Ronald A. Dye

Classifications Manipulation and Nash Accounting Standards

This paper studies a model of “classifications manipulation” in which accounting reports consist of one of two binary classifications, preparers of accounting reports prefer one classification over the other, an accounting standard designates the official requirements that have to be met to receive the preferred classification, and preparers may engage in “classifications manipulation” in order to receive their preferred accounting classification. The possibility of classifications manipulation creates a distinction between the official classification described in the statement of the accounting standard and the de facto classification, determined by the “shadow standard” actually adopted by preparers. The paper studies the selection and evolution of accounting standards in this context. Among other things, the paper evaluates “efficient” accounting standards, it determines when there will be “standards creep,” it introduces and analyzes the notion of a Nash accounting standard, and it compares the standards set by sophisticated standard–setters to those set with less knowledge of firms’ financial reporting environments.

Communication And Post-Decision Information

Managers are frequently requested to provide information about factors which influence their performance which is subsequently used to determine their compensation. Since independent means of verifying the accuracy of the information reported may not be available, and since managers are governed by their own self-interests, it might seem futile for owners to request and rely on such information. Nevertheless, there are a wide variety of circumstances under which these requests are made-management forecasts, standard-setting, and bottom-up capital budgeting. Fulfilling and evaluating these requests consumes resources, so to provide a positive theory of this communication between managers and their principals requires demonstration of the strict superiority of management compensation schemes which depend upon the information transmitted over those schemes which ignore such information. In this paper, I offer a theory of this communication within the context of the principal-agent paradigm. This paper is closely related to Holmstrom [1979]. Holmstrom characterizes the circumstances under which the optimal contracts between a principal and his agent depend upon some publicly available signal other than output. I shall specify sufficient conditions for which optimal contracts will depend upon a signal privately observed only by the agent. This leads to two moral hazard problems in the situation analyzed here: one regarding the agents selection of effort and one regarding the agents

Resource Allocation Effects of Price Reactions to Disclosures

Capital market participants collectively may possess information about the valuation implications of a firms change in strategy not known by the management of the firm proposing the change. We ask whether a firms management can exploit the capital markets information in deciding either whether to proceed with a contemplated strategy change or whether to continue with a previously initiated strategy change. In the case of a proposed strategy change, we show that managers can extract the capital markets information by announcing a potential new strategy, and then conditioning the decision to implement the new strategy on the size of the markets price reaction to the announcement. Under this arrangement, we show that a necessary condition to implement all and only positive net present value strategy changes is that managers proceed to implement some strategies that garner negative price reactions upon their announcement. In the case of deciding whether to continue with a previously implemented strategy change, we show that it may be optimal for the firm to predicate its abandonment/continuation decision on the magnitude of the costs it has already incurred. Thus, what looks like “sunk†cost†behavior may in fact be optimal. Both demonstrations show that, in addition to performing their usual role of anticipating future cash flows generated by a managers actions, capital market prices can also be used to direct a managers actions. It follows that, in contrast to the usual depiction of the information flows between capital markets and firms as being one way — from firms to the capital markets — information also flows from capital markets to firms.

Investor Sophistication and Voluntary Disclosures

This paper studies voluntary disclosures in a model in which investors probabilistically become informed about whether a firm has received information. The firms value is established via a first price, sealed bid, common value auction. The paper demonstrates that the threshold level determining whether the firm withholds or discloses information uniformly declines in the probability investors are informed. The paper also shows that, notwithstanding the risk-neutrality of investors, the expected selling price of the firm strictly decreases (increases) in the probability individual investors are informed when that probability is small (large). These results follow from “winners curse” effects.

Self-Selection via Fringe Benefits

This paper extends the theory of self-selection to circumstances in which economic agents have some access to markets. We use the analysis to explain the existence of multidimensional compensation packages in the presence of limited (re)marketability. Employment contracts that include fringe benefits are prominent examples of such multidimensional packages.

Investment Implications of Information Acquisition and Leakage

This paper studies when a firm will acquire additional information about a potential new project by consulting outsiders, when doing so runs the risk of reducing the value of implementing the project as a consequence of information leakage. The analysis evaluates the firms information acquisition activities in both the presence and absence of moral hazard in project production.

Cost-minimizing welfare programs

Abstract We study opportunities for lowering the cost of welfare programs by exploiting heterogeneity in the unobservable tastes of welfare recipients. Relying on the inability of cash-based programs to achieve self-selection, we provide circumstances in which it is optimal to provide payments-in- kind. Our model differs from other self-selection models because we allow the recipients the opportunity to trade the subsequent to the receipt of their welfare packages. The presence of unreported cash among the recipient population is considered.

Optimal disclosure decisions when there are penalties for nondisclosure

We study a seller of an asset who is liable for damages if the seller fails to disclose to buyers an estimate of the assets value he knew prior to the sale. Our results include as either the “damages multiplier” that determines the size of the damages the seller must pay buyers increases, or as the probability the seller is caught withholding his estimate from buyers increases, the seller discloses his estimate less often, and as the precision of the sellers estimate increases, he sells a larger fraction of the asset.

Discretion in reporting managerial performance

Abstract In a single period agency model in which the agent has some discretion regarding how to report his periods performance, we show when the agents contract is increasing in his report regardless of the characteristics of his production technology, and how to rank changes in the agents reporting technology according to the expected cost of compensating the agent.

Intrafirm Resource Allocation and Discretionary Actions

The purpose of this paper is to investigate some aspects of intrafirm resource allocation as accomplished through transfer pricing techniques. Existing theories of transfer prices have several deficiencies. In the traditional transfer pricing models, researchers have posited that central management possesses as much information about the production technologies of divisions as do the division managers themselves (see, e.g., Hirshleifer [1956], Gould [1964]). Given this assumption, central management, by specifying what quantities each division should produce, can achieve the same level of profits as can be achieved by taking the more circuitous, but equivalent, route of specifying the prices that will induce individual division managers to select these same quantities. Consequently, while traditional transfer pricing models identify the implicit prices of intrafirm transfers (which may have some intrinsic interest), these transfer prices need serve no allocational role, and so the failure to implement a transfer pricing scheme has no impact on firm profits in such models.