Robert E. Verrecchia

Robert E. Verrecchia and Christina Zhu (Working), Liquidity, Trade, and Investor-Identity Disclosure.

Abstract: This study tests whether disclosing a trader's identity dampens or stimulates subsequent trading volume based on the trader's reputation for being informed. Reputation signals the quality of private information that exists in the market. While a reputation for being informed makes markets less liquid, thus inhibiting subsequent trade (“illiquidity effect”), the information others glean from informed trade might motivate subsequent trade (“information effect”). To study which of these countervailing forces dominates, we use a setting where mandated short-position disclosures in Europe reveal the trader's identity at the time of trade. Changes in bid-ask spreads, price adjustments, and changes in subsequent trading volume are positively associated with several proxies for the short seller's reputation: the short seller is local, has higher returns from previous short sales, and is a hedge fund or investment adviser. Despite the positive association between reputation and illiquidity, we show that reputation motivates more subsequent trade from other investors learning from the disclosure. The informational efficiency of prices also increases with trader reputation. Thus, our results support the notion that the “information effect” dominates the “illiquidity effect.” Our study contributes to the literature by investigating the interaction among investor identification, adverse selection, and trade.

Jung Min Kim, Daniel Taylor, Robert E. Verrecchia (2021), Voluntary Disclosure when Private Information and Disclosure Costs are Jointly Determined (Review of Accounting Studies), .

Abstract: Classical models of voluntary disclosure feature two economic forces: the existence of an adverse selection problem (e.g., a manager possesses some private information) and the cost of ameliorating the problem (e.g., costs associated with disclosure). Traditionally these forces are modelled independently. In this paper, we use a simple model to motivate empirical predictions in a setting where these forces are jointly determined––where greater adverse selection entails greater costs of disclosure. We show that joint determination of these forces generates a pronounced non-linearity in the probability of voluntary disclosure. We find that this non-linearity is empirically descriptive of multiple measures of voluntary disclosure in two distinct empirical settings that are commonly thought to feature both private information and proprietary costs: capital investments and sales to major customers.

Jeremy Michels, Stephen Glaeser, Robert E. Verrecchia (2020), Discretionary Disclosure and Manager Horizon: Evidence from Patenting, Review of Accounting Studies, 25 (), pp. 597-635. 10.1007/s11142-019-09520-0

Abstract: We examine the relation between manager horizon and discretionary disclosure, using patenting as a measure of disclosure. Patenting reflects, in part, a manager’s decision to disclose the successful outcome of research and development (R&D). When a firm invests in R&D but does not patent, investors are unsure whether this reflects a failed R&D project or the manager choosing not to patent. We suggest that investors’ beliefs about a manager’s horizon—whether the manager seeks to maximize short-term stock price or long-term profits—moderates their reactions. When investors believe a manager’s horizon is short, they expect the manager to disclose successful outcomes and therefore discount nondisclosure more. We predict that managers will patent more per dollar of R&D spending when their horizons are short and that investors will discount the value of nondisclosing firms more when they believe the manager’s horizon is short. We find evidence consistent with these predictions.

Mirko S. Heinle, Kevin Smith, Robert E. Verrecchia (2018), Risk-Factor Disclosure and Asset Prices, The Accounting Review, 93 (2), pp. 191-208.

Abstract: While researchers and practitioners alike estimate firms' exposures to systematic risk factors, the disclosure literature typically assumes that exposures are common knowledge. We develop a model where the firm's exposure to a factor is unknown, and analyze the effect of factor-exposure uncertainty on share price and disclosure about the exposure. We find that: (i) factor-exposure uncertainty introduces skewness and excess kurtosis in the cash-flow distribution relative to the commonly used normal distribution; (ii) risk--factor disclosure affects all moments of that distribution; and (iii) the pricing of higher moments affects the price response of disclosure and the incentives to disclose. For example, factor-exposure uncertainty may actually increase price when the uncertainty implies positive skewness in the cash flow distribution. Hence, a reduction in uncertainty through disclosure may increase cost of capital. We also extend our model to multiple firms and show that factor-exposure uncertainty manifests as uncertainty about a firm's CAPM beta.

Wayne Guay and Robert E. Verrecchia (Working), Conservative Disclosure.

Stephanie Sikes and Robert E. Verrecchia (Under Revision), Aggregate Corporate Tax Avoidance and Cost of Capital.

