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Abstract:
This paper uses recent experimental studies of financial accounting to illustrate our view of how such experiments can be conducted successfully. Rather than provide an exhaustive review of the literature, we focus on how particular examples illustrate successful use of experiments to determine how, when and (ultimately) why important features of financial accounting settings influence behavior. We first describe how changes in views of market efficiency, reliance on the experimentalist?s comparative advantage, new theories, and a focus on key institutional features have allowed researchers to overcome the criticisms of earlier financial accounting experiments. We then describe how specific streams of experimental financial accounting research have addressed questions about financial communication between managers, auditors, information intermediaries, and investors, and indicate how future research can extend those streams. We focus particularly on (1) how managers and auditors report information, (2) how users of financial information interpret those reports, (3) how individual decisions affect market behavior, and (4) how strategic interactions between information reporters and users can affect market outcomes. Our examples include and integrate experiments that fall into both the "behavioral" and "experimental economics" literatures in accounting. Finally, we discuss how experiments can be designed to be both effective and efficient.

Abstract:
Behavioral finance began as an attempt to understand why financial markets react inefficiently to public information. One stream of behavioral finance examines how psychological forces induce traders and managers to make suboptimal decisions, and how these decisions affect market behavior. Another stream examines how economic forces might keep rational traders from exploiting apparent opportunities for profit. Behavioral finance remains controversial, but will become more widely accepted if it can predict deviations from traditional financial models without relying on too many "ad hoc" assumptions.

Abstract:
Virtual worlds promise to be an excellent venue for research and education in business and related disciplines. This document provides an introduction to virtual worlds, discusses why virtual worlds are so well-suited to the study of real-world business, and describes how a platform could weave together various types of virtual worlds and virtual spaces to achieve a variety of research and educational goals. I close by inviting instructors, students, researchers, textbook authors, publishers, game developers and others to join in a collaboration to make this vision a (virtual) reality.

virtual worlds, experimental economics, business education, accounting, behavioral finance, Second Life, serious games

Abstract:
Firms can effectively take long or short positions on their own equity by holding treasury shares, contributing their shares to their pension fund, write put or call options on their stock, compensate employees with stock options, or invest in other entities (e.g., other firms, stock indexes) that hold shares of their stock. In each of these circumstances, fair value accounting methods can allow firms to report on these "self-generated" unrealized gains or losses ("UGLs").

In this paper we present a model and experimental evidence indicating that, if investors attend to unrealized gains and losses (UGLs) associated with a firm's own equity, equity price changes reflect through subsequent periods to create high volatility and predictable autocorrelations in price. Our results provide evidence that the reflection-induced volatility is determined by an interaction between the extent of the self-investment and the prominence of the self-generated UGLs on the primary reporting statement (with comprehensive income performance statements providing high prominence).

Fair-value accounting, comprehensive income, functional fixation, market efficiency, experiments

Abstract:
Numerous archival papers indicate that investors can generate profit by following disciplined trading strategies that exploit the market's incomplete adjustment for various accounting data. Even assuming efficient markets in which securities are not mispriced, evidence suggests that both individual and professional investors could improve their returns via disciplined trading strategies like market indexing. Yet, investors rarely follow such strategies. We use two experiments to examine factors that we believe affect reliance on trading strategies by affecting whether investors have more confidence in their own judgment or the recommendation of a trading strategy. We find that MBA-student investors deviate from a trading strategy more when the strategy is less accurate (but still more accurate than most well-known trading strategies), when they trade individual securities instead of portfolios, and when they receive positive feedback on trading decisions made prior to learning about the strategy. Thus, investors may lack the discipline to rely on profitable trading strategies, particularly when recent trading success has increased their confidence in their own judgment (as might occur in a sustained bull market like that experienced over the past decade). Our results also suggest ways that individual investors and portfolio managers can increase reliance on profitable trading strategies.

Investor, portfolio, trading strategy, confidence, decision aid, feedback, experiment

Abstract:
Two experiments with MBA-student participants support Barberis, Shleifer, and Vishny's (1998) prediction that investors expect random-walk sequences to shift between continuation regimes (in which changes tend to be followed by like changes) and reversal regimes (in which changes tend to be followed by reversing changes). As predicted, investors overreacted to changes that were preceded by many continuations, and underreacted to changes that were preceded by many reversals. We conclude that regime-shifting models can provide a useful framework for understanding market anomalies, including underreactions to earnings changes and overreactions to long-term earnings trends.

