James Patrick Naughton

Private Litigation Costs and Voluntary Disclosure: Evidence from the Morrison Ruling

We use a natural experiment, the Supreme Court Ruling in Morrison v. National Australia Bank and the subsequent Dodd-Frank Act, to examine whether and how expected private litigation costs affect voluntary disclosure behavior. The Morrison decision applied a presumption against extraterritoriality for all securities actions. Congress quickly responded by exempting SEC actions through the Dodd-Frank Act, with the result that Morrison eliminates only private securities actions for shares purchased on non-US exchanges. These events lowered the expected private litigation costs for foreign firms cross-listed on US exchanges. We find a deterioration in our proxies for voluntary disclosure for these firms relative to a matched sample of US firms. The effects we document are stronger for firms with weaker home country institutions and for firms that experienced a larger decline in expected private litigation costs following Morrison. The evidence is consistent with firms responding to a reduction in expected private litigation costs by reducing voluntary disclosure.

Pension Risk and Equity Returns

We develop an analytical framework that divides the contribution of pension risk to the total systematic risk of the firm into two parts: (1) the risk due to the investment strategy of the pension plan (“Mismatch Risk”); and (2) the risk due to the funded status of the pension plan (“Deficit Risk”). We then use this framework to show that the financial statement treatment of pension plan obligations has implications for how pension risk is impounded into equity returns. Our empirical strategy uses variation in the financial statement effect of two new accounting standards as natural experiments to generate inferences. In contrast with the empirical finding in Jin, Merton and Bodie (2006), we find that pension risk is only reflected in equity returns when the underlying drivers of risk are disclosed and recognized on the firm’s financial statements.

Firm Fundamentals and Variance Risk Premiums

The same firm characteristics that help explain cross-sectional variation in expected stock returns, such as size, book-to-market and the earnings yield, also help explain cross-sectional variation in returns to trading in option-implied stock return volatility. This empirical phenomenon is shown to arise within a tractable accounting-based valuation model that allows for risk aversion and stochastic earnings volatility. The model predicts that expected stock (stock return volatility) returns are positively (negatively) related to a combination of the inverse of size, book-to-market, the earnings yield, and the dividend yield. These predictions are strongly supported using a variety of empirical specifications. The model provides a framework for jointly investing in stocks and options, and the findings highlight the ability of accounting-based valuation models to explain price dynamics across stock and volatility markets.

How Does Algorithmic Trading Improve Market Quality

We use a comprehensive panel of NYSE order book data to show that the liquidity and quoting efficiency improvements associated with algorithmic trading (AT) are attributable to enhanced monitoring by liquidity providers. We find that variation in liquidity provider monitoring uniquely explains quoting behaviors around idiosyncratic versus multi-asset price jumps and small- versus large-stock price jumps. In addition, we find monitoring outperforms measures of overall AT activity in explaining stock-level decreases in liquidity costs, and that residual variation in AT is associated with increased spreads. Importantly, our results indicate that there are diminishing returns to market function from subsequent technological advancements, thus providing a novel explanation for why spreads have not continued to fall since 2007 despite sustained increases in algorithmic trading.