Information Acquisition Costs Research Articles

Analyst information acquisition and the relative informativeness of analyst forecasts and managed earnings

Mixed empirical evidence exists on whether equity analyst forecasts complement (‘interpretation role’) or rather substitute for (‘information role’) the informativeness of corporate earnings. This paper develops a theoretical model in which an analyst acquires costly information to forecast the fundamental information contained in a subsequently released and strategically manipulated earnings announcement. The manager is assumed to manipulate earnings such that his objectives – an uncertain price interest and meeting-or-beating the analyst forecast incentives – are optimized. The model shows that the manager’s incentives are the source of the two roles of the analyst information in the valuation of earnings. In a theoretical regression of share price on earnings and the analyst forecast, it can be shown that a positive forecast response coefficient, and thus the dominance of the information role of analyst forecasts, is only obtained if the analyst’s information acquisition costs are sufficiently low.

Optimal Reporting Systems with Investor Information Acquisition

This paper analyzes a manager’s optimal ex-ante reporting system using a Bayesian persuasion approach (Kamenica and Gentzkow (2011)) in a setting where investors affect cash flows through their decision to finance the firm’s investment opportunities, possibly assisted by the costly acquisition of additional information (inspection). I examine how the informativeness and the bias of the optimal system are determined by investors’ inspection cost, the degree of incentive alignment between the manager and investors, and the prior belief that the project is profitable. I find that a mis-aligned manager’s system is informative only when the market prior is pessimistic and is always positively biased. As investors’ inspection cost decreases, this bias decreases and the optimal system becomes more conservative. In contrast, a well-aligned manager’s system is fully revealing when investors’ inspection cost is high, and is counter-cyclical to the market belief when the inspection cost is low: It is positively (negatively) biased when the market belief is pessimistic (optimistic). I explore the extent to which the results generalize to a case with managerial manipulation and discuss the implications for investment efficiency. Overall, the analysis describes the complex interactions among determinants of firm disclosures and governance, and offers explanations for the mixed empirical results in this area.

Evolving influence: Mitigating extreme conflicts of interest in advisory relationships

An advocate for a special interest provides advice to a planner, who subsequently makes a sequence of decisions. The advocate is interested only in advancing his cause and will distort his advice to manipulate the planner's choices. Each time she acts the planner observes the result, providing a signal that corroborates or contradicts the advocate's recommendation. Without commitment, no influential communication takes place. With commitment, the planner can exploit the information that is revealed over time to mitigate the advocate's incentive to lie. We derive the optimal mechanism for eliciting advice, characterizing the evolution of the advocate's influence. We also consider costly information acquisition, the use of transfers, and a noisy private signal.

Distributed User Association in Energy Harvesting Dense Small Cell Networks: A Mean-Field Multi-Armed Bandit Approach

The emerging Internet of Things (IoT)-driven ultra-dense small cell networks (UD-SCNs) will need to combat a variety of challenges. On one hand, massive number of devices sharing the limited wireless resources will render centralized control mechanisms infeasible due to the excessive cost of information acquisition and computations. On the other hand, to reduce energy consumption from fixed power grid and/or battery, many IoT devices may need to depend on the energy harvested from the ambient environment (e.g., from RF transmissions, environmental sources). However, due to the opportunistic nature of energy harvesting, this will introduce uncertainty in the network operation. In this article, we study the distributed cell association problem for energy harvesting IoT devices in UD-SCNs. After reviewing the state-of-the-art research on the cell association problem in small cell networks, we outline the major challenges for distributed cell association in IoT-driven UD-SCNs where the IoT devices will need to perform cell association in a distributed manner in presence of uncertainty (e.g., limited knowledge on channel/network) and limited computational capabilities. To this end, we propose an approach based on mean-field multi-armed bandit games to solve the uplink cell association problem for energy harvesting IoT devices in a UD-SCN. This approach is particularly suitable to analyze large multi-agent systems under uncertainty and lack of information. We provide some theoretical results as well as preliminary performance evaluation results for the proposed approach.

