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Abstract:
This paper provides evidence that insiders possess, and trade upon, knowledge of specific and economically-significant forthcoming accounting disclosures as long as two years prior to the disclosure. Stock sales by insiders increase three to nine quarters prior to a break in a string of consecutive increases in quarterly earnings. Insider stock sales are greater for growth firms, before a longer period of declining earnings, and when the earnings decline at the break is greater. Consistent with avoiding an established legal jeopardy, there is little abnormal selling in the two quarters immediately prior to the break.

Insider trading, Securities regulation

Abstract:
This paper provides evidence that insiders possess, and trade upon, knowledge of specific and economically-significant forthcoming accounting disclosures as long as two years prior to the disclosure. Stock sales by insiders increase three to nine quarters prior to a break in a string of consecutive increases in quarterly earnings. Insider stock sales are greater for growth firms, before a longer period of declining earnings, and when the earnings decline at the break is greater. Consistent with avoiding an established legal jeopardy, there is little abnormal selling in the two quarters immediately prior to the break.

Insider trading, Securities regulation

Abstract:
We provide large sample evidence that past price extremes influence investors' trading decisions. Volume is strikingly higher, in both economic and statistical terms, when the stock price crosses either the upper or lower limit of its past trading range. This increase in volume is more pronounced the longer the time since the stock price last achieved the price extreme, the smaller the firm, the higher the individual investor interest in the stock, and the greater the ambiguity regarding valuation. These results are robust across model specifications and controls for past returns and news arrival. Volume spikes when price crosses either the upper or lower limit of the past trading range, then gradually subsides. After either event, returns are reliably positive and, among small investors, trades classified as buyer-initiated are elevated. Overall, results are more consistent with bounded rationality - specifically, the attention hypothesis posited by Barber and Odean (2008) - than with other candidate explanations.

decision analysis, prospect theory, value function, reference point, behavioral finance

Abstract:
We provide large sample evidence that past price extremes influence investors' trading decisions. Volume is strikingly higher, in both economic and statistical terms, when the stock price crosses either the upper or lower limit of its past trading range. This increase in volume is more pronounced the longer the time since the stock price last achieved the price extreme, the smaller the firm, the higher the individual investor interest in the stock, and the greater the ambiguity regarding valuation. These results are robust across model specifications and controls for past returns and news arrival. Volume spikes when price crosses either the upper or lower limit of the past trading range, then gradually subsides. After either event, returns are reliably positive and, among small investors, trades classified as buyer-initiated are elevated. Overall, results are more consistent with bounded rationality - specifically, the attention hypothesis posited by Barber and Odean (2008) - than with other candidate explanations.

decision analysis, prospect theory, value function, reference point, behavioral finance

Abstract:
This paper analyzes whether competition between stock exchanges for volume leads to a deterioration of disclosure requirements imposed by those exchanges on listing firms. The model shows that trading concentrates on the high disclosure exchange, prompting exchanges to engage in a "race for the top" by requiring the highest level of disclosure for listed firms. Disclosure requirements affect the allocation of liquidity across exchanges and the listing decisions of firms controlled by corporate insiders. In effect, corporate insiders compete with each other for liquidity to their mutual disadvantage. Introducing risk aversion on the part of liquidity traders creates a diversification motive to allocate demands to a low disclosure exchange. Listing costs, taxes, and other restrictions may prompt some firms to list on the low disclosure exchange. Despite these additional features, each exchange maximizes trading volume by selecting the highest feasible standards.

Abstract:
We use a rational expectations model to examine how public disclosure requirements affect listing decisions by rent-seeking corporate insiders, and allocation decisions by liquidity traders seeking to minimize trading costs. We find that exchanges competing for trading volume engage in a "race for the top" where under disclosure requirements increase and trading costs fall. This result is robust to diversification incentives of risk-averse liquidity traders, institutional impediments that restrict the flow of liquidity, and listing costs. Under certain conditions, unrestricted liquidity flows to low disclosure exchanges. The consequences of cross-listing also are modeled.

Abstract:
We investigate stock option exercise decisions by over 50,000 employees at seven corporations. Controlling for economic factors, psychological factors influence exercise. Consistent with psychological models of beliefs, employees exercise in response to stock price trends--exercise is positively related to stock returns during the preceding month and negatively related to returns over longer horizons. Consistent with psychological models of values that include reference points, employee exercise activity doubles when the stock price exceeds the maximum price attained during the previous year.

