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This study examines the effect of endogenous control choice on budgetary slack. The superior chooses between two alternatives: no control, wherein the superior commits to accept any budget, and a discretionary rejection authority control, wherein the superior decides ex post whether to accept or reject budgets. For both alternatives, we find that slack is lower when the superior chooses an alternative than when it is assigned exogenously. Our theory and results suggest that a superior's choice of whether to introduce controls signals a superior's expectations and intentions. The superior's choice of no control signals trust and an intention to foster a norm of trustworthiness. The superior's choice of rejection authority signals an above-average willingness to use rejections to enforce norms. Our results suggest that the value of participative budgeting may be increased if superiors can communicate to subordinates the expectations and intentions behind the design of the control system. Data Availability: Experiment data are available from the authors upon request. JEL Classifications: C91; D83; M40.

We argue that the market for audit services closely resembles a common value procurement (seller’s) auction, where auditors generate a private estimate of the actual cost of an audit engagement prior to quoting the client a price. Thus, we conduct a systematic examination of audit pricing and audit quality in this market setting using two experiments. In experiment one, we examine a simplified setting in which auditors determine only audit price to investigate whether the “winner’s curse” found to be pervasive in the buyer’s version of the common value auction is also present in the seller’s version. In experiment two, we examine an enriched setting in which auditors determine both audit price and audit effort to investigate the robustness of our results and the effect of the winner’s curse on audit quality. In both experiments, we find that auditors fall prey to the winner’s curse and offer low ball prices on average. But we also find a differential learning process across the two markets. In experiment one, auditors learn to reduce their low ball pricing with market experience. In experiment two, however, auditors do not reduce their low ball pricing but instead reduce their audit effort when they contract at a low ball price. Our evidence suggests that low ball audit pricing arises due to the winner’s curse, and this source of low ball pricing poses a threat to audit quality.

SUMMARY After considering a proposal to require the engagement partner's signature on the audit report (PCAOB 2009), the Public Company Accounting Oversight Board chose instead to only require the disclosure of the engagement partner's name (PCAOB 2015). We make predictions regarding the effects of the two proposed requirements using insights from social norm theory, and test those predictions using an experimental audit market setting found in the literature. We find that both requirements reduce misreporting when compared to a control setting with neither requirement present. We also document that the signature requirement generates an incremental reduction in misreporting when added to the disclosure requirement. Finally, we provide evidence that these effects are driven by participants with higher sensitivity to social norms. This theory and evidence supports the new identity disclosure requirement at the PCAOB and helps explain the existence of signature requirements in many non-U.S. countries. Data Availability: Experimental data are available from the authors upon request.

Researchers in accounting have recently provided evidence of a striking increase in the usefulness of earnings announcements based on stock market price and volume reactions (Beaver et al., 2018; Barron et al., 2018). Price reactions, however, are unable to capture investor disagreement and volume reactions capture both the resolution of prior disagreement and newfound disagreement generated by earnings announcements. Thus, it remains to be determined if earnings announcements have become increasingly useful in leveling the informational playing field, a key public policy objective of financial reporting. To address this possibility, we examine changes in disagreement around annual earnings announcements over the last forty years using analyst forecast measures found in the literature. First, we show that forecast dispersion is reduced around earnings announcements and this reduction has increased over time. Next, we use a forecast measure of informedness from Barron et al. (1998) to show that analysts as a group are more informed by earnings announcements in recent time periods. Finally, we use Barron et al.’s forecast measure of consensus to show that the ability of earnings announcements to make analysts more commonly informed has increased over time.

The increase in investor diversity over the last 35-40 years (ICI 2014) prompted us to revisit trading volume reactions to earnings announcements and how these reactions vary with firm size. This increase in investor diversity would likely lead to an increase in differences in the precision of pre-announcement information and potentially increase the importance of earnings announcements to resolve investor disagreement. We find that the nature of trading volume reactions to earnings announcements has fundamentally changed over the 35-year time period 1977-2011. There has been a dramatic increase in the magnitude and frequency of volume reactions to earnings announcements over this time period, and this effect is more pronounced in large firms where volume reactions were previously infrequent. The increase in large firms’ trading volume reactions is so pronounced that the relation between volume reactions and firm size has turned positive in recent years, thereby reversing Bamber’s (1986, 1987) previously documented negative relation. We provide intuition and empirical evidence that our results are attributable to the resolution of differential prior precision among an increasingly diverse set of investors following large firms.

Hannan, Rankin, and Towry (2006, HRT hereafter) propose that an information system is capable of affecting honesty in the manager's budget report by reducing information asymmetry between the manager and the owner regarding the level of honesty in the budget. They find that going from no information system to a coarse information system increases honesty in managerial reporting. However, they also report evidence that going from a coarse information system to a precise information system decreases honesty in managerial reporting. We extend HRT's study in two ways. First, we extend their behavioral theory by incorporating the possibility that reducing information asymmetry could increase the manager's preference for honesty in the budget (Koford & Penno, 1992; Bicchieri, 2006). Second, we note that HRT held information system accuracy constant at a relatively low level, which is another source of information asymmetry. Thus, we test the robustness of HRT's negative precision result by manipulating information system precision and accuracy at two levels using a computerized version of their manual experiment. We find that information system precision increases honesty in managerial reporting and that this positive precision effect is weaker under low information system accuracy. A supplemental analysis suggests that our data are generally similar to HRT's data in our two low accuracy conditions and that their negative precision result is attributable to an unusual period effect in their coarse information system condition.

