the structure of asset prices and socially useless useful information this paper relates the value of additional information to asset prices in a pure exchange setting the price structure of interest revolves around a pricing hypothesis the prices in an economy with less information are unbiased estimators of the prices that would obtain in a more informative economy two basic results are developed first if the incremental information is useless then the pricing hypothesis applies second if the pricing hypothesis is assumed valid then the information is valuable in a weak sense the results are also considered in the context of empirical research the case is made for viewing statistical tests of association between prices and signals as tests of the social value of information

the dispute settlement mechanism of the wto a brief history and an evaluation from economic contractarian and legal perspectives rule based system has to include a mechanism for the enforcement of its rules and a means for settlement of disputes about alleged violation of rules

convertible debt corporate call policy and voluntary conversion this paper examines why in contrast to the predictions of finance theory firms do not call convertible debt when the conversion price exceeds the call price the empirical results suggest that the principal reason is because some firms enjoy an advantage of paying less in after tax interest than they would pay in dividends were the bond converted this cash flow incentive is the inverse of an investor s incentive to convert voluntarily if the converted dividends are greater than the bond s coupon because of taxation however the decisions by investors and firms are not symmetric and there exist bonds which the firm may not call and an investor will not convert the results also find that voluntary conversion is significantly related to both the conversion price and the differential between the coupon and the dividends on the converted stock

growth forecasts belief manipulation and capital markets abstract we analyze how a benevolent privately informed government agency would optimally release information about the economy s growth rate when the agents hold heterogeneous beliefs we model two types of agent conforming and dissenting the former has a prior that is identical to that of the government agency whereas the latter has a prior that differs from that of the government agency we identify both informative and uninformative equilibria informative equilibria are equilibria in which the government agency s equilibrium signal leads to a revision of beliefs we demonstrate that the uninformative equilibria can in fact dominate the informative ones in terms of ex post social welfare

welfare improving asymmetric information in dynamic insurance markets this article presents a two period asymmetric learning model of insurance markets when information about past accidents is not shared by insurers asymmetries of information develop through time equilibrium contracts exist are payoff unique and display a realistic bonus malus pattern eliminating asymmetries through information sharing is welfare decreasing in contrast with past contributions on insurance and adverse selection when second period contract offers cannot be contingent on initial contract choice a strict increase in welfare is obtained through menus of contracts although initial contract choice is in itself worthless information

facilitating consumer learning in insurance markets what are the welfare effects we model a monopoly insurance market where consumers can learn their accident risks at a cost c we then ask what are the welfare effects of a policy that reduces c if c is sufficiently small c c marginally reducing c hurts the insurer and weakly benefits the consumer finally a reduction in c that is successful meaning that the consumer gathers information after the reduction but not before it can hurt both parties this article is protected by copyright all rights reserved

early and late calls of convertible bonds theory and evidence many convertible bonds are called too early or too late relative to the perfect markets decision rule of ingersoll 1977a and ingersoll 1977b we re examine the convertible call decision under corporate taxation and possible default prior to maturity our model predicts that early calls will be associated with high coupon and low call premium dividend income volatility tax rate and interest rate and late calls will be associated with high call premium dividend income tax rate and interest rate and low coupon and volatility these implications are supported by empirical tests carried out with five years of convertible call data

the value of public information in a cournot duopoly we derive alternative sufficient conditions for the value of public information to be either positive or negative in a cournot duopoly where firms technology exhibits constant returns to scale

market based empirical research in accounting a review interpretation and extension a decade and a half of the most concerted and ambitious research effort in accounting history is evaluated here it is the search into the relationship between publicly disclosed accounting information and the consequences of the use of this information by the major group of usersequity investors as such consequences are reflected in characteristics of common stocks traded in major exchanges this research effort known as market based accounting research mbar obtained its impetus from major developments in finance theory during the late 1950s and early 1960s these were the portfolio selection theory and its offspring the capital asset pricing model capm and the concept of informationally efficient capital markets ecm subsequent developments in information economics agency theory and optimal incentive signaling models were quickly incorporated into mbar while the impetus to this line of research came from other disciplines accounting was not only a beneficiary but also to a modest extent a benefactor mbar is relevant to the study of capital market efficiency the capm information economics and regulation this contribution distinguishes mbar from most accounting areas whose contributions to other disciplines are negligible in