Behavioral Finance, Regime Shifting, Post-Earnings-Announcement Drift, Momentum, Market Efficiency

Abstract:
This paper shows that whether laboratory markets over- or under-react to information is influenced by two factors: the reliability of investors' information and the portfolio formation rule used to identify price anomalies. Consistent with research in psychology, prices tend to over-react to unreliable information and under-react to highly reliable information, because investors' confidence in their information is moderated toward a central level. Forming portfolios on the basis of price changes tends to yield larger apparent overreactions than forming portfolios on the basis of information that is independent of market price, because market prices include mean-reverting random errors (in addition to systematic price errors due to moderated confidence). These results can help empirical researchers develop specific alternative hypotheses to market efficiency, by helping them predict ex ante whether a given research study is likely to reveal over- or underreactions.

Abstract:
This paper uses a laboratory experiment to show that investors systematically over-rely on firms' previous performance levels: when previous performance is high (low), prices are too high (low). This error creates two types of anomalies. Too much reliance on previous levels gives the appearance that investors under-react to changes in performance from that level. Prices therefore remain too low (high) after large increases (decreases) in performance, similar to the post-earnings-announcement drift anomaly. Too much reliance on previous levels also gives the appearance that investors overestimate the degree to which extreme performance in prior periods leads to extreme performance in the target period. Prices therefore remain too high (low) after persistently strong (weak) performance, similar to the long-term over-reaction anomaly. The results therefore suggest that these two anomalies may be caused by a single behavioral effect.

Abstract:
This paper uses experimental asset markets to investigate the evolution of liquidity in an electronic limit order market. Our market setting includes salient features of electronic limit order markets, as well as informed traders and liquidity traders. We focus on the strategies of the traders, and how these are affected by trader type, characteristics of the market, and characteristics of the asset. We find that informed traders use more limit orders than do liquidity traders. Our main result is that liquidity provision shifts as trading progresses, with informed traders increasingly providing liquidity in markets. The change in the behavior of the informed traders seems to be in response to the dynamic adjustment of prices to information; they take (provide) liquidity when the value of their information is high (low). Thus, a market-making role emerges endogenously in our electronic markets and is ultimately adopted by the traders who are least subject to adverse selection when placing limit orders.

Market microstructure, experimental economics, experiments, electronic markets, limit order book, liquidity, continuous auctions, limit orders, trading strategies, informed traders, information asymmetry

Abstract:
We report the results of three experiments based on the model of Hong and Stein (1999). Consistent with the model, results show that when informed traders do not observe prices, uninformed traders generate long-term price reversals by engaging in momentum trade. However, when informed traders also observe prices, uninformed traders generate reversals by engaging in contrarian trading. Results suggest that a dominated information set is sufficient to account for the contrarian behavior observed among individual investors, and that uninformed traders may be responsible for long-term price reversals but play little role in driving short-term momentum.

Market efficiency, behavioral finance, underreaction, overreaction, anomalies, uninformed traders

Abstract:
In response to recommendations by the AICPA Special Committee on Financial Reporting and the Association for Investment Management and Research, the FASB has recently invited comment regarding the question ?Given [efficient] markets, would any disservice be done to the interests of individual investors by allowing professional investors access to more extensive information?? (AICPA, 1996, p 22). Research in psychology (e.g., Griffin & Tversky, 1992) suggests that less-informed investors may suffer from overconfidence and trade too aggressively given their information. This paper reports two experiments designed to address these issues. In both experiments, security values are determined by the price/book ratios of actual firms, ?more-informed? investors observe three value-relevant financial ratios derived from Value-Line reports, and ?less-informed? investors observe only one of those signals. Experiment 1 provides evidence from a pencil-and-paper task that less-informed investors are overconfident relative to their more-informed counterparts, and that this relative overconfidence is reduced by alerting investors to the extent of their informational disadvantage. Trading behavior follows the same pattern as confidence assessments. Experiment 2 provides evidence from laboratory markets that, even after market prices have stabilized after many rounds of trading, less-informed investors systematically transfer wealth to more-informed investors as a result of biased prices and overly aggressive trading, but that alerting less-informed investors to the extent of their informational disadvantage eliminates these welfare losses. The results of both experiments thus suggest that providing information to only professional investors could harm the welfare of less-informed investors if less-informed investors are not aware of the extent of their informational disadvantage.

