We provide a model in which a single psychological constraint, limited attention, explains both under- and overreaction to different earnings components. Investor neglect of earn-ings induces post-earnings announcement drift and the profit anomaly. Neglect of earnings components causes accrual and cash flow anomalies. The model offers empirical implica-tions relating the strength of earnings-related anomalies to the forecasting power of current earnings-related information for future earnings, investor attentiveness, and the volatilities of and correlation between accruals and cash flows. We also show that, owing to atten-tion costs, in equilibrium not all investors choose to attend to earnings or its components. (JEL G12, G14, M41, M43) Market reactions to earnings and earnings components present a striking puzzle. Stock prices on average underreact to earnings surprises (post-earnings an-nouncement drift), but overreact to the operating accruals component of earn-ings.1 Earnings- and accruals-related patterns of return predictability are often referred to as “anomalies, ” “under- ” and “overreaction, ” or reflecting investor “optimism, ” “pessimism, ” or “naı̈veté. ” Such labels offer little guidance as to

[We find a positive association between short selling and accruals during 1988—2009, and that asymmetry between the up- and downsides of the accrual anomaly is stronger when constraints on short arbitrage are more severe (low availability of loanable shares as proxied by institutional holdings). Short arbitrage occurs primarily among firms in the top accrual decile. Asymmetry is present only on NASDAQ. Thus, there is short arbitrage of the accrual anomaly, but short-sale constraints limit its effectiveness.]

Following the dividend flexibility hypothesis used by DeAngelo and DeAngelo (2006), Blau and Fuller (2008), and others, we theoretically extend the proposition of DeAngelo and DeAngelo (2006) optimal payout policy in terms of the flexibility dividend hypothesis. In addition, we also introduce growth rate, systematic risk, and total risk variables into the theoretical model. To test the theoretical results derived in this paper, we use the data collected in the US from 1969 to 2009 to investigate the impact of the growth rate, systematic risk, and total risk on the optimal payout ratio in terms of the fixed-effect model. We find that based on flexibility considerations, a company will reduce its payout when the growth rate increases. In addition, we find that a nonlinear relationship exists between the payout ratio and the risk. In other words, the relationship between the payout ratio and the risk is negative (or positive) when the growth rate is higher (or lower) than the rate of return on total assets. Our theoretical model and empirical results can therefore be used to identify whether flexibility or the free cash flow hypothesis should be used to determine the dividend policy.

We examine the effect of directors' and officers' liability insurance (D&O insurance) on the outcomes of merger and acquisition (M&A) decisions. We find that acquirers whose executives have a higher level of D&O insurance coverage experience significantly lower announcement-period abnormal stock returns. Further analyses suggest that acquirers with a higher level of D&O insurance protection tend to pay higher acquisition premiums and their acquisitions appear to exhibit lower synergies. The evidence provides support for the notion that the provision of D&O insurance can induce unintended moral hazard by shielding directors and officers from the discipline of shareholder litigation.

We examine the empirical relevance of standard theories explaining the motivation of Seasoned Equity Offerings (SEOs) in the Chinese context. Analyzing Chinese SEOs during 1994–2008 and controlling for other factors reflecting features of Chinese corporate finance, we find that Chinese SEOs are mostly motivated by timing the market. Financing for investment and growth receives weak empirical support. We do not obtain any consistent evidence supporting both the tradeoff and the agency theories. In addition, we find that the firm’s SEOs behavior varies between rights issues and public offerings and across different periods along with the progress of China’s market transition. Our results show that Chinese listed firms in general behave similarly as their counterparts in other countries concerning SEOs decisions in that they issue SEOs when there are opportunities to take advantage of market overvaluation. These results are consistent with the well-documented convergence trend of corporate SEOs behavior of firms around the world. In addition, our findings challenge the conventional perception on Chinese SEOs that controlling shareholders use SEOs as a means to expropriate minority shareholders.

ABSTRACT We explicitly consider financial leverage in a simple equity valuation model and study the cross‐sectional implications of potential shareholder recovery upon resolution of financial distress. Our model is capable of simultaneously explaining lower returns for financially distressed stocks, stronger book‐to‐market effects for firms with high default likelihood, and the concentration of momentum profits among low credit quality firms. The model further predicts (i) a hump‐shaped relationship between value premium and default probability, and (ii) stronger momentum profits for nearly distressed firms with significant prospects for shareholder recovery. Our empirical analysis strongly confirms these novel predictions.

ABSTRACT Ex post trimming of extreme returns observations that are not data errors causes spurious inferences in tests of market efficiency and behavioral explanations for anomalies. Trimming causes a downward truncation bias in estimated mean returns that is stronger in ex ante subsamples with more loss firms and in which return distributions are more right-skewed. There is an asymmetric U-shaped relation between return right-skewness and loss frequency across deciles of negative return predictors (Accruals, ΔNOA, and NOA), and a downward sloping relationship for positive return predictors (CFO and FCF). Consequently, a least-trimmed square (LTS) 1 percent deletion of returns induces a spurious inverted-U-shaped relation between returns and negative predictors, and an exaggerated positive relation for positive predictors. Thus, the resulting trimmed relations do not reject behavioral explanations for these anomalies. Trimming also induces a spurious loss anomaly. These findings highlight that in return prediction studies, observations should not be deleted based upon the values of the dependent variable, only based upon clearly identified data errors.

Measurement errors in economic data are pervasive and nontrivial in size. The presence of measurement errors causes biased and inconsistent parameter estimates and leads to erroneous conclusions to various degrees in economic analysis. While linear errors-in-variables models are usually handled with well-known instrumental variable methods, this article provides an overview of recent research papers that derive estimation methods that provide consistent estimates for nonlinear models with measurement errors. We review models with both classical and nonclassical measurement errors, and with misclassification of discrete variables. For each of the methods surveyed, we describe the key ideas for identification and estimation, and discuss its application whenever it is currently available. (JEL C20, C26, C50)

We investigate the stakeholder theory of capital structure from the perspective of a firm’s relations with its employees. We find that firms that treat their employees fairly (as measured by high employee‐friendly ratings) maintain low debt ratios. This result is robust to a variety of model specifications and endogeneity issues. The negative relation between leverage and a firm’s ability to treat employees fairly is also evident when we measure its ability by whether it is included in the Fortune magazine list, “100 Best Companies to Work For.” These results suggest that a firm’s incentive or ability to offer fair employee treatment is an important determinant of its financing policy.