In an attempt to explain the weak evidence of priced exchange rate risk, we hypothesize that in addition to currency derivative usages, earnings management serves as another factor contributing to a reduction in exchange rate exposure. Our evidence reveals that earnings management activities, particularly those undertaken for the purpose of income smoothing, significantly reduce firm-specific exchange rate exposure, and that such role is particularly important if appropriate currency derivative instruments are limited. These results complement prior attempts to explain the puzzle of unpriced exchange rate risk. The investigation also highlights the importance of recognizing different managerial purposes behind discretionary accruals.

Recently, several behavioral finance models based on the overconfidence hypothesis have been proposed to explain anomalous findings, including a short-term continuation (momentum) and a long-term reversal in stock returns. We characterize the overconfidence hypothesis by the following four testable implications: First, if investors are overconfident, they overreact to private information and underreact to public information. Second, market gains make overconfident investors trade more aggressively in subsequent periods. Third, excessive trading of overconfident investors in securities markets contributes to the observed excessive volatility. Fourth, overconfident investors underestimate risk and trade more in riskier securities. To document the presence of overconfidence in financial markets, we empirically evaluate these four hypotheses using aggregate data. Overall, we find empirical evidence in support of the four hypotheses.

The idea that the happiness of an individual depends upon the consumption of others is widely viewed as an important feature of our shared social existence. Recent research in finance has used this idea, through consumption externalities, to explore asset-pricing anomalies. Consumption externalities potentially break the link between Pareto optimality and competitive equilibria and open the door for beneficial government intervention (e.g., Lars Ljungqvist and Harald Uhlig, 2000). In this paper, we delineate two effects that a consumption externality may have. An increase in aggregate consumption may: (a) raise the marginal utility of individual consumption relative to leisure, and/or (b) lower an individual’s utility level. We refer to (a) as “keeping up with the Joneses” (henceforth, KUJ), following Jordi Gali (1994), and we refer to (b) as jealousy. Jealousy is a distinct concept from KUJ. Under KUJ, an individual derives greater utility from additional own consumption relative to leisure when others consume more. At the same time, higher per capita consumption holding fixed individual consumption can trigger either jealousy, so that individual utility falls, or admiration, so that individual utility rises. In Section I of this paper, we show that jealousy implies that the laissez-faire equilibrium consumption level is greater than the optimal level. Whether preferences exhibit KUJ is not necessary for this main result. Intuitively, in the presence of jealousy, consumption is similar to pollution. Overpollution exists because individuals do not take into account the cost of polluting on others, not because an increase in economywide pollution makes the return to individual polluting higher. Similarly, overconsumption exists because individuals do not take into account the negative effect of own consumption on jealous others. Things go in the opposite direction when individuals are admiring. In Section II, we consider a functional form that encompasses several existing models. We show that jealousy determines the optimal tax to correct overconsumption and that KUJ is mainly important for asset pricing.

We provide time-series and cross-sectional evidence on the significance of a risk-return tradeoff in the bond and equity markets. We find a significantly positive intertemporal relation between expected return and risk in the bond market. We also propose novel measures of systematic and idiosyncratic risk for individual corporate bonds and find a significantly positive cross-sectional relation between systematic risk and expected bond returns, whereas there is no significant link between idiosyncratic risk and future bond returns. We provide an explanation for the significance of systematic (idiosyncratic) risk based on different investor preferences and informational frictions in the bond (equity) market.

Long-term reversals in corporate bonds are economically and statistically significant in a comprehensive sample spanning the period 1977 to 2017. Such reversals are stronger for bonds with high credit risk and more binding regulatory, capital, and funding liquidity constraints. Bond long-term reversal is not a manifestation of the equity counterpart and is mainly driven by long-term losers. A long-term reversal factor carries a sizable premium and is not explained by long-established equity and bond market factors. Thus, past returns capture investors’ ex-ante risk assessment and the degree of institutional constraints they face, so losing bonds command higher expected returns.

We construct a dynamic multi-agent moral hazard model to analyze the interactions among the firm owner, the manager and the auditor. Moral hazard may arise in hierarchical agency because a rational monitoring agent may accept a side payment from the monitored agent for misrepresenting information to the principal. This multi-agent moral hazard problem is the essence of the concern for auditor independence. We show that a "low-balling" compensation scheme and the auditor's legal liability constitute an efficient dynamic contracting mechanism for hierarchical agency. In particular, low balling serves as a substitute for legal liabilities for maintaining auditor independence. Low balling reduces the transaction costs associated with the audit engagement relative to the flat-fee structure and can actually improve auditor independence.

The intergenerational earnings mobility of Canadians born to immigrants is examined using the 2001 Census. A detailed portrait of the Canadian population is offered as are estimates of the degree of generational mobility among the children of immigrants from seventy countries. The degree of intergenerational persistence is about the same for immigrants as for the entire population, and there is more generational mobility among immigrants in Canada than in the United States. We also use quantile regressions to distinguish between the role of social capital from other constraints limiting mobility and find that these are present.

In this paper, we investigate how the accounting measurement basis affects the capital market pricing of a firm's shares, which, in turn, affects the efficiency of the firm's investment decisions. We distinguish two broad bases for accounting measurements: input‐based and output‐based accounting. We argue that the structural difference in the two measurement bases leads to a systematic difference in the efficiency of the investment decisions. In particular, we show that an output‐based measure has a natural advantage in aligning investment incentives because of its comprehensiveness. The (first‐)best investment is achieved when the output‐based measure is noiseless and manipulation free. In addition, under an output‐based measure, more accounting noise/manipulation always leads to more inefficient investment choices. Therefore, if an output‐based accounting measure is highly noisy and easy to manipulate in practice, the induced investment efficiency can be quite low. On the other hand, an input‐based accounting measure, while not as comprehensive, may induce more efficient investment decisions than an output‐based measure if some noise is unavoidable in either measure. The reason is twofold. First, input‐based measures may be associated with less noise and limited manipulation in practice. Second, and more importantly, we show that under an input‐based measure, a slight increase in accounting noise/manipulation may lead to more efficient investment choices. In fact, the (first‐)best result is achieved when the noise/manipulability is small but positive. In other words, for an input‐based measure, being less comprehensive makes small but positive accounting noise/manipulability desirable. Two extensions of the basic model are also explored.