The Book-to-Price Effect in Stock Returns: Accounting for Leverage

This paper lays out a decomposition of book‐to‐price (B/P) that derives from the accounting for book value and that articulates precisely how B/P “absorbs” leverage. The B/P ratio can be decomposed into an enterprise book‐to‐price (that pertains to operations and potentially reflects operating risk) and a leverage component (that reflects financing risk). The empirical analysis shows that the enterprise book‐to‐price ratio is positively related to subsequent stock returns but, conditional upon the enterprise book‐to‐price, the leverage component of B/P is negatively associated with future stock returns. Further, both enterprise book‐to‐price and leverage explain returns over those associated with Fama and French nominated factors—including the book‐to‐price factor—albeit negatively so for leverage. The seemingly perverse finding with respect to the leverage component of B/P survives under controls for size, estimated beta, return volatility, momentum, and default risk.     

Risk association: towards a linguistically informed framework for analysing risk in discourse

This article addresses a fundamental feature of risk discourse, namely, risk association, defined as the process whereby an agent establishes a connection between something, x, and the notion of risk. In addition, risk association can be defined as the result of such a process, i.e. an established connection between x and risk. A special case of risk association is when x is linked to harmful properties and thus is represented as a risk. Although fundamental to any analysis of socio-cognitive attention to risks, the process of risk association is often taken for granted in risk research. A layered model of risk association is presented taking linguistic practices, i.e. the use of words, as the point of departure. Accordingly, there are both central and more peripheral means of risk association. The central means include the morpheme ‘risk’. More peripheral means of risk association are close synonyms and antonyms of risk (e.g. ‘hazard’, ‘danger’, ‘safety’ and ‘security’) and other related words (e.g. ‘crisis’, ‘protection’ and ‘threat’). For an illustration, the model is applied to an empirical example: the instructions for Swedish government agencies. The example illustrates how the exact vocabulary considered for operationalization in analysis has important consequences for the conclusions that follow with respect to the extent to which government agencies are associated with risk.     

Evidence on Risk Changes Around Audit Qualification and Qualification Withdrawal Announcements

Qualifications to an audit report may provide the basis for an auditor's claim that the user was warned about an unusual risk. If audit qualifications highlight changes in firm risk that are material, then the announcement of a qualification should be associated with an increase in the risk of the affected firm. In this paper, we test this proposition. Our initial tests do not detect a shift in systematic risk around qualification announcements; however, subsequent analysis shows that firms announcing recurring material uncertainties have higher levels of systematic risk than firms announcing initial qualifications. Furthermore, we document a significant decrease in systematic risk for firms publicly announcing qualification withdrawals. These results are consistent with announcements of qualification withdrawals providing more timely information to capital market participants than announcements of qualification issuances, which are more likely to have been pre-empted by alternative sources of information. Our findings also indicate that unsystematic, or firm-specific, risk changes significantly around qualification and withdrawal announcement dates. Although systematic risk is of primary importance to investors, information regarding company-specific risk may assist other outside users (i.e., lenders, regulators, employees, rating agencies, etc.) in evaluating a given firm's ability to satisfy its existing contracts. In total, this paper provides evidence that may be useful to many external parties regarding the association between the material uncertainties that are highlighted in audit reports and changes in firm risk.     

The influence of perceived risk on Internet shopping behavior: a multidimensional perspective

The present study analyzes the influence that perceived risk in online shopping has on the process of e‐commerce adoption by end consumers. With this aim, the Technology Acceptance Model is taken as a reference framework, proposing an Extended E‐Commerce Acceptance Model that includes the diverse constructs of perceived risk: financial, performance, social, time, psychological and privacy. Empirical evidence is obtained from two samples, one is composed by Internet users with no experience in web shopping and the other is formed by online buyers. The results obtained confirm that the intention to shop through the Internet is positively influenced by general attitude toward the system and negatively influenced by the risk associated with the Web. Regarding the importance of the risk dimensions considered in the study, the economic and performance facets are the ones that have a greater influence on e‐commerce adoption, while social and time dimensions are the less relevant.     

