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.

We find a positive relationship between individual stocks’ implied variance asymmetry, defined as the difference between upside and downside risk-neutral semivariances extracted from out-of-money options, and future stock returns. The high-minus-low hedge portfolio earns the excess return of 0.90% (0.67%) per month in equal-weighted (value-weighted) returns. We show that implied variance asymmetry provides a neat measure of risk-neutral skewness and outperforms the standard risk-neutral skewness in predicting the cross-section of future stock returns. Risk-based equilibrium asset pricing models can not explain such a positive relationship, which instead can be potentially explained by information asymmetry and informed trading.

Based on a reduced-form model of credit risk, we explore mispricing in the credit default swaps (CDS) spreads of North American companies and its economic content. Specifically, we develop a trading strategy using the model to trade out of sample market-neutral portfolios across the term structure of CDS contracts. Our empirical results show that the trading strategy exhibits abnormally large returns, confirming the existence and persistence of a mispricing. The aggregate returns of the trading strategy are positively related to the square of market-wide credit and liquidity risks, indicating that the mispricing is more pronounced when the market is more volatile. When implemented on the Markit data, the strategy shows significant economic value even after controlling for realistic transaction costs.

We examine whether industry product market conditions are important in assessing the benefits and costs of chief executive officer (CEO) power. We find that firms are more likely to have powerful CEOs in high demand product markets where firms are facing entry threats. In these markets, investors react favorably to announcements granting more power to CEOs, and CEO power is associated with higher market value, sales growth, investment, advertising, and the introduction of more new products. Our results remain significant when addressing the endogeneity of CEO power by instrumenting CEO power with past non-CEO executive and director sudden deaths.

Despite the growth of Islamic banks (IBs), little is known about their liquidity creation performance and financial stability consequences relative to conventional banks (CBs). We address these issues using data from 24 countries over 2000–2014. We find IBs create more liquidity per unit of assets than CBs, primarily on the asset side of the balance sheet. Results are economically significant, econometrically robust, hold in high- and low-income countries, and during the Global Financial Crisis and other times. In addition, CB liquidity creation results in reduced national financial stability, particularly in high-income countries, whereas IB liquidity creation does not.

The best worker is not always the best candidate for manager. In these cases, do firms promote the best potential manager or the best worker in their current job? Using microdata on the performance of sales workers at 131 firms, we find evidence consistent with the Peter Principle, which proposes that firms prioritize current job performance in promotion decisions at the expense of other observable characteristics that better predict managerial performance. We estimate that the costs of promoting workers with lower managerial potential are high, suggesting either that firms are making inefficient promotion decisions or that the benefits of promotion-based incentives are great enough to justify the costs of managerial mismatch. We find that firms manage the costs of the Peter Principle by placing less weight on sales performance in promotion decisions when managerial roles entail greater responsibility and when frontline workers are incentivized by strong pay for performance.

We investigate an alternative economic channel of a positive relationship between risk and compensation, as documented by Cheng et al. (2015). We propose that when information asymmetry exists, firms generally seek to use compensation as a signal of their CEOs’ ability. The risks arising from information asymmetry tend to encourage firms to pay higher compensation to their CEOs in a pattern of financial incentives we call the “Lake Wobegon effect”. However, when individual firms pursue complete signaling, a higher equilibrium compensation level can be achieved. This paper explores the factors that give rise to the “Lake Wobegon effect” and the learning process by which this effect can be counterbalanced over time (Hayes and Schaefer, 2009).

Using the U.S. Securities and Exchange Commission's mandate of eXtensible Business Reporting Language (XBRL) as a natural experiment, this study investigates whether and how the decreased information‐processing costs brought about by XBRL influence firms’ breadth of share ownership. We find that the XBRL mandate is associated with an increase in the total number of a firm's shareholders. This finding is consistent with the notion that XBRL facilitates a more transparent environment and decreases information‐processing costs, thereby attracting more shareholders in general. More interestingly, we find that while XBRL adoption is associated with an increase in share ownership of individual and non‐U.S. foreign institutional investors, it is associated with a decrease in share ownership of U.S. domestic institutional investors. Further evidence shows that this asymmetric shift in share ownership is more pronounced for more complex firms. Our findings, taken together, suggest that the decreased information‐processing costs brought about by XBRL help firms establish a level playing field by reducing the information disadvantages of individual and foreign institutional investors over domestic institutional investors. Our results are robust to potential endogeneity concerns and alternative research designs.