the changing time series properties of earnings cash flows and accruals has financial reporting become more conservative abstract this paper documents changes in the patterns of earnings cash flows and accruals over the last four decades in the absence of a generally accepted definition of conservatism a number of measures of reporting conservatism are identified and examined these measures rely on the accumulation of nonoperating accruals the timeliness of earnings with respect to bad and good news characteristics of the earnings distribution and the market to book ratio the patterns are consistent with an increase in conservative financial reporting over time the findings have implications for accounting standard setting regulation of financial information and financial statement analysis

hybrid r d we develop a model of r d collaboration in which individual firms carry out in house research on core activities and undertake bilateral joint projects on non core activities with other firms we develop conditions on the profit functions of the firm under which r d investments in different projects of a firm are complementary we show that this condition is met by standard price and quantity setting oligopoly models we then study the relation between the number of joint projects and investments and profits in this context we identify a second aspect of complementarity equilibrium investments in in house as well as in each joint project are increasing in the number of projects however we find that an increase in number of joint projects of all firms lowers collective profits suggesting the presence of excessive incentives for conducting research

endogenous information flows and the clustering of announcements we consider the strategic timing of information releases in a dynamic disclosure model because investors don t know whether or when the firm is informed the firm will not necessarily disclose immediately we show that bad market news can trigger the immediate release of information by firms conversely good market news slows the release of information by firms thus our model generates clustering of negative announcements surprisingly this result holds only when firms can preemptively disclose their own information prior to the arrival of external information these results have implications for conditional variance and skewness of stock returns jel d21 d83 g12 g14 l11

not only what but also when a theory of dynamic voluntary disclosure we examine a dynamic model of voluntary disclosure of multiple pieces of private information in our model a manager of a firm who may learn multiple signals over time interacts with a competitive capital market and maximizes payoffs that increase in both period prices we show perhaps surprisingly that in equilibrium later disclosures are interpreted more favorably even though the time the manager obtains the signals is independent of the value of the firm we also provide sufficient conditions for the equilibrium to be in threshold strategies

market share market value and innovation in a panel of british manufacturing firms this paper examines the empirical relationship between technological innovations market share and stock market value new developments in the estimation of dynamic count data models are used to control for unobserved firm specific heterogeneity we find a robust and positive effect of market share on observable headcounts of innovations and patents although increased product market competition in the industry tends to stimulate innovative activity furthermore the impact of innovation on market value is larger for firms with higher market shares we argue that our results are consistent with models where high market share firms have incentives to pre emptively innovate

changes in the value relevance of earnings and book values over the past forty years this paper investigates systematic changes in the value relevance of earnings and book values over time we report three primary findings first contrary to claims in the professional literature the combined value relevance of earnings and book values has not declined over the past forty years and in fact appears to have increased slightly second while the incremental value relevance of bottom line earnings has declined it has been replaced by increasing value relevance of book values finally much of the shift in value relevance fiom earnings to book values can be explained by the increasing frequency and magnitude of one time items the increasing frequency of negative earnings and changes in average firm size and intangible intensity across time

networks of collaboration in oligopoly abstract in an oligopoly prior to competing in the market firms have an opportunity to form pair wise collaborative links with other firms these pair wise links involve a commitment of resources and lead to lower costs of production of the collaborating firms we study the incentives of firms to form links and the architecture of the resulting collaboration network we find that incentives to form links are intimately related to the nature of market competition our analysis also suggests that collaborations are used by firms to generate competitive advantage and that strategically stable networks are often asymmetric with some firms having many links while others have few links or are isolated specifically we show that networks with the dominant group architecture stars and inter linked stars are stable we also present some results on the architecture of socially efficient networks

a simulation study of the interactive effects of taxes and inflation on the relative price of land recent experience in the united states with high and variable inflation has led to an outpouring of research concerning inflation s impact on the relative prices of real and financial assets with the exception of three recent papers feldstein 1980a rose 1986a alston 1986 the impact of inflation on the relative price of land has been neglected land is usually eliminated from economic models of the tax system so that the effects of inflation s complex interaction with the income tax system on firm financing and valuation of capital can be highlighted in this paper we take the opposite approach the effects of inflation on corporate financing of capital are suppressed by allowing only bond financing in order to highlight the effects of inflation and tax rate changes on the relative price of land

