Bank size, market concentration, and bank earnings volatility in the US

We examine whether bank earnings volatility depends on bank size and the degree of concentration in the banking sector. Using quarterly data for non-investment banks in the United States for the period 2004Q1-2009Q4 and controlling for the quality of management, leverage, and diversification, we find that bank size reduces return volatility. The negative impact of bank size on bank earnings volatility decreases (in absolute terms) with market concentration. We also find that larger banks located in concentrated markets have experienced higher volatility during the recent financial crisis.     

Nonlinear dynamics in discretionary accruals: An analysis of bank loan-loss provisions

Several studies have analyzed discretionary accruals to address earnings-smoothing behaviors in the banking industry. We argue that the characteristic link between accruals and earnings may be nonlinear, since both the incentives to manipulate income and the practical way to do so depend partially on the relative size of earnings. Given a sample of 15,268 US banks over the period 1996–2011, the main results in this paper suggest that, depending on the size of earnings, bank managers tend to engage in earnings-decreasing strategies when earnings are negative (“big-bath”), use earnings-increasing strategies when earnings are positive, and use provisions as a smoothing device when earnings are positive and substantial (“cookie-jar” accounting). This evidence, which cannot be explained by the earnings-smoothing hypothesis, is consistent with the compensation theory. Neglecting nonlinear patterns in the econometric modeling of these accruals may lead to misleading conclusions regarding the characteristic strategies used in earnings management.     

House prices,bank instability,and economic growth: Evidence from the threshold model

This paper examines the effects of house prices on bank instability when gauged at various levels of income growth. Bank stability may respond differently to house price changes or deviations from fundamental values in an economic boom environment than in a bust circumstance. A threshold estimation technique developed by Hansen (1999) is applied to a panel of 286 U.S. Metropolitan Statistical Areas (MSAs) over the period 1990Q1–2010Q4. We consider two house price indicators: the house price changes and the house price deviations from long-run equilibrium. The results suggest the existence of income growth threshold effects in the relationship between house prices and bank instability. Specifically, there are two income growth thresholds when using the house price changes and one income growth threshold when the house price deviations are applied. Robustness results using the non-MSAs sample from 1995Q1 to 2010Q4 provide further evidence of income growth threshold effects.     

The role of bank monitoring in corporate governance: Evidence from borrowers’ earnings management behavior

In this paper, we examine the corporate governance role of banks by investigating the effect of bank monitoring on the borrowers’ earnings management behavior. Our analyses suggest that a borrowing firm’s earnings management behavior generally decreases as the strength of bank monitoring increases. The strength of bank monitoring is measured as (1) the magnitude of a bank loan, (2) the reputation (rank) of a lead bank, (3) the length of a bank loan, and (4) the number of lenders. These results imply that bank monitoring plays an important role in the corporate governance of bank-dependent firms. We further examine other bank loan characteristics (collateral, refinancing, loan types, and loan purposes) and their effects on borrowers’ earnings management behavior. Our analyses show that collateral and loan types are significantly associated with borrowers’ earnings management behavior while refinancing and loan purposes have no association.     

Managing liquidity: Optimal degree of centralization

Large banking groups face the question of how to optimally allocate and generate liquidity: in a central liquidity hub or in many decentralized branches. We translate this question into a facility location problem under uncertainty. We show that volatility is the key driver behind (de-)centralization. We provide an analytical solution for the 2-branch model and show that a liquidity center can be interpreted as an option on immediate liquidity. Therefore, its value can be interpreted as the price of information, i.e., the price of knowing the exact demand. Furthermore, we derive the threshold above which it is advantageous to open a liquidity center and show that it is a function of the volatility and the characteristic of the bank network. Finally, we discuss the n-branch model for real-world banking groups (10-60 branches) and show that it can be solved with high granularity (100 scenarios) within less than 30 s.     

On the relationship between concentration of prospect theory/mental accounting investors,cointegration, and momentum

We examine the role of cointegration between stock prices and their estimated fundamental values in return momentum. We find that the positive relationship between capital gains overhang and future stock returns in Grinblatt and Han (2005) is significantly stronger among the “non-cointegrated” group of stocks as compared with the “cointegrated” group of stocks. Further, for the cointegrated stocks, the slower the speed of adjustment to the cointegrating equilibrium, the greater (smaller) is the future return of stocks with unrealized capital gains (losses). These findings are robust to various firm characteristics including firm size, book-to-market ratio, past returns, idiosyncratic volatility, dispersion in analysts’ earnings forecasts, turnover, individual investor ownership, and industry returns.     