Geopolitical risk,climate risk and energy markets: A dynamic spillover analysis

This paper provides evidence on the dynamic spillover among geopolitical risk, climate risk, and energy markets from an international perspective. Based on data from 13 countries between December 2002 and February 2022, we firstly confirm an overall connectedness among energy future prices, i.e., crude oil, heating oil and natural gas, with geopolitical risk and climate risk. And then, the dynamic analysis indicates that the spillover effect is frequency dependent and more pronounced at a high frequency. Furthermore, the net dynamic spillover results show that the two major shocks of geopolitical risk associated with Russia on energy markets appear in 2014 and 2022. These effects are also more pronounced at a high frequency, indicating that the conflicts can impose an immediate effect on energy markets. The significant connectedness among energy, geopolitical risk and climate risk remains unchanged after accounting for public attention, adding control variables and using the alternative measures of geopolitical risk and climate risk.     

Downsizing decisions: The joint influence of equity incentives and behavioral biases

Although new investment can be viewed as a decision to pursue projects from a wide number of growth opportunities with easily discernible (and presumably preferable) risk profiles, downsizing (e.g., through layoffs, plant closings, asset divestitures, etc.) is a dichotomous choice to either abandon or continue an existing project where the relative risk between these options is not clear. Our evidence suggests that vega in the pre-downsizing period is associated with risky investment that necessitates future downsizing. We further find that contemporaneous vega is associated with a greater likelihood of downsizing. On the other hand, our evidence suggests that delta is a significant impediment to downsizing. We examine the influence of behavioral factors in the decision-making process and find downsizing decisions are discouraged by managerial overconfidence but encouraged by managers’ aversion to ambiguity. Finally, we investigate whether equity incentives and behavioral factors lead to better downsizing decisions. We find that downsizing firms with high ambiguity perform better after downsizing relative to their matched pair with lower ambiguity.     

Cultural predispositions,specific affective feelings,and benefit–risk perceptions: explicating local policy elites’ perceived utility of high voltage power line installations

Policy controversies concerning the prioritized expansion of the National Energy Grid in the U.S. have drawn our attention to examine the variations of benefit–risk perceptions associated with High Voltage Power Line (HVPL) installation among policy elites, a critical conceptual segment of political actors constituting the U.S. energy policy subsystem. From early psychometric studies to more recent explorations of the emotional aspects of risk appraisal, specifying the role of affective feelings in understanding risk judgment has been a subject of much previous research. This paper seeks to advance such an affect-driven approach in an attempt to account for social psychology-based factors by systemically investigating how specific emotions and personally held intrinsic values and beliefs jointly influence individual-level perceptions of HVPL benefits and risks, relying on recent original survey data containing individual responses from 420 anonymous community leaders and key local policy-makers in the state of Arkansas. Building upon previous research rooted in the dual process model of risk judgment and appraisal tendency framework, a particular emphasis is given to identifying the triadic relationship between culturally biased value predispositions, specific emotional dimensions of affect heuristics, and perceptions pertaining to various aspects of HVPL risks and benefits. Through the implementation of the causal mediation analysis, we found that the effect of cultural value predispositions (i.e. egalitarianism, individualism, hierarchism, and fatalism) on perceived benefits and risks associated with HPVL installation among policy elites is partially mediated by specific affective feelings (i.e. fear, anger, happiness, and excitement) in very distinct ways. We conclude this paper by suggesting that a more robust understanding of the cognitive mechanism of benefit–risk perceptions, particularly those of individuals with more opportunities and resources to shape related policies, promises valuable insight for the development of more effective risk communications and better policy-making practices.     

Extrapolating understanding of food risk perceptions to emerging food safety cases

