Major accounting firms in the United States have singled out elimination of joint and several liability as one of the most needed legal reforms in the country. The recent legislation of the Private Securities Litigation Reform Act of 1995 replaced joint and several liability with proportionate liability. This paper develops a simple model to analyze the economic consequences of such a change in the legal environment facing public accountants. In particular, we examine the incentive effects induced by the proportionate liability rule on the auditor's effort and financial statement users' litigation decisions. Our analysis demonstrates that replacing joint and several liability with proportionate liability can decrease the equilibrium audit effort, lawsuit probability, market price of the firm, and audit fee. More important, even though the proportionate liability rule reduces the equilibrium audit effort, we show that it can actually increase social welfare.

This paper presents a costly voluntary disclosure model in which the information quality of a signal about a firm’s future cash flow is unknown, where the information quality, also called signal quality, refers to signal precision. Disclosure plays a dual role in firm valuation, providing information about both the cash flow and signal quality. We identify a necessary and sufficient condition under which the firm price under disclosure is a nonmonotonic and bounded function of the signal. Under this condition, as the disclosure cost increases, the equilibrium changes from an intermediate pool of undisclosed signals to a low-end pool of undisclosed signals, to two disjoint pools of undisclosed signals, and finally to no disclosure. Our results remain qualitatively unchanged when the firm may or may not have private information. Overall, this study offers alternative explanations for the empirical findings of why some firms disclose (withhold) seemingly bad (good) news.

This paper presents a model in which investors price risk and a firm makes an investment to reduce its cash flow risk. Subsequently, the firm may or may not privately receive information about the future cash flow, whose disclosure is under its discretion. We show that the equilibrium cash flow precision increases with investor risk aversion, but decreases with the likelihood that the firm has private information and the quality of that information. In addition, the equilibrium probability of disclosure increases when the firm is more likely to have higher-quality private information, but it may increase or decrease when investor risk aversion increases. Using these comparative statics, we rationalize mixed empirical findings on the relation between risk and disclosure as equilibrium outcomes. The model is extended to a setting where the firm also makes an investment to increase the mean of its future cash flow.

This study provides evidence that managers' career concerns affect their earnings guidance decisions. We hypothesize that CEO s who are relatively more concerned about assessments of their abilities have stronger incentives to guide the market expectations of earnings downwards to increase the likelihood of meeting or beating the expectations. Consistent with this hypothesis, we find that (i) short‐tenured CEO s, CEO s promoted from inside the firm, and nonfounder CEO s are more likely to provide downward earnings guidance when they have bad news, and (ii) their downward guidance tends to be more conservative. In response, analysts revise earnings forecasts less for the downward guidance provided by more career‐concerned CEO s. This indicates that analysts rationally incorporate these CEO s' stronger incentives to be conservative in their earnings guidance. Consequently, we find that CEO s with greater career concerns are not more likely to beat the market expectations, even when they provide more conservative downward guidance.

A firm manager is concerned about both the firm value and the market assessments of his abilities. When investing in a project, he has private knowledge of his project-related ability that interacts with the project investment, and his general ability that produces a cash flow independent of the project cash flow. The concerns about the general (project-related) ability assessment create a signaling incentive to decrease (increase) investment. In the presence of underinvestment (overinvestment), higher-quality earnings information reduces (improves) equilibrium efficiency. When the manager issues an earnings forecast as an additional signaling device, the forecast is upwardly biased, and the equilibrium investment is smaller than that without a forecast. The latter is because the signaling incentive to decrease investment is strengthened. When the manager’s concerns about the general ability assessment are relatively large, he is better off by committing to no forecast. Novel empirical predictions about investment and earnings forecast emerge.