Abstract:
Those who believe markets are inefficient rarely provide a coherent and refutable alternative to the Efficiency Markets Hypothesis (EMH). This paper presents the Incomplete Revelation Hypothesis (IRH) as such an alternative, and describes its implications for financial reporting research, practice and regulation. Inspired by "noisy rational expectations models," the IRH assumes that the costs of extracting useful statistics from public data keep markets from fully revealing the meaning of those statistics. The IRH can account for many of the phenomena that are central to financial reporting but inconsistent with the EMH. It predicts that investors devote substantial resources to identifying mispriced stocks on the basis of public data, that managers seek to boost stock prices by hiding bad news in footnotes, and that regulators may wish to defeat such efforts, because information that is hard to extract from financial statements will not be reflected in stock prices. The IRH also provides a number of novel and testable predictions that distinguish it from the EMH.

Market Efficiency, Financial Reporting, Earnings Management, Anomalies, Behavioral Finance, Post-Earnings-Announcement Drift

Abstract:
The Securities and Exchange Commission (SEC) issued a call for comment on a proposal to adopt a Roadmap for potential use of international financial reporting standards (IFRS) by U.S. Companies. We comment on five key issues raised by the SEC proposal. First, we propose that the need for a global regulator is overstated. A global regulator is unlikely to help achieve the stated goals of comparability and consistency of financial reporting on a global basis. We favor allowing U.S. companies to choose use of U.S. GAAP or IFRS rather than mandating one global monopoly set of standards. Second, we agree that the focus on auditing is a very relevant issue that deserves more attention from standard setters. Gains from adopting principles based accounting standards such as IFRS are likely to be realized only if auditors are also principles based. Third, while we have serious concerns about governance and financing mechanisms of IASB, we recommend that all regulatory actions cannot be held to a standstill while structural changes are made to the IASB. Fourth, we are not in favor of requiring reconciliation schedules from U.S. companies using IFRS. We view such reconciliations as being costly and unnecessary. Fifth, we recommend that the SEC pay more explicit attention to the educational and professional judgment consequences of its proposals.

This comment was developed by the Financial Accounting Standards Committee of the American Accounting Association and does not represent an official position of the American Accounting Association.

U.S. GAAP, IFRS, SEC, Reconciliation, Roadmap

Abstract:
We use a laboratory market to investigate the behavior of noise traders and their impact on the market. Our experiment features informed traders (who possess fundamental information), liquidity traders (who have to trade for exogenous reasons), and noise traders (who do not possess fundamental information and have no exogenous reasons to trade). We find differences in behavior between liquidity traders and noise traders, justifying their separate treatment. We find that noise traders exert some positive effects on market liquidity: volume and depths are higher and spreads are lower. We provide evidence suggesting that the main effect of the liquidity-enhancing trading strategies of the noise traders is to weaken price reversals (decreasing the temporary price impact of market orders) rather than to reduce the permanent price impact of trades (as liquidity traders supposedly do in market microstructure models with information asymmetry). We find that noise traders adversely affect the informational efficiency of the market, but only when the extent of adverse selection is large (i.e., when informed traders have very valuable private information). Finally, we examine how trader behavior and certain market quality measures are affected by a transaction tax. Although such taxes do reduce noise trader activity, they take a toll on informed trading as well. As a result, while taxes reduce volume, they do not affect spreads and price impact measures, and have at most a weak effect on the informational efficiency of prices.

noise traders, liquidity traders, informed traders, experiments, experimental markets, market microstructure, informational efficiency, liquidity, transaction tax, Tobin tax

Abstract:
Standard setters and most academics maintain that accounting standards ought to rest on a set of guiding principles stated explicitly in a “conceptual framework.” The FASB and IASB are currently involved in a project to refine conceptual framework documents developed earlier. At this point, it is not clear what their final product will look like; its defining characteristics as well as the substantive content can only be surmised. This paper addresses the issues that FASB and IASB face, including the question of what a conceptual framework should be all about. First, we suggest characteristics that a conceptual framework ought to exhibit. Most of these suggestions are based on our critique of the existing framework and the FASB-IASB work in progress. Second, we present a model framework that meets our criteria. We emphasize up front that this framework is quite explicit. It goes to the heart of what a framework document should do: it places specific restrictions on what constitutes admissible accounting standards. The purpose of our effort is to stimulate broad discussion of alternative approaches to foundational documents and to offer a specific example of such an alternative approach.

