross-listed firms by reducing the pool of potential claimants. It did so by eliminating the right of shareholders who purchased shares on non-U.S. exchanges from seeking compensation in U.S. courts. In the post-Morrison period, we find consistent evidence showing a decrease in voluntary disclosure using analyses that exploit the varying impact of the ruling based on both firm- and country-level attributes. Unlike a number of prior studies, we find that the positive relation between litigation and disclosure does not depend on the direction of the news. JEL Classifications: G15; G18; M41. Data Availability: Data are available from the public sources cited in the text.