Does financial reporting regulation influence the value of cash holdings?

We investigate how the value of cash holdings changes following the mandatory adoption of International Financial Reporting Standards (IFRS), which is viewed as an exogenous shock to information asymmetry between firms and outside investors. Using firm-level data from 47 countries, we find that mandatory IFRS adoption has a negative and significant impact on the value of cash holdings. This result suggests that investors reduce their valuation of cash holdings when firms can have access to external financing at a lower cost under IFRS. The negative effect of IFRS is concentrated among financially constrained firms. Furthermore, we show that the effect is more pronounced in countries with strong legal enforcement. Overall, our evidence highlights that financial reporting regulation can have a significant effect on how outside investors value corporate cash holdings across countries.     

Security or opportunity: the influence of risk‐taking tendency on risk information preference

It has been suggested that risk avoiders and risk takers differ in the extent to which they focus on the worst and best outcomes of a risky activity. By implication risk avoiders and risk takers should also differ in their risk information preferences. Specifically, as risk avoiders focus more on the worst outcomes, it was hypothesized that they would prefer negative information about the risk. In contrast, as risk takers focus more on the best outcomes, it was hypothesized that they would prefer positive information about the risk. In an information selection task, subjects could select newspaper headlines that indicated negative and positive information about a variety of risks. Contrary to the hypothesis, risk avoiders selected more positive information than risk takers. The results are discussed in relation to the influence of personality on risk taking. One tentative explanation is that differences in anxiety between risk avoiders and risk takers account for these results in that risk avoiders try to find reassurance by seeking positive information. Another is that the participants were seeking reassurance in a relatively involuntary confrontation with risks.     

Loss of Defensive Capacity in Protective Operations: The Implications of the Überlingen and Linate Disasters

A clear distinction is often drawn between the functions of production and protection in organisations. This implies that they have twin capacities – for production and for protection – that in some respects will be interdependent and in some independent. In the field of operations management productive capacity is a commonly used construct, and there has been some attempt to develop a parallel construct of protective capacity, but this has only been used to refer to capacity that protects productive capacity. It makes no reference to the risk of external harm. This paper presents an attempt to develop the idea of defensive capacity. It uses case studies of two aviation collisions to gain an understanding of what defensive capacity amounts to, and how it can be lost. The results pointed to a way of operationalising defensive capacity that involves preserving its qualitative complexity instead of reducing it to a quantitative variable. They also point to a complex relationship between productive capacity and defensive capacity, which are sometimes complimentary and sometimes opposing. They have certain shared determinants, but certain actions can undermine defensive capacity without there being any observable effect on productive capacity.     

The role of accounting in bank regulation on the eve of japan’s financial crisis: a failure of the new capital adequacy regulation

In contrast to previous examinations of the role of accounting in financial crises, this paper explores the way in which accounting has been woven into a new system of banking regulations. Although the regulatory reform of the mid-1980s was intended to maintain the soundness of banking businesses, it failed to prevent banks from excessive asset expansion in the latter half of the 1980s in Japan. One of the major causes of this regulatory failure is found in the way that the regulatory capital is defined for the new capital adequacy regulation. The latent revaluation reserves are partially counted as capital. Japanese domestic regulatory reform took place in the wider context of the international standardization of capital adequacy regulations (BIS standards). Japanese regulators utilized taken-for-granted practices of accounting to creatively comply with the BIS standards.     

Lessons from the financial crisis: failure of markets or failure of regulation?

The popular, demagogic narrative after the global financial system's collapse in 2008 has held that the financial crisis signalled the failure of capitalism. However, regulators across the world must realize that the financial crisis was not brought about by the failure of markets but by the failure of governments to appropriately regulate markets. Beginning in the 1980s, and continuing over the quarter-century that followed, regulators afforded the world of big finance an unaffordable luxury: insurance against possible failure. As a result, banks and financial institutions became adept at turning their insulation from disorderly failure, as enforced by free markets, into insulation from market discipline, as inflicted by myopic regulators. This ‘too big to fail’ syndrome combined with the incorrect belief perpetrated by the Federal Reserve Chairman Alan Greenspan that financial companies, powered by a rational motive not to lose money, could police themselves and one another. In turn, such sanguine beliefs led to considerable over-supply of financial innovation. The supply created its own demand as the financial world operated under the implicit guarantee (and market distortion) created by the ‘too big to fail’ syndrome.

The errors laid bare by the financial crisis clearly call for regulatory reform. But in designing that reform, regulators across the world should avoid the temptation to seek heavy-handed new approaches. Instead, policymakers should look to the long-term success of the system of rules whose decay brought about the crisis. Prudent regulations must seek to reinforce the fundamental principle that no one, however big or small, can be made immune to failure. Such pro-market regulation of finance is essential to preserving and fostering countries’ economic futures.     

New development: The future of public service regulation—the professional's perspective

Regulatory failures have shifted the debate from the burden of regulation to its effectiveness. In response, regulators will be more sceptical of self-assessments, more responsive to consumers, provide better information, investigate inputs as well as outcomes and work more collaboratively.     

Risk-shifting and the regulation of bank CEOs’ compensation

This paper analyzes the effects of two regulatory mechanisms, namely a regulation of the structure of bank CEOs incentive pay and sanctions for the CEOs of failed banks, on bank risk shifting. We extend a standard model of CEO compensation by incorporating leverage and an investment decision. To the extent that bank depositors and creditors are even partially protected by public guarantees, we show that it is in the interests of bank shareholders to choose more risky investments than would be socially optimal, and therefore to design a CEO contract with excessive risk taking incentives. Thus, we argue that current corporate governance arrangements in the banking sector are not efficient. In this setting, we show that putting in place one of the aforementioned mechanisms could yield the socially optimal outcome at no cost. We also identify some limitations and potential perverse effects of these mechanisms.     