We assert that audit quality can be improved to the extent that social norms for honesty and responsibility are activated in the auditor. To test this assertion, we use an experimental audit market setting found in the literature and manipulate factors expected to activate honesty and responsibility norms in the auditor. We find that auditor misreporting is reduced when the investor is another participant in the experiment rather than computer simulated, and thus, the interests of third-party investors are salient to the auditor. We also find that auditor misreporting is reduced when the auditor is required to sign-off on the audit report, but only when the investor is another participant in the experiment. Consistent with our underlying theory, we find that pre-experimental measures of sensitivity to honesty and responsibility norms help explain the effects of our manipulated variables. Finally, we find that these measures of social norm sensitivity are associated with the moral judgment that auditor misreporting is unethical. Our study helps explain previous anomalous findings in the literature and answers the call in Blay et al. (J Bus Ethics 2017. doi: 10.1007/s10551-016-3286-4 ) for empirical researchers to use social norm theory to develop stronger tests of moral reasoning in the market for auditing services.

This study examines the moderating effect of social norm sensitivity on organizational control using a participative budgeting setting found in the literature. Experimental researchers have documented that subordinates report more honestly in their budget in the presence of an information system that reduces information asymmetry regarding the level of honesty in the budget. Consistent with prior results, we observe an increase in reporting honesty when the information system is randomly assigned. When the information system is chosen by the superior, however, this increase in reporting honesty is significantly reduced. We find that this reduction is attributable to the behavior of subordinates who score high in social norm sensitivity as measured by the Responsibility scale of the JPI-R. Exit questionnaire responses reveal that while both high and low norm sensitivity subordinates viewed the superior’s choice of an information system as a signal of distrust, only high norm sensitivity subordinates felt less obligated to report honestly as a result. A path analysis provides further evidence that the superior’s choice reduced reporting honesty by reducing perceived trust in high norm sensitivity subordinates. This study documents a negative effect of signaling distrust to agents who view themselves as trustworthy, which has broad implications for organizational control.

Recent attempts by policy makers to rein in high power financial incentives are predicated on the belief that such incentives cause managers to engage in excessive risk taking that is not in the best interest of the firm. This potential agency cost, however, has received little attention in the management accounting literature. We examine the effect of incentive power on excessive risk-taking behavior in a controlled experimental setting where managers make incentivized risk choices that affect the pay of the manager and another participant representing the firm. Our main results are, first, that the high power incentive generates more excessive risk taking than the low power incentive, despite both incentives being equivalent in expected value at the optimal level of risk for the firm. Second, changing from the low power to the high power incentive significantly increases excessive risk taking, but changing from the high power to the low power incentive does not significantly decrease excessive risk taking, indicating a stickiness effect that may hinder attempts to decrease this behavior. These results provide useful insights for agency theory and public policy. JEL Classifications: C91; C92; D80; G30; J30; M40.

Rankin, Schwartz, and Young (2008) find experimental evidence that manipulating whether the budget request of the subordinate requires a factual assertion has no effect on budgetary slack when the superior can reject the budget. This calls into question the role of honesty in participative budgeting settings. Using Rankin et al.'s (2008) manipulation to capture honesty effects, we examine the robustness of honesty effects on budget proposals when the superior has rejection authority in two experiments. In Experiment 1, we document that honesty has a strong effect on budgetary slack when the salience of distributional fairness is reduced by withholding the relative pay of the superior from the subordinate. In Experiment 2, we document that honesty continues to have a strong effect on budgetary slack when the salience of reciprocity is increased by giving the superior the ability to set the subordinate's salary. Thus, our evidence suggests that honesty effects on budget proposals are generally robust to giving the superior rejection authority. Our study helps explain prior experimental results and clarifies the role of honesty in participative budgeting settings. Data Availability: Experimental data are available from the authors upon request.

While managers commonly possess private information regarding future production cost when developing their cost budget, they also face outcome uncertainty regarding that future cost. This outcome uncertainty, however, has largely been ignored by experimental researchers examining various controls for opportunistic budgetary slack. Social norm theory suggests that managers may view outcome uncertainty as an opportunity to evade an honesty norm and thereby increase budgetary slack. Alternately, the theory suggests that managers may view outcome uncertainty as a cue that they are expected to behave responsibly in their fiduciary role and thereby decrease budgetary slack. We test these competing theoretical effects using a participative budgeting experiment found in the literature. We find evidence that, rather than encouraging opportunism in managerial reporting, outcome uncertainty activates a responsibility norm that reduces budgetary slack. Specifically, we find that outcome uncertainty primes some managers to voluntarily share the risk of higher production cost with their principal, which leads to a decrease in budgetary slack relative to an experimental condition with no outcome uncertainty. This study extends the literature in participative budgeting by examining norm behavior under outcome uncertainty and helps explain the continued use of this organizational control in practice.

