Knowledge that Transforms

There has been an enormous increase in auditing and accounting standards and in litigation against auditors. This paper examines some of the consequences of these changes by developing a model of the audit market relating auditors' liability to auditing standards. The paper demonstrates how equilibrium audit fees depend on both the informational value of the audit and the option value of the claim financial statement users have on the auditor's wealth in the event the audit is determined to have been substandard. Auditors' attitudes toward and responses to auditing standards are studied, and characteristics of optimal liability rules are evaluated.

An important step in extending the traditional theory of individual rational choice to analyze social issues beyond those usually considered by economists is to incorporate into the theory a much richer class of attitudes, preferences, and calculations. While this approach to behavior builds on an expanded theory of individual choice, it is not mainly concerned with individuals. It uses theory at the micro level as a powerful tool to derive implications at the group or macro level. The lecture describes the approach and illustrates it with examples drawn from my past and current work.

Milton Friedman has claimed that his monetary economics derives from a Chicago Tradition that, in the 1930s, offered a monetary explanation of cyclical fluctuations in general and the Great Depression in particular, an optimistic view of the power of monetary policy, and a case for governing it by rules rather than discretion. It is argued that all the elements of this tradition except the last are to be found in earlier writings of Ralph Hawtrey, Allyn Young, and Lauchlin Currie and that there is much evidence to point to a direct influence running from Hawtrey, through Harvard to Chicago.

We argue that since bank loans and publicly traded sub-investment-grade debt, or junk bonds, are close substitutes for one another, the recent failure of Drexel Burnham Lambert created a competitive opportunity for commercial banks. Consistent with this hypothesis, we observe within the commercial banking industry a positive wealth effect associated with Drexel′s failure. The distribution of the wealth effect across commercial banks and Drexel′s investment banking rivals is consistent with the wealth effect being primarily a reflection of market expectations of a return to traditional intermediated funding of sub-investment-grade debt. Journal of Economic Literature Classification Number: G2, Financial Institutions and Services.

We review the contemporary theory of financial intermediation. The focus is on contributions in the past 15 years or so that have advanced our understanding of why financial intermediaries exist, the credit allocation and other services they provide in spot and forward credit markets, the contractual nature and allocational consequences of the claims they issue, and the optimal design of bank regulation. Journal of Economic Literature Classification Numbers: 310, 312, and 314.

This paper analyzes the effects of market value accounting (MVA) on loan maturity. I show that in the presence of asymmetric information MVA introduces a bias into asset valuation against longer-term illiquid assets. This bias increases interest rates for long-maturity loans and induces a shift to short-term self-liquidating loans. With the liquidity production of banks curtailed, borrowers may face "excessive" liquidation. The desirability of MVA applied to loans is thus questionable. Journal of Economic Literature Classification Numbers: G21, G28, M41.

Two-step selection methods are applied to the 1983 Survey of Consumer Finances to examine the extent to which borrowing constraints restrict household access to debt and the manner in which lenders vary debt limits across borrowers. Results indicate that 30% of young families are credit constrained, and that roughly half of these families would hold at least $12,000 (1982 dollars) more debt if borrowing constraints were relaxed. Debt limits increase with income and wealth, and are relaxed for families with a good credit history. In addition, minorities face tighter debt limits and are more likely to be credit constrained than white families. Journal of Economic Literature Classification Numbers: E51, J71, D12.

In an investigation of possible relationships between shareholder voting turnout, trading volume after the record data, and the intervals between the record and meeting dates, we find that higher trading volume and more trading days between the record date and the receipt of proxy materials both reduce voting turnout. A longer interval between the receipt of proxy materials and the meeting increases turnout, as does greater solicitation expense. Our tests show that management mails proxies further in advance of the meeting when its proposals require a majority of shares outstanding, as opposed to votes cast, for approval.

The greater the managerial stock ownership in closed-end funds, the larger are the discounts to net asset value. The average discount for funds with blockholders is 14%, whereas the average discount for funds without blockholders is only 4%. This relation is robust over time and to various model specifications that control for other factors that affect discounts. We argue that blockholders receive private benefits that do not accrue to other shareholders and that they veto open-ending proposals to preserve these benefits. We support this argument by documenting a range of potential private benefits received by blockholders in closed-end funds.