Abstract: We examine whether variation in regulatory leniency is associated with the cost of deposits in the banking industry. We predict that lenient regulatory supervision allows for greater bank risk-taking due to delayed intervention, thereby resulting in a higher cost of deposits. Our main finding is a positive association between banks' cost of uninsured deposits and the leniency of their state regulators, incremental to observable measures of risk and performance. We further show that this result is stronger for riskier banks and when uninsured depositors have a greater ability or incentive to influence deposit rates. These findings suggest that the leniency of bank regulators is priced in uninsured deposit rates and further our understanding of the factors associated with regulatory leniency and market discipline in the banking industry.



Abstract: We examine the impact of transparency on the convenience yield of AAA-rated asset-backed security (ABS) tranches. AAA tranches of ABS are commonly held by investors to manage financial liquidity and therefore enjoy a price premium beyond what is determined solely by the expected monetary payoff (i.e., convenience yield). The Securities and Exchange Commission (SEC) requires ABS issuers to provide monthly disclosures about the performance of the underlying individual loans for ABS issued after November 23, 2016 to improve transparency. We document that AAA tranches of ABS experience a significant increase in price volatility after the loan-level disclosure mandate. As a result, the use of these tranches as collateral for short-term funding and their convenience yield decrease significantly after the increased disclosure. Our collective evidence contributes to the literature of "optimal opacity" by highlighting an important unintended consequence of increased transparency in the ABS market; it diminishes the pledgeability of long-term safe assets.



Abstract: This study examines corporate integrity culture—that is, a firm's shared values and behaviors related to compliance, trustworthiness, and ethics. Different from prior research that associates culture measures with general firm-level outcomes, we evaluate the pervasiveness of the integrity culture within an organization across two disparate business functions: operations and financial reporting. We first develop a measure of corporate integrity culture based on firms' internal control environments and show that, as predicted, weak integrity culture contributes to both operational and financial non-compliance. We next document the predicted positive contemporaneous association between operational and financial non-compliance, controlling for the integrity culture reflected in the internal control environment. Given the organizational and physical distances and lack of day-to-day interactions between the two business functions, we infer that management's “tone at the top” likely affects non-compliance in both functions. Finally, for firms with existing operational non-compliance, we find more negative market reactions to accounting restatements and higher CEO turnover propensities following restatements. These results indicate that top management must consistently reinforce a culture of compliance and integrity, lest it decay throughout the organization. Our results also imply that regulators evaluating compliance in specific functions could benefit from reviewing compliance in other functions within the firm.



Abstract: We examine whether bank connections via common mutual fund ownership serve as a contagion channel affecting the systemic risk of the banking system. Examining this relation is important because common mutual fund ownership has increased dramatically over the past 20 years, and a buildup of systemic risk was at the heart of the 2008–2009 financial crisis. We predict and document that the extent of a bank's connection with other banks via common ownership increases its contribution to systemic risk. We further predict and find that this association is primarily driven by passive mutual funds. We provide evidence that common passive ownership results in higher systemic risk through two mechanisms: nondiscretionary sell-offs of bank stocks and a common pattern of voting. Our results are also robust to two alternate instrumental variable analyses. This study contributes to the literature by documenting an unintended, macro-level consequence of common mutual fund ownership. Our findings broaden the understanding of common ownership as one mechanism through which systemic risk materializes and should be particularly relevant for regulators who seek to prevent future systemic failures.



Abstract: We explore how an accounting measure of information asymmetry between lead and participating lenders influences syndication structures by examining whether lead lenders’ commercial and industrial (C&I) loan-loss provision validity affects the fraction of loans they retain. We first conduct multiple tests showing that C&I provision validity reflects banks’ underlying screening and monitoring effectiveness. We then find lead lenders’ loan share decreases with C&I provision validity, but not with non-C&I provision validity. Consistent with an information effect, we further find this association is attenuated by (i) alternative information sources about the borrowers and (ii) previous lead/participant relationships and participant/borrower relationships.



Abstract: The SEC's Disclosure Effectiveness Initiative (December 2013) highlights a difference between accounting regulators and academics in their perceptions of Item 1A risk factor disclosure effectiveness. Because most academic evidence relies on pre-financial crisis data, we compare changes in risk factor disclosure informativeness before and after the crisis as a possible explanation for this disconnect. We further explore this discrepancy by considering (i) three classes of market participants, (ii) new, discontinued, and repeated disclosures, and (iii) nonmarket outcomes. Our results confirm previous findings but indicate that those results no longer hold in the subsequent period. Specifically, we find that although equity, option, and bond markets react to unexpected risk factor disclosures in the period leading up to the financial crisis (2006–2008), the market reactions decline significantly in the post-crisis period (2009–2014). Perhaps surprisingly, the documented changes in informativeness are not driven by disclosures repeated from one year to the next but instead result from new disclosures initiated in the current year and, in the option and debt markets, also from disclosures discontinued from the previous year. Finally, using the Altman Z-score as an objective bankruptcy risk measure, we find that the association between risk factor disclosures and companies’ future bankruptcy risk declines significantly in the post financial crisis period. Taken together, these findings contribute to the current disclosure effectiveness debate by highlighting that risk factor disclosures, which were informative in the preceding period, become less reflective of the underlying economic risks and thus less informative to investors in the post-crisis period.


