Abstract Standard Bayesians’ beliefs converge when they receive the same piece of new information. However, when agents initially disagree and have uncertainty about the precision of a signal, their disagreement might instead increase, despite receiving the same information. We demonstrate that this divergence of beliefs leads to a unimodal effect of the absolute surprise in the signal on trading volume. We show that this prediction is consistent with the empirical evidence using trading volume around earnings announcements of U.S. firms. We find evidence of elevated volume following moderate surprises and depressed volume following more extreme surprises, a pattern that is more pronounced when investors hold more distant prior beliefs and are more uncertain about earnings’ precision. The evidence is consistent with the model where investors disagree about stocks’ expected returns and do not know the precision of earnings as a signal about the firm’s value.

Although recent research documents a positive relation between corporate transparency and the proportion of independent directors, the direction of causality is unclear. We examine a regulatory shock that substantially increased board independence for some firms, and find that information asymmetry, and to some extent management disclosure and financial intermediation, changed at firms affected by this shock. We also examine whether these effects vary as a function of management entrenchment, information processing costs, and required changes to audit committee independence. Our results suggest that firms can alter their corporate transparency to suit the informational demands of a particular board structure.

The sensitivity of stock options' payoff to return volatility, or vega, provides risk-averse CEOs with an incentive to increase their firms' risk more by increasing systematic rather than idiosyncratic risk. This effect manifests because any increase in the firm's systematic risk can be hedged by a CEO who can trade the market portfolio. Consistent with this prediction, we find that vega gives CEOs incentives to increase their firms' total risk by increasing systematic risk but not idiosyncratic risk. Collectively, our results suggest that stock options might not always encourage managers to pursue projects that are primarily characterized by idiosyncratic risk when projects with systematic risk are available as an alternative.

We examine the relation between corporate governance and firms' information environments. We use the passage of state antitakeover laws in the U.S. as a source of exogenous variation in an important governance mechanism to identify changes in firms' information environments. We find that information asymmetry and private information gathering decreased and that financial statement informativeness increased following the passage of the antitakeover laws. Cross-sectional analyses indicate that the increased level of financial statement informativeness is attributable to firms that are most likely to access equity markets rather than managerial entrenchment, managerial career concerns, or managers' pursuit of the quiet life.

We use a proprietary data set with detailed executive compensation information to examine the relationship between the incentives of the tax director and GAAP and cash effective tax rates, the book-tax gap, and measures of tax aggressiveness. We find that the incentive compensation of the tax director exhibits a strong negative relationship with the GAAP effective tax rate, but little relationship with the other tax attributes. We interpret these results as indicating that tax directors are provided with incentives to reduce the level of tax expense reported in the financial statements.

ABSTRACT This paper examines when information asymmetry among investors affects the cost of capital in excess of standard risk factors. When equity markets are perfectly competitive, information asymmetry has no separate effect on the cost of capital. When markets are imperfect, information asymmetry can have a separate effect on firms’ cost of capital. Consistent with our prediction, we find that information asymmetry has a positive relation with firms’ cost of capital in excess of standard risk factors when markets are imperfect and no relation when markets approximate perfect competition. Overall, our results show that the degree of market competition is an important conditioning variable to consider when examining the relation between information asymmetry and cost of capital.

Abstract We study the extent to which creditors shape the executive bonus plans of their financially distressed borrowers. Financial distress can exacerbate agency conflicts between creditors and borrowers as concerns with underinvestment become more acute due to managerial myopia and debt overhang. Consequently, we expect creditors to exert their influence to ensure that these managers’ incentive-compensation plans encourage longer-term investments and directly reward outcomes that benefit creditors without exposing managers to unnecessary risk. We argue that bonus plans are an especially important way to provide these incentives because their flexibility allows creditors to more precisely target specific investment objectives. We find that borrowers’ bonus plans tend to have longer horizons and more convex payouts following covenant violations, especially when bonus plans can be a particularly effective way to address distress-related agency conflicts. Our evidence suggests that creditors protect their interests by exercising their control rights to shape their borrowers’ incentive-compensation plans.

ABSTRACT We examine the economic implications of digital traffic on firms’ financial performance, stock valuation, and financial surprises. Our analysis shows that timely flows of digital traffic are contemporaneous and leading indicators of firms’ revenue and profitability—both gross and operating. Moreover, we show that digital traffic contains novel information about firms’ future performance that is not entirely reflected in stock prices, analyst forecasts, or historical (i.e., time series) financial metrics. Notably, digital-traffic-based investment strategies are lucrative and generate substantial abnormal returns. Importantly, we also adduce evidence that corroborates our conjecture about the underlying economic mechanism that explains the valuation implications of digital traffic: These are driven by firms with consumer-oriented websites that facilitate sale transactions. Data Availability: Data are available from the sources cited in the text. JEL Classifications: E32; G32; O33.

Prior research argues that a manager whose wealth is more sensitive to changes in the firm׳s stock price has a greater incentive to misreport. However, if the manager is risk-averse and misreporting increases both equity values and equity risk, the sensitivity of the manager׳s wealth to changes in stock price (portfolio delta) will have two countervailing incentive effects: a positive “reward effect” and a negative “risk effect.” In contrast, the sensitivity of the manager׳s wealth to changes in risk (portfolio vega) will have an unambiguously positive incentive effect. We show that jointly considering the incentive effects of both portfolio delta and portfolio vega substantially alters inferences reported in prior literature. Using both regression and matching designs, and measuring misreporting using discretionary accruals, restatements, and enforcement actions, we find strong evidence of a positive relation between vega and misreporting and that the incentives provided by vega subsume those of delta. Collectively, our results suggest that equity portfolios provide managers with incentives to misreport when they make managers less averse to equity risk.

ABSTRACT We investigate whether differences in the mix of financial covenants in debt contracts (i.e., covenant heterogeneity) reflect—and provide a way for lenders to elicit, or screen—borrowers’ pre-contractual private information about their future risk profile. Consistent with adverse selection theories, we predict and find that borrowers with higher future risk negotiate loans with covenants that are less sensitive to performance, compared to borrowers with lower future risk. We differentiate between screening and incentive explanations for this finding and provide evidence that screening accounts for a substantial portion of this overall relation. Our study highlights how, in addition to shaping borrowers’ incentives through monitoring, covenant heterogeneity reflects borrowers’ future risk profiles and can help lenders screen accordingly. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G21; G32; G34.