Showing papers in "Contemporary Accounting Research in 2003"

Tax-Avoidance Activities of U.S. Multinational Corporations*

Abstract: This paper investigates whether economies of scale exist for tax planning. In particular, do larger, more profitable, multinational corporations avoid more taxes than other firms, resulting in lower effective tax rates? While the empirical results indicate that, ceteris paribus, larger corporations have higher effective tax rates, firms with greater pre-tax income have lower effective tax rates. The negative relation between effective tax rates (ETRs) and pretax income is consistent with firms with greater pre-tax income having more incentives and resources to engage in tax planning. Consistent with multinational corporations being able to avoid income taxes that domestic-only companies cannot, I find that multinational corporations in general, and multinational corporations with more extensive foreign operations, have lower worldwide ETRs than other firms. Finally, in a sample of multinational corporations only, I find that higher levels of U.S. pre-tax income are associated with lower U.S. and foreign ETRs, while higher levels of foreign pre-tax income are associated with higher U.S. and foreign ETRs. Thus, large amounts of foreign income are associated with higher corporate tax burdens. Overall, I find substantial evidence of economies of scale to tax planning.

Auditor Conservatism, Asymmetric Monitoring, and Earnings Management*

Abstract: In this paper, we investigate whether, and how, audit effectiveness differentiation between Big 6 and non-Big 6 auditors is influenced by a conflict or convergence of reporting incentives faced by corporate managers and external auditors. In so doing, we incorporate into our analysis the possibility that managers self-select both external auditors and discretionary accruals, using the two stage “treatment effects” model. Our results show that only when managers have incentives to prefer income-increasing accrual choices are Big 6 auditors more effective than non-Big 6 auditors in deterring/monitoring opportunistic earnings management. Contrary to conventional wisdom, we find Big 6 auditors are less effective than non-Big 6 auditors when both managers and auditors have incentives to prefer income-decreasing accrual choices and thus no conflict of reporting incentives exists between the two parties. The above findings are robust to different proxies for opportunistic earnings management and different proxies for the direction of earnings management incentives.

Analyst Following and Market Liquidity

Abstract: This paper investigates the relation between analyst characteristics (number of analysts following a firm and their forecast dispersion) and market liquidity characteristics (bid-ask spreads and depths and the adverse-selection component of the spread). Prior research has found contradictory results on the relation between analyst following and market liquidity and has offered differing theories on how analysts affect liquidity. While prior research has posited analysts as proxies for privately informed trade or as signals of information asymmetry, I hypothesize that analysts provide public information, implying that analyst following (forecast dispersion) should have a positive (negative) association with liquidity. Cross-sectional simultaneous estimations provide support for this hypothesis. The results are both statistically significant and economically important. Granger causality tests indicate that analyst characteristics lead market liquidity characteristics. These results clarify the role of analysts in providing information to financial markets and highlight benefits of increased analyst following.

Discretionary Accounting Accruals, Managers' Incentives, and Audit Fees*

Abstract: This paper examines the linkages between discretionary accruals (DAs), managerial share ownership, management compensation, and audit fees. It draws on the theory that managers of firms with high management ownership are likely to use DAs to communicate value-relevant information, while managers of firms with high accounting-based compensation are likely to use DAs opportunistically to manage earnings to improve their compensation. OLS regression results of 648 Australian firms show that (1) there is a positive association between DAs and audit fees; (2) managerial ownership negatively affects the positive relationship between DAs and audit fees; and (3) this negative impact is further found to be weaker for firms with high accounting-based management compensation.