Important determinants of risk perceptions associated with foods are the extent to which the potential hazards are perceived to have technological or naturally occurring origins, together with the acute vs. chronic dimension in which the potential hazard is presented (acute or chronic). This study presents a case study analysis based on an extensive literature review examining how these hazard characteristics affect people’s risk and benefit perceptions, and associated attitudes and behaviors. The cases include E. coli incidences (outbreaks linked to fresh spinach and fenugreek sprouts), contamination of fish by environmental pollutants, (organochlorine contaminants in farmed salmon), radioactive contamination of food following a nuclear accident (the Fukushima accident in Japan), and GM salmon destined for the human food chain. The analysis of the cases over the acute vs. chronic dimension suggests that longitudinal quantification of the relationship between risk perceptions and impacts is important for both acute and chronic food safety, but this has infrequently been applied to chronic hazards. Technologies applied to food production tend to potentially be associated with higher levels of risk perception, linked to perceptions that the risk is unnatural. However, for some risks (e.g. those involving biological irreversibility), moral or ethical concerns may be more important determinants of consumer responses than risk or benefit perceptions. (Lack of) trust has been highlighted in all of the cases suggesting transparent and honest risk–benefit communications following the occurrence of a food safety incident. Implications for optimizing associated risk communication strategies, additional research linking risk perception, and other quantitative measures, including comparisons in time and space, are suggested.     

Computing the finite-time expected discounted penalty function for a family of Lévy risk processes

Ever since the first introduction of the expected discounted penalty function (EDPF), it has been widely acknowledged that it contains information that is relevant from a risk management perspective. Expressions for the EDPF are now available for a wide range of models, in particular for a general class of Lévy risk processes. Yet, in order to capitalize on this potential for applications, these expressions must be computationally tractable enough as to allow for the evaluation of associated risk measures such as Value at Risk (VaR) or Conditional Value at Risk (CVaR). Most of the models studied so far offer few interesting examples for which computation of the associated EDPF can be carried out to the last instances where evaluation of risk measures is possible. Another drawback of existing examples is that the expressions are available for an infinite-time horizon EDPF only. Yet, realistic applications would require the computation of an EDPF over a finite-time horizon. In this paper we address these two issues by studying examples of risk processes for which numerical evaluation of the EDPF can be readily implemented. These examples are based on the recently introduced meromorphic processes, including the beta and theta families of Lévy processes, whose construction is tailor-made for computational ease. We provide expressions for the EDPF associated with these processes and we discuss in detail how a finite-time horizon EDPF can be computed for these families. We also provide numerical examples for different choices of parameters in order to illustrate how ruin-based risk measures can be computed for these families of Lévy risk processes.     

Litigation reform,accounting discretion,and the cost of equity

In this paper, we isolate a context – the 1995 Public Securities Litigation Reform Act – where information risk (accruals quality) is likely to change, and investigate whether the increase in accounting discretion associated with litigation reform is viewed by investors as basically opportunistic (i.e., as distorting reported earnings) or as improving the ability of reported earnings to reflect economic value. We measure accounting discretion using both positive (i.e., income-increasing) as well as absolute performance-adjusted abnormal accruals. Our analysis focuses on a constant sample of firms over a 10-year (1992–2001) period, and is structured in two stages. In the first-stage, we utilize an instrumental variable technique that isolates the increase in accounting discretion associated with the 1995 Act. In the second-stage, we relate the predicted increase in accounting discretion associated with litigation reform – obtained from the first-stage regression – to the ex ante equity risk premium for Big N audit clients. Our results suggest that the increase in accounting discretion associated with the 1995 Act was viewed by investors as basically opportunistic. Further, the exogenous nature of the 1995 Act suggests that the observed increase (and pricing) of accounting discretion is related to litigation reform rather than some omitted firm-specific operating characteristic. Overall, our findings suggest that litigation reform affects firm value through managers’ exercise of accounting discretion and cost of equity capital channels.     

CEO Compensation Risk and Timely Loss Recognition

Prior studies demonstrate that high CEO compensation risk encourages managers to engage in risk‐seeking behavior, thus intensifying agency conflicts between creditors and borrowers. We argue and document that accounting conservatism plays an important role in mitigating debt holder and shareholder conflicts over asset substitution arising from high CEO compensation risk. Our empirical results show that firms with high CEO compensation risk tend to use more timely loss recognition and this positive relationship is more pronounced for firms with high leverage. Additional results show that the positive relationship between CEO compensation risk and borrowing costs is reduced for firms using timely loss recognition, suggesting that creditors perceive timely loss recognition as a risk‐reducing mechanism. Using the passage of FAS 123R as a quasi‐natural experiment on managerial compensation risk, we find a significant reduction in the use of timely loss recognition for firms experiencing a decrease in CEO compensation risk after the passage of FAS 123R. Lastly, we show that timely loss recognition is positively associated only with the compensation risk of the firm's primary decision maker (i.e., its CEO) and not with the compensation risk of subordinates.     

