Knowledge that Transforms

We investigate the role that regulatory strictness plays on the enforcement of financial reporting transparency in the U.S. banking industry. Using a novel measure of regulatory strictness in the enforcement of capital adequacy, we show that strict regulators are more likely to enforce restatements of banks' call reports. Further, we find that the effect of regulatory strictness on accounting enforcement is strongest in periods leading up to economic downturns and for banks with riskier asset portfolios. Overall, the results from our study indicate that regulatory oversight plays an important role in enforcing financial reporting transparency, particularly in periods leading up to economic crises. We interpret this evidence as inconsistent with the idea that strict bank regulators put significant weight on concerns about the potential destabilizing effects of accounting transparency.

Drawing on the political theory of judicial decision making, our paper proposes a new and parsimonious ex ante litigation risk measure: federal judge ideology. We find that judge ideology complements existing measures of litigation risk based on industry membership and firm characteristics. Firms in liberal circuits (the third quartile in ideology) are 33.5% more likely to be sued in securities class action lawsuits than those in conservative circuits (the first quartile in ideology). This result is stronger after the U.S. Supreme Court's ruling in the Tellabs case. We next show that the effect of judge ideology on litigation risk is greater for firms with more sophisticated shareholders and with higher expected litigation costs. Furthermore, judicial appointments affect litigation risk and the value of firms in the circuit, highlighting the economic consequences of political appointments of judges. Finally, using our new measure, we document that litigation risk deters managers from providing long‐term earnings guidance, a result that existing measures of litigation risk cannot show.

We use a large pictorial sample of Chinese financial analysts to test the association between facial width‐to‐height ratio ( fWHR ) and performance in men. Financial analysts offer an ideal setting for our investigation because we can objectively track individual analysts’ behaviors and performance. We find that high‐ fWHR analysts are more likely to conduct corporate site visits and they exhibit better performance. The positive fWHR –performance association survives a battery of robustness checks and the association is more pronounced for analysts with lower status, for firms with higher uncertainty, and for analysts facing more intense competition. Our results suggest that the dominant trait predicted by fWHR is achievement drive.

We commemorate the 50th anniversary of Ball and Brown [1968] by chronicling its impact on capital market research in accounting. We trace the evolution of various research paths that post–Ball and Brown [1968] researchers took as they sought to build on the foundation laid by Ball and Brown [1968] to create a body of research on the usefulness, timeliness, and other properties of accounting numbers. We discuss how those paths often link back to the groundwork laid and questions originally posed in Ball and Brown [1968].

We ask whether credit rating agencies receive higher fees and gain greater market share when they provide more favorable ratings. To investigate this question, we use the 2010 rating scale recalibration by Moody's and Fitch, which increased ratings absent any underlying change in issuer credit quality. Consistent with prior research, we find that the recalibration allowed the clients of Moody's and Fitch to receive better ratings and lower yields. We add to this evidence by showing that the recalibration also led to larger fees and to increases in the market shares of Moody's and Fitch. These results are consistent with critics’ concerns about the effects of the issuer‐pay model on the credit ratings market.

We analyze financial markets in which agents face differential constraints on the set of assets in which they can trade. In particular, the assets available to each agent span a partition of the state space that can be strictly coarser than the partition spanned by the assets available in the market. We first show that the existence of differential constraints has an impact on prices and allocations as compared to a complete financial market with unconstrained agents. We consider the implications for survival, taking the work of Blume and Easley (2006) as a starting point. We show that whenever agents have identical correct beliefs and equal discount factors, and their partitions are nested, all agents survive. When agents have heterogeneous beliefs, differential constraints may allow agents with wrong beliefs to survive. Provided constraints are relevant (in a sense we define more precisely), the condition for an agent to survive is that his survival index is at least as large as that of the agents with finer partitions. We also study the impact of deregulation (an increase in the set of assets available to some agents). Unless the agent can adopt beliefs that are closer to the truth on the newly refined partition than those of less constrained agents, increasing his opportunities for trade might harm his chances for survival.

A general selection theorem is presented constructing a measurable mapping from a state space to a parameter space under the assumption that the state space can be decomposed as a collection of countable equivalence classes under a smooth equivalence relation. It is then shown how this selection theorem can be used as a general purpose tool for proving the existence of measurable equilibria in broad classes of several branches of games when an appropriate smoothness condition holds, including Bayesian games with atomic knowledge spaces, stochastic games with countable orbits, and graphical games of countable degree—examples of a subclass of games with uncountable state spaces that we term purely atomic games. Applications to repeated games with symmetric incomplete information and acceptable bets are also presented.

We revisit the Nash bargaining model and axiomatize a procedural solution that maximizes the probability of successful bargaining. Our characterization spans several known solution concepts, including the special cases of the Nash, egalitarian, and utilitarian solutions. Using a probability‐based language, we offer a natural interpretation for the product operator underlying the Nash solution: when the bargainers' individual acceptance probabilities are independent, their product recovers the joint acceptance probability.

We study economies in which agents face Knightian uncertainty about state prices. Knightian uncertainty leads naturally to nonlinear expectations. We introduce a corresponding equilibrium concept with sublinear prices and prove that equilibria exist under weak conditions. In general, such equilibria lead to Pareto inefficient allocations; the equilibria coincide with Arrow-Debreu equilibria only if the values of net trades are ambiguity-free in the mean. In economies without aggregate uncertainty, inefficiencies are generic. We introduce a constrained efficiency concept, uncertainty-neutral efficiency, equilibrium allocations under price uncertainty are efficient in this constrained sense. Arrow-Debreu equilibria turn out to be non-robust with respect to the introduction of Knightian uncertainty.

We define and investigate a property of mechanisms that we call “strategic simplicity,” and that is meant to capture the idea that, in strategically simple mechanisms, strategic choices require limited strategic sophistication. We define a mechanism to be strategically simple if choices can be based on first‐order beliefs about the other agents' preferences and first‐order certainty about the other agents' rationality alone, and there is no need for agents to form higher‐order beliefs, because such beliefs are irrelevant to the optimal strategies. All dominant strategy mechanisms are strategically simple. But many more mechanisms are strategically simple. In particular, strategically simple mechanisms may be more flexible than dominant strategy mechanisms in the bilateral trade problem and the voting problem.