An Empirical Investigation of Audit Fees, Nonaudit Fees, and Audit Committees*

Abstract: This stody examines the association between audit committee characteristics and the ratioof nonaudit service (NAS) fees to audit fees, using data gathered under the Secuiities andExchange Commission's (SEC's) fee disclosure rules. Issues related to NAS fees have beenof concern to practitioners, regulators, and academics for a number of years. Prior researchsuggests that audit committees possessing certain characteristics are important participantsin the process of managing the client—auditor relationship. We hypothesize that audit com-mittees that are independent and active financial monitors have incentives to limit NAS fees(relative to audit fees) paid to incumbent auditors, in an effort to enhance auditor indepen-dence in either appearance or fact. Our analysis using a sample of 538 flrms indicates thataudit committees comprised solely of independent directors meeting at least four timesamiually are significantly and negatively associated with the NAS fee ratio. This evidence isconsistent with audit committee members perceiving a high level of NAS fees in a negativelight and taking actions to decrease the NAS fee ratio.Keywords Audit committee; Audit fees; Auditor independence; Nonaudit seiYicesCoiidenseLes auteurs examinent le lien entre les caracteristiques du comite de verification et le rapportentre les honoraires des services autres que la verification (designes NAS — non-auditsenAces) et les honoraires des services de verification, a l'aide de donnees recueillies auxEtats-Unis, sous le regime des regies imposees par la Securities and Exchange Commission(SEC) en matiere d'ioformation a foumir sur les honoraires. Depuis bon nombre d'annees,les questions relatives aux honoraires des NAS preoccupent les praticiens, les responsablesde !a reglementation et ies chercheurs. La presente etude est motivee par deux decisions

Earnings manipulation in failing firms

Abstract: Prior literature and anecdotal evidence, most recently provided by allegations relative to Enron, Global Crossing, and WorldCom, suggest that failing firms (defined here as prebankruptcy firms) may be motivated to engage in fraudulent financial reporting to conceal their distress. I examine two research questions: (1) Are failing firms' prebankruptcy financial statements more likely to exhibit signs of material income increasing earnings manipulation than those of nonfailing firms? (2) Do auditors detect the overstatements in firms that they perceive to be failing? I predict and find that as (ex post) bankrupt firms that do not (ex ante) appear to be distressed approach bankruptcy, their financial statements reflect significantly greater material income-increasing accrual magnitudes in nongoing-concern years than do control firms. The accrual behavior of these firms resembles that of bankrupt firms that the Securities and Exchange Commission (SEC) has sanctioned for fraud. Like sanctioned firms, the nonstressed bankrupt firms display significantly greater (material) increases in receivables; inventory; property, plant, and equipment; sales; net working capital, current, and discretionary accruals in prebankruptcy nongoing-concern years than do control firms. They also display significantly more negative changes in cash flows from operations and net cash and a greater disparity between accrual-based net income and operating cash flows than do control firms, consistent with Lee, Ingram, and Howard 1999. Finally, I predict and find that these firms' going-concern years reflect evidence consistent with auditor-prompted reversal of previous overstatements. These results are based on parametric and nonparametric tests for various subsample combinations drawn from a sample of 293 bankrupt firms representing approximately 2,500 observations.

Earnings Management to Avoid Losses and Earnings Decreases: Are Analysts Fooled?*

Abstract: This paper explores whether analyst forecasts impound the earnings management to avoid losses and small earnings decreases documented in Burgstahler and Dichev 1997, whether analysts are able to identify which specific firms engage in such earnings management, and the implications for significant forecast error anomalies at zero earnings and zero forecast earnings. We use data from Zacks Investment Research 1999 and find that analysts anticipate earnings management to avoid small losses and small earnings decreases. Further, analysts are much more likely to forecast zero earnings than firms are to realize zero earnings, and analysts are unable to consistently identify the specific firms that engage in earnings management to avoid small losses. This latter inability contributes to significant forecast pessimism associated with zero reported earnings and significant forecast optimism associated with zero earnings forecasts.

The Relative and Incremental Explanatory Power of Earnings and Alternative (to Earnings) Performance Measures for Returns

Abstract: We analyze the ability of earnings and non-earnings performance metrics to explain the variability in annual stock returns for industries where we identify, ex ante, an allegedly preferred (for valuation purposes) summary performance metric. We identify three industries where earnings before interest, taxes, depreciation, and amortization (EBITDA) and cash from operations (CFO) are preferred, and three industries where specific non-GAAP performance metrics are preferred. As a benchmark, we also examine the ability of EBITDA and CFO to explain returns for seven industries for which earnings is the preferred metric. Results for the benchmark earnings industries show that earnings dominates EBITDA and CFO in explaining returns. All other results are inconsistent with the view that perceptions of preferred metrics are reflected in actual aggregate investment behaviors.

Earnings Management Using the Valuation Allowance for Deferred Tax Assets under SFAS No. 109

Abstract: Statement of Financial Accounting Standards No. 109 (SFAS No. 109) allows firms to use their discretion to set arbitrarily high valuation allowances against deferred tax assets. Firms can then later use these "hidden reserves" to manage earnings. Our evidence indicates that most banks do not record a valuation allowance to manage earnings, but rather to follow the guidelines of SFAS No. 109. However, if the bank is sufficiently well capitalized to absorb the current-period impact on capital, then the amount of the valuation allowance increases with a bank's capital. In later years, bank managers adjust the valuation allowance to smooth earnings. The magnitude of the discretionary adjustment increases with the deviation of unadjusted earnings from the forecast or historical earnings.

