The impact of SEC investigations and accounting and auditing enforcement releases on firms’ cost of equity capital

I study the impact of an SEC investigation (as captured by accounting and auditing enforcement releases) on a firm’s cost of equity capital. AAERs are often used in accounting literature as a proxy for fraudulent financial reporting. Fraudulent financial reporting should lead to an increase in cost of equity capital as a firm’s future cash flows become less certain. Overall, this study provides evidence of changes in cost of equity capital for firms targeted by an SEC AAER on the date the investigation is first made public.     

Sovereign ceilings “lite”? The impact of sovereign ratings on corporate ratings

Although credit rating agencies have gradually moved away from a policy of never rating a corporation above the sovereign (the ‘sovereign ceiling’), it appears that sovereign credit ratings remain a significant determinant of corporate credit ratings. We examine this link using data for advanced and emerging economies over the period of 1995–2009. Our main result is that a sovereign ceiling continues to affect the rating of corporations. The results also suggest that the influence of a sovereign ceiling on corporate ratings remains particularly significant in countries where capital account restrictions are still in place and with high political risk.     

The impact of accounting standards convergence on Chinese firms’ overseas mergers and acquisitions

This paper investigates how accounting standards (AS) convergence influences Chinese firms’ overseas mergers and acquisitions (M&As) and shows that this convergence significantly promotes Chinese firms’ overseas M&As. Specifically, we find that both the probability of success and the value of transactions increases significantly in countries that implemented International Financial Reporting Standards (IFRS) prior to 2007. These results suggest that accounting standards (AS) convergence can improve the comparability of accounting information between China and other countries that have adopted IFRS. Moreover, we find that the impact of accounting standards (AS) convergence on state-owned enterprise (SOE) acquirers is weak. These findings demonstrate that accounting standards (AS) convergence can facilitate Chinese firms’ overseas M&As by improving the comparability of accounting information between China and target countries.     

The impact of intangibles on firms’ financial and market performance: UK evidence

This study provides empirical evidence about the effect of intangible assets on firms’ current and future financial and market performance by utilizing a sample the UK FTSE 150 nonfinancial companies. Generally, the findings of this examination reported a strong evidence on the role of intangibles in boosting firms’ performance. In particular, the results indicate that while goodwill (GW) does have a statistically positive effect on firms’ current and future performance, research and development (R&D) is only associated with firms’ future performance. The results of the current research is consistent with the market-based and resources-based theories which posits that intangible investments are the main driving factors of wealth creation in the long-run; Specifically, R&D operations can create new technologies and products that would enhance firms’ performance and value. In addition, the results reveal that both GW and R&D can explain variations in firms’ financial performance measures suggesting that such investments can enhance firms’ earning leading to capitalization such earnings in the market value. Finally, the results of this research provide practical implication for policy makers and managers.     

Large EU banks’ capital and liquidity: Relationship and impact on credit default swap spreads

This paper explores the interrelations between bank capital and liquidity and their impact on the market probability of default. We employ an unbalanced panel of large European banks with listed credit default swap (CDS) contracts during the period 2005–2015, which allow us to consider the impact of the recent financial crisis. Our evidence suggests that bank capital and funding liquidity risk as defined in Basel III have an economically meaningful bidirectional relationship. However, the effect on CDS spread is ambiguous. While capital appears to have a relatively large impact on CDS spread changes, liquidity risk is priced only when it falls below the regulatory threshold.     

Investors’ heterogeneous beliefs and the impact of sovereign credit ratings in foreign exchange and equity markets

We propose a model in which sovereign credit news from multiple rating agencies interacts with market heterogeneity. The model illustrates that the first messenger discloses new information while additional messengers play an important role of coordinating heterogeneous beliefs. Empirical investigations based on sovereign credit ratings, foreign exchange and equity markets confirm that rating news coordinates investors’ beliefs. Sovereign credit rating news from both types of messenger induces a significant impact on exchange rates and stock indices. Volatility measures increase in response to news from the first messenger while ex-post volatility reduces following news from an additional messenger.     