Abstract: We identify a pecuniary externality arising from corporate tax avoidance. As firms engage in more avoidance, the cost of capital increases for all firms. The intuition is that firms share risk with the government via taxation. The lower the tax rate applied to a firm’s earnings, the more risk is borne by its shareholders. As firms avoid more taxes in the aggregate, the variance of the market’s after-tax cash flow increases. Consequently, covariance risk, and thereby the cost of capital, increases for all firms. Consistent with our prediction, we find that firms’ implied cost of capital is positively related to aggregate corporate tax avoidance. This result holds for tax-avoiding and non-tax-avoiding firms, and is stronger for firms whose cash flow covaries more with the market cash flow. U.S. multinationals’ tax avoidance drives the pecuniary externality, consistent with only strategies that reduce a firm’s marginal tax rate on income reducing risk-sharing.

Christopher Armstrong, Daniel Taylor, Robert E. Verrecchia (2016), Asymmetric Reporting, Journal of Financial Reporting, 1 (1), pp. 15-32.

Abstract: We extend the CAPM to a setting where a firm reports earnings prior to selling shares to investors. We show that an entrepreneur, as representative of a firm's initial owners, will choose to report earnings that asymmetrically reflect future cash flow. In modeling the entrepreneur's reporting choice, we deliberately abstract away from the stewardship role of accounting. In our model, the sole purpose of reported earnings is to facilitate valuation by the firm's equity investors. Nevertheless, we show that a firm's earnings will reflect future cash flow to a greater (lesser) extent in bad states (good states) when that cash flow is anticipated to be low (high). Importantly, we also show that the asymmetry in reporting generates asymmetry in the firm's systematic risk. When a firm's earnings reflect future cash flow to a greater extent in bad states, the firm's covariance with the market portfolio will be lower in bad states.

Paul Fischer, Mirko S. Heinle, Robert E. Verrecchia (2016), Beliefs-driven price association, Journal of Accounting and Economics, 61 (2-3), pp. 563-583.

Abstract: In addition to being a function of traditional fundamentals such as cash-flow persistence and the discount rate, the equilibrium association between a security price and a value-relevant statistic can simply be a function of what rational investors believe the association will be. We refer to this phenomenon as beliefs-driven price association (BPA). By explicitly considering the phenomenon of BPA, we show that the price response to information releases can vary over time even if the risk-free interest rate and investor preferences are static and the earnings/cash flow generating process is stable. This observation suggests, for example, that price-to-earnings associations and price volatility can vary over time even if a stable pattern of economic fundamentals suggests otherwise. The possibility of BPA suggests that measures of the cost of capital, information content, and growth prospects inferred from observed market prices will be confounded. While we do not predict when periods of BPA will arise, we provide empirically testable predictions about how prices should behave during periods of BPA. In particular, we predict that, during sufficiently long periods of high (positive or negative) BPA, price volatility, price levels, and expected returns will be higher than would be implied by a fundamental valuation framework. Finally, while BPA in the pricing of one security does not cause BPA in the pricing of other securities, the price levels of those other securities will be affected if the securities with BPA are sufficiently large relative to the market as a whole.

Mirko S. Heinle and Robert E. Verrecchia (2016), Bias and the Commitment to Disclosure, Management Science, 62 (10), pp. 2859-2870.

Abstract: This paper studies the propensity of firms to commit to disclose information that is subsequently biased, in the presence of other firms also issuing potentially biased information. An important aspect of such an analysis is the fact that firms can choose whether to disclose or withhold information. We show that allowing the number of disclosed reports to be endogenous introduces a countervailing force to some of the empirical predictions from the prior literature. For example, we find that as more firms issue reports or as the correlation across firms’ cash flows increases, the firm biases its report less. However, when we treat firms’ disclosure choices as endogenous, we show that the number of firms that commit to disclose decreases as the correlation across these cash flows increases, and this, in turn, offsets the direct effect of the correlation on bias.

Stephanie Sikes and Robert E. Verrecchia (2015), Dividend Tax Capitalization and Liquidity, Review of Accounting Studies, 20 (4), pp. 1334-1372.

Abstract: We provide a new explanation for cross-sectional variation in dividend tax capitalization. Our analysis is twofold. First, we conduct a theoretical analysis that shows that liquidity (illiquidity) mitigates (magnifies) the positive effect of dividend taxes on expected rates of return documented in prior literature. Second, we conduct an empirical analysis centered around the Jobs and Growth Tax Relief and Reconciliation Act of 2003, which reduced the difference between the maximum statutory dividend and capital gains tax rates, and find results consistent with our theory. We also provide results suggesting that institutional ownership’s mitigating effect on dividend tax capitalization documented in prior studies is attributable to stocks with greater institutional ownership being more liquid and not to the “marginal investor” being insensitive to dividend taxes.