Policy makers and corporations have recently emphasized a code of ethics as an effective aspect of corporate governance. The corporate governance literature in accounting, however, provides little empirical or theoretical support for this emphasis. We address this gap between public policy and the literature by studying the effectiveness of a code of ethics in an experimental setting. Using Bicchieri's (2006) model of social norm activation, we predict that a code of ethics will improve manager return behavior and investor confidence to the extent that it activates social norms that control opportunistic behavior. Further, we predict that adding a certification choice whereby the manager can publicly certify that he will adhere to the code will enhance the potential for the code of ethics to activate such norms. We find that a code of ethics only improves manager return behavior and investor confidence when the code incorporates a public certification choice by the manager. When the code is present but there is no certification choice, manager return behavior does not improve and investor confidence erodes over time because of increased expectations that are not met by managers. An analysis of individual return decisions and exit questionnaire responses supports the activation of social norms as the underlying mechanism behind our results. Data Availability: Experimental data are available from the authors upon request.

Given traditional agency theory assumptions and unobservable effort in a single-period setting, a moral hazard arises in which the agent is expected to shirk and provide the minimal possible effort after contracting with the principal. Traditional solutions to this agency problem include paying the agent a financial incentive tied to some noisy measure of performance or allowing the agent to develop a reputation over multiple periods. As the noisiness of the performance measure increases, however, these traditional solutions become increasingly costly and ineffective. In many single- and multi-period agency settings in the firm, however, the agent can communicate a promised level of effort to the principal prior to contracting. We document that this pre-contract communication, which is non-enforceable and therefore considered “cheap talk” by traditional economic theory, can be highly effective in mitigating the moral hazard problem in agency theory. In a repeating single-period experimental setting where production is observable but is a very noisy indicator of effort, communication of a promised level of effort results in higher pay for the agent, higher effort, and higher expected profit for the principal than the control group. When the principal and agent interact over multiple periods, reputation building is ineffective, but cheap talk continues to yield superior outcomes. These results are consistent with recent economic theory incorporating social norms such as the norm of promise-keeping. Data Availability: The experimental data used in this paper are available from the authors upon request.

This paper reviews, synthesizes, and critiques the capital market literature examining trading volume around earnings announcements and other financial reports. Our purposes are to assess what we have learned from examining trading volume around these announcements and to suggest directions for future research. We conclude that researchers have yet to realize the potential Beaver (1968) identified for trading volume to yield unique insights regarding the nature of earnings announcements and other financial reports, and the effects of these announcements on market participants. This state of the literature is attributable to a dearth of volume theory early on, and more recently to a disconnect between theoretical development and empirical research. Thus, we begin by briefly summarizing developments in trading volume theory since Beaver (1968). We also discuss unique measurement challenges in trading volume research, including identifying appropriate proxies for abnormal trading volume and for individual investors’ beliefs. In light of theory and empirical measurement issues, we interpret the current literature and identify directions for future research. We conclude that extant research just scratches the surface of what trading volume can reveal about the characteristics of financial disclosures and the effects of these disclosures on investors.

We study moral judgments regarding budgetary slack made by participants at the end of a participative budgeting experiment in which an expectation for a truthful budget was present. We find that participants who set budgets under a slack-inducing pay scheme, and therefore built relatively high levels of budgetary slack, judged significant budgetary slack to be unethical on average, whereas participants who set budgets under a truth-inducing pay scheme did not. This suggests that the slack-inducing pay scheme generated a moral frame by setting economic self-interest against common social norms such as honesty or responsibility. We also find that participants who scored high in traditional values and empathy on a pre-experiment personality questionnaire (JPI-R) were more likely to judge significant budgetary slack to be unethical. These results suggest that financial incentives play a role in determining the moral frame of the budgeting setting and that personal values play a role in determining how individuals respond to that moral frame.