Independence in Appearance and in Fact: An Experimental Investigation*

Abstract: In this study, we use experimental markets to assess the effect of the Security and Exchange Commission's (SEC's) new independence rule on investors' perceptions of independence, investors' payoff distributions, and market prices. The new rule requires client firms to disclose in their annual proxy statements the amount of nonaudit fees paid to their auditors. The new disclosure is intended to inform investors of auditors' incentives to compromise their independence. Our experimental design is a 2 3 between-subjects design, where we control the presence (unbiased reports) or absence of auditor independence in fact (biased reports). While independence in fact was not immediately observable to investors, we controlled for independence in appearance by varying the public disclosure of the extent of nonaudit services provided by the auditor to the client. In one market setting, investors were not given any information about whether the auditor provided such nonaudit services; in a second setting, investors were explicitly informed that the auditor did not provide any non-audit services; and in a third setting, investors were told that the auditor provided nonaudit services that could be perceived to have an adverse effect on independence in fact. We found that disclosures of nonaudit services reduced the accuracy of investors' beliefs of auditors' independence in fact when independence in appearance was inconsistent with independence in fact. This then caused prices of assets to deviate more from their economic predictions (lower market efficiency) in the inconsistent settings relative to the no-disclosure and consistent settings. Thus, disclosures of fees for nonaudit services could reduce the efficiency of capital markets if such disclosures result in investors forming inaccurate beliefs of auditor independence in fact - that is, auditors appear independent but they are not independent in fact, or vice versa. The latter is the maintained position of the American Institute of Certified Public Accountants (AICPA), which argued against the new rule. Further research is needed to assess the degree of correspondence between independence in fact and independence in appearance.

Accounting Policy Disclosures and Analysts' Forecasts

Abstract: Using an international sample, I investigate whether the extent of firms’ disclosure of theiraccounting policies in the annual report is associated with properties of analysts’ earningsforecasts. Controlling for firm- and country-level variables, I find that the level of account-ing policy disclosure is significantly negatively related to forecast dispersion and forecasterror. In particular, I find that accounting policy disclosures are incrementally useful to analystsover and above all other annual report disclosures. These findings suggest that account ing policydisclosures reduce uncertainty about forecasted earnings. I find univariate but not multivari-ate support for the hypothesis that accounting policy disclosures are especially helpful toanalysts in environments where firms can choose among a larger set of accounting methods. Keywords Accounting policy disclosures; Financial analysts; Forecast dispersion anderror; InternationalCondense Selon les normalisateurs comptables, l’information relative aux conventions comptablesd’une entite publiante est essentielle aux utilisateurs des etats financiers a qui elle permetd’interpreter ces etats (voir, par exemple, la norme comptable internationale (IAS) 1,l’Accounting Principles Board Opinion 22 et le Statement of Standard Accounting Practice 2).L’auteur se demande si l’etendue de l’information que publient les entreprises sur leurs con-ventions comptables importe pour les analystes financiers, qui constituent un ensembleimportant d’utilisateurs des etats financiers. A l’aide d’un echantillon regroupant plusieurspays et couvrant la premiere moitie des annees 90, l’auteur verifie si l’etendue de l’informa-tion relative aux conventions comptables fournie dans le rapport annuel est en relation nega-tive avec deux proprietes des previsions de resultats des analystes : la dispersion et l’erreur.L’auteur se demande egalement si l’information relative aux conventions comptables quepublient les entreprises est plus importante pour les analystes lorsque le contexte offre a cesentreprises un choix de methodes comptables plus varie. Jusqu’a maintenant, les chercheursn’ont pas etudie la relation entre la communication d’informations sur les conventions

Exploring Diversity in Accounting through Faculty Journal Perceptions

Abstract: The accounting research community has frequently been described as being both diverse and focused on local issues. At the same time, increasing pressure is being placed on researchers to publish in internationally highly regarded journals. Since faculty evaluations depend on journal rankings, such rankings need to take into account the diversity of the research community. Therefore, this study examines how contextual factors such as a researcher's location and research orientation may influence journal quality perceptions and readership patterns based on an international sample of 1,230 accounting academics. The perceived quality of journals is measured across a number of dimensions, including journal familiarity, average rank position, percent of respondents who classify a journal as top tier, and readership. The results support that a significant variation in journal quality perceptions exists based on a researcher's geographic origin, research orientation, and affiliation with a journal.