Do Foreign Investors Encourage Value-Enhancing Corporate Risk Taking?

This paper examines whether foreign investors in Korea affect incentives for firms to take risks in corporate investment. The short-term focus of foreign investors encourages managers to engage in conservative investment behavior. On the other hand, foreign investors encourage managers to focus on long-term value rather than short-term returns as active participants in corporate governance. These competing views are examined by testing for the association between foreign ownership and variations in corporate cash flow, a proxy for the risk of chosen investments. Furthermore, we examine whether risk taking is positively associated with firm growth, which is a primary concern in debates regarding the myopic behaviors of foreign investors. The results show that firms with high foreign ownership are less likely to avoid risk taking—and that risk taking is, in turn, positively associated with firm growth, implying that foreign investors perform a monitoring function in encouraging value-enhancing risk taking.     

Delayed Expected Loss Recognition and the Risk Profile of Banks

This paper investigates the extent to which delayed expected loan loss recognition (DELR) is associated with greater vulnerability of banks to three distinct dimensions of risk: (1) stock market liquidity risk, (2) downside tail risk of individual banks, and (3) codependence of downside tail risk among banks. We hypothesize that DELR increases vulnerability to downside risk by creating expected loss overhangs that threaten future capital adequacy and by degrading bank transparency, which increases financing frictions and opportunities for risk‐shifting. We find that DELR is associated with higher correlations between bank‐level illiquidity and both aggregate banking sector illiquidity and market returns (i.e., higher liquidity risks) during recessions, suggesting that high DELR banks as a group may simultaneously face elevated financing frictions and enhanced opportunities for risk‐shifting behavior in crisis periods. With respect to downside risk, we find that during recessions DELR is associated with significantly higher risk of individual banks suffering severe drops in their equity values, where this association is magnified for banks with low capital levels. Consistent with increased systemic risk, we find that DELR is associated with significantly higher codependence between downside risk of individual banks and downside risk of the banking sector. We theorize that downside risk vulnerability at the individual bank level can translate into systemic risk by virtue of DELR creating a common source of risk vulnerability across high DELR banks simultaneously, which leads to risk codependence among banks and systemic effects from banks acting as part of a herd.     

Reexamining the empirical relation between loan risk and collateral: The roles of collateral liquidity and types

This paper offers a possible explanation for the conflicting results in the literature concerning the empirical relation between collateral and loan risk. We posit that differences in collateral characteristics, such as liquidity, may be associated with the empirical dominance of different risk-collateral relations implied by economic theory. Using credit registry data and a novel identification strategy to control for borrower and lender selection effects allows us to differentiate between the ex ante and ex post theories of collateral. We find that collateral overall is associated with lower risk premiums and higher default rates. The results indicate an important role for collateral in mitigating losses and reducing risk-taking incentives, consistent with ex post theories. Liquid collateral is associated with especially low risk premiums, and these loans perform better than those with illiquid collateral or no collateral. We also find that individual collateral types exhibit significant variation in terms of risk-collateral relations, with some consistent with ex ante theories and others with ex post theories. Our results suggest that the conflicting results in the literature may occur because different samples may be dominated by different types of collateral with different economic characteristics.     

Not all bank systemic risks are alike: Deposit insurance and bank risk revisited

This study investigates how deposit insurance, especially in terms of its design features, affects the sources of banking systemic risk. We do so by decomposing a bank's contribution to systemic risk into idiosyncratic tail risk (Alpha), the exposure to fundamental macroeconomic and finance factors (Beta) and bank interconnectedness (Gamma). Our results indicate that while deposit insurance may increase Alpha, there is a U-shaped relationship between deposit insurance coverage and Beta and Gamma, indicating the existence of an optimal coverage level that minimizes systemic risk. We also find that insurance design characteristics significantly affect the U-shaped relationship. Deposit insurance designed to be independently organized, with public administration, additional supervision and risk minimization functions, and private funding, further reduces the systemic risk associated with any given level of coverage. With several robustness checks, including potential endogeneity, heterogeneity, and possible limits in the sample, the results remain valid. Our results should benefit policymakers who design and optimize deposit insurance schemes to ensure that they play a positive role.     