housing price land supply and revenue from land sales in a recent study peng and wheaton empirically examine the effect of restrictive land supply on hong kong house prices however we argue that the impact of the supply of new land by the hong kong government is not as important as they maintain in accounting for the volatile house prices in hong kong we show that there is no causal relationship between land supply and housing prices our estimations based on the annual data of hong kong s public land sales find that the government acts to maximise land revenue maximisation of revenue from land sales is however consistent with the efficient allocation of resources we also show that the amount of land sales by the government and land in developers land banks tend to decrease when market interest rates increase land banking behaviour is governed by economic conditions long term land holding costs should cover interest costs

multiproduct equilibrium price dispersion abstract the model of burdett and judd econometrica51 1993 955 969 is generalized to the case of may goods consumers choose the best price observed for each good there are two classes of equilibria those that involve constant expected profits for each good independently of price and those with increasing profits for each good in price a continuum of the latter type always exists these equilibria are qualitatively different than the unique equilibrium of the single good case journal of economic literature classification numbers d83 d43 l13

the effects of anticipated inflation on housing market equilibrium an increase in the anticipated rate of inflation causes distortions in the housing market due to a nonindexed tax system since nominal rather than real interest payments are tax deductible an increase in inflation decreases the aftertax cost of capital for homeowners which in turn increases the demand for housing and increases its real price this tax gain is shown to be larger for rental housing than for owner occupied housing in a competitive market this implies that although the real price of housing increases with a rise in anticipated inflation real rental rates fall in the last decade the real price of corporate capital fell while the price of housing increased dramatically during this same period the rate of inflation increased substantially empirical studies have found a negative relationship between stock returns and the inflation rate 1 while housing has been found to have been a good hedge against inflation 2 tax distortions related to the change in the rate of inflation provide one popular explanation for the negative relationship between stock prices and inflation 3 the effect of similar tax induced distortions on the equilibrium in the housing market will be studied in this paper it is shown that the real price of housing increases with the anticipated rate of inflation while the real rental rate declines these results are consistent with published data for the period 1967 77 during which the anticipated rate of inflation increased substantially 4 the general price level as measured by the consumer price index increased 81 5 percent between 1967 and 1977 5 in this

housing market equilibrium almost without vacancies the swiss housing market is characterised by an extraordinarily low vacancy rate generally in the vicinity of 1 per cent is the swiss housing market permanently in a condition of severe shortage this paper uses both a standard non accelerating rent inflation rate of vacancy approach and a new perception based approach to answer this question the available evidence confirms that a vacancy rate of 1 1 5 per cent is indeed sufficient for the swiss housing market to be in equilibrium provided only dwellings that are not only unoccupied but also actually offered for rent or purchase are counted which makes this rate not easily comparable with other countries the standard equilibrium vacancy rate approach suggests that even lower rates are sufficient in more densely built places whereas the approach based on perceptions makes no difference this suggests that the dwellings listed by people who wish to move reduce the pressure on rents but not the feeling of housing shortage

marking to market versus taking to market while the debate on cost and market value accounting has been raging for years economists lack a framework allowing a comparison of their relative merits this paper considers an agency model in which the measurement of an asset can be based on public market data marking to market and or on the realization of its value through costly resale to an informed buyer taking to market at the optimal contract noisier market data lead to cost accounting and gains trading selling winners keeping losers whereas accurate data naturally favor market value accounting the quality of market data and the magnitude of resale costs both depend on the volume of transactions and therefore on accounting rules the paper studies the mutual feedback between individually optimal accounting rules and asset market liquidity this equilibrium approach reveals a socially excessive use of market value accounting that dries up market liquidity and reduces the informativeness of price signals

debtholders demand for conservatism evidence from changes in directors fiduciary duties debtholders demand has been widely discussed as a key determinant of conservatism but clear causal evidence is not yet established using a natural experiment setting wherein a delaware court ruled that the fiduciary duties of directors in near insolvent delaware companies extend to creditors we predict and find that firms subject to the ruling significantly increased their accounting conservatism in addition our results suggest that the increase in conservatism is more pronounced in near insolvent delaware firms with stronger boards confirming that the court ruling takes effect through the channel of the board of directors our results are robust to using alternative measures of conservatism and near insolvency status and controlling for potential confounding factors and other stakeholders demand for conservatism overall our study provides empirical evidence to support the causal relation between debtholders demand and accounting conservatism previously suggested in the literature and offers some insights into the role of the board of directors in financial reporting