does anticipated information impose a cost on risk averse investors a test of the hirshleifer effect this paper theoretically and empirically investigates how the risk of future adverse price changes created by the anticipated arrival of information influences risk averse investors trading decisions in institutionally imperfect capital markets specifically i examine how the selling activity of individual investors immediately following an earnings announcement is influenced by the tradeoff between risk sharing benefits of immediate trade and explicit transaction costs imposed on such trades consistent with my theoretically derived predictions i find that investors current trading decisions are less sensitive to the incremental transaction costs created by short term capital gains taxes on trading profits as both the duration and intensity of the risk of future adverse price changes increase this evidence is consistent with an incremental cost to investors that results from the revelation of precise information which is commonly referred to as the hirshleifer effect

information and securities a note on pareto dominance and the second best a unified analysis is provided of two related problems the first concerns the welfare impact of changing the set of tradeable securities in an incomplete market economy the second concerns the welfare implications of changing the common information structure faced by all agents both problems arise from a common second best framework in which expanding the set of trading opportunities can lead to a pareto worsening journal of economic literature classification number 026 rl 1987 academic press inc in this note we provide a unified analysis of two related problems the first concerns the welfare impact of changing the set of tradeable securities in an incomplete market economy the second concerns the welfare implifications of changing the common information structure faced by all agents we will discuss apparent paradoxial results that arise in both problems using a single geometric example the example provides a clear illustration of the source of the apparent paradoxes both problems arise from a common second best framework by second best we mean the lipsey lancaster 20 idea of additional constraints on allocations over and above resource availability constraints our discussion brings together two related but distinct literatures the we are greatly indebted to james ohlson for many constructive comments and to david kreps and n v long for comments on a previous draft

corporate call policy for nonconvertible bonds we examine corporate call policy for 1 642 nonconvertible bonds that were called during the period 1975 94 the vast majority of firms delay calls and call when the bond price exceeds the call price we find that larger less liquidity constrained firms with a larger opportunity cost of delaying a call have shorter call delays there is no evidence that refunding transaction costs wealth redistribution effects call notice periods or a desire to eliminate restrictive covenants influences the timing of calls an examination of call motives suggests that there is no one underlying motive that fits the average call copyright 2000 by university of chicago press

optimality of the disclosure of private information in a production exchange economy this study provides an analysis of the effects on individual welfare of information revelation in a production exchange economy it is shown that the total effect of information revelation on an agent s utility level may be decomposed into three elements a price effect a shareholding effect and a production effect through this decomposition it is demonstrated that although a pareto improvement need not result from information revelation there are perspectives from which the release can be considered beneficial the major conclusion of previous studies of information revelation in a heterogeneous beliefs economy is that the release will not result in general in an economic equilibrium pareto superior to that which would have existed without the disclosure this result by itself does not give an understanding of how information revelation affects agents utility nor does it give much guidance to those regulatory bodies charged with deciding whether or not to mandate information disclosure this study provides further insight into the effects on individual welfare of information revelation in a general production exchange economy it is shown that the total effect of information revelation on an agent s utility level may be decomposed into three elements a price effect a shareholding effect and a production effect the price effect is the change in the agent s utility caused by the change in prices resulting from the revelation of information keeping shareholdings and production fixed the shareholding effect is the change in his utility resulting from the change in his shareholdings caused by the release of information the production effect is the change in his utility caused by the change in the production plan of each firm due to the information revelation conditions are given under which the signs of these three effects will be positive or negative for a given agent the finding that the production effect is positive for some agents and negative for others is of particular interest since it is counter to a result of arrow and hirshleifer they have argued that owners of production processes gain utility by having information revealed before production plans are fixed because they are then able to adjust those plans to account for the additional information it is shown here that such a conclusion can only be made in general when owners of each production process have homogeneous beliefs finally it is