Openness,financial structure,and bank risk: International evidence

Using panel data from a large cross-country sample covering 97 countries over the period 1996–2017, we combine 2SLS procedure with system GMM estimation to study the relationship between openness, financial structure and bank risk. The main contribution of the paper is that we identified a new channel, i.e. the financial structure channel, through which financial openness reduces bank risk. In particular, we find that as financial openness increases, a country's financial system tends to be more market-based, and a more market-based financial system is associated with higher bank market power, better information sharing and more revenue diversification, all of which contribute to the reduction in bank risk. We also find that the effect of inflow restrictions on bank risk is more pronounced than that of outflow restrictions. These results highlight the importance of an appropriate design of a country's opening-up strategy to match the evolution of its financial structure to increase bank stability.     

Credit default swaps and the market for sovereign debt

In this paper, we analyze the determinants and effects of credit default swap (CDS) trading initiation in the sovereign bond market. CDS trading initiation is associated with a 30–150 basis point reduction in sovereign bond yields, with greater yield reductions accruing to higher default risk economies. For countries with high default risk, rated B or lower by Standard and Poor’s, CDS initiation is also associated with significant price efficiency benefits in the underlying market. CDS trading initiation is more likely following increases in local equity index volatility, index spreads for regional and global CDS markets, or depreciation of the local currency relative to the US dollar, and decreases in a country’s ability to service foreign debt. Our results are robust to selection bias controls based on these factors.     

Robust and consistent estimation of generators in credit risk

Bond rating Transition Probability Matrices (TPMs) are built over a one-year time-frame and for many practical purposes, like the assessment of risk in portfolios or the computation of banking Capital Requirements (e.g. the new IFRS 9 regulation), one needs to compute the TPM and probabilities of default over a smaller time interval. In the context of continuous time Markov chains (CTMC) several deterministic and statistical algorithms have been proposed to estimate the generator matrix. We focus on the Expectation-Maximization (EM) algorithm by Bladt and Sorensen. [J. R. Stat. Soc. Ser. B (Stat. Method.), 2005, 67, 395–410] for a CTMC with an absorbing state for such estimation. This work’s contribution is threefold. Firstly, we provide directly computable closed form expressions for quantities appearing in the EM algorithm and associated information matrix, allowing to easy approximation of confidence intervals. Previously, these quantities had to be estimated numerically and considerable computational speedups have been gained. Secondly, we prove convergence to a single set of parameters under very weak conditions (for the TPM problem). Finally, we provide a numerical benchmark of our results against other known algorithms, in particular, on several problems related to credit risk. The EM algorithm we propose, padded with the new formulas (and error criteria), outperforms other known algorithms in several metrics, in particular, with much less overestimation of probabilities of default in higher ratings than other statistical algorithms.     

Does the Pricing of Financial Reporting Quality Change Around Dividend Changes?

We examine whether accrual earnings quality is a priced information risk factor in a dividend change setting. We define information risk as the probability that firm‐specific financial statement information pertinent to investor pricing decisions is of low precision, and use the factor‐mimicking portfolio returns formed on the Dechow‐Dichev [2002] accrual quality (AQ) metric to proxy for the information risk (IR) factor returns. We augment the Fama‐French three‐factor model with this IR factor, and find that dividend initiation and increase firms exhibit a decrease in the factor loadings on the IR factor while dividend decrease firms exhibit an increase in the corresponding factor loadings, but such changes in the factor loadings occur months prior to the dividend change announcements. The results are robust to further controls for operating risk and using an alternative measure of information risk. Further analysis on changes in information characteristics such as AQ, the probability of informed trading score (PIN), forecast dispersion, and return volatility surrounding dividend change events are consistent with the asset pricing results. Overall, we interpret our results as being consistent with investors treating the information risk associated with the precision of financial statement information as a priced risk factor, with both the precision and pricing changing in predictable directions around dividend changes. However, while we attempt to control for operating risk changes in additional tests, we cannot completely rule out changes in operating risk as a competing alternative explanation for our observed results.