In August 2009, a new urban public high school featuring project-based science, technology, engineering, and mathematics (STEM) education opened with a population of African-American, low-income, and special needs students. A planning team comprised of lead teachers and the school principal sought to create a positive school culture with a clear vision and core values that would engender relational trust, a strong sense of community, and principal and teacher co-leadership. The culture was to be supported by social structures instituted through teams, professional development, student orientations, venues for instructional innovation, and informal gathering places. This account, written by the principal, a teacher, and a university researcher, presents a first-hand narrative of how the school culture was created. Introduction In November 2007, the State of Ohio issued a Request for Proposals for seed grants to fund the establishment of five new public high schools with innovative programs focusing on science, technology, engineering, and mathematics (STEM). The new schools were to be geared toward the development of intellectual, entrepreneurial, and technical talent, and do so in partnership with higher education institutions, industries, and businesses. A partnership was formed in Cincinnati between Cincinnati Public Schools (CPS), Cincinnati Federation of Teachers (CFT), the University of Cincinnati (UC), Cincinnati State Technical and Community College, and STRIVE--a regional education, business, and municipal consortium. The partnership was awarded one of the grants in March 2008, and the school district decided to transform an existing public high school, Hughes High School, into a new STEM school. The new school would operate as a choice-based high school with a first-come, first-serve open enrollment policy for children residing in the district. The student population would reflect the racial, ethnic and socio-economic makeup of the district. Grades 9-12 would be phased in one year at a time beginning with the 9th grade in 2009. When the school was opened, 86% of students were African-American, 28% had special needs, and 84% received free and reduced lunches. Ninth graders in the inaugural class came from 48 feeder schools. The plan was to offer programs that would develop students' interest in STEM careers and prepare them for college. The principal, teachers, university faculty members, and others involved in the planning process understood at the outset that the key to success was the creation of a positive school culture, an insight well supported by decades of research and planners' own prior experiences in public high schools (Cheong, 1993; Fullan, 2001, 2007; Joyce, Hersh, & McKibbon, 1983; Rutter et al., 1979; Sarason, 1996). A deliberate effort was made to create a positive school culture with a clear vision and core values that would engender relational trust, a strong sense of community, and principal and teacher leadership. Planners recognized that positive culture was not possible without the support of social structures instituted through collaborative team arrangements, professional development, student orientation programs and advisement, venues for innovative instruction and, also, as they found out after the school was opened, informal gathering places. This account, written by the school principal, Dr. Virginia Rhodes; a technology teacher, Douglas Stevens; and a university faculty member, Dr. Annette Hemmings, tells the story of this effort. It presents a firsthand narrative of what the principal and teachers did to create a positive school culture, the lessons they learned, and what they are facing as they look ahead to succeeding years. Positive School Culture Innovative, interdisciplinary STEM education is being lauded as an optimal means for providing k-12 students with opportunities to learn about the world through pedagogical approaches that couple rigorous academic curriculum with real-world lessons in contexts that connect schools, communities, and work and integrate young people into the new global economy (Kaufman, Moss, & Osborn 2003). …

In agency theory, offering a flat salary contract under unobservable effort creates a moral hazard problem because the agent is motivated to shirk and provide less than a previously agreed-upon level of effort. We examine a moral solution to this moral hazard problem. In particular, we present a principal-agent model where the agent possesses some level of moral sensitivity that causes him disutility if he provides less than the agreed-upon level of effort. We examine the interplay between moral sensitivity and firm productivity in determining the optimal salary contract, and contrast our moral solution with the traditional incentive solution that becomes necessary when moral sensitivity is assumed to be zero. This allows us to highlight the benefits of the agent’s moral sensitivity to both the principal and the agent, and thereby, point out the potential cost of ignoring this moral sensitivity. We conclude that adding moral sensitivity increases the descriptive, prescriptive, and pedagogical usefulness of the principal-agent model.

This study provides empirical evidence on factors that drive differential interpretation of earnings announcements. We document that Kandel and Pearson's forecast measures of differential interpretation are decreasing in proxies for earnings quality and pre-announcement information quality. This evidence yields new and useful insights regarding which earnings announcements are less likely to generate newfound disagreement among analysts and investors. Recent research suggests that investor disagreement can increase investment risk, increase the cost of capital, and cause stock prices to deviate from fundamental value. Therefore, our results support prior intuition that increasing the quality of earnings and pre-announcement information can improve the efficiency of capital markets.

We assert that some forms of opportunistic behavior within the organization are relatively transparent and, therefore, public in nature. Further, while organizations can tightly control such public opportunism, it may not be optimal for them to do so in the presence of private opportunism. To study how public and private forms of opportunism differ and interact, we jointly examine budget and effort behavior in a participative budgeting experiment. We group participants into producer/manager pairs and set the parameters such that the producer extracts the largest share of surplus from the manager by publicly setting the budget at zero and privately providing low effort. When the producer unilaterally sets the budget, the public opportunism of budgetary slack is higher and more affected by learning than the private opportunism of low effort. Giving the manager the power to reject the budget not only reduces budgetary slack by about 50 percent, but also generates reciprocity expectations and behavior. In particular, managers who allow more budgetary slack expect and receive higher effort from their producers on average. This reciprocity increases organizational performance by increasing the expected pay of the manager without decreasing the expected pay of the producer.

This study examines the effect of endogenous contract selection on budgetary slack using two slack-inducing contracts found in the literature: a trust contract where the superior must accept any feasible budget submitted by the subordinate and a discretion contract where the superior can accept or reject the budget. We find that both contracts generate less budgetary slack when they are endogenously selected by the superior than when they are randomly assigned by the experimenter. Exit questionnaire responses support our expectation that selecting a trust contract signals trust and expectations of trustworthiness whereas selecting a discretion contract signals distrust and an increased willingness to reject unreasonable budgets. We find the greatest level of efficiency with the endogenously selected discretion contract, which is not significantly different in efficiency than the optimal hurdle contract under traditional agency assumptions. Thus, our results suggest that endogenous contract selection improves efficiency whether it signals trust or distrust and signaling distrust may be optimal for the firm in some contracting settings.

