In this paper we propose a new variance estimator for OLS as well as for nonlinear estimators such as logit, probit and GMM. This variance estimator enables cluster-robust inference when there is two-way or multi-way clustering that is nonnested. The variance estimator extends the standard cluster-robust variance estimator or sandwich estimator for one-way clustering (e.g. Liang and Zeger (1986), Arellano (1987)) and relies on similar relatively weak distributional assumptions. Our method is easily implemented in statistical packages, such as Stata and SAS, that already offer cluster-robust standard errors when there is one-way clustering. The method is demonstrated by a Monte Carlo analysis for a two-way random effects model; a Monte Carlo analysis of a placebo law that extends the state-year effects example of Bertrand et al. (2004) to two dimensions; and by application to two studies in the empirical public/labor literature where two-way clustering is present.

Proxy advisory and corporate governance rating firms (such as RiskMetrics/ISS, GovernanceMetrics International, and The Corporate Library) play an increasingly important role in U.S. public markets. They rank the quality of firm corporate governance, advise shareholders how to vote and sometimes press for governance changes. We examine whether commercially available corporate governance rankings provide useful information for shareholders. Our results suggest that they do not. Commercial ratings do not predict governancerelated outcomes with the precision or strength necessary to support the bold claims made by most of these firms. Moreover, we find little or no relation between the governance ratings provided by RiskMetrics with either their voting recommendations or the actual votes by shareholders on proxy proposals.

We propose a two-dimensional framework for assessing the quality of implied cost of capital (ICC) estimates as proxies for firm-level expected returns. Under fairly general assumptions, better expected return estimates should have higher cross-sectional predictive power for future stock returns and lower time-series measurement error variance. Using this framework, we evaluate seven alternative ICCs and find that several perform well along both dimensions, and all do significantly better than Beta-based estimates. Moreover, we find that the lagged industry median ICCs also predict firm-level returns and exhibit low error variance. Overall, ICCs appear to be attractive firm-level expected return proxies.

This study examines the link between disclosure, cash flow uncertainty, and the option value of equity. Building upon Merton (1974), I model the equity of a levered firm as a call option whose equilibrium value is increasing in the variance of future cash flows. Modeling levered equity as an option allows for calculation of the firm’s vega, where vega measures the sensitivity of equity value to increases in expected cash flow variance. Using multiple measures of disclosure, I find that higher vega firms are more likely to issue disclosures that increase or sustain expected cash flow variance, consistent with firms promoting uncertainty when the marginal benefit is high. Specifically, I find that higher vega firms are associated with increases in option-implied volatilities in short-windows surrounding managerial guidance. Higher vega firms are also less likely to issue guidance but, when doing so, their earnings guidance is less specific and followed by increases in analyst forecast dispersion. Similarly, I find a negative relation between vega and a hand-collected index of voluntary disclosures. Finally, I demonstrate a positive relation between vega and absolute earnings surprises suggesting that higher vega firms are less likely to pre-empt earnings news. Taken together, the results are consistent with the option value of equity creating incentives for firms to raise uncertainty through disclosures.

This paper investigates the role of the board in monitoring corporate risk. Proponents of riskrelated governance structures such risk committees or Enterprise Risk Management (ERM) programs contend that risk monitoring adds value by ensuring that corporate risks are managed. An alternative view is that such governance structures are nothing more than window-dressing in response to regulatory or public pressure. Consistent with the former view, I find that, in the period before the 2007-2008 financial crisis, firms with more observable risk oversight structures exhibit (i) lower idiosyncratic and systematic equity risk, (ii) lower credit risk, and (iii) less extreme performance than firms with fewer or no observable risk oversight structures. I also provide evidence that firms with more observable risk oversight structures experienced higher returns during the worst days of the recent financial crisis and were less susceptible to market fluctuations than firms with fewer or no observable risk oversight structures. Finally, I find that firms without observable risk oversight structures experienced higher abnormal returns to recent legislative events relating to risk management than firms with observable risk oversight structures.

data used. Ana C. Díaz and Miguel Á. Martínez acknowledge research support from the Ministerio de

Both institutional owners and short sellers decrease their positions prior to earnings announcements, and increase their positions in the post-announcement period. Preannouncement changes in institutional holdings and short interest have significant explanatory power with respect to abnormal earnings announcement returns, where most of the power comes from institutions and short sellers closing positions in order to avoid losses. Analysis of post-announcement returns indicates that aggressive trading by short sellers in reaction to earnings releases enhances immediate price discovery, which reduces their ability to profit from post-earnings announcement drift. The more muted reaction of institutional traders to earnings releases has no significant impact on earnings response coefficients, and allows institutions to successfully target stocks that underreact to earnings news. JEL Classification: G14

The valuation role of balance sheet information in the corporate bond market

I develop a novel diagnostic procedure to estimate the associations between measurement errors of expected returns proxies and …rm characteristics. Application to GLS, a popular implementation of the implied cost of capital ("ICC"), yields the …rst direct empirical evidence that ICC measurement errors i) are persistent, ii) can be associated with …rms’risk or growth characteristics, and therefore iii) can lead to spurious inferences in regressions. I devise a novel methodology to account for the in‡uence of ICCs measurement errors in regression settings, and show that its application i) can explain some puzzling associations between GLS and …rm characteristics and ii) can improve upon GLS, by forming new ICCs that better sort realized returns. Together, the innovations of this paper allow researchers to better understand ICC measurement errors and provide a robust empirical strategy for future research.

This paper examines the effect of investor information processing costs on firms ’ disclosure choice. Using the recent eXtensible Business Reporting Language (XBRL) regulation as an exogenous shock to investors ’ processing costs, but not to firms ’ disclosure requirements, I find that firms increase their quantitative footnote disclosures after adoption of XBRL detailed tagging requirements designed to reduce investor processing costs. These results hold in a difference-in-difference design using non-adopting firms as the control group. To reinforce my finding that the disclosure increase is prompted by reduced investor processing costs, I examine cross-sectional settings where investor processing costs are likely to vary, showing that the disclosure increase is greater for firms where detailed information is more pertinent than summary measures (those with operations in multiple industries, more volatile earnings, and more disperse analyst forecasts), and smaller for firms with sophisticated investors. These findings suggest that investor processing costs can be significant enough to impact firms ’ disclosure decisions.