I am pleased to offer a comment on this very interesting article by an author who is always in the forefront of the research on empirical financial models. This article presents data analysis that estabishes the stylized facts about stock market volatility around market crashes. He concludes that volatility is high during periods of stock market decline and that it gradually returns to more normal levels. In the case of 1987, the peak was higher than usual and the decline was more rapid. The article uses 28,000 daily observations but does not really estimate a usable model; instead, it explores the data by estimating highly overparameterized models that reveal important features of the data. I suggest that this be considered an exploratory investigation and that in the face of more parsimonious models, rather interesting and somewhat different conclusions are revealed. The basic model estimated by Schwert is a 22-order autoregression of daily returns with a heteroskedastic error standard deviation which is itself assumed to be a 22-order autoregression in the absolute errors. Even with 28,000 observations, there is apparently a lot of noise in the coefficients. To allow for a risk premium, the mean is related to the variance, and in this case it is therefore related to 22 lagged absolute residuals. This part of the model uses 66 parameters. An alternative model is a first-order generalized autoregressive conditionally heteroskedastic model with variance influencing the mean [GARCH (l, l)-m], with a first-order moving average to correct for non-synchronous trading as used in Engle, Lilien, and Robins (1987), French, Schwert, and Stambaugh (1987), or Chou (1988), following the earlier work of Engle (1982). This requires only four coefficients! In the context of the parsimonious model, the parameter regulating the risk-return trade-off can be interpreted as the median agent’s taste for risk or his coefficient of relative-risk aversion. One naturally asks whether this parameter is constant over time, and we then recognize that the Schwert parameterization cannot answer the question

This paper provides a detailed examination of the cost imposed by thrift institutions resolved during the period 1980–1988. A simple model is presented to explain the cost of resolution. This model is tested empirically with a comprehensive data set that permits us to avoid some of the econometric problems present in earlier studies. The empirical evidence suggests that the model that explains resolution costs in the late 1980s is significantly different from the model for either the middle or early 1980s. This evidence is consistent with the changing nature of the thrift crisis and changes in the regulator's closure rule. Our econometric evidence, moreover, is consistent with the hypothesis that, for troubled institutions, tangible net worth systematically understates market-value net worth. In addition, the importance of including time effects as well as institution effects as determinants of the cost of resolution is revealed

This paper provides a detailed examination of the cost imposed by thrift institutions resolved during the period 1980-88. A simple model is presented to explain the cost of resolution. This model is tested empirically with a comprehensive data set that permits us to avoid some of the econometric problems present in earlier studies. The empirical evidence suggests that the model that explains resolution costs in the late 1980s is significantly different from the model for either the middle or early 1980s. This evidence is consistent with the changing nature of the thrift crisis and changes in the regulator's closure rule. Our econometric evidence, moreover, is consistent with the hypothesis that, for troubled institutions, tangible net worth systematically understates market-value net worth. In addition, the importance of including time effects as well as institution effects as determinants of the cost of resolution is revealed

This paper provides a detailed examination of the cost imposed by thrift institutions resolved during the period 1980–1988. A simple model is presented to explain the cost of resolution. This model is tested empirically with a comprehensive data set that permits us to avoid some of the econometric problems present in earlier studies. The empirical evidence suggests that the model that explains resolution costs in the late 1980s is significantly different from the model for either the middle or early 1980s. This evidence is consistent with the changing nature of the thrift crisis and changes in the regulator's closure rule. Our econometric evidence, moreover, is consistent with the hypothesis that, for troubled institutions, tangible net worth systematically understates market‐value net worth. In addition, the importance of including time effects as well as institution effects as determinants of the cost of resolution is revealed

The traditional view of the futures clearinghouse as an insurer that eliminates the need for customers to evaluate default risk is inaccurate. A clearinghouse member default in 1985 confirms that the clearinghouse only guarantees payment from member to member, not from customer to customer or member to customer. Thus, non‐defaulting customers are subject to losses as a result of the action of individuals with whom thay have no contractual obligations. This study models the behavior of customers choosing a futures commission merchant (FCM) given the current legal position of the clearinghouse. In a single‐period model with symmetric information, customers can eliminate their exposure to defaults of other customers or of their FCM only by choosing to trade through “boutique” (undiversified) FCMs. In practice, monitoring and rebalancing costs may impede the attainment of zero default risk. However, FCM diversification remains an important factor in customer choice of an FCM. When setting capital requirements, clearinghouses and government regulators need to consider the implications of diversification for both customer and market protection

There is gathering evidence of insider trading around corporate announcements of dividends, capital expenditures, equity issues and repurchases, and other capital structure changes. Although signaling models have been used to explain the price reaction of these announcements, a usual assumption made in these models is that insiders cannot trade to gain from such announcements. An innovative feature of this paper is to model trading by corporate insiders (subject to disclosure regulation) as one of the signals. Detailed testable predictions are described for the interaction of corporate announcements and concurrent insider trading. In particular, such interaction is shown to depend crucially on whether the firm is a growth firm, a mature firm, or a declining firm. Empirical proxies for firm technology are developed based on measures of growth and Tobin's q ratio. In the underlying “efficient” signaling equilibrium, investment announcements and net insider trading convey private information of insiders to the market at least cost . The paper also addresses issues of deriving intertemporal announcement effects from the equilibrium (cross‐sectional) pricing functional. Other announcement effects relate the intensity of the market response to insider trading, variance of firm cash flows, risk aversion of the insiders, and characteristics of firm technology (growth, mature, or declining