which is a better investment choice in the hong kong residential property market a big or small property the relationship between property size and property investment yield is an interesting issue in the real estate market previous studies usually use the mean variance criterion to compare the return risk profiles of the yields of different property sizes in the united states however this criterion has a few shortcomings this article provides the first attempt to use a stochastic dominance approach to analyse this issue we adopt two powerful stochastic dominance tests to compare the yields of five property size classes in the hong kong residential property market in our study we analyse two possible investment outcomes 1 investors could not rent out their properties and thus they would gain lose from the appreciation depreciation of residential property prices 2 investors could also gain from rental incomes our empirical results provide strong evidence to show that the yields of smaller property classes stochastically dominate the yields of bigger property classes suggesting that buying smal

the information content of losses abstract this study hypothesizes that because shareholders have a liquidation option losses are not expected to perpetuate they are thus less informative than profits about the firm s future prospects the results are consistent with the hypothesis they also show that the documented increase in the earnings response coefficent as the cumulation period increases appears to be due exclusively to the effect of losses the liquidation option effect extends to profitable cases where earnings are low enough to make the option attractive alternating explanations for the low informativeness of losses such as mean reversal of earnings are not supported by the tests

the role of accruals in asymmetrically timely gain and loss recognition we investigate the role of accrual accounting in the asymmetrically timely recognition incorporation in reported earnings of gains and losses timely recognition requires accruals when it precedes complete realization of the gains and losses in cash we show that nonlinear accruals models incorporating the asymmetry in gain and loss recognition timelier loss recognition or conditional conservatism offer a substantial specification improvement explaining substantially more variation in accruals than equivalent linear specifications conversely conventional linear accruals models by omitting the loss recognition asymmetry exhibit substantial attenuation bias and offer a comparatively poor specification of the accounting accrual process linear specifications also understate the ability of current earnings to predict future cash flows these findings have implications for our understanding of accrual accounting and conservatism as well as for researchers estimating discretionary accruals earnings management and earnings quality

initial public offerings in hot and cold markets the literature offers many explanations for why the ipo market cycles from hot to cold these include theories in which hot markets represent clusters of ipos in a new industry and signaling models that predict that hot markets draw in better quality firms others suggest hot market ipos stock returns reflect their poor quality we compare ipos over cycles during 1975 2000 and find that hot and cold ipo markets do not differ so much in the characteristics of the firms that go public as in the quantity of firms that go public both hot and cold ipos are largely concentrated in the same narrow set of industries and they have few distinctions in profits age or growth potential our results suggest that hot markets are not driven primarily by changes in adverse selection costs managerial opportunism or technological innovations but more likely reflect greater investor optimism

r d networks we develop a model of strategic networks that captures two distinctive features of interfirm collaboration bilateral agreements and nonexclusive relationships our analysis highlights the relationship between market competition firms incentives to invest in r d and the architecture of collaboration networks in the absence of firm rivalry the complete network where each firm collaborates with all others is uniquely stable industry profit maximizing and efficient by contrast under strong market rivalry the complete network is stable but intermediate levels of collaboration and asymmetric networks are more attractive from a collective viewpoint this suggests that competing firms may have excessive incentives to form collaborative links

the effects of accounting diversity evidence from the european union in this paper we investigate the financial statement effects of differences in accounting measurement practice in france germany and the united kingdom u k we find evidence of significant differences in financial ratios and the stock market valuation of accounting data the differences do not appear to be explained by the composition of the sample or by macroeconomic factors they are predictable given crosscountry differences in reporting philosophies and they are present for the components of net income which one would expect based on differences in accounting practice the differences across countries appear largely unaffected by legislation enacted in response to the european union eu directives which were intended to create an integrated set of reporting standards to serve as a basis for cross listing and facilitate cross border investment 1 this research provides descriptive evidence from a capital markets perspective on how cross country differences in measurement practices affect the comparability of the resulting accounting data europe provides a relevant context to examine this issue for several reasons first

earnings as an explanatory variable for returns in this paper we investigate whether the level of earnings divided by price at the beginning of the stock return period is relevant for evaluating earnings returns associations the primary model motivating this research relies on the idea that book value owners equity and market value are both stock variables indicating the wealth of the firm s equity holders the related flow variables after adjusting for dividends are respectively earnings divided by price at the beginning of the return period a p 1 and market returns it then follows that earnings divided by beginning of period price should be associated with stock returns although models based on a relation between market value and book value are used occasionally in the accounting research literature see for example landsman 1986 harris and ohlson 1987 and barth

