Orie E. Barron

Misstatement Direction, Litigation Risk, and Planned Audit Investment

This study reports the results of an experiment showing that auditor assessments of litigation risk and planned audit investments are higher when potential errors overstate financial performance than when those errors understate performance. This result is much stronger in the presence of high levels of litigation risk in the client’s industry. These results suggest that in industries where litigation risk is high audited financial statements may contain more unintentional material understatement errors than overstatement errors. Thus, litigation risk—through its effect on auditors—may encourage financial statements that understate firm performance

Analyst Pessimism and Forecast Timing

In this study, we show that on average relatively pessimistic analysts tend to reveal their earnings forecasts later than other analysts. Further, we find this forecast timing effect explains a substantial proportion of the well-known decrease in consensus analyst forecast optimism over the forecast period prior to earnings announcements, which helps explain why analysts’ longer term earnings forecasts are more optimistically biased than their shorter term forecasts. We extend the theory of analyst self-selection regarding their coverage decisions to argue that analysts with a relatively pessimistic view–compared to other analysts–are more reluctant to issue their earnings forecasts, with the result that they tend to defer revealing their earnings forecasts until later in the forecasting period than other analysts.

The Information Environment and Cost of Capital

In empirical tests guided by recent theory (e.g., Hughes, Liu and Liu 2007; and Lambert, Leuz and Verrecchia 2011), we examine the joint effects of information precision, information asymmetry and the level of market competition on firms’ cost of equity capital. Consistent with theory, we find that average information precision and the level of market competition reduce the positive effect of information asymmetry but do not eliminate it. Besides examining various aspects of the environment jointly, our study is also unique in that we follow the suggestions of Sheng and Thevenot (2012) for modifying the Barron, Kim, Lim and Stevens (1998) measures of information asymmetry and precision. We find that cost of equity capital varies greatly with the modified measures of information asymmetry and average information precision. For example, our regression estimates suggest that information asymmetry and average information precision are more important than equity beta and firm size in determining firms’ cost of capital, and that such a substantial effect from information asymmetry and information precision is not apparent using unmodified BKLS measures.

Leveling the Informational Playing Field

This study uses experimental data to compare the information generated by professional and nonprofessional investors when both groups receive access to the same financial disclosures. We also manipulate the disclosure level for both subject groups. Using the method developed by Barron, Kim, Lim and Stevens (1998), we then analyze the information contained in stock price forecasts that were made by the experimental subjects. Professionals generally possessed more information than nonprofessionals. The higher level of disclosure did not affect the information possessed by the professional investors. However, we find that a higher level of disclosure is associated with more private information being produced (or inferred) by nonprofessional investors. As a result, these subjects realized a significant improvement in the accuracy of their mean forecasts relative to their individual forecasts. This finding suggests that the enhanced capacity of firms to widely disclose information to all market participants via the Internet, together with the SEC’s new “Fair Disclosure (FD)” regulation, has the potential to produce a significant increase in privately inferred information for on-line nonprofessionals, potentially resulting in the aggregation of more diverse information into share prices.

The Changing Behavior of Trading Volume Reactions to Earnings Announcements: Evidence of the Increasing Use of Accounting Earnings News by Investors: Changing Volume Reactions to Earnings

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.