FASB, IASB, Conceptual Framework, Accounting Standards, Financial Reporting

Abstract:
SEC Chairman Arthur Levitt recently called on investors to discourage firms' earnings management by expecting reliable reporting and punishing deceptive reporters (Levitt 1998a, 1999). This paper presents a game-theoretic model in which such punishments can induce managers to develop reputations for reliable reporting. Our first experiment confirms that investors can induce managers to report reliably when one investor visibly commits to a strategy of expecting reliable reporting and punishing reporters who fail to meet that expectation. However, our second experiment shows that reliable reporting is much more difficult to sustain without such a visibly committed investor. These results suggest that managers and investors may have difficulty avoiding the pareto-dominated equilibrium in which managers exploit all of the discretion permitted by GAAP.

Abstract:
We provide experimental evidence that relaxing margin restrictions to allow more short-selling can exacerbate overpricing, even though it reduces equilibrium price levels. This is because smart-money traders initially profit more by front-running optimistic investor sentiment than by disciplining prices. When short-selling is not possible, competitive pressures among arbitrageurs rapidly drive them to the equilibrium. However, the risk of margin calls slows the convergence process, because arbitrageurs who sell short too early face substantial losses if they are unable to synchronize their trades with other arbitrageurs (as in Abreu and Brunnermeier 2002; 2003).

Market Efficiency, Limits to Arbitrage, Bubbles, Experimental Economics

Abstract:
Errors in estimated product costs often lead firms to win business that is unprofitable, because firms are more likely to win business when underestimated product costs lead them to bid below actual cost (Cooper et al. 1992; Stalk and Lachenauer 2004; Hilton 2005). Feedback from repeated competitive bidding markets can teach people to bid well above estimated costs to avoid this winners' curse (Kagel 1995; Kagel and Levin 2002). We present experimental evidence that such learning is substantially hampered by managers' sense of responsibility for the costs. We hypothesize and find that, compared to bidders who are assigned cost-management initiatives for the firms they control, bidders who select their own initiatives bid more aggressively, lose more money, and learn less from market experience than bidders who are not responsible for choosing cost-management initiatives. This effect is consistent with psychological evidence that people tend to attribute bad outcomes to environmental factors out of their control, such as cost estimation errors, and attribute good outcomes to their own skills, such as their ability to choose effective cost management initiatives (Miller and Ross 1975; Zuckerman 1979). The results suggest that there are benefits to separating responsibilities for cost management and pricing in firms where accurate cost estimation is difficult.

Winner's curse, auctions, behavioral economics, cost accounting, laboratory experiment

Abstract:
This study describes a "cheap-talk" model in which sellers can credibly convey unverifiable information by choosing whether or not to exaggerate verifiable information. We find that unexaggerated claims can communicate favorable unverifiable information if buyers are not too likely to verify claims, and sellers with better information care more about future prices than sellers with worse information. However, there is always another equilibrium in which sellers exaggerate all verifiable claims. We use a laboratory experiment to test when each equilibrium arises. When buyers infrequently verify the sellers' claims, we find that the strategies used by players during the learning process determine which equilibrium is selected. When buyers are very likely to verify claims, players fail to converge to any equilibrium. Both of these results are consistent with an evolutionary learning model, but inconsistent with the intuitive criteria of Cho and Kreps (1987). We discuss the implications of our results for both consumer markets and financial markets.