monetary mystique secrecy and central banking abstract the paper contains a discussion of the role of secrecy in the implementation of monetary policy it documents the federal reserve s defense of secrecy as argued in a recent freedom of information act suit the federal reserve s arguments are evaluated on the basis of economic theory theoretical papers related to the secrecy issue are reviewed the discussion highlights a number of potential benefits and costs of central bank secrecy and identifies some conditions under which secrecy could be socially beneficial

sufficient conditions for public information to have social value in a production and exchange economy conditions are derived under which all consumers in a production and exchange economy will prefer at least weakly disclosure of public information to no such disclosure the conditions involve consumer endowments the allocative efficiency of the financial market and value maximizing behavior by firms cases exist where consumers will prefer disclosure of public information in a production and exchange economy although they would be indifferent to such disclosure in an otherwise similar pure exchange economy the difference in results is due purely to the fact that in production and exchange economies information may be used to reallocate resources across time and firms thus highlighting the fundamental difference between the role of information in pure exchange and in production and exchange economies

the sensitivity of american options to suboptimal exercise strategies the value of american options depends on the exercise policy followed by option holders market frictions risk aversion or a misspecified model for example can result in suboptimal behavior we study the sensitivity of american options to suboptimal exercise strategies we show that this measure is given by the gamma of the american option at the optimal exercise boundary more precisely if b is the optimal exercise price but exercise is either brought forward when or delayed until a price b has been reached the cost of suboptimal exercise is given by b b b 2 where b denotes the american option gamma therefore the cost of suboptimal exercise is second order in the bias of the exercise policy and depends on gamma this result provides new insights on american options

the use of mathematical models in financial accounting well over a year ago it was proposed that i write a survey paper for this conference which discussed the role of mathematical models in financial accounting the difficulty with this assignment is that mathematical models have been used to address a wide variety of issues in financial accounting and a paper which touched on all of them would probably be unable to examine any single one in depth therefore i have chosen in financial accounting three popular mathematical modeling themes and have interpreted these themes in the context of a competitive equilibrium market model to lend greater cohesiveness to the discussion i refer to the three topics chosen as 1 assessing the consequences of public disclosure 2 formalizing the notion that markets are efficient with respect to information and 3 understanding the effect of increased public disclosure on private incentives to acquire information other areas in financial accounting which use mathematical models but are not discussed here include income measurement valuation models i e models which map accounting variables or other information into equi

convertible bonds are not called late starting with ingersoll 1977b the academic literature has repeatedly sought to explain why convertible bonds are called late the findings here demonstrate there is no call delay to explain this paper finds that most convertible bonds given their call protection are called as soon as possible for those that are not there are significant cash flow advantages to delaying the median call delay for all convertible bonds is less than four months if a safety premium is desired to assure the conversion value will exceed the call price at the end of call notice period the median call period is less than a month the question of what is the optimal call policy for convertible bonds has attracted considerable attention since brennan and schwartz 1977 and ingersoll s 1977a seminal work that work suggests that the optimal call policy is to call the bond when the conversion value first exceeds the call price since forcing conversion eliminates the bondholders premium or option value however empirical studies e g ingersoll 1977b and constantinides and grundy 1987 claim that firms consistently deviate from this call policy and delay calls this claim is based on ingersoll s finding that firms wait on average until the conversion value exceeds the call price by 43 9 a result confirmed in mikkelson 1985 trying to explain this call delay phenomenon has generated an impressive literature to date however no one has actually documented whether there is a delay or measured how long the delay is in addition the existing empirical work has focused either on a subsample of called bonds or on a subsample of bonds remaining uncalled at a given point in time these partial samples are not adequate to empirically determine average call delays for convertible bonds or to distinguish between the various hypotheses proposed for call

