Working Paper: NBER ID: w17696
Authors: Viral V. Acharya; Bart M. Lambrecht
Abstract: We consider a setting in which insiders have information about income that outside shareholders do not, but property rights ensure that outside shareholders can enforce a fair payout. To avoid intervention, insiders report income consistent with outsiders' expectations based on publicly available information rather than true income, resulting in an observed income and payout process that adjust partially and over time towards a target. Insiders under-invest in production and effort so as not to unduly raise outsiders' expectations about future income, a problem that is more severe the smaller is the inside ownership and results in an "outside equity Laffer curve". A disclosure environment with adequate quality of independent auditing mitigates the problem, implying that accounting quality can enhance investments, size of public stock markets and economic growth.
Keywords: income smoothing; information asymmetry; insider ownership; auditing quality; economic growth
JEL Codes: D82; D92; G32; G35; M41; M42; O43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Insider Ownership (G34) | Income Smoothing (E25) |
| Income Smoothing (E25) | Reported Income (D31) |
| Measurement Errors (C83) | Income Smoothing (E25) |
| Quality of Independent Auditing (M42) | Asymmetric Information (D82) |
| Quality of Independent Auditing (M42) | Investment (G31) |
| Quality of Independent Auditing (M42) | Economic Growth (O49) |
| Insider Ownership (G34) | Production Decisions (L23) |
| Production Decisions (L23) | Reported Income (D31) |