In response to recent calls to extend the underlying theories used in the literature (O’Fallon and Butterfield in J Bus Ethics 59(4):375–413, 2005; Craft in J Bus Ethics 117(2):221–259, 2013), we review the usefulness of social norm theory in empirical business ethics research. We begin by identifying the seeds of social norm theory in Adam Smith’s (in: Raphael and Macfie (eds) The Theory of Moral Sentiments, the Glasgow Edition, Oxford University Press, Oxford, 1759/1790) seminal work, The Theory of Moral Sentiments. Next, we introduce recent theory in social norm activation by Bicchieri (The grammar of society: The nature and dynamics of social norms, Cambridge University Press, New York, 2006) and compare the new theory to two theoretical frameworks found in the literature: Kohlberg’s (in: Goslin (ed) Handbook of socialization theory and research, Rand McNally, Chicago, IL, 1969; in: Lickona (ed) Moral development and behavior, Holt, Rinehart & Winston, New York, 1976) theory of moral development and Cialdini and Trost’s (in: Gilbert et al. (eds) The handbook of social psychology, Oxford University Press, Boston, 1998) taxonomy of social norms. We argue that the new theory provides useful insights by emphasizing the ability of situational cues and information to generate common expectations for social/moral norms. The theory is particularly useful for empirical research in business ethics because it gives both organizational and individual factors a role in motivating norm-based behavior. To demonstrate this usefulness, we present examples where the theory has been effectively applied in experimental accounting research to generate new insights. We conclude by citing specific examples where the theory may prove useful in empirical business ethics research.

Prior archival studies of analysts' forecasts have found evidence for systematic underreaction, systematic overreaction, and systematic optimism bias. Easterwood and Nutt (1999) attempt to reconcile the conflicting evidence by testing the robustness of Abarbanell and Bernard's (1992) underreaction results to the nature of the information. Consistent with systematic optimism, forecasts are found to underreact to negative earnings information but overreact to positive information. However, Easterwood and Nutt are unable to distinguish between misreaction caused by incentives unique to analysts with misreaction caused by human decision bias that may be typical of investors. We address this issue by analyzing forecast reactions to positive versus negative information in the controlled experimental setting of Gillette, Stevens, Watts, and Williams (1999). The forecast data reveal systematic underreaction to both positive and negative information, and the underreaction is generally greater for positive information than negative information. This suggests that prior empirical evidence of forecast overreaction to positive information is unlikely to be attributable to human decision bias.

This study provides evidence regarding the effects of online trading on stock price and trading volume reactions to quarterly earnings announcements. We test for differences in stock price and volume reactions to quarterly earnings announcements between a period with a significant amount of online trading (1996-99) and a period without online trading (1992-95). We conjecture that online trading has increased the proportion of naive investors in the market. We predict that this will result in (1) a decrease in the average precision of investor information prior to earnings announcements leading to higher earnings response coefficients (ERCs), (2) an increase in differential interpretation of earnings leading to higher trading volume reactions that are unrelated to price change, and (3) a decrease in differential prior precision leading to a decrease in the association between trading volume and absolute price change. We find evidence consistent with all three predictions. Our findings are relevant for assessing the validity of concerns about online trading expressed by regulators and the validity of theoretical models of trade with asymmetrically informed investors.

We apply insights from a model of social norm activation to an agency model of capital budgeting to develop a positive behavioral relation between information system precision and honesty in managerial reporting. This relation is based on the ability of a precise information system to reduce information asymmetry between the owner and the manager and thereby promote the activation of an honesty norm. Next, we use this behavioral theory to predict that high operating uncertainty in the information system offsets this positive relation by allowing the manager to hide behind the uncertainty and thereby evade the honesty norm. Using an experimental agency setting in the literature, we find evidence consistent with our behavioral theory. Information system precision increases managerial honesty under low but not under high operating uncertainty and managerial honesty is the highest under a precise information system with low operating uncertainty. An analysis of exit questionnaire responses confirms our underlying behavioral theory based on social norm activation and norm evasion. This study helps explain prior experimental results and emphasizes the importance of considering operating uncertainty in determining the optimal information system.

This experimental study tests the effects on budgetary slack of two potential controls for opportunistic self-interest—reputation and ethics. I manipulate the level of information asymmetry between the subordinate and the superior regarding productive capability and measure the subordinate's reputation and ethical concerns regarding budgetary slack. In this setting, I examine how information asymmetry affects reputation and ethical concerns, and test the effects of these concerns on budgetary slack. Consistent with prior findings, subordinates restrict the slack in their budgets to well below the maximum under a slack-inducing pay scheme, even after five periods of experience. Budgetary slack is negatively associated with a measure of ethical responsibility from a pre-experiment personality questionnaire as well as reputation and ethical concerns expressed in an exit questionnaire. Subordinates express lower reputation concerns as information asymmetry regarding productive capability increases, thereby reducing the superior's ability to monitor the slack in their budget. Ethical concerns, however, are not diminished with increases in information asymmetry. These results suggest that reputation is a socially mediated control, whereas ethics is an internally mediated control for opportunistic self-interest.

