Are banks using hidden reserves to beat earnings benchmarks? Evidence from Germany

Section 340f of the German Commercial Code allows banks to provision against the special risks inherent to the banking business by building hidden reserves. Beyond risk provisioning, these reserves are implicitly accepted as an earnings management device. By analyzing financial statements of German banks for the period 1997–2009, we see these hidden reserves being used to (1) avoid a negative net income, (2) avoid a drop in net income compared to the previous year, (3) avoid a shortfall in net income compared to a peer group, and (4) reduce the variability of banks’ net income over time. Our analysis also shows that if bank managers are unable to reach the targets as set out in (1)–(3), they are more inclined to keep the hidden reserves for use in future periods.     

Are there economies of scale in the demand for money by firms? Some panel data estimates

We estimate elasticities of scale in the demand for money by firms using firm level panel data from Spain, the UK, and the US. This elasticity is one for Spain and the UK but smaller for the US. We find that the errors in the money demand equations contain two terms that are correlated with sales. Firstly, a permanent firm effect that captures differences in technological sophistication. Secondly, a measurement error in sales, which becomes relevant when relying on changes in sales to account for fixed effects. Failure to control for these correlated unobservable terms results in important biases in the estimated sales elasticities.     

Are Employee Selection and Incentive Contracts Complements or Substitutes?

There is a debate in the literature as to whether employee selection is a substitute or complement to incentive contracting. We argue that incentive contracts and selection can be both complements and substitutes conditional on the contracting difficulty faced by the firm. We examine these control choices in a setting where contracting difficulties arise due to the firm's choice of strategy and from the volatility created by the firm's external environment. We select a firm's commitment to organizational learning (OL) as our strategic choice variable as this provides a useful proxy for identifying settings where explicit incentive contracting is difficult. The results show that, as firms become increasingly committed to OL, incentive contracts and employee selection operate as complements. However, with a high commitment to OL and an increasing level of external volatility, contracting on performance measures will become less effective. In this context, our results indicate that there is a substitution effect toward employee selection.     

Seeing is believing? Executives' facial trustworthiness,auditor tenure,and audit fees

Psychology and neuroscience studies document that facial trustworthiness perceptions may affect observers' decision-making process. Our study examines whether auditors' perceptions of client executives' facial trustworthiness are associated with their audit fee decisions. We employ a machine-learning-based face-detection algorithm to measure executives' facial trustworthiness. We find that auditors charge 5.6% less audit fee to firms with trustworthy-looking CFOs than to those with untrustworthy-looking CFOs in initial audit engagements. Auditor tenure weakens the negative association between CFOs' facial trustworthiness and audit fee. Further evidence shows that CFO's facial trustworthiness is associated with neither financial reporting quality nor litigation risk.     

Mobile Communication and Local Information Flow: Evidence from Distracted Driving Laws

We examine the influence of mobile communication on local information flow and local investor activity using the enforcement of statewide distracted driving restrictions, which are exogenous events that constrain mobile communication while driving. By restricting mobile communication across a potentially sizable set of local individuals, these restrictions could inhibit local information flow and, in turn, the market activity of stocks headquartered in enforcement states. We first document a decline in Google search activity for local stocks when restrictions take effect, suggesting that constraints on mobile communication significantly affect individuals’ information search activity. We further find significant declines in local trading volume when restrictions are enforced. This drop in liquidity is (1) attenuated when laws provide substitutive means of mobile communication and (2) magnified when locals have long car commutes and when their daily commutes overlap with regular exchange hours. Moreover, trading volume suffers the most for local stocks with lower institutional ownership, less analyst coverage, and more intangible information. Additional analyses show lower intraday volume during local commute times when mobile connectivity is constrained. Together, our results suggest that local information and local investors matter in stock markets and that mobile communication is an important mechanism through which these elements operate to affect liquidity and price discovery.     

Accounting-based versus market-based cross-sectional models of CDS spreads

Models of financial distress rely primarily on accounting-based information (e.g. [Altman, E., 1968. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance 23, 589–609; Ohlson, J., 1980. Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research 19, 109–131]) or market-based information (e.g. [Merton, R.C., 1974. On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance 29, 449–470]). In this paper, we provide evidence on the relative performance of these two classes of models. Using a sample of 2860 quarterly CDS spreads we find that a model of distress using accounting metrics performs comparably to market-based structural models of default. Moreover, a model using both sources of information performs better than either of the two models. Overall, our results suggest that both sources of information (accounting- and market-based) are complementary in pricing distress.     

Comparative Value Relevance Studies: Country Differences Versus Specification Effects

This paper sheds light on the sensitivity of findings in comparative international value relevance studies regarding two fundamental methodological choices. We hypothesize and find that, first, using the regression vs. the portfolio returns specification and, second, the choice of the return window, is not arbitrary. Both choices will have an impact on country rankings and the significance of cross-country differences in comparative designs. This makes us conclude that findings in previous comparative international value relevance studies are partly driven by differences in market characteristics across countries. Extending the findings of Francis and Schipper (1999) and Collins and Kothari (1989), our results suggest that previous comparative studies might thus have overstated value relevance differences and institutional variables' power to explain these differences across countries. Findings are based on a treatment sample of 56,000 firm-year observations from 12 countries and from 12 matched U.S. control samples, with observations from 1988 to 2007.