Production Efficiency and the Pricing of Audit Services

Abstract: In this paper, we examine the relative efficiency of audit production by one of the then Big 6 public accounting firms for a sample of 247 geographically dispersed audits of U.S. companies performed in 1989. To test the relative efficiency of audit production, we use both stochastic frontier estimation (SFE) and data envelopment analysis (DEA). A feature of our research is that we also test whether any apparent inefficiencies in production, identified using SFE and DEA, are correlated with audit pricing. That is, do apparent inefficiencies cause the public accounting firm to reduce its unit price (billing rate) per hour of labor utilized on an engagement? With respect to results, we do not find any evidence of relative (within-sample) inefficiencies in the use of partner, manager, senior, or staff labor hours using SFE. This suggests that the SFE model may not be sufficiently powerful to detect inefficiencies, even with our reasonably large sample size. However, we do find apparent inefficiencies using the DEA model. Audits range from about 74 percent to 100 percent relative efficiency in production, while the average audit is produced at about an 88 percent efficiency level, relative to the most efficient audits in the sample. Moreover, the inefficiencies identified using DEA are correlated with the firm's realization rate. That is, average billing rates per hour fall as the amount of inefficiency increases. Our results suggest that there are moderate inefficiencies in the production of many of the subject public accounting firm's audits, and that such inefficiencies are economically costly to the firm.

Do Investors Overrely on Old Elements of the Earnings Time Series

Abstract: This paper reports an experiment demonstrating that MBA students overrely on old earnings performance when predicting future earnings performance in a laboratory setting. In the experiment, MBA students relied too heavily on old annual ROE information to predict future annual ROE. The experiment shows how a common cognitive error (overreliance on unreliable information) interacts with the structure of the earnings time series to create particular patterns of prediction errors. The results also suggest directions for research on two well-known anomalies, long-run overreactions (De Bondt and Thaler 1985, 1987) and post-earnings-announcement drift (Bernard and Thomas 1990).

Are Fundamentals Priced in the Bond Market

Abstract: To date, the discussion of the Lev and Thiagarajan 1993 fundamentals in the prior literature has been exclusively in the context of the stock market. Our study is the first to examine the value-relevance of these fundamentals for default risk. By focusing on the market for new bond issues, we examine the value-relevance of the fundamental score using expected rather than realized returns. Also, by focusing on the bond market we provide a different perspective than that brought by prior studies relying solely on stock prices. We find the fundamentals to be priced in the market for new bond issues as indicators of expected future earnings and to be value-relevant in enabling the market to discern differences in bond credit quality over and above the published bond ratings.

Earnings management in response to the introduction of the Australian gold tax

Abstract: Earnings from gold mining in Australia remained tax-exempt for almost seven decades until January 1, 1991. In the early 1980s, rapid economic prosperity induced by escalated gold prices brought the Australian gold-mining industry under intense political scrutiny. Using a variant of the modified Jones model, this paper provides evidence of significant downward earnings management by Australian gold-mining firms, which is consistent with their attempts to mitigate political costs during the period from June 1985 to May 1988. In contrast, test of earnings management over a similar period in a control sample of Canadian gold-mining firms produced insignificant results. Further, empirical results are robust to several sensitivity tests performed. During the period from June 1988 to December 1990, the Australian firms were found to have engaged in economic earnings management. This is consistent with the sample firms' incentive of maximizing economic earnings immediately prior to the introduction of income tax on gold mining. The findings of this study help to understand the impact of earnings management on the efficient resource allocation in an economy. They also contribute toward understanding the linkage between regulation of accounting for special purposes and general-purpose financial. reporting.