The joint impact of accountability and transparency on managers’ reporting choices and owners’ reaction to those choices

We report the results of an experiment designed to investigate the fundamental conflict of interest between managers and owners in a financial reporting setting. In our setting, owners seek accurate reports of financial performance whereas managers have incentives to distort performance reports in a self-serving fashion. Regulatory responses to such conflicts often call for improved disclosure, including more accountability and transparency (e.g., Sarbanes-Oxley Act and Dodd-Frank Act). We use the term accountability to imply answerability—wherein managers are required to reconcile the difference between reported and actual performance. We predict and find that when managers’ incentives are transparently disclosed, accountability does not rein in managers’ opportunistic reporting. By comparison, when managers’ incentives are less transparently disclosed (opaque), accountability dampens managers’ propensity to misreport. However, this reduction in opportunistic reporting due to accountability comes about because managers offset higher reporting bias in compensation periods with lower reporting bias in other periods. Therefore, not only are the benefits of accountability restricted to the setting where managers’ incentives are opaque, but the reduced reporting bias might arise due to window-dressing. Although managers seem to care enough about accountability to engage in window-dressing, financial incentives seem to dominate accountability, at least in our setting. We also find that managers’ payoffs are higher when their incentives are opaque, but owners’ payoffs are invariant regardless of whether incentives are transparent or opaque. Our analyses suggest that owners may be relying on accountability to curb opportunistic reporting by managers—a reliance that may be misplaced. Our findings have implications for regulatory responses aimed at addressing conflicts of interest.     

The cost of firms’ debt financing and the global financial crisis

We provide an assessment of the determinants of the risk premium paid by non-financial corporations on long-term bonds. By looking at 5500 issues over the period 2005–2012, we find that in recent years the sovereign debt market turbulence has been a major driver of corporate risk. Compared with the three-year period 2005–2007 before the global financial crisis, in the years 2010–2012 Italian, Spanish and Portuguese firms paid on average between 70 and 120 basis points of additional premium due to the negative spillovers from the sovereign debt crisis, while German firms received a discount of 40 basis points.     

Liquid asset sheltering,or cost of capital? The effect of political corruption on corporate cash holdings

I posit that political corruption affects firms through an entrenchment between entrepreneurs and politicians instead of coercive extortion. Based on this postulate, I refute the claim that firms in a more corrupt environment hold less cash due to liquid assets sheltering from political extraction. Instead, I propose that firms in a more corrupt environment hold less cash because of the high cost of capital. In fact, I find that firms in more corrupt countries hold cash beyond their optimum for the given cost of carry due to severe financial constraints. This excess cash results in value destruction. I call this phenomenon the financial effect of corruption. Thus, I challenge the conventional wisdom and argue that the effects of political corruption on corporate cash holdings are primarily indirect through financial mechanisms.     

The impact of large tax settlement favorability on firms’ subsequent tax avoidance

Review of Accounting Studies - I consider how large tax settlements compare to management expectations and then test how the favorability of a resolution (from the firm’s perspective) affects...     

Multiple corporate governance attributes and the cost of capital – Evidence from Germany

This paper investigates the extent to which corporate governance affects the cost of debt and equity capital of German exchange-listed companies. I examine corporate governance along three dimensions: financial information quality, ownership structure and board structure. The results suggest that firms with high levels of financial transparency and bonus compensations face lower cost of equity. In addition, block ownership is negatively related to firms' cost of equity when the blockholders are other firms, managers or founding-family members. Consistent with the conjecture that agency costs increase with firm size, I find significant cost of debt effects only in the largest German companies. Here, the creditors demand lower cost of debt from firms with block ownerships held by corporations or banks. My findings demonstrate that a uniform set of governance attributes is unlikely to satisfy suppliers of debt and equity capital equally.     

The effect of neglecting the slope parameters’ heterogeneity on dynamic models of corporate capital structure

We present a parsimonious representation of debt-ratio dynamics that is able to nest the Trade-Off, Pecking-Order and Market-Timing theoretical models, at the same time avoiding the poolability of the slope parameters. The inference on the heterogeneous speed of adjustment of the firm towards the target debt ratio is based on a comparison of the unit root results from both individual company and (this is a relative novelty in the case of micro-data) panel data. Results show that company behavior is largely heterogeneous with regard to the theory underlying the historical data. Our proposed methodology may be usefully employed in order to identify sub-samples of companies behaving in an homogeneous manner, and can be extended to study the empirical capital structure models with more appropriate quantitative instruments. This would avoid the arbitrary a priori selection of sub-samples and the imposition of untested poolability assumptions as commonly occurs in the empirical literature.     

Does corporate social responsibility affect the cost of capital?

We examine the effect of corporate social responsibility (CSR) on the cost of equity capital for a large sample of US firms. Using several approaches to estimate firms’ ex ante cost of equity, we find that firms with better CSR scores exhibit cheaper equity financing. In particular, our findings suggest that investment in improving responsible employee relations, environmental policies, and product strategies contributes substantially to reducing firms’ cost of equity. Our results also show that participation in two “sin” industries, namely, tobacco and nuclear power, increases firms’ cost of equity. These findings support arguments in the literature that firms with socially responsible practices have higher valuation and lower risk.     