Abstract:
We investigate stock option exercise decisions by over 50,000 employees at seven corporations. Controlling for economic factors, psychological factors in*uence exer- cise. Consistent with psychological models of beliefs, employees exercise in response to stock price trends|exercise is positively related to stock returns during the pre- ceding month and negatively related to returns over longer horizons. Consistent with psychological models of values that include reference points, employee exercise activity roughly doubles when the stock price exceeds the maximum price attained during the previous year.

Abstract:
We investigate the relationship between insider trading and candidate measures for the degree of information asymmetry between insiders and other market participants. The coefficient estimates on certain of the candidate measures assume a sign that is inconsistent with the predicted relationship between the measure and the degree of information asymmetry. For those measures, either the measures are poor proxies for asymmetry or models of informed trade are not descriptive. Overall, the median absolute abnormal return over past earnings announcements (MAG_AR) and whether the firm reports R\&D expenditures perform consistently with predictions for measures of information asymmetry in a price-taking theory of informed trade. Insider profits are significantly higher when MAG_AR is greater.

Accounting, Disclosure, Informed trade, Returns, Securities regulation

Abstract:
Regulation requiring insiders to publicly disclose their stock trades after the fact complicates the trading decisions of informed, rent-seeking insiders. Given this requirement, we present an insider's equilibrium trading strategy in a multiperiod rational expectations framework. Relative to Kyle (1985), price discovery is accelerated and insider profits are lower. The strategy balances immediate profits from informed trades against the reduction in future profits following trade disclosure and, hence, revelation of some of the insider's information. Our results offer a novel rationale for contrarian trading: dissimulation, a phenomenom distinct from manipulation, may underlie insiders' trading decisions.

Insider trading, price discovery, liquidity, securities regulation

Abstract:
Regulation requiring insiders to publicly disclose their stock trades after the fact complicates the trading decisions of informed, rent-seeking insiders. Given this requirement, we present an insider's equilibrium trading strategy in a multiperiod rational expectations framework. Relative to Kyle (1985), price discovery is accelerated and insider profits are lower. The strategy balances immediate profits from informed trades against the reduction in future profits following trade disclosure and, hence, revelation of some of the insider's information. Our results offer a novel rationale for contrarian trading: dissimulation, a phenomenom distinct from manipulation, may underlie insiders' trading decisions.

Insider trading, price discovery, liquidity, securities regulation

Abstract:
We examine the stock option exercise decisions of over 50,000 employees at seven corporations to provide evidence on the distribution of price-relevant non-public information among employees. When option exercise (adjusted for other factors affecting exercise) is low, stock returns in the coming six months are 10% higher than when option exercise is high. The exercise decisions of relatively junior employees contain at least as much price-relevant information as the exercise decisions of more senior employees.

accounting, compensation, disclosure, regulation, securities

Abstract:
We examine the stock option exercise decisions of over 50,000 employees at seven corporations to provide evidence on the distribution of price-relevant non-public information among employees. When option exercise (adjusted for other factors affecting exercise) is low, stock returns in the coming six months are 10% higher than when option exercise is high. The exercise decisions of relatively junior employees contain at least as much price-relevant information as the exercise decisions of more senior employees.

accounting, compensation, disclosure, regulation, securities

Abstract:
Research in sociology and ethics suggests that individuals adhere to social norms of behavior established by their peers. Within an agency framework, we model endogenous social norms by assuming each agent's cost of implementing an action depends on the social norm for that action, defined to be the average level of that action chosen by the agent's peer group. We show how endogenous social norms alter the effectiveness of monetary incentives, determine whether it is optimal to group agents in a single or two separate organizations, and may give rise to a costly adverse selection problem when agents' sensitivities to social norms are unobservable.

alternative utility functions, earnings management, multi-task agency, organization design, professional codes of conduct

Abstract:
Research in sociology and ethics suggests that individuals adhere to social norms of behavior established by their peers. Within an agency framework, we model endogenous social norms by assuming each agent's cost of implementing an action depends on the social norm for that action, defined to be the average level of that action chosen by the agent's peer group. We show how endogenous social norms alter the effectiveness of monetary incentives, determine whether it is optimal to group agents in a single or two separate organizations, and may give rise to a costly adverse selection problem when agents' sensitivities to social norms are unobservable.