This paper examines how market prices, volume, and traders' dividend expectations respond to public information releases in laboratory markets for a long-lived financial asset. The objective is to study deviations from the symmetric information risk-neutral rational expectations (RE) benchmark, which predicts no trade in such settings. The results of a series of double-auction and call markets are reported in which traders manage a portfolio of cash and asset shares over 15 rounds of trading. A public signal regarding the value of the liquidating dividend is released every third round, and traders' subjective expectations of the liquidating dividend are elicited each round as cash-motivated forecasts. We find that, despite the public dividend signal, traders' dividend forecasts are heterogeneous. Forecasts and prices both underreact to the public signals, with prices under-reacting more than forecasts. In general, price changes are not closely associated with public signals, and there is greater excess price volatility in double auctions than in call markets. Forty-three percent of trades are inconsistent with the trader's forecasts, and inconsistent trades occur more frequently in the double-auction markets. On average, approximately 10 percent of the outstanding shares are traded in each round, and trading volume is increasing in the mean absolute forecast revision and decreasing in the contemporaneous dispersion in forecasts. These results suggest that differential processing of the public signal and/or speculative trading for short-term gain may help to explain why symmetric information RE predictions are often not supported in empirical and experimental settings. They also suggest that market reactions to public information releases may be influenced by market microstructure.

This study investigates the potential causes of a recent empirical regularity in the financial markets — the asset growth effect (Cooper et al., 2008) — by examining insider trading patterns. Insiders have a sophisticated understanding of their own firms, which they often use to trade on misevaluation. This study shows that insiders exploit the trading opportunities suggested by the asset growth effect, suggesting that the asset growth effect results from misevaluation instead of a rational discount result, as proposed by Watanabe et al. (2013). We further identify the specific information underlying asset growth that the stock market misevaluates. We show that the asset growth effect is more likely to be caused by a market misunderstanding of growth firms’ real investment activities rather than accounting disclosure distortion (e.g., earnings management before an acquisition or IPO). A comparative analysis between CEO and CFO trading indicates that insiders do not all have the same insight as to the asset growth effect. While CEO trading leads to 13.2 percent more size-adjusted returns beyond the return to the asset growth effect (20.3 percent), CFO trading does not provide any incremental returns to investors. Based on such findings, this study proposes that when relying on insider trading to understand the asset growth effect, investors need to distinguish the roles of different insiders.

Cosmic strings can give rise to a large variety of interesting astrophysical phenomena. Among them, powerful bursts of gravitational waves (GWs) produced by cusps are a promising observational signature. In this Letter we present a search for GWs from cosmic string cusps in data collected by the LIGO and Virgo gravitational wave detectors between 2005 and 2010, with over 625 days of live time. We find no evidence of GW signals from cosmic strings. From this result, we derive new constraints on cosmic string parameters, which complement and improve existing limits from previous searches for a stochastic background of GWs from cosmic microwave background measurements and pulsar timing data. In particular, if the size of loops is given by the gravitational backreaction scale, we place upper limits on the string tension Gμ below 10(-8) in some regions of the cosmic string parameter space. ispartof: PHYSICAL REVIEW LETTERS vol:112 issue:13 ispartof: location:United States status: published

Nearly a century after Einstein first predicted the existence of gravitational waves, a global network of Earth-based gravitational wave observatories1,2,3,4 is seeking to directly detect this faint radiation using precision laser interferometry. Photon shot noise, due to the quantum nature of light, imposes a fundamental limit on the attometre-level sensitivity of the kilometre-scale Michelson interferometers deployed for this task. Here, we inject squeezed states to improve the performance of one of the detectors of the Laser Interferometer Gravitational-Wave Observatory (LIGO) beyond the quantum noise limit, most notably in the frequency region down to 150 Hz, critically important for several astrophysical sources, with no deterioration of performance observed at any frequency. With the injection of squeezed states, this LIGO detector demonstrated the best broadband sensitivity to gravitational waves ever achieved, with important implications for observing the gravitational-wave Universe with unprecedented sensitivity Fil: Aasi, J.. California Institute of Technology; Estados Unidos Fil: Abadie, J.. California Institute of Technology; Estados Unidos Fil: Abbott, P.. California Institute of Technology; Estados Unidos Fil: Abbott, R.. California Institute of Technology; Estados Unidos Fil: Abbott, T. D.. State University of Louisiana; Estados Unidos Fil: Kozameh, Carlos Nicolas. Universidad Nacional de Córdoba; Argentina. Consejo Nacional de Investigaciones Científicas y Técnicas; Argentina Fil: Winkelmann, L.. Max Planck Institut f¨ur Gravitationsphysik; Alemania. Leibniz Universit¨at Hannover; Alemania Fil: Winkler, W.. Max Planck Institut f¨ur Gravitationsphysik; Alemania. Leibniz Universit¨at Hannover; Alemania Fil: Wip, C. C.. Massachusetts Institute of Technology; Estados Unidos Fil: Wittel, H.. Max Planck Institut f¨ur Gravitationsphysik; Alemania. Leibniz Universit¨at Hannover; Alemania Fil: Woan, G.. University of Glasgow; Reino Unido Fil: Wooley, R.. Livingston Observatory; Estados Unidos Fil: Worden, J.. Hanford Observatory; Estados Unidos Fil: Yablon, J.. Northwestern University; Estados Unidos Fil: Yakushin, I.. Livingston Observatory; Estados Unidos Fil: Yamamoto, H.. California Institute of Technology; Estados Unidos Fil: Yancey, C. C.. University of Maryland; Estados Unidos Fil: Yang, H.. Caltech-CaRT; Estados Unidos Fil: Yeaton Massey, D.. California Institute of Technology; Estados Unidos Fil: Yoshida, S.. Southeastern Louisiana University; Estados Unidos Fil: Yum, H.. Northwestern University; Estados Unidos Fil: Zanolin, M.. Embry-Riddle Aeronautical University; Estados Unidos Fil: Zhang, F.. Massachusetts Institute of Technology; Estados Unidos Fil: Zhang, L.. California Institute of Technology; Estados Unidos Fil: Zhao, C.. University of Western Australia; Australia Fil: Zhu, H.. State University of Pennsylvania; Estados Unidos Fil: Zhu, X. J.. University of Western Australia; Australia Fil: Zotov, N.. Louisiana Tech University; Estados Unidos Fil: Zucker, M. E.. Massachusetts Institute of Technology; Estados Unidos Fil: Zweizig, J.. California Institute of Technology; Estados Unidos