a comparison of the skewness of stock return distributions at earnings and non earnings announcement dates abstract this paper presents evidence that stock return prediction errors are less positively skewed in the time period surrounding accounting earnings report announcements than in a subsequent non announcement period assuming that information available about firms in non announcement periods depends on discretionary disclosure practices of firms and discretionary search for information by investors the results suggest that earnings reports cause more extreme bad news to be reflected in stock prices relative to discretionary sources of information

disclosure and choice an agent chooses among projects with random outcomes his payoff is increasing in the outcome and in an observer s expectation of the outcome with some probability the agent will be able to disclose some information about the true outcome to the observer we show that choice is inefficient in general we illustrate this point with a characterization of the inefficiencies that result when the agent can perfectly disclose the outcome with some probability and can disclose nothing otherwise as in dye 1985a in this case the agent favours riskier projects even with lower expected returns on the other hand if information can also be disclosed by a challenger who prefers lower beliefs of the observer the chosen project is excessively risky when the agent has better access to information excessively risk averse when the challenger has better access and efficient otherwise we also characterize the agent s worst case equilibrium payoff we give examples of alternative disclosure technologies illustrating other forms the inefficiencies can take for example in a two dimensional setting we demonstrate a hitting for the fences effect where the agent systematically focuses on the harder dimension at the expense of success on the easier

hedonic prices and contractual contingencies abstract hedonic models are widely used to analyze markets for differentiated goods this paper examines the appropriate specification of characteristics to be included in the hedonic price function we develop a model that shows that the characteristics of the contract used to transfer a good from the buyer to the seller should also be included in the price function and present an empirical application of the model using data for single family house transactions the results indicate that the market exacts a price for the uncertainties created by contractual contingencies in the way described by the model

were japanese stock prices too high abstract this paper asks whether market fundamentals can explain the recent run up and decline of japanese equity values and price earnings ratios accounting differences explain about half of the long run disparity between u s and japanese p e s for example if japanese firms used u s accounting rules the japanese p e ratio would have been 32 6 not 53 7 in 1989 accounting differences cannot however explain the doubling of this ratio in 1986 nor its decline in 1990 similarly we are unable to isolate changes in required stock returns or growth expectations that are large enough to explain recent japanese stock price movements

the value relevance of german accounting measures an empirical analysis in this study we compare the value relevance of accounting measures for u s and german firms matched on industry and firm size and evaluate the incremental informativeness of earnings adjusted on the basis of a formula proposed by analysts german companies have been at the center of a controversy between the new york stock exchange nyse and the securities and exchange commission sec the controversy arises from the sec s insistence that to list on a u s stock exchange non u s companies must reconcile earnings and shareholders equity to u s generally accepted accounting practice u s gaap fuerbringer 1992 and jarrell 1992 41 the nyse s concern has been that

firm heterogeneity and the pattern of r d collaborations we consider an oligopoly setting in which firms form pairwise collaborative links in rd 2 some firms have more innovative capabilities than others these two situations provide clear insights about how firms heterogeneity affects both equilibrium and efficient networks we also show that the most valuable collaborative links do not always appear in equilibrium and a public policy that increases the value of the most valuable links may lead to a loss of social welfare

housing vacancy and rental adjustment evidence from hong kong the traditional rental adjustment equation is flawed in that the equilibrium paths for the adjustment of rents and vacancy rates cannot hold simultaneously over time this paper suggests a two equation model of rental adjustments based on adaptive expectations rather than the single equation model presented in the traditional literature and provides empirical tests annual data from the housing market in hong kong during the 1980 96 period are consistent with the adjustment equation the results also show that the rate of change of real rents is neutral with respect to inflation

earnings management to avoid earnings decreases and losses this paper provides evidence that firms manage reported earnings to avoid earnings decreases and losses specifically in cross sectional distributions of earnings changes and earnings we lind unusually low frequencies of small decreases in earnings and small losscs and unusually high frequencies of small increases in earnings and small positive income we find evidence that two components of earnings cash flow from operations and changes in working capital are used to achieve increases in earnings we present two theories based on stakeholder use of information processing heuristics and prospect theory about the motivation for avoidance of earnings decreases and losses

