Phillip C. Stocken

Credibility of Management Forecasts

We examine how the markets ability to assess the truthfulness of management earnings forecasts affects the extent to which managers bias their forecasts, and we evaluate whether the markets response to management forecasts is consistent with it identifying the predictable bias in forecasts. We find that managers more likely to face litigation release less optimistic forecasts than managers less likely to face litigation, and this incentive is dampened when it is more difficult to detect whether managers have misrepresented their forward-looking information. Further, when it is more difficult to detect forecast bias, we find that managers are more likely to offer forecasts that increase their profits from insider transactions and managers of financially distressed firms are more optimistic than those of healthy firms. With regard to the stock price response to forecasts, we find the markets immediate response varies with the predictable bias in good but not bad news forecasts. The markets subsequent response, however, is consistent with investors eventually identifying the bias in bad news forecasts and modifying their valuation of the firm in the appropriate direction.

Credibility of Voluntary Disclosure

I examine the credibility of a managers disclosure of privately observed nonverifiable information to an investor in a repeated cheap-talk game setting. In the single-period game no communication occurs. In the repeated game, however, the manager almost always truthfully reveals his private information provided the manager is sufficiently patient, the accounting report is sufficiently useful for assessing the truthfulness of the managers voluntary disclosure, and the managers disclosure performance is evaluated over a sufficiently long period. These factors may explain a managers propensity to release private information to investors.

The Effects of Business Risk on Audit Pricing

This paper examines the pricing of business risk by homogeneous auditors in a two period model. Incumbent auditors learn the clients business risk type during the course of the engagement. They subsequently compete in prices with prospective auditors. In such an environment, we show that equilibrium audit fees do not fully reflect the cost of business risk. Moreover, there exists differential auditor turnover between high and low risk firms; cross-subsidization of the audit fees of high risk firms by low risk firms; and low-balling by auditors.

Location of Decision-Rights Within Multinational Firms

Using U.S.-based multinational firm data gathered over more than two decades, we examine factors associated with the location of decision rights within these firms, whether the inappropriate assignment of decision rights is associated with poor firm performance, and whether these firms relocate decision rights in response to their evolving environments. We find that a mismatch between the location of decision rights and a firms environment is associated with weak firm performance. We also show that the likelihood a parent company will alter the assignment of decision rights to a subsidiary is increasing in the extent of a mismatch although this likelihood is decreasing in the strength of the subsidiarys performance.

Strategic Accounting Disclosure

This monograph surveys the analytic accounting disclosure literature in which firms strategically communicate information to investors. Its purpose is to identify guidelines that firm management might consider when voluntarily disclosing or mandatorily reporting information to investors and also factors that investors might recognize when using a firms disclosure. It discusses persuasion games, costless signaling games, and costly signaling games. The monograph highlights the primary features of the equilibria in these games and how communication varies in each of these settings. It then surveys work that uses these frameworks. This work suggests that a firms disclosure policy depends on the features of its environment. The monograph concludes that characterizing firm disclosure policies for a set of generic features of the reporting environment awaits further research.

Corporate Governance in a Competitive Environment

We examine a firms corporate governance choices within a competitive environment. A firm can choose a passive board that delegates decision rights to the executive manager, or an active board that retains these rights. We characterize the equilibrium governance choices and find that there generally is no systematic relation between governance systems and firm performance. We discuss how the governance choice is affected by the rate of technological innovation, board expertise, the discount rate, the benefit of using new technology, and the cost of operating an internal control system. Finally, we analyze consequences of the Sarbanes-Oxley Act.

Optimal Firm (Non-)Disclosure

We re-examine the seminal persuasion model of Dye (1985), focusing on the contracting power of current shareholders. Current shareholders determine the disclosure policy of a manager, who may be informed about the firms value. Current shareholders desire higher future stock prices and dislike volatility. We show that the optimal policy is complete non-disclosure. The key intuition is that the disclosure policy cannot affect the expected future stock price, but can affect price volatility, which is minimized under non-disclosure. Our results extend to cheap talk settings and Bayesian persuasion games.

Persuasion Under Higher-Order Uncertainty

We study a general model of persuasion games under higher-order uncertainty about the senders knowledge of an uncertain state variable. Unlike situations where such uncertainty is absent, we show that higher-order uncertainty eliminates truth-telling as an equilibrium. Instead, equilibrium consists of a convex interval of states where either disclosure or complete non-disclosure occurs, depending on the relative slopes of the ideal action lines of the sender and receiver. When choosing between senders differing in both expertise and preference alignment, we offer conditions where expertise dominates regardless of the degree of preference misalignment. Absent higher-order uncertainty, we provide an algorithm for constructing a truthful equilibrium, as well as necessary and sufficient conditions for equilibrium uniqueness.