Earnings Opacity and Closed-End Country Fund Discounts

Closed-end country funds are interesting in that they have two sets of prices for the same underlying assets—the net asset value (NAV) of the fund holdings as measured using the underlying firms’ stock prices in their home markets and the fund price at which the fund trades on a U.S. stock exchange. Utilizing the theoretical framework of information asymmetry in two separate markets for an identical asset, we find that the difference between the fund’s NAV and its trading price (i.e., the fund discount) is positively associated with the earnings opacity of the underlying companies. Such a positive association is consistent with the notion that U.S. investors face higher information acquisition and processing costs when compared with local investors, and therefore earnings opacity exacerbates the information disadvantage of U.S. investors, leading to a larger fund discount. We further show that the positive relation varies predictably with U.S. investors’ information acquisition and processing costs and with the extent to which host stock markets are segmented from the U.S. market. Specifically, we find that the positive relation between earnings opacity and fund discounts is weaker for those funds with more U.S. cross-listings in fund holdings, with underlying companies following financial reporting standards similar to U.S. standards, and with less segmented local markets.

Information Acquisition and the Equilibrium Incentive Problem

I study the optimal incentive provision in a principal–agent relationship with costly information acquisition by the agent. I emphasize that adverse selection or moral hazard is the principal's endogenous choice by inducing or deterring information acquisition. The principal designs the contract not only to address an existing incentive problem but also to implement its presence. Implementation of adverse selection relies on a steeper information rent to the agent than the standard menu, such that the agent is motivated to distinguish the efficient state of nature from the inefficient. Moral hazard is implemented by replacing the benchmark debt contract with a debt‐with‐equity‐share contract, such that the agent does not attempt to acquire information to either avoid debt or to extract rent.

Pricing When Customers Have Limited Attention

We study the optimal pricing problem of a monopolistic firm facing customers with limited attention and capability to process information about the value (quality) of a single offered product. We model customer choice based on the theory of rational inattention in the economics literature, which enables us to capture not only the impact of true quality and price, but also the intricate effects of customer’s prior beliefs and cost of information acquisition and processing. We formulate the firm’s price optimization problem assuming that the firm can also use the price to signal the quality of the product to customers. To delineate the economic incentives of the firm, we first characterize the pricing and revenue implications of customer’s limited attention without signaling, and then use these results to explore perfect Bayesian equilibria of the strategic pricing signaling game. As an extension, we consider heterogeneous customers with different information costs as well as prior beliefs. We discuss the managerial implications of our key findings and prescribe insights regarding information provision and product positioning. This paper was accepted by Gad Allon, operations management.

Cognitive Empathy in Conflict Situations

Two individuals are involved in a conflict situation in which preferences are ex ante uncertain. While they eventually learn their own preferences, they have to pay a small cost if they want to learn their opponent’s preferences. We show that, for sufficiently small positive costs of information acquisition, in any Bayesian Nash equilibrium of the resulting game of incomplete information the probability of getting informed about the opponent’s preferences is bounded away from zero and one.

Pricing When Customers Have Limited Attention

We study the optimal pricing problem of a firm facing customers with limited attention and capability to process information about the value (quality) of the offered products. We model customer choice based on the theory of rational inattention in the economics literature, which enables us to capture not only the impact of true qualities and prices, but also the intricate effects of customer’s prior beliefs and cost of information acquisition and processing. We formulate the firm’s price optimization problem and characterize the pricing and revenue implications of customer’s limited attention. We test the robustness of our results under various modelling generalizations such as prices signaling quality and customer heterogeneity, and study extensions such as multiple products, competition, and joint inventory and pricing decisions. We also show that using alternative pricing policies that ignore the limited attention of customers or their ability to allocate this attention judiciously can potentially lead to significant profit losses for the firm. We discuss the managerial implications of our key findings and prescribe insights regarding information provision and product positioning.

Economics of leadership and hierarchy

This paper explores leadership within hierarchical organizations. For each hierarchy, I consider a dynamic signaling game in which each player observes only the actions of his direct superiors before choosing his action. At the top of the hierarchy are the leaders, who learn the state from nature. The hierarchy controls the flow of information and the timing of the game, and determines the equilibrium output and welfare. I show that the welfare-optimal hierarchy is the chain, because it maximizes the incentive of players to “lead by example” for their subordinates. The chain remains optimal even in the presence of verifiable or unverifiable costly information acquisition by the leaders.

