People exaggerate the degree to which their future tastes will resemble their current tastes. We present evidence from a variety of domains which demonstrates the prevalence of such projection bias, develop a formal model of it, and use this model to demonstrate its importance in economic environments. We show that, when people exhibit habit formation, projection bias leads people to consume too much early in life, and to decide, as time passes, to consume more—and save less—than originally planned. Projection bias can also lead to misguided purchases of durable goods. We discuss a number of additional applications and implications.

Environmental regulation in the United States has undergone a slow evolution from command and control strategies towards market-based regulations. One such innovation is the Toxics Release Inventory (TRI), a regulation that requires polluting firms to publicly disclose information about their toxic emissions. The basic tenet of this regulation is that it corrects for informational asymmetries between polluters and households, allowing communities to pressure polluters to decrease their emissions. Policy-makers have judged the TRI a tremendous success, as national releases declined by 43% between 1988 and 1999. Yet many of the fundamental problems which are known to lead to the classic failure of the Coase theorem (such as high transaction costs and difficulties in organizing) cast doubt on the effectiveness of disclosure rules, alone, to lead to an efficient outcome in the case of pollution. We use an event study methodology with high-quality data on house prices and other local attributes to assess the extent to which the public values changes in toxic releases and thus the success of TRI. Our major findings include: (1) declines in toxic releases appear unrelated to any political economy variables that might lead to public activism; (2) initial information released under TRI had no significant effect on the distribution of house prices; and (3) house prices show no significant impact of declines in reported toxic releases over time. Standard errors are small enough that we can reject the hypothesis that large declines in toxic releases lead to more than a 0.5% increase in house prices. These results also hold when we control for differences in the availability of information on TRI and the possible effect of expectations. Our findings cast doubt on the ability of the public to process complex information on hazardous emissions and support the Coase theorem in that right-to-know laws such as TRI may not be the most effective form of environmental regulation.

We model managers' equilibrium strategies for voluntarily disclosing information about their firm's risk. We consider a multifirm setting in which the variance of each firm's future cash flow is uncertain. A manager can disclose, at a cost, this variance before offering the firm for sale in a competitive stock market with risk-averse investors. In our partial disclosure equilibrium, managers voluntarily disclose if their firm has a low variance of future cash flows, but withhold the information if their firm has highly variable future cash flows. We establish how the manager's discretionary risk disclosure affects the firm's share price, expected stock returns, and beta, within the framework of the Capital Asset Pricing Model. We show that whereas one manager's discretionary disclosure of his firm's risk does not affect other firms' share prices, it does affect the other firms' betas. Also, we demonstrate that a disclosing firm has lower risk premium and beta ex post than a nondisclosing firm. Finally, we show that ex ante, the expected risk premium and expected beta of each firm are higher under a mandatory risk disclosure regime than in the partial disclosure equilibrium that arises under a voluntary disclosure regime.

This paper empirically analyzes bidding behavior and information asymmetries of stock auctions using a discriminatory auction model framework. Analyzing stock auctions using auction theory is important because it provides a logical framework for explaining observable behaviors and a solid foundation for empirical testing. Because of limited availability of stock auction data, existing empirical research based on auction theory focus mainly on treasury auctions. Away from the treasury markets, however, there is a significant paucity of literature on this subject. In this study, we make use of a detailed stock auction data set from the Taiwan Stock Exchange to empirically examine the behaviors of the Taiwan stock auction market within the framework of the auction theory. Our results show that the level of competition, the dispersion of opinion among bidders, and the bidder’s risk aversion are significant in determining auction prices. Results also show that if the offering prices are set equal to the average offering prices, the first-day post-initial public offering abnormal return will be equal to zero. Additionally, we find institutional bidders possess superior bidding skills compared to small bidders and that underwriter’s characteristics influence the bidding results.

We examine the link between the excess value of a diversified firm and the value of its internal capital market. Subsidies to small financially constrained segments with good relative investment opportunities significantly increase excess value, while transfers of resources from segments with good relative investment opportunities significantly decrease excess value. Of interest is that subsidies to small financially constrained segments with poor relative investment opportunities also significantly increase excess value. However, there is little evidence that this result depends on the diversity of a firm's investment opportunities. We conclude that financing constraints drive the relationship between the internal capital market and firm value.

In this paper, we examine the relative efficiency of audit production by one of the then Big 6 public accounting firms for a sample of 247 geographically dispersed audits of U.S. companies performed in 1989. To test the relative efficiency of audit production, we use both stochastic frontier estimation (SFE) and data envelopment analysis (DEA). A feature of our research is that we also test whether any apparent inefficiencies in production, identified using SFE and DEA, are correlated with audit pricing. That is, do apparent inefficiencies cause the public accounting firm to reduce its unit price (billing rate) per hour of labor utilized on an engagement? With respect to results, we do not find any evidence of relative (within‐sample) inefficiencies in the use of partner, manager, senior, or staff labor hours using SFE. This suggests that the SFE model may not be sufficiently powerful to detect inefficiencies, even with our reasonably large sample size. However, we do find apparent inefficiencies using the DEA model. Audits range from about 74 percent to 100 percent relative efficiency in production, while the average audit is produced at about an 88 percent efficiency level, relative to the most efficient audits in the sample. Moreover, the inefficiencies identified using DEA are correlated with the firm's realization rate. That is, average billing rates per hour fall as the amount of inefficiency increases. Our results suggest that there are moderate inefficiencies in the production of many of the subject public accounting firm's audits, and that such inefficiencies are economically costly to the firm.

We find that institutional ownership concentration is positively related to the pay‐for‐performance sensitivity of executive compensation and negatively related to the level of compensation, even after controlling for firm size, industry, investment opportunities, and performance. These results suggest that the institutions serve a monitoring role in mitigating the agency problem between shareholders and managers. Additionally, we find that clientele effects exist among institutions for firms with certain compensation structures, suggesting that institutions also influence compensation structures through their preferences.

Although institutional investors have a preference for large capitalization stocks, over time they have shifted their preferences toward smaller, riskier securities. These changes in aggregate preferences have arisen primarily from changes in the preferences of each class of institution, rather than changes in the importance of different classes. Evidence also suggests that recent growth in institutional investment combined with this shift in preferences helps explain why markets in general, and smaller stocks in particular, have exhibited greater firm-specific risk and liquidity in recent years. Additional analyses suggest that institutional investors moved toward smaller securities because such securities offer “greener pastures.”

The Interaction of Public Retirement Income Programs in the United States by Elizabeth T. Powers and David Neumark. Published in volume 93, issue 2, pages 261-265 of American Economic Review, May 2003

In this paper, we examine specific process gains and losses arising from the review process by considering the interaction between attributes of the preparer and attributes of the reviewer. Specifically, we investigate determinants of reviewers' performance in the presence of potential stylization attempts by audit workpaper preparers. We assess whether reviewers' detection of conclusion errors and documentation errors depends on three factors: nature of the preparer's stylization (by way of the preparer's differential emphasis on conclusion and documentation errors), auditor rank, and the reviewer's sensitivity to such stylization attempts. Our results show that, depending on the reviewers' stylization sensitivity, their cognitive templates can both facilitate and interfere with reviewers' effectiveness in responding to these stylization attempts, resulting in both potential gains and losses from the review process. Our paper identifies conditions related to whether and how reviewers can provide adaptive responses to stylization attempts, and demonstrates that conclusions about rankrelated performance differences in the review process should consider complex interactions between attributes of the reviewer and the preparer. Implications are discussed.