The petrochemical industry employs assets subject to temporal and site specificity. The OPEC oil price shocks of the 1970s made it difficult to write contracts covering business dealings in the industry. I use this production and economic setting as a natural experiment to test transaction cost theory. In support of the theory, I find that input price uncertainty in the 1970s positively affected the extent of vertical integration by firms into input stages. Moreover, the positive reaction of vertical integration to price uncertainty mainly occurs in transactions subject to asset specificity. I also examine price controls and market power as alternative explanations for vertical integration in the industry, but fail to find support for these hypotheses.

John H. Evans III, Optimal Contracts with Costly Conditional Auditing, Journal of Accounting Research, Vol. 18, Studies on Economic Consequences of Financial and Managerial Accounting: Effects on Corporate Incentives and Decisions (1980), pp. 108-128

Accounting choices, Investment decisions, Investors

This paper examines the effect of managerial legal liability coverage on earnings conservatism. Using directors’ and officers’ (D&O) liability insurance coverage and cash for indemnification as a proxy for managerial legal liability coverage, we find that the higher the managerial liability coverage, which reduces the expected legal liability of managers, the less conservative the firm's earnings. We also find that managerial legal liability coverage has a stronger influence on earnings conservatism in a legal regime with higher litigation risk. Our results are consistent with the threat of litigation conditioning managers to practice conservative accounting.

We examine the effect of option listing on the immediate stock-price response to earnings announcements. Contrary to prior studies using earlier data, we find firms initiating option trading after 1986 fail to exhibit a significant decline in earnings response. We then examine 420 firms initiating option trading during 1973–1993. In a series of tests controlling for market-wide effects and changing firm size we find some evidence that option listing may actually increase the stock-price response to earnings, but no evidence listing reduces the response. Both longitudinal and cross-sectional tests produce similar results.

There are frequent expressions of concern in the accounting, economics, and legal literature about managers' conflicting duties and incentives in management buyouts. This study is motivated by a concern about the managerial incentive to reduce reported earnings prior to the announcement of the buyout proposal. Our analysis of a sample of 175 management buyouts during 1981-88 provides evidence of manipulation of discretionary accruals in the predicted direction in the year preceding the public announcement of management's intention to bid for control of the company.

I examine the capital expenditures of a sample of 700 takeover targets and firms that went private over the period 1972–1987. For the complete sample, I do not find evidence that takeover targets increase their capital expenditures over the four-year period before the acquisition or that they overinvest in capital expenditures relative to several benchmarks. Subsample results provide some evidence of overinvestment in oil and gas firms and large firms. There is no evidence of overinvestment, however, for firms acquired in a hostile takeover or firms that went private. In general, these results are not consistent with the conjecture that takeovers are motivated by the need to reduce excess investment in capital expenditures in target firms.

In this article we derive necessary and sufficient conditions that must be satisfied by equilibrium asset price processes in a pure exchange economy. We examine a world in which asset prices follow a diffusion process, asset markets are dynamically complete, all investors maximize their (state-independent) expected utility of consumption at some future date, and investors have nonrandom exogenous income. We show that it is necessary and sufficient that the coefficients of an equilibrium diffusion price process satisfy a partial differential equation and a boundary condition. We also examine how the dynamics of asset prices are related to the shape of the representative investor's utility function through the boundary condition. For example, in a constant-volatility economy, the expected instantaneous return of the market portfolio is mean reverting if and only if the relative risk aversion of the representative investor is decreasing in terminal wealth.