This paper compares the disclosures firms would seek to make voluntarily with mandated disclosures in a single period, multi-firm model, in which there are covariances between firms' cash flows. This comparison is important because, in those circumstances in which the two types of disclosure coincide, it is possible to economize on the process of setting mandatory disclosures. The principal factors which contribute to the existence or absence of a correspondence between mandatory and voluntary disclosures are (1) the nature of the externality associated with a firm's disclosure, (2) the relation between the risk preferences of the shareholders of the firms making the disclosures and outside investors, (3) how much relative weight is placed on existing shareholders and outside investors' preferences in the social welfare function determining the optimal mandatory disclosure policy, and (4) the covariance structure between firms' cash flows. T | nHIS paper compares the disclosure policies that firms select voluntarily with the policies an accounting standards board or other regulatory body would mandate to maximize social welfare. This comparison is important because of the considerable resources devoted to developing accounting standards and related disclosure requirements. When an accounting standards I wish to thank Mike Fishman, Steve Hansen, Bill Kinney, Bob Magee, and seminar participants at the University of Minnesota for helpful comments on a previous draft, and the Accounting Research Center at Northwestern University for financial support. I especially want to thank Jerry Feltham (a referee) and an anonymous referee. They contributed significantly by extending some results and, in several instances, proposing (and proving) important additional results. Manuscript received August 1987. Revisions received June 1988 and December 1988. Accepted July 1989. This content downloaded from 207.46.13.129 on Sat, 25 Jun 2016 06:03:27 UTC All use subject to http://about.jstor.org/terms 2 The Accounting Review, January 1990 board merely succeeds in mandating the disclosures which firms would adopt voluntarily, the resources used in setting the standards are wasted. By identifying a variety of situations in which mandatory and voluntary disclosures coincide, the paper provides some evidence for Beaver's (1977) proposal that promulgators of accounting standards should be obliged to provide explicit cost-benefit analyses to support the expansion of disclosure regulations. The claim that voluntary and mandatory disclosure requirements should be presumed to be the same, unless otherwise demonstrated, stands in contrast to much of the prevailing scholarly literature on the subject. Proponents of additional mandatory disclosures argue that information about firms' financial conditions constitutes a public good which will be under-provided without regulation. They also assert that firms will tend to suppress the disclosure of unfavorable information. I Opponents of regulation counter by arguing that managers have incentives to disclose information about the firms they run to differentiate themselves from more poorly run enterprises. This incentive, as well as the incentive of investors to obtain trading profits through costly search, are considered to provide sufficient motives for voluntary information production and disclosure so as to ensure a properly functioning securities' market.2 This paper does not directly contradict either of these views. The point made is that, in presenting these externality-based arguments for or against additional disclosures, one must differentiate between the various kinds of externalities that can arise. We consider two alternative types of externalities here, and financial. A disclosure by one firm is said to create a real externality for other firms if the disclosure alters those firms' cash flows. For example, the disclosure of a firm's trade secrets generates positive real externalities for its competitors. In contrast, a disclosure by one firm generates only financial externalities on other firms if the disclosure has the potential of altering the equilibrium prices of those firms without altering the actual distributions of their cash flows. Financial externalities arise when one firm's disclosures affect only investors' perceptions of the distributions of other firms' cash flows. For example, disclosures by one firm in an industry may alter investors' beliefs about the profitability of other firms in the same industry, and thereby change their market values (Foster 1981). Mandatory and voluntary disclosure policies do not always coincide when disclosures generate only financial externalities. Shareholders' attitudes toward risk, shareholders' relative weights in the social welfare function defining the optimal mandatory disclosure policy, and the covariance structure between firms' cash flows can all affect whether voluntary and mandatory disclosure policies coincide. However, there are a variety of circumstances in which these distinctly motivated disclosure policies do coincide when financial externalities alone exist. These disclosure issues are studied using a *snap-shot of an overlapping generations model (Samuelson 1958; Dye 1988) in which one generation of I See, for example, Beaver (1977,1981) or Gonedes and Dopuch(1974) forasummary of these efficiency arguments for and against regulated disclosures. 2 For example, Hirshleifer (1971), Demski (1974), and Wilson (1975) illustrate the possibility of excessive information production by private parties. This content downloaded from 207.46.13.129 on Sat, 25 Jun 2016 06:03:27 UTC All use subject to http://about.jstor.org/terms Dye-Mandatory Versus Voluntary Disclosures 3 shareholders is forced by life-cycle considerations to sell its firms to the next generation of shareholders before the firms' cash flows are realized. Because of this forced-sale assumption, the first generation of shareholders cannot directly share in the risk of the firms' cash flows with the second generation of shareholders. However, they indirectly share in this risk by participating in the stock market on which shares are transferred from one generation to the next. Disclosure policies matter here because disclosures affect the perceived riskiness of the securities when the exchange of shares takes place, and so disclosure policies affect risk-sharing between the two generations of shareholders. This paper builds upon Demski (1973, 1974) who showed that (1), in general, rankings of information systems may not be complete, and (2) the selection among financial reporting systems may have redistributive consequences. These papers indicate that progress in comparing financial reporting systems depends on identifying more restricted settings where such rankings are viable. The present paper pursues this line of inquiry and reveals the following: in many contexts where comparisons of information systems are most easily made-where only financial externalities are present-mandated disclosures are superfluous, because the optimal mandated disclosures simply coincide with firms' voluntary disclosure decisions. Where comparisons of information systems are most difficult-where real externalities are present-optimal mandatory and equilibrium voluntary disclosure tend to diverge. The paper proceeds as follows. Section I outlines the basic model. Section II provides the preliminary analysis, by studying the disclosures which representative market participants with common objectives make. Sections III and IV, respectively, study disclosures with financial and real externalities. Section V concludes the paper. I. Model Description for Disclosures with Financial Externalities The basic chronology of events corresponding to this model of disclosure requirements is summarized in the following time line: Entrepreneurs Entrepreneurs Security market Investors learn (indexed by choose disclosures opens; entrepreneurs realized values (i) =1. . .,n) own all policies (ri), and sell their firms of cash flows. firms. Firm i's cash produce information (at prices P) flows, denoted 2, (x,) according to the to investors. are distributed disclosure policies ( .ll ... * , I they select. ~-N(jA,). Priors on

