I review empirical research on the relation between capital markets and financial statements. The principal sources of demand for capital markets research in accounting are fundamental analysis and valuation, tests of market efficiency, and the role of accounting numbers in contracts and the political process. The capital markets research topics of current interest to researchers include tests of market efficiency with respect to accounting information, fundamental analysis, and value relevance of financial reporting. Evidence from research on these topics is likely to be helpful in capital market investment decisions, accounting standard setting, and corporate financial disclosure decisions.

This paper considers discounted repeated games with boundedly rational players. In each period, player i chooses his current action on the basis of his forecast about the forthcoming n(i) action profiles; his assessment of the payoffs he will obtain next depends on his state of mind, which is non-deterministic. A limited forecast equilibrium is such that after every history the limited horizon forecasts formed by the players are correct. The set of all limited forecast equilibria is characterized and constructed. Application to the repeated prisoner's dilemma shows that limited foresight may sometimes induce purely cooperative paths while purely non-cooperative paths cannot arise.

We investigate the problem of a firm wishing to finance a project by issuing securities under asymmetric information. We find that, when outside investors can produce (noisy) information on the firm's quality, the degree of information asymmetry resulting in equilibrium is endogenous and depends on the information sensitivity of the security issued. Thus, in contrast to the prediction of the pecking order theory (see, e.g. Myers and Majluf, J. Financial Econom. 13 (1984) 187) a security with low sensitivity to private information, such as debt, does not always dominate one with high information sensitivity, such as equity. A firm's preference for equity rather than debt depends on the costs of information production, the precision of the information-production technology, and the extent of the information asymmetry. We also study the optimal security design problem and find that, depending on the cost and precision of the information-production technology, risky debt or a composite security with a convex payoff emerges as optimal securities.

Two explanations are commonly offered for the large number of recent IPOs by Internet firms. The first argues that Internet firms are trying to grab market share in an industry with large economies of scale. The second argues that Internet firms are rushing to go public when Internet stock prices are irrationally high. In this paper we examine the actions of those closest to Internet firms – firm managers, underwriters, and venture capitalists – to determine their motives for going public. Numerous strategic alliances and mergers and acquisitions provide strong evidence of a rush to grab market share. Other factors provide only weak evidence that Internet IPOs are attempts to sell overpriced stock.

We construct a degree-of-total-leverage framework to test whether and how shifts in product mix affect earnings volatility at 472 U.S. commercial banks between 1988 and 1995. Our framework, which accounts for cost and revenue synergies not captured in most previous studies, conceptually links earnings volatility to revenue volatility, expense fixity, and product mix. We find that replacing traditional lending activities with fee-based activities—an ongoing trend that may be strengthened by recent financial modernization—is associated with both higher revenue volatility and higher total leverage, which in this framework implies higher earnings volatility. Journal of Economic Literature Classification Numbers: G21, G32, D24.

This paper examines the effects of disclosure and recognition requirements on investment decisions when shareholders have limited liability. Firms' investment projects have either high initial pollution prevention costs or high subsequent clean-up costs, and their liability for clean-up costs may be either individual or joint and several. Even with individual liability for clean-up costs, shareholders' limited liability creates an incentive to select the latter project type and to impose costs on the rest of the economy. This tendency is exacerbated when clean-up liability is joint and several. We show that a disclosure requirement cannot have an unambiguous effect on the selection of the “cleaner” project. However, an accrual requirement, together with an accounting-based dividend restriction, is shown to promote choice of the project that imposes lower expected costs on the rest of the economy. Moreover, we find that it is possible for a recognition requirement to have a greater impact in a joint-and-several liability regime than in an individual liability regime.

The rules under which jurisdictions (nations, provinces) can deny immigration or expel residents are generally governed by a constitution, but there do not exist either positive or normative analyses to suggest what types of exclusion rules are best. We stylize this problem by suggesting four constitutional rules of admission: free mobility, admission by majority vote, admission by unanimous consent, admission by a demand threshold for public goods. In a simple model we characterize the equilibria that result from these rules, and provide a positive theory for which constitutional rules will be chosen.

Classroom education has public good aspects. The technology is such that when one student disrupts the class, learning is reduced for all other students. A disruption model of educational production is presented. It is shown that optimal class size is larger for better-behaved students, which helps explain why it is difficult to find class size effects in the data. Additionally, the role of discipline is analyzed and applied to differences in performance of Catholic and public schools. An empirical framework is discussed where the importance of sorting students, teacher quality, and other factors can be assessed.

Public discussion about corporate use of derivatives focuses on whether firms use derivatives to reduce or increase firm risk. In contrast, em- pirical, academic studies of corporate derivatives-use take it for granted that firms hedge with derivatives. Using data from financial statements of 425 large u.s. corporations, we investigate whether firms systematically reduce or increase their riskiness with derivatives. We find that many firms manage their exposures with large derivatives positions. Nonetheless, compared to firms that do not use financial derivatives, firms that use derivatives display few, if any, measurable differences in risk that are associated with the use of derivatives.

A seller with two objects faces a group of bidders who are subject to budget constraints. The objects have common values to all bidders but need not be identical, and may be either complements or substitutes. In a simple complete information setting we show: (1) if the objects are sold by means of a sequence of open ascending auctions, then it is always optimal to sell the more valuable object first; (2) the sequential auction yields more revenue than the simultaneous ascending auction used recently by the FCC if the discrepancy in the values is large, or if there are significant complementarities; (3) a hybrid simultaneous-sequential form is revenue superior to the sequential auction; and (4) budget constraints arise endogenously.