Ball, Robin and Wu (Journal of Accounting and Economics, 2003, this issue) investigate the relationship between accounting standards and the structure of other institutions on the attributes of the financial reporting system. They find evidence consistent with the hypothesis that beyond accounting standards, the structure of other institutions, such as incentives of preparers and auditors, enforcement mechanisms and ownership structure affects the outcome of the financial reporting system. However, interpretation of the evidence with respect to the notion of quality of the financial reporting system and the quality of accounting standards that the authors introduce is problematic.

Using a unique set of banking data containing both originally-reported and subsequently-revised financial variables, we study accounting restatements. Our results indicate the worse a bank's financial condition, the more likely it is for originally-reported data to understate financial losses. Also, we find supervisory exams have an important role in uncovering financial problems and prompting accounting restatements to correct loss underreporting. While revisions are directly related to financial difficulties, exam-based restatements are evident at even the earliest stages of deterioration, indicating substantial accounting misstatements—at both banks and other types of companies—can occur well outside severe business circumstances.

This essay reviews Networks and Markets, edited by James E. Rauch and Alessandra Casella. This book provides a useful vehicle for clarifying the main conceptual and operational issues facing the growing study of economic networks. Three types of networks are discussed: networks as concentrated or patterned exchange; as primordial relations; and, the most general, networks as structures of mutual orientation. An overview is provided of the challenges faced by research on the economic implications of three types of networks. The strengths and weaknesses of current research on economic networks are examined via a review of the contributions in the book.

Abstract Fama and French (1992) show that size and book-to-price dominate CAPM beta and other variables such as the price-earnings ratio and dividend yield in explaining the cross-section of US stock returns. Comparable evidence for the UK points to a book-to-price effect, but not a size effect (Chan and Chui, 1996; Strong and Xu, 1997). In this paper, our first contribution is to show that a measure of research and development (RD) helps explain cross-sectional variation in UK stock returns. Our cross-sectional results on the association between stock returns and RD are consistent with recent US evidence reported by Lev and Sougiannis (1996, 1999) and Chan, Lakonishok and Sougiannis (2001).Fama and French (1993, 1995, 1996) also show that a three-factor model captures a high proportion of the time series variation in portfolio returns, again for the US. Our second contribution is to show, for the UK, that a modification to the three-factor model to take account of RD activity can significantly enhance the explanatory power of the three-factor model. We show that, as a practical matter, estimated risk premia based on the modified three-factor model can differ considerably from risk premia estimated using the CAPM or the three-factor model. In particular, risk premia for industries in which few firms undertake RD activities tend to be over-estimated.

In this paper, I examine the nature of hostages in long-term contracts. The definition of a hostage is improved relative to the rents attached to a contract. In addition, I show that hostages need to reflect marginal deterrence (fitting the crime) and operate similarly to the same principle in the criminal law. Some empirical observations are presented from franchise systems and support the marginal-deterrence hypothesis.

Minimum-variance hedging of a contingent claim in discrete time is suboptimal when the contingent claim is hedged for multiple periods and the objective is to maximize the expected utility of cumulative hedging errors. This is because the hedging errors are not independent. The difference between a minimum-variance hedge and the optimal multiperiod hedge is called the hedging demand and depends on the hedger's preferences, the characteristics of the contingent claim, the trading frequency and horizon, and most importantly the joint distribution of the contingent claim and the underlying security prices. Since modeling this joint distribution is empirically controversial, I examine nonparametrically the economic importance of hedging demands in the case of hedging Standard & Poor's 500 index options.

We examine the impact of immigration on self‐employed natives. In a new general equilibrium model of self‐employment and wage/salary work, a range of plausible parameter values implies small negative effects of immigration on native self‐employment rates and earnings. Using 1980 and 1990 Census microdata, we then examine the relationship between changes in immigration and native self‐employment rates and earnings across 132 of the largest U.S. metropolitan areas. We find evidence suggesting that self‐employed immigrants displace self‐employed natives but do not have a negative effect on native self‐employment earnings. The effects are much larger than those predicted by the theoretical model.