Impact of FDICIA internal controls on bank risk taking

The Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991 was designed, among other things, to introduce risk-based deposit insurance, increase capital requirements, and improve banks’ internal controls. Of particular interest in this study are the requirements for annual audit and reporting of management’s and auditor’s assessment of the effectiveness of internal control for banks with $500 million or more in total assets (raised to $1 billion in 2005). We study the impact of these requirements on banks’ risk-taking behavior prior to the recent financial crisis and the consequent implications for bank failure and financial trouble during the crisis period. Using a sample of 1138 banks, we provide evidence that banks required to comply with the FDICIA internal control requirements have lower risk taking in the pre-crisis period. Specifically, the volatility of net interest margin, the volatility of earnings, and Z score show less risk-taking behavior. Furthermore, these banks are less likely to experience failure and financial trouble during the crisis period.     

Earnings Smoothing,Cash Flow Volatility,and CEO Cash Bonus

Prior studies generally relate managers’ decisions to smooth earnings to their desire to maximize their overall compensation and to smooth their consumption. However, earnings smoothing could also be driven by the firm's expected benefits from reporting a smooth earnings stream. Our paper provides empirical support for the latter explanation of earnings smoothing. Specifically, we find that while CEO bonus on average increases with earnings smoothing, the increase is larger when the firm's cash flow volatility is higher. Further, CEO bonus is shielded from the negative effects of lower earnings arising from the need to report a smoother earnings stream.     

The impacts of large trades by trader types on intraday futures prices: Evidence from the Taiwan Futures Exchange

We find that China's P/E ratio is comparable to that of the U.S. S&P 1500 index, a broad based index covering large, middle, and small capitalization firms. We provide an explanation as to why China's seemingly low P/E ratio is not surprising in light of the economic growth that it has experienced. Specifically, we show that (i) the P/E ratio is negatively associated with earnings volatility in both the Chinese and U.S. stock markets with an economically significant magnitude; and (ii) historical earnings volatility is considerably higher in China than in the U.S. Higher earnings volatility in China offsets higher growth prospect in setting the P/E ratio, making its P/E ratio much closer to what is observed empirically than otherwise implied by its growth rate.     

Bank capital buffer and portfolio risk: The influence of business cycle and revenue diversification

The relationship between macroeconomic developments and bank capital buffer and portfolio risk adjustments is relevant to assess the efficacy of newly created countercyclical buffer requirements. Using the U.S. bank holding company data over the period 1992:Q1–2011:Q3, we find a negative relationship between the business cycle and capital buffer. Our results offer some support for the Basel III agreements that countercyclical capital buffer in the banking sector is necessary to help the performance of the real economy during recessions. We find a robust evidence of inverse relationship between business cycle and bank default risk. Our analysis provides evidence of diversification benefits. The probability of insolvency risk decreases for diversified banks and banks with high revenue diversity achieve capital savings.     

The earnings announcement premium around the globe

U.S. stocks have been shown to earn higher returns during earnings announcement months than during non-announcement months. We document that this earnings announcement premium exists across the globe. Moreover, it is not isolated to a few countries. Of the 20 countries with enough data to conduct a within-country analysis, nine exhibit a significantly positive premium. A cross-country analysis finds that the premium is strongest in countries with the greatest increase in idiosyncratic volatility around the time of their firms' earnings announcements, suggesting that uncertainty over the earnings information to be disclosed is a primary driver of the global announcement premium.     

Banks’ exposure to interest rate risk, their earnings from term transformation, and the dynamics of the term structure

We use a unique dataset of German banks’ exposure to interest rate risk to derive the following statements about their exposure to this risk and their earnings from term transformation. The systematic factor for the exposure to interest rate risk moves in sync with the shape of the term structure. At bank level, however, the time variation of the exposure is largely determined by idiosyncratic effects. Over time, changes in earnings from term transformation have a large impact on interest income. Across banks, however, the earnings from term transformation do not seem to be a decisive factor for the interest margin.     

Seasonality in the cross-section of stock returns

This paper presents a new pattern in the cross-section of expected stock returns. Stocks tend to have relatively high (or low) returns every year in the same calendar month. We recognize the annual cross-sectional autocorrelation pattern documented in Jegadeesh [1990. Evidence of predictable behavior of security returns. Journal of Finance 45, 881–898] at lags of 12, 24, and 36 months as part of a general pattern that lasts up to 20 annual lags, superimposed on the general momentum/reversal patterns. This pattern explains an economically and statistically significant magnitude of the cross-sectional variation in average stock returns. Volume and volatility exhibit similar seasonal patterns but they do not explain the seasonality in returns. The pattern is independent of size, industry, earnings announcements, dividends, and fiscal year. The results are consistent with the existence of a persistent seasonal effect in stock returns.     