An Empirical Analysis of the Effects of Online Trading on Stock Price and Trading Volume Reactions to Earnings Announcements

Abstract: This study provides evidence regarding the effects of online trading on stock price and trading volume reactions to quarterly earnings announcements. We test for differences in stock price and volume reactions to quarterly earnings announcements between a period with a significant amount of online trading (1996-99) and a period without online trading (1992-95). We conjecture that online trading has increased the proportion of naive investors in the market. We predict that this will result in (1) a decrease in the average precision of investor information prior to earnings announcements leading to higher earnings response coefficients (ERCs), (2) an increase in differential interpretation of earnings leading to higher trading volume reactions that are unrelated to price change, and (3) a decrease in differential prior precision leading to a decrease in the association between trading volume and absolute price change. We find evidence consistent with all three predictions. Our findings are relevant for assessing the validity of concerns about online trading expressed by regulators and the validity of theoretical models of trade with asymmetrically informed investors.

Improving Financial Reports by Revealing the Accuracy of Prior Estimates

Abstract: Several researchers (e.g., Lundholm 1999; Ryan 1997; Petroni, Ryan, and Wahlen 2000) have proposed a reporting mechanism to enhance the reliability of estimates and other forward-looking information in financial reports. Their proposals require companies to report reconciliations of prior-year estimates to actual realizations as supplemental information in their financial reports. Such disclosures would enable investors to distinguish between accurate and opportunistic reporting behavior, and, arguably, should create incentives for companies to estimate accurately in the first place. Our study provides evidence on these proposals. Specifically, we conduct two experiments within the context of an important intangible asset requiring estimation - software development costs. Our results show that the proposed reporting mechanism is effective in communicating information about the accuracy of financial estimates. We find, however, that not all disclosures are equally useful. The most effective disclosures explicitly describe the implications of misestimation (if any) on both the balance sheet and on earnings, thereby reducing the computational complexity associated with less explicit disclosures. Furthermore, our results show that when the disclosures explicitly describe the implications of misestimation, investors reward accurate estimators but do not explicitly punish those who are inaccurate. We conclude that information about previous estimate accuracy is useful to investors and that regulators should consider the type of disclosure, because not all disclosures may be equally effective in creating management incentives for accurate estimation. Moreover, the competitive advantage conferred on firms that provide accurate estimates arguably should create incentives for all companies to estimate accurately in the future.

A Note on the Interdependence between Hypothesis Generation and Information Search in Conducting Analytical Procedures

Abstract: This study examines the linkage among the initial hypothesis set, the information search, and decision performance in performing analytical procedures. We manipulated the quality of the initial hypothesis set and the quality of the information search to investigate the extent to which deficiencies (or benefits) in either process can be remedied (or negated) by the other phase. The hypothesis set manipulation entailed inheriting a correct hypothesis set, inheriting an incorrect hypothesis set, or generating a hypothesis set. The information search was manipulated by providing a balanced evidence set to auditors (i.e., evidence on a range of likely causes including the actual cause - analogous to a standard audit program) or asking them to conduct their own search. One hundred and two auditors participated in the study. The results show that auditors who inherit a correct hypothesis set and receive balanced evidence performed better than those who inherit a correct hypothesis set and did their own search, as well as those who inherited an incorrect hypothesis set and were provided a balanced evidence set. The former performance difference arose because auditors who conducted their own search were found to do repeated testing of non-errors and truncated their search. This suggests that having a correct hypothesis set does not ensure that a balanced testing strategy is employed, which, in turn, diminishes part of the presumed benefits of a correct hypothesis set. The latter performance difference was attributable to auditors' failure to generate new hypotheses when they received evidence about a hypothesis that was not in the current hypothesis set. This demonstrates that balanced evidence does not fully compensate for having an initial incorrect hypothesis set. These findings suggest the need for firm training and/or decision aids to facilitate both a balanced information search and an iterative hypothesis generation process.

The North American Industry Classification System and Its Implications for Accounting Research

Abstract: Industry classification is an important component of the methodological infrastructure of accounting research. Researchers have generally used the Standard Industrial Classification (SIC) system for assigning firms to industries. In 1999, the major statistical agencies of Canada, Mexico, and the United States began implementing the North American Industry Classification System (NAICS). The new scheme changes industry classification by introducing production as the basis for grouping firms, creating 358 new industries, extensively rearranging SIC categories, and establishing uniformity across all NAFTA nations. We examine the implications of the change for accounting research. We first assess NAICS's effectiveness in forming industry groups. Following Guenther and Rosman 1994, we use financial ratio variances to measure intra-industry homogeneity and find that NAICS offers some improvement over the SIC system in defining manufacturing, transportation, and service industries. We also evaluate whether NAICS might have an impact on empirical research by reproducing part of Lang and Lundholm's 1996 study of information-transfer and industry effects. Using SIC delineations, they focus on whether industry conditions or the level of competition is the main source of uncertainty resolved by earnings announcements. Across all levels of aggregation, we find inferences are similar using either SIC or NAICS. How-ever, we also observe that the regression coefficients in Lang and Lundholm's model show smaller intra-industry dispersion for NAICS, relative to SIC, definitions. Overall, the results suggest that NAICS definitions lead to more cohesive industries. Because of this, researchers may encounter some differences in using NAICS-industry definitions, rather than SIC, but these will depend on research design and industry composition of the sample.