forcing firms to talk financial disclosure regulation and externalities we analyze a model of voluntary disclosure by firms and the desirability of disclosure regulation in our model disclosure is costly it has private and social value and its precision is endogenous we show that i a convexity in the value of disclosure can lead to a discontinuity in the disclosure policy ii the nash equilibrium of a voluntary disclosure game is often socially inefficient iii regulation that requires a minimal precision level sometimes but not always improves welfare iii the same is true for subsidies that change the perceived cost of disclosures and iv neither regulation method dominates the other article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

how naive is the market s use of firm specific earnings information recent studies suggest the apparent delay in the stock price response to earnings announcements i e post earnings announcement drift is caused by investors who underestimate the autocorrelation of seasonally differenced earnings persistence i present results that suggest 1 a firm s future persistence is predictable on the basis of its past persistence 2 the immediate stock price response to earnings is positively related to historical persistence 3 post earnings announcement drift is independent of historical persistence and 4 consistent with 2 and 3 the difference between a firm s current observed persistence and that implied in stock prices is independent of its historical persistence these results extend prior research by demonstrating that investors are aware not only that seasonally differenced earnings are autocorrelated but that investors recognize firm specific differences in the magnitude of the autocorrelation

international differences in the timeliness conservatism and classification of earnings in this paper we analyze differences in the timeliness of income recognition between the u s and u k gaap financial reporting regimes building on previous work in the area we focus on the links between current reported earnings and current and past changes in market value in the light of basu 1997 we present a formal model in which the response of reported earnings to changes in market value varies according to whether the value change is good news or bad this model yields a number of insights with regard to the definition and measurement of earnings conservatism we also report evidence indicating that controlling for cross jurisdictional classification differences affects comparisons of earnings timeliness and earnings conservatism specifically we find that apparent differences in conservatism between the u s and u k accounting regimes are sensitive to the inclusion or exclusion of extraordinary items in u k accounting earnings recent research documents significant variation in the information content of earnings across international gaap regimes e g alford et al tlancaster university tuniversity of manchester the research support of the eco

does inflation affect real behavior the case of housing an important tradition in economics is to assume that demand depends upon relative prices and is homogenous of degree zero for the most part this has been interpreted as meaning inflation changes in the price level leaves demand unchanged recent work by a number of economists has challenged this position for the case of housing demand two arguments have been made that inflation acting in concert with existing institutions alters the quantity of housing demanded and the decision to rent or own a house the first argument states that inflation and the standard fixed payment mortgage combine to reduce the size of the mortgage loan a household can obtain for the purpose of buying a home this works to reduce the quantity of owner occupied housing demanded given the importance of mortgage finance to the demand for owner occupied housing the second argument focuses on the inflation adjusted after tax cost of owner occupied housing it simply states that an increase in the rate of anticipated inflation of the general price level reduces the after tax cost of housing thus increasing the demand for housing and the demand for homeownership there has been little empirical testing of these two arguments the purpose of this paper is to formulate and estimate a model which will give an indication of the quantitative significance of the two arguments a housing demand equation and a tenure choice equation own versus rent are estimated using a sample of about 6000 households from the 1975 annual housing survey 10 the estimates suggest that inflation dampens housing demand and homeownership opportunity for most households even though the inflation adjusted after tax cost of owner occupied housing declines as inflation heats up the paper consists of six sections including the introduction section two examines the ways inflation affects housing choices in more detail the third section contains the specification of the econometric model that forms the basis of the study section four is a discussion of econometric problems and the data used the results of the estimates are discussed in the fifth section the paper concludes with a presentation of the major conclusions and policy implications of the study

theories of earnings announcement timing abstract recent empirical research has found that when a firm releases its earnings report earlier than expected its stock price rises on average while if the report is late its stock price declines the analysis here focuses on two alternative explanations for these findings each based on the premise that some firms with unfavorable earnings increase their reported income through earnings management in one case earnings management necessitates a reporting delay while in the other a delay is caused by the manager s desire to first observe other firms earnings both cases lead to market reactions consistent with the empirical findings

inflation taxes and housing a theoretical analysis abstract this paper examines the real effects of inflation under a distortionary tax system the presence of a tax subsidy to housing substantially alters the effects of inflation on the capital intensity of production and on the market interest rate the analysis suggests that not taxing the flow of services from housing has caused inflation to reduce capital intensity thereby decreasing u s productivity furthermore this tax subsidy has caused inflation to raise the real interest rate while reducing the after tax real returns to assets