Earnings Management, Financial Reporting, Cheap Talk, Experimental Game Theory, Market Inefficiency

Abstract:
The FASB and the IASB recently issued a joint discussion paper entitled, Preliminary Views on Revenue Recognition in Contracts with Customers. The Boards requested comments on whether their proposed model for revenue recognition would improve the usefulness of the financial statement information for financial decision makers. This paper sets forth the AAA's Financial Accounting Standards Committee's responses to several of the Boards' specific questions. In summary, we support the Boards' proposed comprehensive revenue recognition standard based on the following options: (1) the customer consideration approach (based on initial contract price measurement); (2) no recognition of revenue at contract inception (by assigning the initial contract price to performance obligations); (3) allocation of the transaction price to multiple performance obligations based on the relative stand-alone prices of each performance obligation. We also recommend that the Boards carefully consider the following clarifications as they develop the final exposure draft. The definition of a contract should include the words legally enforceable to describe the contract. A performance obligation must be verifiable. While the transfer of an asset to the customer or the acceptance of a service by the customer normally signals the recognition of revenue, we encourage the Boards to carefully consider situations (like long-term construction or mining) when the completion of intermediate performance obligations could trigger revenue recognition prior to the transfer of title. Absent special consideration of these situations, companies may be forced to re-write contracts in sub-optimal ways in an effort to recognize revenue continuously throughout a long-term construction project or in the process of mining or farming. Consider the difficulties that may arise in allocating the initial transaction price to multiple performance obligation contracts when the individual performance obligations are not normally sold on a stand-alone basis.

Financial Accounting Standards Board, International Accounting Standards Board, Revenue Recognition, Contracts

Abstract:
This article uses two experiments to assess whether security characteristics are associated with returns because investors believe they affect risk, or because investors believe they reflect mispricing. We examine how beta, market-to-book ratios, and firm size affect the returns Wall Street professionals expect, and how those factors affect perceived risk and mispricing. Consistent with traditional asset pricing models, professionals expect firms with higher betas to be riskier investments and to generate higher returns. Consistent with behavioral models, professionals expect firms with higher market-to-book ratios to be overpriced (and riskier). Professionals expect large firms to be less risky, but most do not view firm size to be a sign of mispricing.

Abstract:
Most tests of asset pricing models rely on realized returns as a proxy for expected returns, and cannot determine whether security characteristics are associated with returns because they affect risk or because they reflect mispricing. This paper avoids these problems by conducting two experiments in which we directly elicit how Beta, Market-to-Book ratios and firm size affect the returns expected by Wall Street professionals, and how those factors affect perceived risk and mispricing. Consistent with traditional asset pricing models, professionals expect firms with higher Betas to be riskier investments and generate higher returns. Consistent with behavioral models, professionals expect firms with higher Market-to-Book ratios to be over-priced (and riskier). Professionals expect large firms to be less risky, but do not view firm size to be a sign of mispricing.

Abstract:
Prior research provides only weak and controversial evidence that people overestimate the likelihood of desirable events (wishful thinking), but strong evidence that people bet more heavily on those events (wishful betting). Two experiments show that wishful betting contaminates beliefs in financial markets because wishful betters appear to possess more favorable information than they actually do. As a consequence, market interaction exacerbates rather than mitigates wishful thinking. This phenomenon, "contagion of wishful thinking," could be problematic in many settings where people infer others' beliefs from their behavior.

behavioral financial, wishful thinking, motivated reasoning, contagion, laboratory markets, experimental economics, behavioral finance, market efficiency, anomalies, overconfidence, desirability bias, unrealistic optimism, markets, investors, investing, information aggregation

Abstract:
The Financial Accounting Standards Board's (FASB's) and the International Accounting Standard Board's (IASB's) issued a joint Discussion Paper entitled, Preliminary Views on Financial Statement Presentation. The Boards are seeking comments on whether their proposed model for financial statement presentation would improve the usefulness of the financial statement information for financial decision makers. This paper sets forth the AAA's Financial Accounting Standards Committee's summary comments as well as responses to several of the Boards' specific objectives and principles-related questions. Overall, we believe that the model has several appealing qualities, but also has several potential problems. Many of the problems that we discuss related to potential learning impediments for users to adapt to the new presentation format.

Financial Accounting Standards Board, International Accounting Standards Board, Exposure Draft, Financial Statement Presentation

Abstract:
Two laboratory experiments on a single-echelon inventory task show that inventory durability interacts with transit lags to create order volatility that exceeds demand volatility (the bullwhip effect). Durability creates bullwhip effects because players adjust orders insufficiently to reflect current inventory and backlogs, much as they adjust orders insufficiently to reflect holding and backlog costs in newsvendor studies (e.g., Schweitzer and Cachon 2000). Transit lags exacerbate bullwhip-like effects by interfering with players' ability to correct prior errors. Our results suggest that bullwhip effects can be driven by characteristics of inventory and supply chains, even in the absence of the inter-echelon coordination problems studied by Sterman (1989a, 1989b) and Croson, Donohue, Katok and Sterman (2005).