On the systematic volatility of unpriced earnings

Some important puzzles in macro finance can be resolved in a model featuring systematically varying volatility of unpriced shocks to firms? earnings. In the data, the correlation between corporate debt and stock market valuations is low. The model accounts for this via the opposing effect of unpriced earnings risk on levered debt and equity prices. The model also explains the low (or nonexistent) risk-reward relation for the market portfolio of levered equity via the opposing effects of unpriced and priced uncertainty (both components of stock volatility) on the levered equity risk premium. Versions of the model calibrated to empirical measures of both types of fundamental risk can quantitatively substantiate these explanations. Variation in residual earning dispersion accounts for a significant fraction of observed disagreement between debt and equity valuations and of realized stock volatility. The implication that the two components of risk should forecast the levered equity risk premium with opposite signs is also supported in the data. The results are a notable advance for risk-based asset pricing.     

Board characteristics and Chinese bank performance

Using a sample of 50 largest Chinese banks during the period of 2003–2010, we explore a comprehensive set of board characteristics (size, composition and functioning of the board) and analyze their impacts on bank performance and bank asset quality in China. We find that the number of board meetings and the proportion of independent directors have significantly positive impacts on both bank performance and asset quality while board size has a significantly negative impact on bank performance. We find new evidence that the degree of bank boards’ political connection is negatively correlated with bank performance and asset quality. The findings suggest that the board of directors plays a significant role in bank governance in China.     

Banks and bubbles: How good are bankers at spotting winners?

This paper examines the bank lending relations of a large sample of technology and nontechnology firms that went public during the 1996–2000 period. We use a unique hand-collected data set to examine the characteristics of firms that establish pre- Initial Public Offering (IPO) bank lending relations and whether post-IPO performance is related to the existence and size of pre-IPO banking relations. We find that the majority of IPO firms have banking relations before they go public. Firms with banking relations are older, more profitable or, in the case of tech firms, have lower losses, and are more likely to have funding from venture capitalists than firms without banking relations. We also find that banks lent aggressively to technology firms in the sense that current earnings and cash flows were significantly less important in determining banking relations for technology firms than for nontechnology firms. Consistent with the importance of so-called soft information in lending decisions, we find that, controlling for ex ante observable risk measures, there is a positive and significant relation between improvements in post-IPO operating performance and the existence and size of pre-IPO banking relations. Overall, our results indicate that firms with the best current and future prospects establish banking relations. Our findings provide an explanation as to why investors could interpret lending relations as a positive signal of firm quality.     

Effects of earnings management on bank cost of debt

This study investigates how earnings management influences credit ratings, and thus the cost of debt, using bank data from 85 countries. Using cross‐country data also facilitates the investigation of how information asymmetry affects the influence of earnings management on ratings. The results indicate that raters downgrade ratings when they perceive earnings management, after controlling for other potential determinants of bank credit ratings, implying that earnings management increases borrowing costs. The negative effect of earnings management is mitigated for banks in countries with more extensive and effective banking regulations owing to lower information asymmetry, but aggravated in counties with less robust banking regulations.     

Industry Signals Relayed by Corporate Earnings Restatements

This study finds that downward earnings restatements are associated with negative industry valuation effects. These effects are more pronounced when the valuation effects and the change in earnings of the firm restating its earnings are worse, when the restatement is initiated for reasons other than fraud, when the bubble was bursting, and when the restatement is subsequent to the publicity regarding Enron's fraud. The negative industry effects are more pronounced in industries that have a higher level of accruals and intangible assets, weaker sales growth, and a higher degree of stock volatility.     

Economic value,competition and financial distress in the European banking system

In this paper we examine the impact of a large number of factors at the bank level (liquidity and credit risks, asset size, income diversification and market power), at the industry level (banking concentration) and macro-level (real GDP growth) on bank financial distress using an unbalanced panel of 308 European commercial banks between 1996 and 2009. The observations falling below a given threshold of the empirical distribution of the Shareholder Value Ratio proxy bank financial distress. We employ a panel probit regression and, given the presence of overlapping data giving rise to residual autocorrelation, we use the Bertschek and Lechner (1998) robust estimator of the covariance matrix of parameters. We show that credit risk, liquidity risk and bank market power are the most influential determinants of distressed Shareholder Value Ratio. Finally we evaluate the model out-sample forecasting performance over the 2008–2009 crisis period.     

Does board structure in banks really affect their performance?

We study whether board structure (board size, independence and gender diversity) in banks relates to performance. Using a broad panel of large US bank holding companies over the period 1997–2011, we find that both board size and independent directors decrease bank performance. Although gender diversity improves bank performance in the pre-Sarbanes-Oxley Act (SOX) period (1997–2002), the positive effect of gender diminishes in both the post-SOX (2003–2006) and the crisis periods (2007–2011). Finally, we show that board structure is particularly relevant for banks with low market power, if they are immune to the threat of external takeover and/or they are small. Our two-step system generalised method of moments estimation accounts for endogeneity concerns (simultaneity, reverse causality and unobserved heterogeneity). The findings are robust to a wide range of other sensitivity checks including alternative proxies for bank performance.