toward a theory of financial accounting welfare and public information in this paper we employ the concepts of neoclassical welfare economics to consider the role of publicly available information in various market configurations modeling pure exchange economies the need for such a study arises for several reasons first while the existing process of producing and disseminating accounting information may with some oversimplification be described as generating publicly available information there has been no systematic study of the effects of such a process on either the allocational efficiency of a market or on the broader welfare implications of such information for the participants transacting in such a market second the existing literature fails at least to some extent to capture the flavor or spirit of the role of public information in a market setting at first glance it might appear that information would have no social benefit in a pure exchange economy since it does not increase the aggregate supply of consumptive goods across states and dates as will be demonstrated this impression is not justified as a general conclusion the important dimension of information is that it affects perceived risks

a game options approach to the investment problem with convertible debt financing we consider a firm that operates a single plant and has an expansion option to invest in a new plant with convertible debt financing this conversion feature introduces another complication not only because of the added conversion timing problem by the bond holder but also because the equity holder needs to take future conversion into account when evaluating her expansion financing decision we have two main objectives here we use game options techniques to analyze optimal strategies involved in this convertible debt financed expansion problem the first goal is to provide a comprehensive framework and procedure for solving the problem in a mathematically tractable way secondly we illustrate our solution method through a concrete example with economic analysis this includes a comparison with straight bond financing and comparative statics with respect to price volatility and conversion ratio in this regard we attempt to clarify how the conversion feature affects the equity holder s investment decisions throughout the paper we study expansion options by viewing a firm s existing operation bankruptcy threat conversion decisions and financing decisions all together

speculation optimism and differential information speculative trading has for quite some time been an important question for at least two reasons firstly as a positive question of whether speculative behavior basically is caused by differences in information or by differences in aversion to risk secondly the question is related to the informational efficiency of decentralized market systems if access to information not currently available to the market makes possible a speculative profit the incentive to acquire information may be too excessive from a social point of view the aim of this paper is to clarify the relationship between information and speculation in his seminal article on information acquisition in decentralized market economies hirshleifer 12 showed that the private value of acquiring information depends critically on the speculative profits to be made from this information hirshleifer 12 distinguished between information foreknowledge which affects productive decisions and information which only has implications for exchange similarly fama and laffer 5 distinguish between operational information which improves a firms operating decisions and trading information which only affects trading decisions it is argued due to the speculative profits to be made from having access to information not available to the market that there are excessive private incentives to acquire information without any relevance for productive decisions

debt and the marginal tax rate abstract do taxes affect corporate debt policy this paper tests whether the incremental use of debt is positively related to simulated firm specific marginal tax rates that account for net operating losses investment tax credits and the alternative minimum tax the simulated marginal tax rates exhibit substantial variation due to the dynamics of the tax code tax regime shifts business cycle effects and the progressive nature of the statutory tax schedule using annual data from more than 10 000 firms for the years 1980 1992 i provide evidence which indicates that high tax rate firms issue more debt than their low tax rate counterparts

the value of information in efficient risk sharing arrangements suppose that agents share risks in competitive markets we show that better information makes everyone worse off if the economy has a representative agent that is the economy s demand for state contingent consumption equals the demand of a hypothetical agent who owns all the economy s wealth the representative agent moreover is normatively unrepresentative although each agent dislikes information the representative agent is indifferent although we emphasize pure exchange our results imply that a representative agent model might seriously misstate the welfare effects of improved information in an economy with production and risk sharing even if it performs well otherwise

sources of gains to shareholders from bankruptcy resolution abstract using a logistic regression model we identify the characteristics of firms whose shareholders are likely to benefit from bankruptcy resolution that is winners losers are firms whose shareholders experience positive negative excess returns after bankruptcy filing we find that winners are relatively smaller firms with higher proportions of convertible debt tend to file for bankruptcy for strategic reasons have low share ownership concentration and suffer comparatively larger pre filing stock price declines among winners shareholder returns are greater for firms that have higher levels of private debt and research and development r d expenditures and operate in more concentrated industries in addition our analysis indicates that an ex ante trading strategy of purchasing bankrupt stocks with a greater than 50 probability of being a winner on the day after bankruptcy filing and holding the stocks for a year on an average can generate average compounded and excess compounded holding period returns of 71 and 42 respectively