alternative utility functions, earnings management, multi-task agency, organization design, professional codes of conduct

Abstract:
Among the reactions to recent corporate scandals are calls for greater transparency of insiders' trades. The Securities and Exchange Commission's recent rule on fair disclosure is accompanied by a safe harbor from prosecution under insider trading laws for insiders who pre-commit to trades. A blue-ribbon commission convened to address recent financial scandals and subsequent decline in investor confidence recommended that insiders be required to preannounce sales of stock in their companies. The commission's call for insiders to preannounce their sales echoes proposals made over a decade ago in the legal press, law reviews, and the U.S. Congress that would require pre-announcement of all trades. We consider the effects of insiders pre-announcing their trades on their preferences for public disclosure that would pre-empt their private information when other motives for insiders to trade are present. Two principal forces emerge. With pre-announcement, insiders cannot expect to profit on their private information, but cannot ignore the incentive to do so when market makers are unable to disentangle insiders' motives. Pre-emptive public disclosure allows insiders to avoid the dysfunctional consequences of this incentive. However, such disclosure before insiders have an opportunity to trade exposes them to greater price risk than would otherwise be the case. Our analysis demonstrates these effects.

compensation, insider trading, risk aversion, sunshine trading, government regulation, accounting standards, stock-based compensation

Abstract:
Evidence contrasting U.S. insider trades in high- and low-jeopardy periods and across firms at high and low risk for 10b-5 litigation indicates that insiders condition their trades on foreknowledge of price-relevant public disclosures, but avoid profitable trades when the jeopardy associated with such trades is high, such as immediately before earnings announcements. Insiders avoid profitable trades before quarterly earnings are announced and sell (buy) after good (bad) news earnings announcements. Insiders trade most heavily after earnings announcements and profit from foreknowledge of price-relevant information in the forthcoming Form 10-K or 10-Q filing.

accounting standards, government regulation, insider trading, litigation risk, stock-based compensation

Abstract:
Evidence contrasting U.S. insider trades in high- and low-jeopardy periods and across firms at high and low risk for 10b-5 litigation indicates that insiders condition their trades on foreknowledge of price-relevant public disclosures, but avoid profitable trades when the jeopardy associated with such trades is high, such as immediately before earnings announcements. Insiders avoid profitable trades before quarterly earnings are announced and sell (buy) after good (bad) news earnings announcements. Insiders trade most heavily after earnings announcements and profit from foreknowledge of price-relevant information in the forthcoming Form 10-K or 10-Q filing.

accounting standards, government regulation, insider trading, litigation risk, stock-based compensation

Abstract:
We examine allegations that sharp increases in equity-based compensation in the 1990s bubble encouraged managers to inflate earnings and that managers' reporting choices succeeded in keeping stock prices high and rising. We find that managers generally inflate earnings before selling shares. Moreover, the magnitudes of the price correction experienced by particular stocks after the bubble burst are strongly associated with the abnormal accruals the firm reported during the bubble. We conclude that heightened incentives and consequent earnings inflation contributed to the bubble.

equity incentives, insider trading, financial reporting, smoothing

Abstract:
The trading decisions of a rent-seeking corporate insider who possesses long-lived private information are complicated by the regulatory requirement that he publicly disclose his trades after the fact. Such disclosure may allow other market participants to infer the insider's information. Yet the empirical evidence suggests that some corporate insiders buy and sell frequently, and insiders' profits on stock trades are abnormally large. We present a closed form solution for an insider's equilibrium stock trading strategy in a multiperiod rational expectations framework. The insider uses a mixed strategy to diminish the market maker's ability to infer the insider's private information. Relative to the benchmark established by Kyle (1985), we find that disclosure accelerates price discovery, and, in contrast to earlier models by Fishman and Hagerty (1995) and John and Narayanan (1997), mandatory disclosure unambiguously reduces insider profits. Regulatory implications are considered.

Abstract:
We investigate the relationship of candidate information asymmetry measures to aspects of insiders' trades. For two of the measures, the median absolute abnormal return over past earnings announcements (MAG_AR) and whether the firm reports R&D expenditures, associations are consistent with the predictions of a price-taking theory of informed trade. Also, insiders' profits are significantly higher when MAG_AR is greater. For the other measures we consider, associations are inconsistent with the predicted relationships, suggesting that either those measures are poor proxies for information asymmetry or models of informed trade are not descriptive.

