Reviews the book "Intrafirm Trade and Global Transfer Pricing Regulation," by Roger Y.W. Tang

Regulating insider trading lessens the adverse selection problem facing market makers, enabling them to quote better prices. An Optimal enforcement policy must balance these benefits against the costs of enforcement. Such a policy must specify (i) the conditions under which the regulator conducts an investigation, (ii) the penalty schedule imposed if an insider is caught, and (iii) a transaction tax to fund enforcement. We derive the policy that maximizes investors welfare. This policy entails investigations following large trading volumes or large price movements or both. Insiders caught making large trades are assessed the maximum penalty, but small trades are not penalized. Given this policy, insiders trade most aggressively on news with an intermediate price impact but refrain from trading on moderate or extreme news

[This paper investigates the reporting and contracting responses of electric utilities to SFAS No. 106. Expense-increasing accounting standards generally have no direct cash flow consequences for nonregulated firms, but they reduce these firms' reported net income and increase their reported liabilities. Past research documents that managers of nonregulated firms seek to avert potential contracting costs associated with such mandated accounting changes through operating, financing or reporting decisions that mitigate the financial statement impact of the accounting change. In contrast, expense-increasing accounting standards do not usually affect rate-regulated firms' net income, but do have a positive effect on their cash flows because the rate recovery mechanism is based on accounting numbers. Managers of rate-regulated firms therefore have incentives to respond to expense-increasing accounting standards in ways that enhance the financial statement impact of the accounting change. This study documents that managers of rate-regulated firms that face greater uncertainties about future rate recoveries have greater incentives to use discretionary choices that intensify the impact of expense-increasing accounting changes on current financial statements

This paper investigates the reporting and contracting responses of electric utilities to SFAS No. 106. Expense-increasing accounting standards generally have no direct cash flow consequences for nonregulated firms, but they reduce these firms' reported net income and increase their reported liabilities. Past research documents that managers of nonregulated firms seek to avert potential contracting costs associated with such mandated accounting changes through operating, financing or reporting decisions that mitigate the financial statement impact of the accounting change. In contrast, expense- increasing accounting standards do not usually affect rate-regulated firms' net income, but do have a positive effect on their cash flows because the rate recovery mechanism is based on accounting numbers. Managers of rate- regulated firms therefore have incentives to respond to expense-increasing accounting standards in ways that enhance the financial statement impact of the accounting change. This study documents that managers of rate-regulated firms that face greater uncertainties about future rate recoveries have greater incentives to use discretionary choices that intensify the impact of expense- increasing accounting changes on current financial statements

Electric utilities in the United States are subject to a cost‐plus normal profits pricing that is designed to align the market value of equity with the balance sheet book value. Perfect alignment implies the equality of the market and book values. Extant empirical evidence suggests that, for these utilities, actual cost/profit recovery does not follow a pure cost‐plus pricing, raising the prospect that income statement items contribute to the determination of market value. What is not obvious is the extent to which the noted departure from pure cost‐plus pricing results in misalignment of the market and book values, or the relative contribution of income statement items to the valuation of electric utility shares. This study pursues this question, using benchmark results for a sample of manufacturing firms to highlight the degree of market‐to‐book alignment for regulated and competitive firms. The results show a considerable alignment of the market and book values for utilities. In examining the relevance of book value and income statement items in the determination of market value, it is found that the contribution of earnings level to explaining market value diminishes markedly in the presence of book value for electric utilities, and the contribution of earnings change to explaining returns diminishes markedly in the presence of earnings levels. Earnings level complements book value in explaining market value for manufacturing firms, while earnings change complements earnings level in explaining returns. The results further show that the market and accounting values exhibit pronounced misalignments in returns‐earnings models, especially for utilities

This paper assesses how the bias and accuracy of managers' earnings forecasts in prospectuses were affected by a 1989 regulation that required the forecasts to be audited by public accountants. Theory suggests that auditors' association with the forecasts would reduce positive (optimistic) bias, by reducing moral hazard. Regulators expected that the audit requirement would also improve the accuracy of the forecasts. Both predictions were tested using management earnings forecasts disclosed in prospectuses of Canadian initial public offerings. The results show that audited forecasts contained significantly less positive bias than reviewed forecasts, but there was only a marginally significant improvement in accuracy

We present evidence that insured deposit financing shields banks from the full costs of market discipline. Moody's downgrades, indicators of increasing risk, are associated with negative abnormal equity returns that are increasing in the bank's reliance on insured deposits. Moreover, banks raise their use of insured deposits following increases in risk. These findings cast doubt on the ability of capital market participants to effectively discipline bank behavior within the current regulatory environment. More generally, our findings highlight the potential for regulation to undermine market discipline in regulated industries

Targeting is the practice of inspecting firms most likely to violate a regulation. This paper provides empirical evidence on the role of targeting in regulatory compliance. I propose that self-reporting by a firm is used to demonstrate that firms are willing to cooperate. The results indicate that there is a one-quarter penalty period following a violation. Inspections are also determined by the economic situation of the surrounding community, demonstrating that targeting opens the door to interestgroup influence. Inspections that detect violations encourage selfreporting, showing that firms demonstrate their desire to cooperate with regulators by disclosing violations

This paper presents a model of incentive compatible bank regulation under moral hazard and adverse selection. We derive a wide range of simple and conceptually implementable mechanisms that can solve each type of incentive problem separately and also achieve the first-best outcome – but only when regulatory instruments involve ex post pricing that is contingent on the bank's performance relative to the market. An important feature of these mechanisms is that they do not involve a subsidy to the bank. When the regulator faces both moral hazard and adverse selection simultaneously, we identify the conditions under which the same mechanism can achieve the first-best solution