economic interests and regional trading arrangements the case of nafta this article examines lobbying in the united states on the north american free trade agreement nafta i argue that economies of scale and production sharing across borders create incentives for firms to seek regional trade liberalization statistical analysis demonstrates that sectors with these characteristics were more likely to lobby for free trade in north america these sectors were also exposed to free trade more rapidly under the tariff phasing schedule in the nafta treaty however corporate restructuring to rescale production for the regional market and to increase offshore assembly presented adjustment costs for u s workers which created divisions between labor unions and their employers i conclude that regional arrangements are an attractive mechanism to liberalize trade for firms in need of larger than national markets to take advantage of economies of scale or to develop production sharing networks

social value of public information re examined abstract as an extension of hirshleifer s horse race example into a competitive exchange market framework this paper quantitatively re examines the condition under which social value of public information can be positive for a prototype economy of two risk averse traders we prove that their discordance of beliefs makes the social value of a certain class of inconclusive information either positive or negative depending on whether their endowments are or are not predominantly associated with states they regard as more probable whereas it has been known that information acquisition is always socially wasteful under concordant beliefs

asset pricing in large information networks we study asset pricing in economies with large information networks we focus on networks that are sparse and have power law degree distributions in line with empirical studies of large scale social networks our theoretical framework yields a rich set of novel asset pricing implications we derive closed form expressions for price volatility profitability and trading volume as functions of the network topology we also study agent welfare and show that the network that optimizes total welfare is typically a uniform one with an intermediate degree of connectedness

securityholder taxes and corporate restructurings previous studies have found that positive abnormal stock returns are associated with corporate spin offs and divestitures using a simplified model of the process of investor tax trading we show that an improvement in the value of the tax timing option component of securities prices is a likely contributing factor to those abnormal returns the analysis indicates that the same phenomenon also may be part of the explanation for the generally higher returns observed for spin offs than for divestitures both when leverage is and is not present in the restructuring transactions

market response to financial reports abstract a two date rational expectations model is analyzed at the first date traders can privately acquire a costly signal that provides imperfect information about a public report that will be issued at the second date equilibrium characterizations are provided for the fraction of traders that become informed and the informativeness of the first date price as well as the price change variance and the expected trading volume at the second date comparative statics identify how the above variables are influenced by changes in the information content of the public report and in particular how market phenomena at the public release date are influenced by endogenous prior information acquisition and trading in response to the forthcoming public release

proxies for the corporate marginal tax rate abstract this paper focuses on how best to measure the corporate marginal tax rate which is an important input into financial analysis of the cost of capital financing policy corporate hedging and corporate reorganizations the results indicate that the simulated tax rate used by shevlin 1990 and graham 1996 although difficult to calculate is the best available proxy for the true marginal tax rate if the simulated rate is unavailable an easy to calculate trichotomous variable or the statutory marginal tax rate which captures the progressivity in the tax schedule are reasonable alternatives better than most commonly used tax variables

sufficient and necessary conditions for information to have social value in pure exchange this paper extends corrects and unifies earlier statements concerning the social value of public information as well as the no trading conditions in pure exchange sufficient and necessary conditions are provided for both the single period and two period cases in a postsignal trading model the social value of information is shown to be closely linked to the allocational efficiency of the market the degree of homogeneity of prior beliefs and of information structures the time additivity of preferences and the efficiency of endowments we conclude that the case in favor of public information is much stronger than previously suggested

the social value of hidden information in adverse selection economies abstract when agents possess imperfect hidden knowledge at the time contracts are negotiated the social value of agents having access to additional hidden knowledge before contracts are implemented is positive to the extent that incentive constrained agents are sorted more finely but is negative to the extent that incentive constraining agents impose more stringent signalling requirements on others hence the intuition developed by hirshleifer 1971 marshall 1974 and milgrom and stokey 1982 that privately acquired information has neither positive nor negative social value when agents possess no prior hidden knowledge does not apply when agents possess imperfect hidden knowledge during contractual negotiations

