L6: Capital Budgeting - Project Selection & Financial Frictions Flashcards
What does Huddart, S., & Lang, M. (2003) suggest about information aggregation (stock options)?
- Examine the information content of employee stock option exercise using detailed employee-level data (rank-and-file workers) for 7 large companies.
- The aggregation of all employees’ stock option exercise contains as much information about the firm’s stock returns over the next six months as the stock option exercise of executives.
What is an information cascade?
Banerjee, A. V. (1992):
An information cascade occurs when external information overrides one’s own information, regardless of the relative correctness of the former.
What does Da, Z., & Huang, X. (2019) suggest about evidence on information cascades?
Estimize: open financial estimates platform designed to collect forward looking financial estimates from independent, buy-side, and sell-side analysts, along with those of private investors and academics.
In collaboration with academics, Estimize ran a series of experiments that restricted information available to randomly selected stocks/users.
- “independent” forecasts resulted in less accurate individual predictions
- “independent” forecasts resulted in a more accurate consensus
What does Dye, Ronald A. (1985) suggest about disclosure of nonproprietary information?
- If credible disclosure of private information were costless, then information asymmetry vanishes.
- Best “type” would disclose, then second-best “type” would disclose, and so on.
Famous result. If informed people can credibly convey their private information without cost, then there is no information asymmetry problem.
–> Since they worry about info asymmetry: conveying private info is costly and/or difficult
What does Darrough, M. N., & Stoughton, N. M. (1990) suggest about financial disclosure?
- Additional information may not be valuable
- Revealing positive information results in better financing terms
- Revealing positive information may encourage competitors to enter your market
Not disclosing allows you to innovate more. You can learn from those who disclose and improve (freeride). It is a tradeoff between tipping off competitors and getting better financing terms (less information asymmetry).
What does Philip G. Berger, Jung Ho Choi, and Sorabh Tomar suggest about cost disclosures?
- Exploit a 2004 rule in South Korea that allowed firms to not disclose the Cost of Sales Schedule (CSS).
- Companies that stopped disclosing the CSS innovated more and recorded productivity gains of 6-7% relative to companies that continued to report.
What does Bae, B., Han, E., Choi, C., Noh, Y., Shin, J., & Li, L. (2013) suggest about the effect of voluntary cost disclosure on cost of debt?
Firms that disclose the schedule of manufacturing costs have lower cost of capital.
What does Oh, H., Park, S., & Jeon, H. (2017) suggest about voluntary cost disclosure on analysts’ earnings forecasts?
Firms that disclose have more precise analyst estimates.
What is the wisdom of the crowd?
- Information that analysts receive are conditionally independent
- Putting together all analysts’ diverse signals generates a more precise signal.
What lessons can we learn from the analyst game example?
The decision based on many pieces of less-precise information may be better than a decision based on one piece of more-precise information (wisdom of the crowd).
Moral hazard problems may prevent individual forecasters in a big group from diligently collecting information.
- But incentivizing the accuracy of individual forecasts may cause the aggregate forecast to be less accurate.
Managing forecasts requires an understanding of this trade-off.
In what way is risk management linked to information asymmetry?
- Risk management inherently involves the collection of information.
- Collection of information focused on those parameters that are most payoff relevant.
- The collected information makes management better informed than potential investors (equity market, banks, etc).