As with prior experimental studies in the literature, we examine a potential rationale for low balling behavior in the market for audit services. We argue that the market for audit services closely resembles a common value procurement (seller’s) auction. That is, a small number of audit firms typically offer a potential client an audit service whose cost is uncertain but similar across all firms, and each firm must estimate the true cost prior to quoting an offer price. Thus, the winner’s curse could contribute to low balling in the market for audit services. To test this possibility, we examine the behavior of experimental audit markets that take the form of a common value procurement auction. We find that auditors in our auction markets fall prey to the winner’s curse and low ball their audits on average. Low balling behavior is reduced but not eliminated with experience. In contrast with the extant literature’s characterization of low balling as an intentional, rational response to the expectation of future quasi-rents, we document a form of low balling that is an unintentional, behavioral response to cost uncertainty within a competitive market. We discuss the potential for this form of low balling to impair auditor independence.

Given traditional agency theory assumptions and unobservable effort in a single-period setting, a moral hazard arises in which the agent is expected to shirk and provide the miminal possible effort after contracting with the principal. Traditional solutions to this agency problem include paying the agent a financial incentive tied to some noisy measure of performance or allowing the agent to develop a reputation over multiple periods. As the noisiness of the performance measure increases, however, these traditional solutions become increasingly costly and ineffective. In many single- and multi-period agency settings in the firm, however, the agent can communicate a promised level of effort to the principal prior to contracting. We document that this pre-contract communication, which is non-enforceable and therefore considered “cheap talk” by traditional economic theory, can be highly effective in mitigating the moral hazard problem in agency theory. In a repeating single-period experimental setting where production is observable but is a very noisy indicator of effort, communication of a promised level of effort results in higher pay for the agent, higher effort, and higher expected profit for the principal than the control group. When the principal and agent interact over multiple periods, reputation building is ineffective but cheap talk continues to yield superior outcomes. These results are consistent with recent economic theory incorporating social norms such as the norm of promise-keeping.

This paper reviews, synthesizes, and critiques the capital market literature examining trading volume around earnings announcements and other financial reports. Our purposes are to assess what we have learned from examining trading volume around these announcements and to suggest directions for future research. We conclude that researchers have yet to realize the potential Beaver (1968) identified for trading volume to yield unique insights regarding the nature of earnings announcements and other financial reports, and the effects of these announcements on market participants. This state of the literature is attributable to a dearth of volume theory early on, and more recently to a disconnect between theoretical development and empirical research. Thus, we begin by briefly summarizing developments in trading volume theory since Beaver (1968). We also discuss unique measurement challenges in trading volume research, including identifying appropriate proxies for abnormal trading volume and for individual investors’ beliefs. In light of theory and empirical measurement issues, we interpret the current literature and identify directions for future research. We conclude that extant research just scratches the surface of what trading volume can reveal about the characteristics of financial disclosures and the effects of these disclosures on investors.

We document a change in the nature of trading volume reactions to quarterly earnings announcements over the time period 1976-2005. Consistent with Landsman and Maydew (2002), we find that the magnitude of abnormal trading volume around quarterly earnings announcements has increased over time and that this increase is greater for large firms than small firms. We show, however, that this trend has reversed the negative relation between firm size and trading volume documented by Bamber (1987). Applying insights from recent trading volume theory, we predict and provide evidence that the increase in abnormal trading volume across time and firm size is due to increases in pre-announcement private information. Specifically, we show that the component of abnormal trading volume associated with price change, which theory suggests reflects pre-announcement private information, is increasing across time and firm size. Our results suggest that investors are motivated to acquire private information prior to earnings announcements about firms that have relatively high quality information environments. Thus, our results have implications for policies aimed at reducing information asymmetry between investors by increasing public disclosure.

This study examines whether differential interpretation of earnings announcements is affected by earnings and firm characteristics. We find that Kandel and Pearson's (1995) forecast measures of differential interpretation are: 1) negatively related to earnings predictability, firm size, and price-to-book ratio, and 2) positively related to earnings surprise, negative earnings, and analyst coverage. This evidence suggests that differential interpretation of earnings announcements is decreasing in the quality of the earnings, the quality of pre-announcement disclosure, and the cost of analyzing a firm's value.

