Ian D. Gow

Linguistic Complexity in Firm Disclosures: Obfuscation or Information?

Prior research generally interprets complex language in firms’ disclosures as indicative of managerial obfuscation. However, complex language can also reflect the provision of complex information; for example, informative technical disclosure. As a consequence, linguistic complexity commingles two latent components—obfuscation and information—that are related to information asymmetry in opposite directions. We develop a novel empirical approach to estimate these two latent components within the context of quarterly earnings conference calls. We validate our estimates of these two latent components by examining their relation to information asymmetry. Consistent with our predictions, we find that our estimate of the information component is negatively associated with information asymmetry while our estimate of the obfuscation component is positively associated with information asymmetry. Our findings suggest that future research on linguistic complexity can construct more powerful tests by separately examining these two latent components of linguistic complexity.

Capital Budgeting: The Role of Cost Allocations

A common issue for firms is how to allocate capital resources to various investment alternatives. An extensive literature in finance has examined various aspects of capital budgeting, including capital constraints, the determination of discount rates, and alternative approaches to estimating cash flows and handling risk, such as real options techniques. In terms of organizational structure, a central feature of the capital budgeting process in large firms is that relevant information about the profitability of potential investment projects resides with one or several managers. It is generally accepted that preferences of these managers may not coincide with those of the firm’s owners (the principal). Consequences of asymmetric information include strategic reporting by better-informed managers (for example, “sandbagging” or “creative optimism”) and a need to measure performance ex post. Surveys consistently find that internal rate of return (IRR) criteria remain prevalent in capital budgeting decisions. Furthermore the use of artificially high hurdle rates suggests widespread capital rationing [15, 20].