[In this study I reexamine the impact of merger accounting method by using a sample of tax-free mergers drawn from a different time period and using more refined cumulative average residual (CAR) methodology. As in the Hong et al. study, the purchase method sample exhibits significant positive CARs over the entire period, which appear to originate in the interval preceding the announcement. The pooling method sample does not generate any significant residuals or CARs. To identify variables for which merger accounting method may be proxying, covariance analysis is used to determine that variables omitted from the capital asset pricing model (CAPM) do not influence the abnormal returns. Furthermore, probit analysis is used to investigate potential indirect cash-flow effects such as managerial income manipulation. A positive relationship between leverage and income-reducing policies is observed. This suggests that firms with high financial risk (leverage) may prefer purchase accounting to reduce reported earnings and regulators' attention. Tax characteristics of the acquired firms (net operating loss and investment tax credit carryforwards) are also examined as they can result in indirect cash-flow effects, such as reduced postmerger corporate income taxes. The limited data available indicate that tax factors have little impact on the CARs. Finally, a variable representing the relative bargaining strengths of the merging firms is tested for association with accounting method used. A statistically significant relationship is observed, and two implications follow from this result: (1) acquiring firms in a strong bargaining position are more likely to use the purchase method, and (2) as the bargaining strength of the acquiring firm decreases, the consideration given to the target firm increases while the magnitude of the CARs decreases. The contributions of the study are as follows. First, the abnormal returns to tax-free purchase method mergers, first observed by Hong et al., are found to persist and appear to originate during the preannouncement period. Second, other CAPM-omitted variables do not appear to influence these results. Finally, two tests of the association between potential indirect cash-flow effects and the CARs are significant and provide a partial explanation for the observed abnormal returns

[Auditors and regulators claim that low balling (when an auditor prices the initial audit below his or her costs) occurs in the audit market and impairs audit quality. This paper uses the experimental economics methodology to examine the economic rationale for such a practice and to test the hypothesis of low balling under different conditions of transaction costs. Assuming competitive markets, cost advantages are predicted to accrue to the incumbent auditor when transaction costs are positive. In this setting, auditors would low ball in the initial engagement, and would earn client-specific quasi-rents in subsequent engagements. Competition in the market ensures that the auditor earns from any particular client "zero" cumulative profits over time. That is, the loss incurred in the initial engagement exactly offsets the total profits earned in subsequent periods. The method of testing the low-balling hypothesis consists of six controlled laboratory market experiments. In these markets, numerous buyers and sellers form single-period contracts using a sealed-offer institution extending over a two-period trading year. Each market consists of 17 independently repeated two-period years. Two markets possess zero transaction costs, while the other four markets contain varying levels of positive transaction costs. The results are consistent with low-balling behavior and predictions. Low balling is not observed in markets with no transaction costs; i.e., sellers do not price below their costs. In this case, seller profits per year are zero and incumbent sellers are not retained by buyers in Period 2 of a trading year. In the positive transaction cost markets, low balling occurs (sellers set Period 1 prices below their costs) and incumbent sellers in Period 2 charge prices that earn them positive profits for the period. Period 2 (Period 1) prices are at (approaching) predicted levels. Seller profits for a two-period year are generally zero, implying that Period 1 losses are offset by Period 2 profits. Additionally, the incumbent seller is retained by buyers in the second period of a given trading year. Overall, the results of this study support low-balling behavior and suggest that positive transaction costs might be the cause. This study also establishes a framework that can be expanded to investigate other phenomena such as auditor quality