Abstract: Operating leases have grown significantly as a source of corporate financing over the last 30 years. Their off-balance sheet treatment, which may in part explain their popularity, raises concern that financial risk may be misjudged and capital misallocated. Prior research evidence on the above issue is mixed. To improve reporting transparency, regulators propose a new accounting concept, right of use, which will add the present value of most leases to the balance sheet. We examine the effect of operating leases on loan pricing by banks, a sophisticated financial statement user. Since leases are a potential debt substitute, we expect them to be important in our setting. With loan spreads as the dependent variable, we test the differential explanatory power and model fit of as-reported financial ratios versus financial ratios adjusted for the capitalization of operating leases. We find that lease-adjusted financial ratios better explain loan spreads, especially for larger lenders. Our results also suggest that retailer leases that are closer in substance to rental agreements than financed asset purchases are less relevant for credit risk assessments. Thus we conclude that banks not only price operating leases, on average, but also make distinctions about which leases should be priced. Second, we explore the role of credit rating agencies and confirm that credit ratings also reflect capitalized operating leases, and find support for an informational role for others’ credit assessments. However, unlike banks, rating agencies appear to capitalize all operating leases mechanically. Overall, our results suggest that banks and rating agencies adjust for the off-balance sheet presentation of operating leases and, at least in the case of banks, attempt to do so to reflect the underlying economics of the leases. This evidence lessens concern over the potential negative consequences of existing operating lease accounting and raises concern over proposed accounting that capitalizes all leases regardless of their economic characteristics.



Abstract: This research examines whether the fair value of mortgage servicing rights (MSRs) based on managerial inputs (Level 3) better reflects the cash flow and risk characteristics of the underlying assets than the fair value of MSRs based on market inputs (Level 2). Using mortgage servicing fees as a proxy for the underlying cash flows, we find that the valuation multiples for MSRs based on Level 3 inputs are more positively associated with the persistence of future servicing fees compared with the fair value of MSRs based on Level 2 inputs. We also document that only the valuation multiples based on Level 3 fair values are negatively associated with proxies for risk factors. Our results suggest that, although unobservable inputs are subject to managerial discretions, managers can generate higher quality fair value estimates than market inputs due to their information advantage, especially when the market for the underlying asset is inactive.


Abstract: We examine the commitment effect provided by mandatory disclosure and the information effect of voluntary disclosure on market illiquidity by exploring a regulatory change that allows smaller reporting companies to reduce the disclosure of certain information in their SEC filings. This regime change allows us to separate the commitment effect provided by mandatory disclosure from the information effect of voluntary disclosure. We find that firms that are eligible to reduce their disclosure, but voluntarily maintain their disclosure level, experience an increase in market illiquidity. We also find that the increase in illiquidity is more pronounced for firms with higher agency costs. These findings suggest that mandatory disclosure serves as a credible commitment mechanism and that losing such commitment by disclosure deregulation is costly in the absence of a loss of information. Our study suggests that while voluntary disclosure is effective in reducing information asymmetry, it cannot replace mandatory disclosure in addressing information problems.


Abstract: We provide large sample evidence that credible hedge commitments reduce the agency costs of debt and that accounting conservatism enhances hedge commitments. We examine 2,338 bank loans entered into by 263 mandatory derivative users that are contractually obligated by interest rate protection covenants, 709 voluntary derivative users, and 1,366 non-users. We show that loan contracts are more likely to include interest rate protection covenants when borrowers are less likely to maintain the hedge position once the financing is completed. We find that borrowers who credibly commit to hedge using these covenants significantly reduce their interest rates. While we do not find an average interest savings for voluntary derivative users, we do find a reduction in their loan rates when they practice conservative financial reporting. Our results suggest that accounting conservatism helps borrowers resolve shareholder-creditor conflicts by committing to maintain their hedge positions after completing debt financing.



Abstract: We investigate whether the pattern of quarterly earnings changes provides a signal of earnings management. We identify firms for which the sign of (seasonal) earnings changes observed in interim quarters reverses in the fourth quarter. We hypothesize that a firm performing poorly in interim quarters may attempt to increase earnings of the fourth quarter to achieve a desired annual earnings target, while a firm performing well in interim quarters may attempt to decrease earnings of the fourth quarter to build “reserves” for the future. Our results show that reversal of earnings changes in the fourth quarter is a common phenomenon and its occurrence is greater than would be expected by chance. Other indicators of earnings management, such as the size and direction of discretionary accruals, reversals in subsequent accruals, the use of special items in the income statement, and adjustment of R&D spending, suggest that firms with earnings reversals are more likely to have managed earnings than industry and performance matched control firms. The capital market appears to attach lower credibility to earnings reported by the reversal samples. Our collective evidence leads us to suspect that fourth-quarter reversals on average reflect earnings management behavior. We recommend that analysts use earnings reversals as a heuristic to detect potential cases of earnings management in conjunction with other indicators. 



Abstract: I examine the effect of the accounting standard for derivative instruments (SFAS No. 133) on corporate risk-management behavior. I classify a derivative user as an “effective hedger” (EH firm) if its risk exposures decreased after the initiation of the derivatives program, and as an “ineffective hedger/speculator” (IS firm) otherwise. I find that volatility of cash flows and risk exposures related to interest rate, foreign exchange rate, and commodity price decrease significantly for IS firms but not for EH firms, suggesting that IS firms engaged in more prudent risk-management activities after the adoption of SFAS No. 133.