Research Lab

In earlier work we presented a mathematical exposition of a theory that demonstrated that mass privatization without institutions to limit asset-stripping may not lead to a demand for the rule of law. The present note makes the same argument in terms of simple diagrams. The central idea is that economic actions (to build value or strip assets) and political positions of individuals are interdependent.

The collapse of Long Term Capital Management ("LTCM") in Fall 1998 and the Federal Reserve Bank's subsequent efforts to orchestrate a bailout raise important questions about the structure of the Bankruptcy Code. The Code contains numerous provisions affording special treatment to financial derivatives contracts, the most important of which exempts these contracts from the "automatic stay" and permits counterparties to terminate derivatives contracts with a debtor in bankruptcy and seize underlying collateral.

In fall 1998 the Federal Reserve Bank ("Fed") arranged a bailout of the massive hedge fund, Long Term Capital Management (LTCM), which faced the prospect of immediate liquidation if it filed a petition under Chapter 11 of the Bankruptcy Code. The Fed's intervention to aid LTCM calls into question the policy rationale underlying the Bankruptcy COde's special treatment of derivatives. In this paper, we make the following claim: derivatives may deserve special treatment, but not for the reason commonly given.

Globalization has been sold as bringing unprecedented prosperity to the billions of people who have remained mired in poverty for centuries. Yet, globalization faces enormous resistance especially in the Third World. Why so? I argue that globalization today has been oversold.

Bayesian learning implies decreasing weights on prior beliefs and increasing weights on the accuracy of the analyst?s past forecast record, as the number of forecast errors comprising her forecast record (its length) increases. Consistent with this model of investor learning, empirical tests show that investors? reactions to forecast news are increasing in the product of the accuracy and length of analysts? forecast records. Moreover, the Bayesian learning predicted by our model is more descriptive of investor reactions than is a static model which predicts that investors?

We survey and interview more than 400 executives to determine the factors that drive reported earnings and disclosure decisions. We find that managers would rather take economic actions that could have negative long-term consequences than make within-GAAP accounting choices to manage earnings. A surprising 78% of our sample admits to sacrificing long-term value to smooth earnings. Managers also work to maintain predictability in earnings and financial disclosures.

In this paper, we analyze the optimal policy for a risk averse agent who wants to sell a large block of shares of a risky security in the presence of price impact and transactions costs. Our framework reduces to the standard Merton portfolio problem in the absence of any market frictions. Optimal liquidation results in revenue distributions which are substantially different from those generated by a naive strategy. The main tradeoff involves choosing between revenue distributions which have high means versus those which have low variances.

This article works out a general formulation of residual income valuation. It shows how to construct valuaton functions using accounting book value, earnings, and earnings forecasts. The approach developed applies to linear as well as nonlinear valuation functions.

A fictional example illustrates how interdependencies among products in the production process, and the costs associated with those interdependencies, challenge the ability of cost accounting systems to generate decision-useful product cost information. The cost interdependency in the current example is a production-line change-over cost that is incurred to retool a machine whenever the production process changes from one product to another.