Behavioral Operations, Newsvendor Problem, Decision Biases, Durability, Time Lags, Demand Shock, Ordering Decisions, Inventory Management, Supply Chain Management

Abstract:
Results from a laboratory study show that initial-control presence determines which principles decision makers believe govern appropriate behavior. The initial presence of controls leads agents to apply a principle of self-interest in a social dilemma, while the initial absence of controls allows agents to apply a principle of social-interest. Because principles based on social-interest are inherently outward-looking, those principles also increase conformity to the observed behavior of others. The results clarify the mechanisms by which accounting controls, accounting regulations, and accounting-based performance compensation schemes can ¿crowd out¿ socially desirable behaviors, such as honesty (Hannan et al. 2006b), collaboration between firms (Christ et al. 2006), and taxpayer compliance (Feld and Frey 2005), and yields predictions that differ substantially from extant models of conformity (such as Fischer and Huddart (2007) and Davis et al. (2003)), which typically assume that pressures for conformity are independent of control strength.

controls, conformity, social norms, crowding out, public goods

Abstract:
Virtual worlds can allow experimental researchers to create and examine settings with far more institutional complexity than is possible in a traditional laboratory setting. This document discusses how studies with greater complexity can complement more traditional experimental methods for those who are studying financial reporting; explores both the opportunities and challenges virtual worlds present to experimentalists; presents some examples of how to implement complex institutions; and discusses how the costs and benefits of the virtual-world laboratory vary across different experimental traditions.

Virtual Worlds, Experimental Economics, Accounting, Second Life, Experiments

Abstract:
The Canadian Accounting Standards Board (AcSB) issued an exposure draft on a proposal to adopt a separate 'Made in Canada' GAAP for private enterprises. This new GAAP is justified as being consistent with the current FASB/IASB conceptual framework, but as being responsive to the different cost/benefit considerations facing private entities vis-à-vis public entities. We viewed this proposal as being innovative and responsive to the differential financial reporting needs of private entities. We proposed that the AcSB should develop a separate conceptual framework to guide the future evolution of this new GAAP and not rely only on cost-benefit considerations. We sketched a preliminary conceptual framework that could be used to develop and justify the type of changes proposed in this exposure draft. We then responded to the specific questions asked in the exposure draft and were very supportive of the concepts proposed. First, we support the proposed GAAP which is based on historical cost with very minimal reliance on fair values. Second, we expressed agreement with the proposal to reduce the amount of required disclosures for private enterprises given their significant economic differences from public companies. Third, we agreed with the proposal to drop provision of significant guidance and especially (ex-post) emerging issues committee interpretations (EIC’s). We are in favour of a principles based GAAP and the provision of detailed authoritative guidance is not conducive to professional judgment. We also suggested a series of transition issues that the AcSB should consider including the mechanism for financing the standard setting board, the need to ensure compatibility between accounting and auditing standards, and a process for adjusting the education system (both in Universities and professional exams) to support this new private enterprise GAAP. This comment was developed by the Financial Accounting Standards Committee of the American Accounting Association and does not represent an official position of the American Accounting Association.

accounting standards, private GAAP

Abstract:
Analysts and the financial press are often accused of paying too much attention to one another, instead of providing their own independent analyses of fundamental information. Prior research suggests that such mutual observation can render consensus forecasts too extreme, more redundant, and less informative, and that investors will fail to anticipate these effects, leading investors to hold overly extreme beliefs with excessive confidence. We find that mutual observation in a laboratory setting does increase the extremity of consensus forecasts, but not excessively, and improves accuracy when incentives for accuracy are high as a result of the target firm experiencing recent abnormal performance. A second experiment shows that investors account appropriately for the effects of mutual observation. Overall, the results are consistent with an economic model in which analysts and investors are effort-averse Bayesians.

