Mingcherng Deng’s research while affiliated with The Graduate Center, CUNY and other places

While there have been vast discussions on the materialistic benefits of continuous improvement from the Toyota and Honda experiences, the academic literature pays little attention to information sharing. In this paper, we construct a dynamic adverse selection model in which the supplier privately observes her production efficiency, and in the contractual duration the manufacturer obtains an informative but imprecise signal regarding this private efficiency. Despite the disclosure of proprietary information, we show that information sharing may benefit the supplier; the supplier's voluntary participation is more likely to occur when the shared information is rather imprecise. On the other hand, our analysis also reveals that this information sharing unambiguously gives rise to an upward push of the production quantity, and may sometimes lead to an upward distortion that ultimately hurts the supply chain. We also document the non-trivial impact of the timing of information sharing on the supplier's incentive to participate.This article is protected by copyright. All rights reserved.

We consider a two-stage principal-agent screening environment in a decentralized supply chain with retailers, distributors, and a supplier. The retailers possess private information regarding their local market profitabilities. The distributors can partially observe the retailers' profitabilities and are heterogeneous with regard to the precision of that information. The supplier determines the level of production, but knows neither the local market profitabilities nor the precision of the distributors' information. In the first stage, the supplier allocates finished products to distributors. In the second stage, given the allocated quantity by the supplier, the distributors contract with local retailers with a capacity constraint.We find that due to the distributors' superior information, the quantity distortion on the retailers' side is mitigated, and the upstream information asymmetry (between the supplier and the distributors) subsequently affects the quantity allocation among the downstream retailers. The supplier may not benefit from contracting with the distributors. In addition, no distributor is excluded based on the heterogeneity of the information precision, even though some distributors do not have better information than the supplier. In the numerical examples, we further analyze how the local market heterogeneity and inventory costs affect the capacity allocation, the retailers' payoffs, and the supply chain profits. We document some counter-intuitive quantity allocation rules that arise from the distributors' information advantage.

Global sourcing has made quality management a more challenging task, and supplier certification has emerged as a solution to overcome suppliers' informational advantage about their product quality. This paper analyzes the impact of certification standards on the supplier's investment in quality when a buyer outsources the production process. Based on our results, deterministic certification may lead to under-investment in quality improvement technology for efficient suppliers, thereby leading to potential supply chain inefficiency. The introduction of noisy certification may alleviate this under-investment problem when the cost of information asymmetry is high. While allowing noisy certification always empowers the buyer to offer a menu to screen among heterogeneous suppliers, the buyer may optimally choose only a limited number of certification standards. Our analysis provides a clear-cut prediction of the types of certifiers the buyer should employ for heterogeneous suppliers, and we identify the conditions under which the supplier benefits from noisy certification.

Conventional wisdom holds that joint audits would improve audit quality by enhancing audit evidence precision, because "Two heads are better than one," and by enhancing auditor independence, because it is more expensive for a company to "bribe" two audit firms than one. Our paper challenges this wisdom. We show that joint audits by one big firm and one small firm may impair audit quality, because joint audits (1) induce a free-riding problem between audit firms, lowering audit evidence precision, and (2) create an opportunity for internal opinion shopping, compromising auditor independence. We further derive a set of empirically testable predictions comparing audit evidence precision, auditor independence, and audit fees under joint and single audits. This paper, the first theoretical study of joint audits, contributes to a better understanding of the economic consequences of joint audits on audit quality.

In modern businesses, firms face new challenges of managerial retention in capital budgeting process. We consider a model in which a manager privately observes the capital productivity of a project and has access to multiple outside financing options. We show that if the manager can obtain funding from either internal or external capital (but not both), the firm may exclude highly profitable investment projects but fund those projects that have moderate capital productivity, even when there is no limit on capital allocation. Furthermore, the firm may voluntarily impose capital rationing in order to keep the projects within the firm, even though it has sufficient capital to fund such profitable projects. However, if the firm can utilize both the internal and external capital, highly profitable projects are always retained and the voluntary capital rationing is not optimal. Our analysis identifies testable empirical predictions on the association between capital budgeting and external capital.

To restore investors' confidence in the reliability of corporate financial disclosures, the Sarbanes-Oxley Act of 2002 mandated stricter regulations and arguably increased auditors' liability. In this paper, we analyze the effects of increased auditor liability on the audit failure rate, the cost of capital, and the level of new investment. We focus on a setting in which, with imperfect auditing, a firm has better information than investors about its prospects and seeks to raise capital for new investments in a lemons market. The equilibrium analysis derives corporate reporting and investing choices by the firm, attestation opinions by the auditor, and valuation by rational investors. Three empirically testable predictions emerge: although increasing auditor liability decreases the audit failure rate and the cost of capital for new projects, it also decreases the level of new profitable investments.

We examine errors in enterprise and equity valuation based on multiples of firm fundamentals. Our study, which is based on a more representative sample (including firms with losses, smaller start up firms, etc.), complements extant studies, which are based on larger, profitable firms followed by analysts. Contrary to the results in the extant studies, we find that: (1) valuation errors for multiples based on sales are often lowest for both enterprise and equity value; and, (2) when we compare book value and earnings as valuation fundamentals, we find that book-value-based multiples outperform earnings-based multiples. Our focus is on multiples of current financial variables. We show vast improvement in valuation errors when an average omitted variable (intercept) is incorporated in the calculation of harmonic means. We extend the extant literature by demonstrating how harmonic means can be calculated when different multiples are combined, enabling us to examine the change in valuation errors when a combination of multiples is used instead of just a single multiple. Our results show that valuation errors are significantly improved when combining fundamentals from different financial statements; the largest improvement is observed when balance sheet fundamentals (net operating assets and book value of equity) are combined with fundamentals from the income statement (for example, EBITDA).