adverse selection with endogenous information in insurance markets abstract models of adverse selection assume that risk type is known to the consumer but not to the insurer many analyses suggest that information has zero social value and negative prior value why then would consumers become informed what is the incentive to gather information and why does adverse selection arise we show that the private value of information is non negative only if insurers cannot observe consumers information status or if consumers can conceal their informational status we examine the existence and characterization of equilibria under different configurations of information costs and benefits finally we examine some welfare implications of the endogenous information model for public policy regarding genetic testing and for state regulations concerning hiv testing

blackwell s ordering and public information abstract we characterize a precise comparative static on welfare and the amount of public information in an economy under uncertainty results dating to hirshleifer amer econom rev 61 1971 561 have suggested that information can have negative value in such a setting but counterexamples using competitive equilibrium outcomes have suppressed general results to this effect we show that under the solution concept of implementable allocations the negative relationship between more public information in the sense of blackwell and welfare is fully general furthermore blackwell s ranking is necessary as well as sufficient to obtain our ranking and hence ours provides an equivalent characterization of his ordering

a complete analysis of full pareto efficiency in financial markets for arbitrary preferences this paper provides a complete analysis of the necessary and sufficient conditions for financial markets to achieve fully pareto efficient allocation of aggregate wealth through trade in economies with arbitrary preferences we show that full pareto efficiency obtains only if the market structure of contingent claims spans the information partition of a minimal aggregate wealth statistic and a halmos savage sufficient statistic for the beliefs of the traders all the known allocation efficiency results in the literature due to arrow hakansson john ross and others are unified by this result a security is a certificate that entitles the holder to a stream of cash flows

the role of time value in convertible bond call policy abstract since the seminal work of ingersoll 1977b the optimal time in which a firm should redeem its outstanding convertible bonds has received large attention by the financial literature several studies have put forward a number of possible costs and benefits for a firm if it interrupts the life of its convertible bonds prior to their contractual maturity however in this paper we argue that the managerial decision to call back a convertible bond is mainly driven by a fundamental variable almost neglected up until now the time value extraction from bondholders conversion option accordingly we propose a measure for the effective convenience of calling which we define as net time value advantage and we show using a survival analysis that it is more effective than previously proposed measures in explaining the firms observed call policy

defaults of original issue high yield convertible bonds recent studies using aging analysis have found high rates of default for rated nonconvertible high yield bonds this paper examines the remainder of the market and concludes that rated and nonrated convertible high yield bonds had significantly lower default rates it also provides some evidence that nonrated nonconvertible securities may have lower default rates even after controlling for issue size and coupon rates in a logit model these differences remain statistically significant the success in marketing original issue high yield bonds has generated significant interest in their default experience studies comparing defaults to the par value of outstanding issues such as altman 1987 altman and nammacher 1985 and weinstein 1987 have found relatively low default rates however these studies understate default rates because of the rapid increase in the par value of outstanding issues and because cumulative default rates increase with years from issuance two recent studies by altman 1989 and asquith mullins and wolff 1989 have corrected these problems by using aging analysis to follow rated nonconvertible high yield bonds over time they find cumulative default rates for such bonds 10 years after issuance exceeding 30 percent this study extends the literature on high yield default rates to convertible and nonrated securities not examined in previous studies the high yield market can be partitioned into rated nonconvertible rated convertible nonrated nonconvertible and nonrated convertible securities other things equal one would expect higher default risk to be associated with higher yields however other things are not equal for example securities may have high yields because of differences in liquidity or differences in conversion options therefore yields reflect more than just expected default risk they also incorporate premiums for other characteristics of individual securities when the securities are partitioned by rating and convertibility the results of this paper show that the cumulative default rates are lower for rated convertible securities than for rated nonconvertible securities because in