Abstract:
In this research we investigate the behavior of noise traders and their impact on the market. We do this in an experimental market setting that allows us to determine not only how noise traders fare in a competitive asset market with other traders, but also how the equilibrium changes if a securities transactions tax ("Tobin tax") is imposed. We find that noise traders lose money on average: they do not engage in extensive liquidity provision, and their attempt to make money by trend chasing is unsuccessful as they lose most in securities whose prices experience large moves. Noise traders adversely affect the informational efficiency of the market: they drive prices away from fundamental values, and the further away the market gets from the true value, the stronger this effect becomes. With a securities transaction tax, noise traders submit fewer orders and lose less money in those securities that exhibit large price movements. The tax is associated with a decrease in market trading volume, but informational efficiency remains essentially unchanged and liquidity (as measured by the price impact of trades) actually improves. We find no significant effect, however, on market volatility, suggesting that at least this rationale for a securities transaction tax is not supported by our data.

Abstract:
Advances in virtual world technology pose risks for the safety and welfare of children. Those advances also alter the interpretations of key terms in applicable laws. For example, in the Miller test for obscenity, virtual worlds constitute places, rather than "works," and may even constitute local communities from which standards are drawn. Additionally, technological advances promise to make virtual worlds places of such significant social benefit that regulators must take care to protect them, even as they protect children who engage with them.

Virtual Worlds, Community Standards, First Amendment, Obscenity, Child Labor

Abstract:
Advances in virtual world technology pose risks for the safety and welfare of children. Those advances also alter the interpretations of key terms in applicable laws. For example, in the Miller test for obscenity, virtual worlds constitute places, rather than "works," and may even constitute local communities from which standards are drawn. Additionally, technological advances promise to make virtual worlds places of such significant social benefit that regulators must take care to protect them, even as they protect children who engage with them.

virtual worlds, obscenity, free speech, privacy, child welfare, serious games

Abstract:
This paper uses experimental asset markets to investigate the evolution of liquidity in anelectronic limit order market. Our market setting includes salient features of electronic markets, as well as informed traders and liquidity traders. We focus on the strategies of the traders, andhow these are affected by trader type, characteristics of the market, and characteristics of the asset. We find that informed traders use more limit orders than do liquidity traders. We also find that liquidity provision shifts over time, with informed traders increasingly providingliquidity in markets. This evolution is consistent with the risk advantage informed traders have in placing limit orders. Thus, a market making role emerges endogenously in our electronic markets.

Abstract:
This article sketches the features required of a platform (which I refer to as ‘World of Bizcraft’) that supports virtual worlds dedicated to research and education on business-related topics. Key features include progressivity of content and challenges, which is a standard feature in most educational processes; certification of players’ achievements, rather than the achievements of the players’ characters; the ability to control participant interaction, collaboration and creation of game assets; implementation of induced value, which forms the foundation of experimental research in economics; production functions that capture the realities of real businesses; sophisticated property rights that support complex software-enforced contracts; and comprehensive systems for business reporting.

Virtual Worlds, Gaming, Business Education

Abstract:
The SEC has proposed a strategic plan which sets out its mission, vision, and values, identifies four strategic goals, a set of desired outcomes associated with each strategic goal, and a list of performance measures for assessing the SEC’s effectiveness in attaining its goals. We affirm the need for vigorous enforcement of securities law and offer some research based insights and performance indicators. We also acknowledge the importance of disclosure, but propose that the SEC needs to develop a disclosure framework and develop better operational indicators of quality of disclosure. It is important to appreciate the benefits of disclosure as well as its limits and potential dysfunctional consequences. We also discuss the need for an independent accounting standard setter and recommend that the SEC take a greater role in enhancing the independence of FASB.


This comment was developed by American Accounting Association’s Financial Accounting Standards Committee and does not represent an official position of the American Accounting Association.

SEC Plan, Disclosure Accounting Standards, Enforcement

Abstract:
The Canadian Accounting Standards Board (AcSB) recently issued an exposure draft to adopt separate GAAP for private enterprises. This new GAAP is justified as being consistent with the current FASB/IASB conceptual framework, but is sensitive to the different cost/benefit considerations facing private entities. We view this proposal as being innovative and responsive to the differential reporting needs of private entities. In this article we explain our reasoning and conclusions on several issues raised by the exposure draft starting with a discussion about the need for a separate conceptual framework for private enterprises. We sketch a preliminary conceptual framework that could be used to develop and justify the type of changes proposed in this exposure draft. We then discuss key issues raised in the exposure draft such as reliance on historical cost as the key basis of measurement, the significant reduction in disclosure requirements for private enterprises, and stopping the emerging issues committee from providing implementation guidance (no EIC’s). We also comment on the mechanism for financing the standard setting board, the need to ensure compatibility between accounting and auditing standards, and a process for adjusting the education system to support this new private enterprise GAAP.