The impact of audit firms’ characteristics on audit fees following information security breaches

Given the importance of auditors’ assessing business risks and evaluating internal controls, we investigate whether an audit firm’s industry expertise, tenure, and size can help its auditors better understand external and internal threats faced by the client with less effort. Using reported information security breach incidents from 2004 to 2013, we find that, consistent with prior studies, audit fees are higher after the occurrence of an information security breach. However, such an association is negatively moderated when the audit firm has industry-specific expertise, longer experience with the client, and is one of the Big 4 firms. Our results suggest that because of their better knowledge about a specific industry, increased familiarity with the client’s operations, and more resources to understand a client’s vulnerabilities and/or information security policies and procedures, these auditors are more capable of assessing the potentially changing information security risks implied by the occurrence of information security breach incidents. Our results are robust to a variety of sensitivity checks.     

The global financial crisis and the capital structure of firms: Was the impact more severe among SMEs and non-listed firms?

Using a dataset covering about 276,998 firms across 75 countries over the period 2004–2011, this paper examines the short-run evolution of firms' capital structures following the start of the global financial crisis and its immediate aftermath, comparing the experience of already levered SMEs, large non-listed firms, and listed companies. We find that firm leverage and debt maturity declined both in advanced economies and in developing countries, even in those that did not experience a crisis. The deleveraging and maturity reduction were particularly significant for non-listed firms, including both SMEs as well as large non-listed companies. For SMEs, these effects were larger in countries with less efficient legal systems, weaker information sharing mechanisms, less developed financial sectors, and with more restrictions on bank entry. In contrast, there is weaker evidence of a significant decline in leverage and debt maturity among listed companies which are typically much larger than other firms and likely to benefit from the “spare tire” of easier access to capital market financing. Though our results are robust to many changes in sample and specification, we cannot rule out that survivorship bias and attrition could affect our estimates to some degree.     

Firms cash management,adjustment cost and its impact on firms’ speed of adjustment: a cross country analysis

Review of Quantitative Finance and Accounting - We investigate the firms’ specific attributes that determine the difference in speed of adjustment (SOA) towards the cash holdings target in...     

The role of parent firms in business groups’ internal capital markets

Using a unique dataset of unconsolidated financial statements, we investigate the investment and financing policies of parent firms in South Korea's business groups over the period 2003–2016. Parent firms add to their equity-stake holdings substantially each year to support affiliated firms’ capital expenditures. Parent firms finance their equity-stake investment primarily with external funds. These tendencies are more pronounced if parents sit high in the pyramidal chain or are central to controlling other group firms and if parents belong to large business groups. Overall, parent firms prioritize their role as capital raisers and distributors for affiliated firms, and business groups’ internal capital markets are supported by external finance.     

Analysts’ earnings forecast errors and cost of equity capital estimates

This study investigates the relation between analysts’ forecast errors and cost of equity capital estimates implied from analysts’ earnings forecasts and price. My analysis predicts and removes forecast errors from analysts’ earnings forecasts on an out-of-sample basis and then uses these adjusted analysts’ forecasts to reverse-engineer cost of equity capital estimates. While the correction for predictable analysts’ forecast errors meaningfully lowers each of three firm-level implied COEC estimates employed in this study and commonly used in the literature, I do not find that this correction improves their association with realized returns.     

The impact of central bank transparency on systemic risk—Evidence from Central and Eastern Europe

The aim of this paper is to analyze the impact of central bank transparency on systemic risk in emerging banking markets using a sample composed of 34 banks from Central and Eastern Europe for a period spanning from 2005 through 2012. Results indicate a positive and significant relationship between central bank transparency and financial institutions’ contribution to systemic risk. On the other side, increased central bank transparency significantly reduces the idiosyncratic risk of banks. The relationship is influenced by the restrictiveness of regulatory framework. We argue that a more transparent central bank is beneficial for the banking sector from a microprudential perspective. However, it may create incentives for financial institutions to engage in risky activities and through herd behavior may increase individual contribution to the risk of the banking system.     

The effect of information sharing between lenders on access to credit,cost of credit,and loan performance – Evidence from a credit registry introduction

Using a rich dataset from a commercial bank in Albania, we utilize the introduction of a public credit registry by the Albanian central bank in January 2008 as a natural experiment to analyze the effect of information sharing between lenders on (1) access to credit, (2) cost of credit, and (3) loan performance. Our results suggest that information sharing by means of a credit registry does not affect access to or cost of credit, but improves loan performance. Specifically, loans granted after the introduction of the credit registry are 3% points less likely of turning problematic, representing a 35% reduction of the overall sample average arrear probability. We further find that the effect is more pronounced for repeat borrowers and in areas, where competition is weak. This indicates that information sharing among lenders improves loan performance mainly by disciplining borrowers to repay in their concern about future access to credit.