We study cross-sectional differences in pre-announcement and event-period private information acquisition across firm size and institutional ownership using trading volume reactions to earnings announcements. We find that abnormal volume associated with absolute price change increases with both firm size and institutional ownership, suggesting that pre-announcement private information acquisition increases with firm size and institutional ownership. We also find that abnormal volume independent of absolute price change increases with institutional ownership, suggesting that event-period private information acquisition increases with institutional ownership. In contrast, abnormal volume independent of absolute price change decreases with firm size, reflecting the previously documented positive relation between firm size and the precision of pre-announcement public information. By demonstrating that firm size and institutional ownership are determinants of pre-announcement and event--period private information acquisition, this study provides new insights regarding the incentive to acquire private information around earnings announcements and helps explain prior empirical results in trading volume reaction studies.

We study the feasibility and desirability of integrating ethics with traditional principal-agent theory. After discussing common objections and potential benefits, we present a principal-agent model that incorporates ethics in a manner that maintains the essential features of the traditional LEN framework. In our integrative model, the principal specifies a standard for effort at the time of contracting and the agent suffers a disutility if he chooses to violate the standard after agreeing to the contract. The magnitude of the disutility depends upon the level of violation and the ethical sensitivity of the agent. Setting ethical sensitivity to zero yields the traditional result that a flat salary is incapable of inducing effort from the agent. When ethical sensitivity becomes nonzero, however, a flat salary solution emerges. We examine the interplay between ethical sensitivity and firm productivity in determining the optimal salary contract. Our study suggests that incorporating ethics enhances both the internal and external validity of principal-agent theory.

We examine the realism of the assumption of self-interested opportunism in agency theory. We place subjects into manager/producer pairs and set parameters so that the producer extracts the highest share of residual earnings from the manager by setting the budget at zero (100% slack) and providing low effort (shirking). Because the budget is public and effort is private, this setting allows us to examine two different forms of opportunism. To establish common knowledge of incentives, we give subjects extensive experience in both manager and producer roles. Finally, we manipulate pair rotation and the ability of the manager to reject the budget. Fully opportunistic levels of slack and shirking are not observed on average, and the two forms of opportunism differ systematically. With experience, subjects learn to build more slack into their budget but do not shirk more. Fairness concerns reduce both forms of opportunism but ethics concerns reduce shirking only. Subject rotation increases shirking but has no effect on slack. While rejection power reduces slack, it also increases shirking with all variables in the model. We discuss the implications of these results for theory and practice.

Atiase [1980] hypothesized that private information production and dissemination prior to an earnings announcement is an increasing function of firm size. The economic rationale behind this hypothesis was that large firms have higher share liquidity, which conceals informed trade and increases the return to private information acquisition. While empirical researchers commonly use firm size as a control variable for the quality of predisclosure information, the economic rationale behind the differential information hypothesis has not been verified. Using all 10 CRSP firm size deciles, we document a positive relation between predisclosure share turnover and firm size. We find that predisclosure share turnover is positively related to institutional investment and analyst following, suggesting that sophisticated investors are attracted to highly liquid firms where they can conceal their informed trades. We also find evidence that predisclosure share turnover increases the amount of earnings-related information impounded in stock price in the predisclosure period, but this effect is driven by small firms. Investors in large firms appear to be successful at concealing their informed trades.

We study the implications of introducing ethics into the traditional principal-agent model. In our model, the principal specifies a standard for effort at the time of contracting and the agent suffers a utility loss if he chooses not to provide the standard after agreeing to the contract. The magnitude of the loss depends upon the agent's ethical sensitivity. We demonstrate the emergence of an optimal flat salary contract. We then examine the interplay between ethical sensitivity and firm productivity in determining the optimal salary contact, and contrast it with the traditional incentive solution. Our results are intuitive and help explain a variety of contracting behavior that is inconsistent with traditional agency predictions.

Prior archival studies of analysts' forecasts have found evidence for systematic underreaction, systematic overreaction, and systematic optimism bias. Easterwood and Nutt (1999) attempt to reconcile the conflicting evidence by testing the robustness of Abarbanell and Bernard's (1992) underreaction results to the nature of the information. Consistent with systematic optimism, forecasts are found to underreact to negative earnings information but overreact to positive information. However, Easterwood and Nutt are unable to distinguish between misreaction caused by incentives unique to analysts with misreaction caused by human decision bias that may be typical of investors. We address this issue by analyzing forecast reactions to positive versus negative information in the controlled experimental setting of Gillette, Stevens, Watts, and Williams (1999). This experimental setting has the potential to detect human decision bias because it is void of potentially confounding incentives of analysts, contains a simple forecasting objective (a random-walk series), and provides learning opportunities and economic incentives to minimize forecast error. We find a systematic forecast underreaction to both positive and negative information, and the underreaction is generally greater for positive information than negative information. These results suggest that prior empirical evidence of forecast overreaction to positive information is unlikely to be attributable to human decision bias.

In this paper we model return-earnings regressions in a setting in which analysts' forecasts are used to proxy for investors' expectations. We show how disparites between investors' and analysts' information sets could affect the regression coefficients and the R2. Our findings provide new and untested implications and yield insights into recent return-earnings evidence in the empirical literature.