Accounting, Disclosure, Securities, Regulation

Abstract:
We consider partnerships among risk-averse professionals endowed with (i) a risky and personally-costly production technology and (ii) a personally-costly monitoring technology providing contractible noisy signals about partners' productive efforts. Partners shirk both production and monitoring tasks because efforts are unobservable. We characterize optimal partnership size, profit shares and incentive payments when every partner performs the same tasks, and show that medium-sized partnerships are dominated by either smaller or larger partnerships. Prohibiting some partners from monitoring increases the incentives for others to monitor. We illustrate how task assignments and incentives interact, leading to improvements in partner welfare.

Incentive contracting, monitoring, risk aversion, syndicates

Abstract:
We consider partnerships among risk-averse professionals endowed with (i) a risky and personally-costly production technology and (ii) a personally-costly monitoring technology providing contractible noisy signals about partners' productive efforts. Partners shirk both production and monitoring tasks because efforts are unobservable. We characterize optimal partnership size, profit shares and incentive payments when every partner performs the same tasks, and show that medium-sized partnerships are dominated by either smaller or larger partnerships. Prohibiting some partners from monitoring increases the incentives for others to monitor. We illustrate how task assignments and incentives interact, leading to improvements in partner welfare.

Incentive contracting, monitoring, risk aversion, syndicates

Abstract:
We examine whether taxes affect stock sales by mutual funds. For certain funds, the expected amount of a given stock sold in a given quarter is 62% greater when liquidation would trigger a capital loss equal to 1% of the value of the portfolio than when a like-size gain would be triggered, a greater effect than is associated with either contemporaneous excess stock returns of 50% or unexpected EPS equal to 50% of the stock price. For growth funds, responses to tax factors are consistent from year to year, and dispositions vary with the year-to-date realized gain.

Investment advisers, Overhang, Realized, Unrealized

Abstract:
We examine whether taxes affect stock sales by mutual funds. For certain funds, the expected amount of a given stock sold in a given quarter is 62% greater when liquidation would trigger a capital loss equal to 1% of the value of the portfolio than when a like-size gain would be triggered, a greater effect than is associated with either contemporaneous excess stock returns of 50% or unexpected EPS equal to 50% of the stock price. For growth funds, responses to tax factors are consistent from year to year, and dispositions vary with the year-to-date realized gain.

Investment advisers, Overhang, Realized, Unrealized

Abstract:
We examine whether taxes affect stock sales by mutual funds. For certain funds, the expected amount of a given stock sold in a given quarter is 62% greater when liquidation would trigger a capital loss equal to 1% of the value of the portfolio than when a like-size gain would be triggered, a greater effect than is associated with either contemporaneous excess stock returns of 50% or unexpected EPS equal to 50% of the stock price. For growth funds, responses to tax factors are consistent from year to year, and dispositions vary with the year-to-date realized gain.

Investment advisers; Overhang; Realized; Unrealized

Abstract:
Like Cournot competitors in product markets, financial market insiders with common private information trade more aggressively than a monopolist with the same information, and thereby dissipate expected profits. Where the same insiders repeatedly receive private information, they may tacitly collude to limit trades and increase profits. Present rules requiring public reporting of insider trades (unintendedly) may allow insiders to improve upon aggregate volume or price in monitoring each other's trades, thereby facilitating collusion. Relative to product markets, the presence of a strategic market maker complicates the equilibrium. The results imply regulators may reduce tacit collusion by not publicizing insider trades.

Abstract:
Under Statement of Financial Accounting Standards No. 123, the grant date value of executive stock options excludes the value of any reload feature because, at the time of writing the standard in 1995, the Financial Accounting Standards Board believed it was not feasible to value a reload feature at the grant date. We show how the Binomial Option Pricing Model can be used to determine the grant date value of such options. Ignoring the reload feature can substantially understate the value of the option: the reload feature increases the value of an otherwise similar option by 24 percent in the example we consider. In view of the potential significance of the reload feature and the versatility of the Binomial Option Pricing Model, the Financial Accounting Standards Board may wish to reconsider the accounting for options with a reload feature.

