Executive pay disparity, as measured by chief executive officer (CEO) pay slice (CPS), is positively associated with the implied cost of equity, even after controlling for other determinants of the cost of equity. The difference in the cost of equity can explain 43% of the difference in the valuation effect attributable to CPS reported by Bebchuk, Cremers, and Peyer (2011). Further analysis shows that the positive association is stronger when agency problems of free cash flow are more severe and when CEO succession planning is more important. Our evidence suggests that a large CPS is associated with CEO entrenchment and high succession risk.

Based on a difference-in-differences approach, we find strong evidence that the initial enforcement of insider trading laws improves capital allocation efficiency. The effect is concentrated in developed markets and manifests shortly after the enforcement year. Further analysis shows that the improvement is positively associated with the increase in liquidity around the enforcement year and the opaqueness of the information environment before the enforcement year. The improvement is more pronounced for firms operating in more competitive markets, being more financially constrained, and with more severe agency problems. Finally, we find increased accounting performance after the enforcement and the increase is positively associated with the improvement in capital allocation efficiency. Overall, our evidence suggests that the initial enforcement of insider trading laws improves capital allocation efficiency by providing more information to guide managerial decisions and by reducing market frictions arising from information asymmetry and agency problems.

Executive pay disparity, as measured by chief executive officer (CEO) pay slice (CPS), is positively associated with the implied cost of equity, even after controlling for other determinants of the cost of equity. The difference in the cost of equity can explain 43% of the difference in the valuation effect attributable to CPS reported by Bebchuk, Cremers, and Peyer (2011). Further analysis shows that the positive association is stronger when agency problems of free cash flow are more severe and when CEO succession planning is more important. Our evidence suggests that a large CPS is associated with CEO entrenchment and high succession risk.

Until recently, studies in accounting research have predominantly focused on using earnings information to explain stock returns. This article examines how information provided by the other primary financial statement—the balance sheet—is incrementally useful for determining returns. Based on existing models of equity value, the author shows theoretically that returns should be related to three balance sheet–related variables—the previous period’s (equity) capital investment, contemporaneous capital investment, and the profitability change—in addition to the earnings variables used in previous studies. Our empirical analysis yields the following results. First, the three balance sheet–related variables each have a statistically and economically significant effect that is incremental to those of the earnings variables on equity returns, and together they improve the explanatory power of an earnings-only-based model from 11.5% to 13.9% in annual cross-sectional samples. Second, over time, the incremental explanatory power (IEP) of the balance-sheet variables is negatively correlated with the explanatory power of earnings. Third, in cross sections, the balance sheet–related variables have a greater IEP for firms whose earnings are less informative (negative vs. positive earnings firms and young vs. mature firms) and for firms whose future earnings are more uncertain (firms with high vs. low analyst forecast errors, and firms with high vs. low analyst forecast dispersions). These results suggest that information from the balance sheet complements that contained in the income statement about equity returns.

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