Robert E. Verrecchia

Constraints on short-selling and asset price adjustment to private information

This paper models effects of short-sale constraints on the speed of adjustment (to private information) of security prices. Constraints eliminate some informative trades, but do not bias prices upward. Prohibiting traders from shorting reduces the adjustment speed of prices to private information, especially to bad news. Non-prohibitive costs can have the reverse effect, but this is unlikely. Implications are developed about return distributions on information announcement dates. Periods of inactive trade are shown to impart a downward bias to measured returns. An unexpected increase in the short-interest of a stock is shown to be bad news.

Market liquidity and volume around earnings announcements

Abstract This paper suggests that earnings announcements provide information that allows certain traders to make judgements about a firms performance that are superior to the judgements of other traders. As a result, there may be more information asymmetry at the time of an announcement than in nonannouncement periods. More information asymmetry implies that bid–ask spreads increase, suggesting that market liquidity decreases at the time of an earnings announcement. Furthermore, informed opinions resulting from public disclosure may lead to an increase in trading volume, despite the reduction in liquidity that accompanies announcements.

Information aggregation in a noisy rational expectations economy

Abstract This paper analyzes a general equilibrium model of a competitive security market in which traders possess independent pieces of information about the return of a risky asset. Each trader conditions his estimate of the return both on his own private source of information and price, which in equilibrium serves as a ‘noisy’ aggregator of the total information observed by all traders. A closed-form characterization of the rational expectations equilibrium is presented. A counter-example to the existence of ‘fully revealing’ equilibrium is developed.

Information quality and discretionary disclosure

Abstract Using the model of discretionary disclosure suggested in Verrecchia (1983), I show that an increase in the quality of private information received by a manager results in more disclosure on his part. I also discuss how this result influences a managers choice over levels of quality.

Pre-announcement and event-period private information

Abstract Pre-announcement information is private information gathered in anticipation of a public disclosure. Event-period information is private information useful in conjunction with the announcement itself. Typically rational models of trade are based exclusively on one type of information. Such models are less descriptive of real market settings and misspecified empirically. Therefore, we introduce a model of rational trade with both features and discuss its implications.

The Relation Among Capital Markets, Financial Disclosure, Production Efficiency, and Insider Trading

The purpose of this paper is to establish a link among (1) the nature of the capital market from which a firm secures its investment funds, (2) the firms chosen level of financial disclosure, (3) the firms cost of capital, (4) the extent of its residual agency problems, and (5) the extent of insider trading in its shares, in a model in which the costs and benefits associated with disclosure are endogenous. The nature of the capital market is characterized in our discussion by the potential liquidity needs of investors from whom capital is raised. The level of disclosure is determined by trading off a production efficiency effect and a compensation subsidy effect, both of which fall with increased disclosure, against a market illiquidity effect and its effect on the cost of capital, both of which also fall with increased disclosure. Production efficiency falls because more disclosure means less information about the managers action is impounded in price, so that price-based

The Effect Of Sequential Information Releases On The Variance Of Price Changes In An Intertemporal Multi-Asset Market

This paper considers several determinants of the magnitude of price reactions to information releases from a theoretical perspective, and indicates how those factors affect the magnitude of price responses to new information. We model the change in price to a sequence of public information releases about the liquidating dividends of two risky assets. The market possesses prior information about the mean and variance of the liquidating dividends of the two assets, as well as their cross-sectional correlation. There are two information releases about each of the risky assets and each information release is received simultaneously by all

Introducing convexity into optimal compensation contracts

Abstract We study when it is appropriate to add a convex component such as stock options to an optimal, managerial compensation contract. We show that convexity is introduced when managers have moderate levels of relative risk aversion and decreasing absolute risk aversion. In addition, we study how convexity is affected as the distribution of outcomes becomes more skewed toward low outcomes. Here we show that while convexity increases when skewness is increased without regard to the effect on mean stock price, the opposite effect results when increases in skewness leave the mean stock price unchanged.

The Use of Mathematical Models in Financial Accounting

Well over a year ago it was proposed that I write a survey paper for this conference which discussed the role of mathematical models in financial accounting. The difficulty with this assignment is that mathematical models have been used to address a wide variety of issues in financial accounting, and a paper which touched on all of them would probably be unable to examine any single one in depth. Therefore, I have chosen in financial accounting three popular mathematical modeling themes and have interpreted these themes in the context of a competitive equilibrium market model, to lend greater cohesiveness to the discussion. I refer to the three topics chosen as: (1) assessing the consequences of public disclosure; (2) formalizing the notion that markets are efficient with respect to information; and (3) understanding the effect of increased public disclosure on private incentives to acquire information. Other areas in financial accounting which use mathematical models, but are not discussed here, include income measurement, valuation models (i.e., models which map accounting variables, or other information, into equi-

Endogenous proprietary costs through firm interdependence

Abstract In the preceding paper Darrough and Stoughton suggest that firm interdependence, modelled as an entry game among firms in a product market, can yield endogenous proprietary costs. This allows the costs associated with the dissemination of information about the firm to depend upon the informations content in some direct way. My comments focus on: first, the structure of the game, which emphasizes the potential for full disclosure; second, the extent to which the entry game exaggerates the usefulness of ‘bad news’; and third, their suggestion that more competition among firms implies more, and not less, disclosure, an observation seemingly contrary to Verrecchia (1983).