Knowledge that Transforms

We study a relatively recent change in voluntary disclosure practices by management, namely, the issuance of cash flow forecasts. We predict and find that management issues cash flow forecasts to signal good news in cash flow, to meet investor demand for cash flow information, and to precommit to a certain composition of earnings in terms of cash flow versus accruals, thus reducing the degree of freedom in earnings management. Our results also suggest that management discloses good news in cash flow to mitigate the negative impact of bad news in earnings, to lend credibility to good news in earnings, and to signal economic viability when the firm is young. Our finding that management cash flow forecasts primarily convey good news is in contrast to the generally negative nature of management earnings guidance and suggests that different incentives drive firms' disclosure of different financial information.

This study examines Statement of Financial Accounting Standards 142 adoption decisions, focusing on the trade‐off between recording certain current goodwill impairment charges below the line and uncertain future impairment charges included in income from continuing operations. We examine several potentially important economic incentives that firms face when making this accounting choice. We find evidence suggesting that firms' equity market concerns affect their preference for above‐the‐line vs. below‐the‐line accounting treatment, and firms' debt contracting, bonus, turnover, and exchange delisting incentives affect their decisions to accelerate or delay expense recognition. Our study contributes to the accounting choice literature by examining managers' use of discretion when adopting a mandatory accounting change and by developing and testing explicit cross‐sectional hypotheses of the determinants of firms' preferences for immediate below‐the‐line versus delayed above‐the‐line expense recognition.

In this paper we investigate a firm's decision to redact proprietary information from its material contract filings. Information redaction results when the Security and Exchange Commission (SEC) grants a firm's request to withhold information from investors in its material contract filings, presumably because the information is proprietary. We hypothesize that when firms redact information, measures of adverse selection deteriorate. That is, the redaction of proprietary information from material contracts should be associated with: a larger adverse selection component of the bid‐ask spread, reductions in market depth, and lower market turnover. In addition, we conjecture that the decision to redact depends on whether the firm plans on raising capital, the competitiveness of the firm's industry, and the performance of the firm. Overall the results of our analysis generally support our predictions. We find that when firms redact information, contemporaneous measures of the adverse selection component of the bid‐ask spread rise, and market depth and share turnover deteriorate; this suggests an increase in adverse selection. We also find firms are less likely to redact when they issue long‐term debt and are more likely to redact when they are in a competitive industry or experience losses.

We compare executive equity incentives of firms accused of accounting fraud by the Securities and Exchange Commission (SEC) during the period 1996–2003 with two samples of firms not accused of fraud. We measure equity incentives in a variety of ways and employ a battery of empirical tests. We find no consistent evidence that executive equity incentives are associated with fraud. These results stand in contrast to assertions by policy makers that incentives from stock-based compensation and the resulting equity holdings increase the likelihood of accounting fraud.

Accounting conservatism allows me to identify a previously undocumented source of predictable cross‐sectional variation in Standardized Unexpected Earnings' autocorrelations viz. the sign of the most recent earnings realization and present evidence that the market ignores this variation (“loss effect”). It is possible to earn returns higher than from the Bernard and Thomas (1990) strategy by incorporating this feature. Additionally, the paper shows that the “loss effect” is different from the “cross quarter” effect shown by Rangan and Sloan (1998) and it is possible to combine the two effects to earn returns higher than either strategy alone. Thus, the paper corroborates the Bernard and Thomas finding that stock prices fail to reflect the extent to which quarterly earnings series differ from a seasonal random walk and extends it by showing that the market systematically underestimates time‐series properties resulting from accounting conservatism.

This paper studies the accounting treatment of uncertainty and how it affects a firm's capital structure. We distinguish two sources of uncertainty that raise reliability concerns: inherent uncertainty and incentive uncertainty. By inherent uncertainty, we refer to uncertainty about the quality of raw information regarding future cash flows. By incentive uncertainty, we refer to uncertainty about the quality of accounting numbers conveying the raw information. We explore features of accounting that can effectively deal with these two types of uncertainties in order to aid in the debt-equity decision of the firm. To handle inherent uncertainty, preferable accounting involves flexible revenue/expense recognition rules that recognize more profit when the uncertainty level is low. To deal with incentive uncertainty, a stringent revenue/expense recognition rule may be desirable to fend off management's opportunistic reporting behavior. Inflexible accounting rules cause a firm's financing choices to deviate from what would hold with complete information. Given any accounting rule, an information environment with a lower (higher) uncertainty regarding future cash inflows leads to higher (lower) expected debt financing. This is because assessed default risk is increasing in the uncertainty of future cash inflows, holding the uncertainty of the outflows constant.

The sensitivity of Bayesian implementation to agents' beliefs about others suggests the use of more robust notions of implementation such as ex post implementation, which requires that each agent's strategy be optimal for every possible realization of the types of other agents. We show that the only deterministic social choice functions that are ex post implementable in generic mechanism design frameworks with multidimensional signals, interdependent valuations, and transferable utilities are constant functions. In other words, deterministic ex post implementation requires that the same alternative must be chosen irrespective of agents' signals. The proof shows that ex post implementability of a nontrivial deterministic social choice function implies that certain rates of information substitution coincide for all agents. This condition amounts to a system of differential equations that are not satisfied by generic valuation functions.

We characterize dominant-strategy incentive compatibility with multidimensional types. A deterministic social choice function is dominant-strategy incentive compatible if and only if it is weakly monotone (W-Mon). The W-Mon requirement is the following: If changing one agent's type (while keeping the types of other agents fixed) changes the outcome under the social choice function, then the resulting difference in utilities of the new and original outcomes evaluated at the new type of this agent must be no less than this difference in utilities evaluated at the original type of this agent.

Most theoretical or applied research on repeated games with imperfect monitoring has focused on public strategies: strategies that depend solely on the history of publicly observable signals. This paper sheds light on the role of private strategies: strategies that depend not only on public signals, but also on players' own actions in the past. Our main finding is that players can sometimes make better use of information by using private strategies and that efficiency in repeated games can be improved. Our equilibrium private strategy for repeated prisoners' dilemma games consists of two states and has the property that each player's optimal strategy is independent of the other player's state.

Most applications of Nash bargaining over wages ignore between-employer competition for labor services and attribute all of the workers' rent to their bargaining power. In this paper, we write and estimate an equilibrium model with strategic wage bargaining and on-the-job search and use it to take another look at the determinants of wages in France. There are three essential determinants of wages in our model: productivity, competition between employers resulting from on-the-job search, and the workers' bargaining power. We find that between-firm competition matters a lot in the determination of wages, because it is quantitatively more important than wage bargaining à la Nash in raising wages above the workers' “reservation wages,” defined as out-of-work income. In particular, we detect no significant bargaining power for intermediate- and low-skilled workers, and a modestly positive bargaining power for high-skilled workers.