evaluating corporate bonds and analyzing claim holders decisions with complex debt structure abstract although many different aspects of debt structures such as bond covenants and repayment schedules are empirically found to significantly influence values of bonds and equity many theoretical structural models still oversimplify debt structures and fail to capture phenomena found in financial markets this paper proposes a carefully designed structural model that faithfully models typical complex debt structures containing multiple bonds with various covenants for example the ability for an issuing firm to meet an obligation is modeled to rely on its ability to meet previous repayments and the default trigger is shaped according to the characteristics of its debt structure such as the amount and schedule of bond repayments thus our framework reliably provides theoretical insight and concrete quantitative measurements consistent with extant empirical research such as the shapes of yield spread curves under various firm s financial statuses and the impact of payment blockage covenants on newly issued and other outstanding bonds we also develop the forest a novel quantitative method to handle contingent changes in the debt structure due to premature bond redemptions a forest consists of several trees that capture different debt structures for instance those before or after a bond redemption this method can be used to analyze how poison put covenants in the target firm s bonds influence the bidder s costs of debt financing for a leveraged buyout or investigate how the presence of wealth transfer among the remaining claim holders due to a bond redemption influences the firm s call policy or further reconcile conflicts among previous empirical studies on call delay phenomena

inside trading and incentives the traditional arguments against inside trading insiders take advantage of other investors inside trading profits overcompensate managers see ross 1979 too much information is collected if inside trading is allowed see fama and laffer 1971 hirshleifer 1971 emphasize the social costs of prohibiting such trading without explaining the private incentives shareholders have to sanction this trading the efficiency argument in favor of inside trading inside trading improves the functioning of the stock market because information as a public good will be underproduced unless those who acquire it profit through inside trading demsetz 1969 does not explain shareholders support of inside trading because the owners of a firm do not seek to improve the efficiency of the stock market by sacrificing trading profits to insiders several alternative hypotheses for shareholders failure to impose restrictions on inside trading have been advanced this paper analyzes shareholders incentives to sanction inside trading i show that if a manager of a firm is initially compensated with earnings contingent contracts then the welfare of that manager and all of the firm s shareholders can be improved by allowing the manager to trade on his private information this result is established in the context of a multiple principal the shareholders single agent the manager model with the manager s trades observable ex post and is robust with respect to the specification of investors preferences and the definition of stock market equilibrium the topic of this paper originated in conversations with steve allen his comments as well as those of nicholas dopuch daniel fischel sanford grossman merton miller robert verrecchia and other members of the workshops on the applications of economics and on accounting research both at the university of chicago are gratefully acknowledged 1 for a list of such arguments see references in manne 1966 chap 1

disagreements among shareholders over a firm s disclosure policy this paper examines the issue of voluntary disclosure of information by firms with heterogeneous shareholders it shows that in a rational expectations setting better iniformed shareholders prefer less disclosure than less well informed shareholders this is due to differences in the adverse risk sharing effect and the beneficial cost saving effect of disclosure among shareholders with differenit risk tolerances aild information acquisition cost functions the presence of individual liquidity shocks is shown to reduce shareholder disagreements regarding a firm s disclosure policy many firms voluntarily disclose information beyond l evels mandated by financial and accounting regulations still other firms seem to disclose as little information as they can the paper seeks to explain this difference prior studies dealing with disclosure typically are concerned with whether firms would disclose too little or too much information in the absence of mandatory rules 1 results differ across models depending on whether positive or negative externalities are considered for example in a model where disclosure only adversely affects shareholders risk sharing opportunities the optimal level of disclosure is zero and mandatory disclosure rules make all shareholders worse off 2 in contrast mandatory disclosure rules are viewed in this paper as a result of conflicts among firms shareholders with different risk attitudes and different access to inside information in general there is no optimal disclosure policy that is best for all shareholders 3 this paper is based on the model of diamond 1985 diamond considers two opposing effects a positive externality and a negative externality of disclosure to explain the existence of voluntary disclosure when acquiring private information is costly first disclosure adversely affects risk sharing