16 Theory (THEO)
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ItemSequential Reporting Bias( 2021)Firms with correlated fundamentals often issue reports sequentially, leading to information spillovers. The theoretical literature has investigated multi-firm reporting, but only when firms report simultaneously. We examine the implications of sequential reporting, where firms aim to maximize their market price and can manipulate their reports. Our model demonstrates that the introduction of sequentiality in the presence of information spillovers significantly alters the biasing behavior of firms and the resulting informational environment relative to simultaneous reporting. In particular, a lead firm always manipulates more when reports are issued sequentially. Interestingly, this occurs because follower firms, who benefit from information spillovers, place less weight on their own private information when issuing a report. This information loss leads the market to place greater weight on the leader’s report, which increases the incentive of the lead manager to manipulate her report. Moreover, the information loss from sequentiality leads to less efficient and less volatile prices. Additionally, we find that stronger correlation in firm fundamentals can amplify the lead firm's incentive for manipulation under sequentiality, in contrast to simultaneous reporting. We offer additional results regarding, for example, market response coefficients, and provide a number of empirical implications.
ItemMonitoring spillovers between competing passive and active funds( 2021)We examine monitoring interactions and spillovers between passive and active funds. In our model, funds use fees and monitoring capacities to compete with each other over fund flows from a set of heterogeneous risk-averse investors. We show that passive funds find positive monitoring optimal in equilibrium. We provide conditions for when passive and active fund monitoring are strategic complements, leading to monitoring of the same firms, or strategic substitutes, leading to monitoring of different firms. Additional results speak to the corporate governance implications of restrictions on passive or active shareholder voting and limits on disclosure of active fund portfolios.
ItemFair Value Accounting, Illiquid Assets, and Financial Stability( 2021)Prudential regulation relies on asset values measured using fair value accounting standards. However, determining fair values of illiquid assets is difficult because doing so involves judgment and estimation. This paper examines how prudential regulation aimed at solving agency problems affects financial institutions' incentives to use Level 2 versus Level 3 fair value reporting, as well as financial stability. Crucially, Level 3 reporting allows financial institutions to use their noisy private information, whereas Level 2 fair values are measured with public information. My analysis shows regulators optimally leave to bankers the discretion to report illiquid assets at Level 2 or Level 3. Interestingly, bankers report at Level 3 only if they have good private information about the assets' quality. Moreover, relative to Level 3 reporting, Level 2 reporting increases systemic risk, because it relies on public information. Thus, prudential rules relying on precise Level 2 fair values are a double-edged sword: they are efficient at solving agency problems within financial institutions but decrease financial stability. The paper reconciles the conflicting empirical evidence on the link between fair value accounting and financial stability.
ItemDisclosure Paternalism( 2021)Investors lacking good judgment may miscalculate the strategic motives causing withholding of material information. The resulting inadequate professional skepticism encourages excessively optimistic expectations after a non-disclosure and break the economic forces causing immediate unravelling to full disclosure. A regulator may intervene to correct the problem by mandating disclosure over events that would be otherwise be withheld; however, such paternalistic interventions come with a severe drawback: over-protection prevents investors from learning to be skeptical through repeated experiences of nondisclosure losses. While an unregulated market will converge over time to full disclosure, paternalism will lead to cycles characterized by high levels of compliance followed by excessive optimism. The model further predicts an association between positive price drift and transparency, and explains why regulators may sometimes choose to shut down entire markets.
ItemClinging Onto the Cliff: A Model of Financial Misconduct( 2021)We propose a novel model of financial misconduct. In line with empirical evidence thereon, our model interprets white-collar crime as gambles with skewed payoffs, as opposed to Becker’s analysis of criminal activity that postulates positive expected payoffs associated to crime. In our model, criminal motives arise as optimal responses to a “tunnel vision” that engross firm managers, whereby the intense pressure to attain the focused goal triggers strong demand for negatively skewed bets in the form of crime. The key mechanism is consistent with the notion of a “slippery slope to crime” that is finding growing support in the literature as well as in practitioner accounts. Comparative static analyses on the model reveal several empirical implications –for example, a “pecking order of crime” indicating that serious infringements will only follow the depletion of the more preferred (and possibly prevalent) option of milder incursions of law, e.g., minor violations of financial reporting standards – many of which find empirical support in the literature.
ItemReporting Rules in Bank Runs( 2021)We study the role of reporting rules in the context of bank runs. In our model, a financial institution receives an early but imprecise estimate of the performance of its investment and issues a report subject to a reporting rule. We find that, from a financial-stability standpoint, the optimal reporting rule requires full disclosure when the financial institution’s early estimate is sufficiently unfavorable, but no disclosure otherwise. Importantly, the threshold below which the financial institution reports should be tailored to the financial institution’s exposure to bank-run risk. In particular, the optimal reporting threshold is non-monotonic and U-shaped in the bank-run risk. We also relate our results to current accounting standards for asset impairments.