The New Rules of the Rating Game: Market Perception of Corporate Ratings

We analyze the impact of credit rating changes on the pricing and liquidity of US corporate bonds, focussing on whether the informativeness of rating events varies in different economic environments, particularly after the Dodd-Frank Act. We find that the informativeness of rating changes is low before the crisis, particularly for financial bonds. However, after Dodd-Frank, rating changes lead to significantly stronger market reactions for non-financial bonds, and to weaker ones for financial bonds, indicating ambiguous effects of the new regulation. We link these findings to differences in the cost of information acquisition and underlying credit risk across securities by testing various hypotheses based on existing models of rating agency behavior.

False Positives in Scientific Research

This paper develops a model of costly information acquisition, focusing on an application to scientific research. When research protocols are not fully transparent, scientists are incentivized to make their experiments more susceptible to false positives, despite their preference for better information. On the other hand, non-transparency can induce a well-intentioned scientist to undertake a costlier but more informative experiment if it also enables her to commit to acting scrupulously. Our analysis suggests, counterintuitively, that policies establishing greater transparency in scientific methodology might therefore ultimately lead to some scientists undertaking research that is worse for those interested in the results.

Come on in, the Water's Fine! An Experimental Examination of Hybrid IPO Auctions with a Public Pool

We offer experimental and theoretical evidence that the auction method for initial public offerings (IPOs) may be improved through the use of hybrid auctions with separate retail tranches or ‘public pools’. Such hybrids, which combine a price-setting tranche (an auction or book building) with a separate tranche that allows investors to place orders without specifying a price (the public pool), have been used for IPOs around the world. We develop theory, then run laboratory experiments to examine the effects of a public pool on multi-unit uniform price auction IPOs. Our experimental auction design incorporates key features of the IPO process such as endogenous bidder entry, costly information acquisition, differing capacity constraints and uncertainty with respect to the intrinsic value. Simulations are used to characterize the Symmetric Bayesian Nash Equilibria (SBNE) for both pure and hybrid auctions in a model that is calibrated to key parameters from our experimental data, generating predictions for the remaining variables. As predicted, a public pool tranche improves auction performance by increasing proceeds, lowering price volatility, reducing price error and reducing the incentive for small bidders to free ride by submitting extremely high bids. Underpricing occurs in both treatments but is less severe with the public pool. We also show that in collusive-seeming multi-unit auction equilibria, it may be optimal for informed, rational bidders to place clinching bids strictly above the expected value per unit, leading to very steep demand curves. Overall, our results imply that both IPO auctions and crowdfunding may be improved by restricting retail investors to a separate, non-price-setting tranche.

Social Eavesdropping in Zebrafish: Tuning of Attention to Social Interactions.

Group living animals may eavesdrop on signalling interactions between conspecifics in order to collect adaptively relevant information obtained from others, without incurring in the costs of first-hand information acquisition. This ability (aka social eavesdropping) is expected to impact Darwinian fitness, and hence predicts the evolution of cognitive processes that enable social animals to use public information available in the environment. These adaptive specializations in cognition may have evolved both at the level of learning and memory mechanisms, and at the level of input mechanisms, such as attention, which select the information that is available for learning. Here we used zebrafish to test if attention in a social species is tuned to the exchange of information between conspecifics. Our results show that zebrafish are more attentive towards interacting (i.e. fighting) than towards non-interacting pairs of conspecifics, with the exposure to fighting not increasing activity or stress levels. Moreover, using video playbacks to manipulate form features of the fighting fish, we show that during the assessment phase of the fight, bystanders’ attention is more driven by form features of the interacting opponents; whereas during the post-resolution phase, it is driven by biological movement features of the dominant fish chasing the subordinate fish.