The Association between Changes in Interest Rates, Earnings, and Equity Values*

Abstract: Numerous studies have documented that stock returns are negatively related to changes in interest rates, but there has been little corroborating research on the information in interestrate changes about the fundamentals that the stock market prices. The negative correlation is often attributed to changes in the discount rate, a denominator effect in a valuation model. However, there may also be a numerator effect on the expected payoffs that are discounted. This paper shows that changes in interest rates are positively related to subsequent earnings, but the change in earnings is typically not large enough to cover the change in the required return. Hence, the net (numerator and denominator) effect on equity value is negative, consistent with the results of the research on interest rates and stock returns.

Audit Strategies and Multiple Fraud Opportunities of Misreporting and Defalcation

Abstract: We examine how an auditor assesses the risk of fraud and formulates an audit plan when the auditee has the opportunity to commit various types of fraud. Unlike previous studies, the audi-tee can misappropriate assets (defalcation), misreport financial information (fraudulent financial reporting), or misreport financial information in combination with defalcation. Our results identify four possible equilibria whose characteristics depend on the auditee's relative rewards and penalties from the various types of fraud, the cost of audit effort, and expectations about the auditee-firm's performance. When the cost of audit effort is sufficiently small, fraud risk assessment depends on the auditee's rewards and penalties associated with each type of fraud, but not on the auditor's beliefs about firm performance. The auditor develops an audit plan that focuses on the type of fraud the auditee is most motivated to commit, and in turn, the audit plan deters all other types of fraud.

Corporate Investment Incentives and Accounting‐Based Debt Covenants*

Abstract: This paper studies the conditions under which accounting-based debt covenants increase firm value in a setting that incorporates the conflicting incentives of shareholders, bondholders, and managers. We construct a model in which debt is needed to discipline managerial investment decisions despite endogenous compensation contracts. We show that accounting covenants increase value when (1) debt serves as a credible commitment to penalize poor investment decisions; (2) the firm faces other (exogenous) sources of uncertainty that can make debt risky despite good investment decisions; and (3) accounting information serves as a contractible proxy for firm's economic performance. In these circumstances, accounting covenants ensure that shareholders do not offer compensation schemes that would encourage bondholder wealth expropriation when the debt becomes risky. A covenant specifying a required level of accounting performance provides additional bondholder power when performance is low. An accounting-based dividend covenant allows a disbursement to maintain investment incentives when performance is high without allowing dividend-based expropriation. The optimal covenants depend on the reliability of accounting information, and the interaction between accounting performance and the different incentive conflicts provides new insight into the empirical literature on accounting-based covenants.

Cancellation of Executive Stock Options: Tax and Accounting Income Considerations*

Abstract: Canadian firms face a trade-off between reporting higher accounting income and paying lower taxes that arises from their ability to cancel in-the-money executive stock options and making a substitute cash payment to the executive instead of issuing shares. Firms' trade-off hypotheses are operationalized in a multilateral framework and empirically tested using insider-trading data. The multilateral approach is designed to control for the incentive effects of alternative compensation schemes and to determine the cancellation payment that keeps the executive indifferent between receiving cash or shares. The results show that firms consider both taxes and financial reporting costs in determining their option cancellation behavior.

Ex Post Voluntary Disclosure Strategies for Insiders

Abstract: Asymmetric information between corporate insiders and other market participants can lead to large bid-ask spreads or even a collapse of trade in financial markets. In this paper, we discuss how voluntary disclosure by insiders can remedy this problem. When insiders make disclosure decisions after they become informed, other market participants update their prior beliefs on the basis of both the information disclosed and the information not disclosed. Insiders then give up some or all of their information advantage to weakly increase their profits. These results do not rely on ex ante commitments on the part of the insiders.