the efficiency and stability of r d networks we investigate the efficiency and stability of r d networks in a model with network dependent indirect spillovers we show that the efficient network structure critically depends on the marginal cost of r d collaborations when the marginal cost is low the complete graph is efficient while high marginal costs imply that the efficient network is asymmetric and has a nested structure regarding the stability of network structures we show the existence of both symmetric and asymmetric equilibria the efficient network is stable for small industry size and small cost in contrast for large industry size there is a wide region of cost in which the efficient network is not stable this implies a divergence between efficiency and stability in large industries

disclosures and asset returns public information in financial markets often arrives through the disclosures of interested parties who have a material interest in the reactions of the market to the new information when the strategic interaction between the sender and the receiver is formalized as a disclosure game with verifiable reports equilibrium prices can be given a simple characterization in terms of the concatenation of binomial pricing trees there are a number of empirical implications the theory predicts that the return variance following a poor disclosed outcome is higher than it would have been if the disclosed outcome were good also when investors are risk averse this leads to negative serial correlation of asset returns other points of contact with the empirical literature are discussed

when to drop a bombshell sender who is either good or bad wishes to look good at an exogenous deadline sender privately observes if and when she can release a public flow of information about her private type releasing information earlier exposes to greater scrutiny but signals credibility in equilibrium bad sender releases information later than good sender we find empirical support for the dynamic predictions of our model using data on the timing of u s presidential scandals and u s initial public offerings in the context of elections our results suggest that october surprises are driven by the strategic behaviour of bad sender

relative valuation roles of equity book value and net income as a function of financial health abstract this study tests predictions that pricing multiples on and incremental explanatory power of equity book value net income increase decrease as financial health decreases tests using a sample of 396 bankrupt firms and tests using a larger pooled sample both yield inferences consistent with predictions findings are robust to inclusion of controls for industry size return on equity and volatility of equity returns equity book value and net income multiples and incremental explanatory power vary predictably across three illustrative industries selected based on the likely extent of unrecognized intangible assets

have financial statements lost their relevance the authors explore the concern that financial statements no longer have the same relevance to investors that they had in the past they test for value relevance by measuring the total return that could have been earned from prior knowledge of financial statement information and by examining the explanatory power of accounting information on market values and annual market adjusted returns both analyses are applied to a broad sample of exchange listed and nasdaq firms for the 1952 94 period the authors find mixed evidence on value relevance of financial statement reporting during the test period

why bank credit policies fluctuate a theory and some evidence in a rational profit maximizing world banks should msdntain a credit policy of lending if and only if borrowers have positive net present value projects why then are changes in credit policy seemingly correlated with changes in the condition of those demanding credit this paper argues that rational bank managers with short horizons will set credit policies that influence and are influenced by other banks and demand side conditions this leads to a theory of low frequency business cycles driven by bank credit policies evidence from the banking crisis in new england in the early 1990s is consistent with the assumptions and predictions of the theory

industry competition earnings management and leader follower effects this article examines the impacts of industry competition on the leader follower effects in different earnings management activities the empirical results show that there are the leader follower e

the price adjustment process for rental housing and the natural vacancy rate institute of a university of ii business and california economic research berkeley center for real estate and urban economics working paper series working paper 82 53 the price adjustment process for rental housing and the natural vacancy rate by kenneth t rosen lawrence b smith these ers are preliminary in natu heir purpose 39 to stimulate discussion comm therefore t are n ted or q d in any pub on wit the express permissi the author graduate school of business administration

debt and creative destruction why could subsidizing corporate debt be optimal the existing theoretical literature provides little justification for a corporate debt subsidy we illustrate the welfare benefit of this subsidy and study how the social costs and benefits change with the duration of industry distress in our model two firms engage in socially wasteful competition for survival in a declining industry firms differ on two dimensions exogenous productivity and endogenously chosen amount of debt financing resulting in a two dimensional war of attrition debt financing increases incentives to exit which although costly for the firm is socially beneficial these benefits decline as industry distress shortens our normative model sheds light on why the debt tax subsidy still persists around the world analogously the model can also rationalize a seemingly ad hoc feature of the u s tax system which subsidizes the conflict of interest between debt and equity regarding firm liquidation this paper was accepted by amit seru finance