Accruals Quality, Disclosure Costs, and Management Guidance

Research examining managers’ propensity to provide earnings guidance generally focuses on external costs and benefits of such disclosure. Motivated by voluntary disclosure theory, I argue that internal costs of disclosure likely play a significant role in the forecasting decision. Prior research suggests accruals quality (AQ) provides an indication of the quality of managers’ earnings-related information, as accruals that are of higher (lower) quality presumably arise from higher (lower) quality information. I contend that innate and discretionary components of AQ have opposite relations with information acquisition costs, an important theoretical determinant of disclosure. Specifically, higher levels of innate AQ suggest managers bear low information acquisition costs, leading to a positive theoretical association with voluntary disclosure. Conversely, higher discretionary AQ indicates greater information acquisition costs, which offsets the benefit of high quality information. Using forecast occurrence, frequency, timeliness, and specificity as proxies for the quality of voluntary disclosures, I find evidence consistent with these predictions. Further, improvements in innate AQ correspond to a higher (lower) likelihood of starting (stopping) a policy of forecasting. Finally, I show that the quality of “low-cost” information (innate AQ) moderates the effects of several previously identified determinants of forecasting, including institutional holdings, abnormal audit fees, product market competition, and litigation risk. Overall, my results are consistent with theory suggesting information acquisition costs play important roles in managers’ forecasting decisions.

Does increased board independence reduce earnings management? Evidence from recent regulatory reforms

We examine whether recent regulatory reforms requiring majority board independence reduce the extent of earnings management. Firms that did not have a majority of independent directors before the reforms (referred to as noncompliant firms) are required to increase their board independence. We find that, while noncompliant firms on average do not experience a significant decrease in earnings management after the reforms compared to other firms, noncompliant firms with low information acquisition cost experience a significant reduction in earnings management. The results are similar when we examine audit committee independence and when we use alternative proxies for information acquisition cost and earnings management. These findings indicate that independent directors’ monitoring is more effective in a richer information environment.

Analyst Coverage, Corruption and Financial Secrecy: A Multi-Country Study

This study extends the literature on analyst coverage by examining the impact of both the experience of corruption at country-level and firm actions to prevent corruption on analyst coverage. It also extends the literature on analyst coverage by examining the effect of financial secrecy at country-level on the number of analysts following a firm, using a large multi-country sample for the year 2011. Furthermore, we examine the impact of these experimental variables on analyst coverage for advanced and emerging markets separately. The results show that high levels of corruption and financial secrecy at country-level significantly reduce analyst coverage consistent with the hypothesis that they are associated with higher levels of information acquisition costs. This result is consistent for both advanced and emerging economies, but because the financial secrecy and corruption variables at country-level are highly correlated in emerging markets, we should consider their impact on analyst coverage individually. The results also indicate that the adoption of anti-bribery and corruption policies at the firm-level may not in itself be sufficient to induce analyst coverage, indicating that it is the actual conduct rather than policies on paper that attracts analyst coverage.

Compulsory Voting and Information Acquisition

I develop a theory of strategic voting that captures an endogenous link between the costly decision to vote and the costly decision to become politically informed. I then use the theoretical model to study the effects of different public policy instruments on the incentives of voters to cast informed votes. I show that policies that directly target the cost of political engagement, by influencing either the cost of information acquisition or the cost associated with casting a vote, have an ambiguous effect on the overall level of informed voting, and thus have unclear welfare implications. I also show that compulsory voting provides an incentive for voters to acquire political information so as to ensure that the vote they are compelled to cast actually benefits them, which overall, increases the level of informed voting.

Multi-Agent Inference in Social Networks: A Finite Population Learning Approach

When people in a society want to make inference about some parameter, each person may want to use data collected by other people. Information (data) exchange in social networks is usually costly, so to make reliable statistical decisions, people need to weigh the benefits and costs of information acquisition. Conflicts of interests and coordination problems will arise in the process. Classical statistics does not consider people’s incentives and interactions in the data-collection process. To address this imperfection, this work explores multi-agent Bayesian inference problems with a game theoretic social network model. Motivated by our interest in aggregate inference at the societal level, we propose a new concept, finite population learning, to address whether with high probability, a large fraction of people in a given finite population network can make “good” inference. Serving as a foundation, this concept enables us to study the long run trend of aggregate inference quality as population grows. Supplementary materials for this article are available online.

Board independence and firm performance in China

We provide the first comprehensive and robust evidence on the relationship between board independence and firm performance in China. We find that independent directors have an overall positive effect on firm operating performance in China. Our findings are robust to a battery of tests, including endogeneity checks using instrumental variables, the dynamic generalized method of moments estimator, and the difference-in-differences method. The positive relationship between board independence and firm performance is stronger in government-controlled firms and in firms with lower information acquisition costs. We also document that Chinese independent directors play an important role in constraining insider self-dealing and improving investment efficiency.