Abstract:
This paper examines whether the trading decisions of institutional investors can be explained in part by the effects of taxation on portfolio returns. We find that advisers managing portfolios on behalf of persons who are taxable entities are 26 percent less likely to sell securities that trigger large capital gains than securities that trigger no capital gains. Also, tax considerations seem to weigh more heavily in trading decisions later in the fiscal year. The decision to sell a particular security appears to depend on the cumulative gain or loss realized by the institutions so far in the tax year. Tax-exempt institutional investors do not exhibit these tendencies. Surprisingly, all institutions are less likely to sell securities that would trigger a large loss. The inventory flow assumption adopted for tax purposes affects the size of the gain or loss realized in the sale of a block of stock. Consistent with tax planning, a HIFO (highest in, first out) inventory rule is most significant for taxable institutions; a FIFO inventory rule is most significant for non-taxable institutions.

Abstract:
This paper examines the valuation of employee stock options (ESOs). Because ESOs are inalienable, the employee's optimal exercise policy differs from the policy a naive reading of the finance literature would suggest. The employee prefers to exercise options before maturity under certain conditions on risk aversion, investment opportunities, and wealth. Since the ESO's cost to the employer depends on the employee's exercise policy, this finding has implications for changes to the accounting treatment of ESOs under consideration by the Financial Accounting Standards Board. Numerial examples suggest the employer's cost is much less than the options' Black-Scholes value.

Abstract:
This paper describes the exercise behavior of over 50,000 employees who hold long term options on employer stock at eight corporations. Exercise is strongly associated with recent stock price movements, the market-to-strike ratio, proximity to vesting dates, time to maturity, and volatility. Much of the exercise activity occurs years before the options expire. Employees commonly sacrifice half of the Black-Scholes value by exercising before expiration. The employee's level within the company explains, in part, differences in behavior. These findings have implications for the FASB as it develops a new disclosure standard for stock compensation.

Abstract:
In large part, the form of investment advisers' compensation contracts is imposed by the Securities and Exchange Commission. Given these contractual forms, this paper considers the portfolio choices that emerge when advisers rationally cultivate their reputations. In a two-period model of investment management in which (i) investors reallocate their wealth across advisers after observing performance in the first period, and (ii) advisers' compensation is in the form of periodic asset fees, this paper shows a reputation effect causes one adviser to choose a portfolio in the first period that is extreme given his private information about asset returns. Extreme portfolios are costly for risk-averse advisers and investors because mutual funds are riskier than in one-period or single-adviser settings. Imposing a performance fee ameliorates these distortions and results in superior ex ante payoffs to investors without altering adviser welfare.

Numerical examples show that asset fees may increase or decrease as uninformed advisers enter the industry. Taking asset trading costs into account, performance fees are most likely to be used when (i) there are many investors with small amounts of wealth to invest, (ii) assets are difficult to buy directly (e.g., foreign stocks), or (iii) benchmark portfolios are not tradable (e.g., real estate). The analysis also suggests these mechanisms are most likely to be used when reputation considerations are acute: when young advisers have little history of investment returns or when differences in ability across managers are small.

Abstract:
This paper examines a two-period model of investment management. Investors reallocate their wealth between two mutual funds managed by different investment advisers after observing the performance of each adviser in the first period. A reputation effect causes one adviser to use his private information about investment returns too aggressively in the first period. This is costly for risk-averse advisers and investors because mutual funds are riskier than in one-period or single-adviser settings. A commitment by investors not to reallocate their investment among advisers or the adoption of a performance fee mitigate undesirable reputation effects and results in superior ex ante payoffs to investors.

Abstract:
This paper analyzes tax planning opportunities when tax rates change for issuers and holders of employee stock options. Then the paper examines the response of a sample of optionees to proposed changes in the tax law alleged to have precipitated the exercise of many employee stock options in the last quarter of 1992. Consistent with tax planning, the frequency of option exercise late in 1992 is higher for high-income employees affected by the proposed tax change than for (i) lower-income employees less likely to be affected by the tax increase who contemporaneously held identical options and (ii) employees with similar incomes who held similar options in 1990, 1991, and 1993. However, a comparison of the after-tax value of an option exercised in 1992 with the present value of the expected after-tax value payoff of the option exercised in the future suggests that only 21% of employees in a sub-sample that would benefit from early exercise for tax reasons alone in fact chose to exercise early. The median value of the forgone after-tax benefit in this group is $6,741 or 2.6% of 1993 salary. Since early exercise of non-qualified options also would increase liquidity, reduce risk and AMT exposure, and would not prevent employees from profiting from private information, the findings are consistent with a reluctance on the part of some individuals to act in anticipation of tax law changes.