Regulatory Competition, Private Enterprises, GAAP

Abstract:
We use a laboratory market to investigate the behavior of traders who lack informational advantages and have no exogenous reason to trade. We find that these uninformed traders behave largely as irrational contrarian “noise traders,” trading against recent price movements to their own detriment. The uninformed traders provide some benefits to the market: increasing market volume and depth, while reducing bid-ask spreads and the temporary price impact of trades. However, their noise trading also diminishes the ability of market prices to adjust to new information. A securities transaction tax reduces uninformed trader activity, but it reduces informed trader activity by approximately the same amount; as a result, the tax does not alter the impact of noise trading on the informational efficiency of the market.

D03, G12, G14

Abstract:
We provide experimental evidence that relaxing margin restrictions to allow more short selling can exacerbate overpricing, even though it reduces equilibrium price levels. This is because smart-money traders initially profit more by front-running optimistic investor sentiment than by disciplining prices. When short selling is not possible, competitive pressures among arbitrageurs rapidly drive prices to the equilibrium. However, the risk of margin calls slows the convergence process, because arbitrageurs who sell short too early face substantial losses if they are unable to synchronize their trades with other arbitrageurs (as in Abreu and Brunnermeier. 2002. Journal of Financial Economics 66(2-3):341-60; 2003. Econometrica 71(1):173-204).

G14, C92

Abstract:
Improved disclosure increases prices and liquidity in a laboratory financial market, and does so more strongly when investors face the risk of unpredictable demand shocks. These results are consistent with a broad class of theoretical and empirical studies. Disclosure has larger effects on prices and liquidity at greater market depths. We conclude that archival studies looking only at quoted transaction prices and spreads (which typically pertain to small transactions) may underestimate the potential importance of disclosure on larger transactions that occur at greater market depths.

Abstract:
This paper investigates whether transparent markets can survive when faced with direct competition from less transparent markets. We first construct a game-theoretic model in which in equilibrium the low-transparency dealers capture early order flow, and use the resulting informational advantage to quote narrower spreads and earn more profits than their more transparent competitors. We then conduct a laboratory experiment that tests and supports all of these predictions. A second experiment shows that most dealers choose to be of lower transparency when they are allowed to do so. However, the informational advantage of low-transparency decreases as there are more such dealers, while the high-transparency dealers get increasing benefit from informed traders who attempt to broadcast deceptive trades. As a result, a small number of transparent dealers persist in our markets.

Market microstructure, experimental economics, stock market competition

Abstract:
This study uses laboratory experiments to determine the effects of trade and quote disclosure on market efficiency, bid-ask spreads and trader welfare. We show that trade disclosure increases the informational efficiency of transaction prices, but also increases opening bid-ask spreads, apparently by reducing market makers' incentives to compete for order flow. As a result, trade disclosure benefits market makers at the expense of liquidity traders and informed traders. We find that quote disclosure has no discernible effects on market performance. Overall, our results demonstrate that the degree of market transparency has important effects on market equilibria and on trader and market maker welfare.

Abstract:
Theoretical and empirical research suggests that firms can reduce their cost of capital by providing more informative disclosures about the value of their securities. We provide convergent evidence on this issue by demonstrating that improved disclosure reduces cost of capital in a controlled laboratory environment in which we can more accurately measure disclosure quality, the cost of capital and transaction costs. We also find that, as suggested by Amihud and Mendelson (1986, 1989), disclosure has greater benefits when the firm's investor clientele has a short trading horizon, primarily because short-horizon investors place a greater value on the improved liquidity and lower transaction costs associated with higher quality disclosures.

Abstract:
This study examines the behavior of laboratory markets in which two uninformed market makers compete to trade with heterogeneously informed investors. The data provide three main results. First, market makers set quotes to protect against adverse selection and to control inventory. Second, when investors are less well-informed, their trades are less reliable measures of their information, and market makers respond to those trades with greater skepticism. Third, errors in market makers' reactions to trades cause the time-series behavior of quotes and prices to depend on the information environment in ways beyond those captured in extant theory.