Determinants of the capital adequacy ratio of foreign banks’ subsidiaries: The role of interbank market and regulation

This paper examines the factors influencing the capital adequacy ratio (CAR) of foreign banks. We test whether the CAR of subsidiaries and branches in developed and developing countries depends on the same factors. We use data from 310 subsidiaries and 265 branches to test the impact of the parent banks’ fundamentals on subsidiaries’ and branches’ capital ratios. We also study how the economic condition and regulatory environment in a bank's home country determine foreign banks’ CAR. Our results provide strong evidence that the CAR of subsidiaries and branches operating in developing and developed countries do not depend on the same set of explanatory factors. We also find that the regulatory framework of a parent bank's home country affects the capitalization of its foreign subsidiaries in the host countries. Finally, we show that specific variables of the parent bank have a stronger effect for foreign banks highly related to the interbank market.     

Money,politics, and the regulation of public accounting services: Evidence from the Sarbanes–Oxley Act of 2002

Because public accounting is a regulated practice, the profession actively manages its relationship with the state. While prior studies have analyzed the profession’s efforts to shape its regulatory environment, few studies have examined the profession’s pointed attempts to influence a specific regulatory policy that affects the practice of auditing in the United States. Drawing on extant theories of regulation and political economy, this study investigates the rationality and effectiveness of political action committee (PAC) contributions paid to members of the US Congress by the US public accounting profession during the policy formulation period of the Sarbanes–Oxley Act of 2002. Based on the results of empirical tests, we conclude that the US profession strategically manages its relationship with the federal government, in part, through direct involvement in the financing of political campaigns. Furthermore, the profession’s pattern of contributions implies an ideologically conservative as well as a professional regulatory motivation for providing financial support to federal legislators. Thus, although the US profession continues to proclaim the primacy of its public interest orientation, it does not appear to be politically neutral when attempting to influence public policy.     

Public meetings about local cancer clusters: exploring the relative influence of official versus symbolic risk messages on attendees’ post‐meeting concern

Scholars have long lobbied for a view of risk communication that supplants a conventional ‘transmission’ model of risk communication with an alternative that considers the complex social environment that accompanies any risk communication effort. Along these lines, this study examines the relative influence of official health messages versus symbolic risk messages on public meeting attendees’ post‐meeting concern about cancer clusters in six US communities. As part of a larger study of cancer clusters, we obtained written responses from 125 individuals who attended a government‐sponsored public meeting in their community. We asked respondents whether attending the meeting influenced their concerns and, if so, why. The results found that, despite the largely reassuring messages that health officials were giving, most attendees reported feeling more concerned after the meetings in their communities. Regarding why, explanations that denoted symbolic risk messages – unofficial sources of risk information and procedural cues – outnumbered explanations that pointed to official risk messages – scientific presentations – by a score of three to one. The results lend support for a broader view of risk communication, which accounts not only for multiple sources of risk information but also for procedural cues regarding the trustworthiness of an investigation.     

Portfolio diversification: the influence of herding,status-quo bias,and the gambler’s fallacy

This experimental study examines the influence of herding [following the majority of fellow gamblers or the most successful gambler (guru)], status-quo bias, and the gambler’s fallacy on diversification behavior. We find that neither herding nor status-quo bias contributes significantly to non-optimal portfolio choices. The gambler’s fallacy, however, plays an important role in these decisions. Many subjects appear to find patterns in a history of random events and then use these “patterns” to infer the sequence of future events. The gambler’s fallacy is significantly responsible for the fact that the optimal structure of a portfolio is considered in only 37.7% of all choices made by an investor.     

IASB's independence in the due process: an examination of interest groups’ influence on the development of IFRS 9

This mixed-method study examines whether and how the International Accounting Standards Board (IASB) was influenced by interest groups during the development of the expected credit loss (ECL) model for IFRS 9 Financial Instruments. Content analysis of 327 comment letters revealed that the IASB was influenced. However, Fisher's exact test and chi-square goodness-of-fit test showed that, to a greater extent, the influence was not significant. Furthermore, qualitative analyses of the arguments put forward by interest groups showed that as a result of interest groups’ inputs, accounting requirements for the ECL model were made more operational, less complex and potentially productive of more comparable financial information.     

Twenty‐five years of the Taffler z‐score model: Does it really have predictive ability?

Although copious statistical failure prediction models are described in the literature, appropriate tests of whether such methodologies really work in practice are lacking. Validation exercises typically use small samples of non‐failed firms and are not true tests of ex ante predictive ability, the key issue of relevance to model users. This paper provides the operating characteristics of the well‐known Taffler (1983) UK‐based z‐score model for the first time and evaluates its performance over the 25‐year period since it was originally developed. The model is shown to have clear predictive ability over this extended time period and dominates more naïve prediction approaches. This study also illustrates the economic value to a bank of using such methodologies for default risk assessment purposes. Prima facie, such results also demonstrate the predictive ability of the published accounting numbers and associated financial ratios used in the z‐score model calculation.     

Does auditor tenure influence the reporting of conservative earnings?

In this study, we examine the relation between auditor tenure and the reporting of conservative earnings. Using several measures of conservatism, we document a positive association between the conservatism in reported earnings and the length of the auditor–client relationship. We further document an increase in conservatism between short and medium tenure that does not deteriorate over long tenure. Collectively, the results imply lower conservatism for short auditor tenure, which suggests that mandating auditor rotation may have an adverse affect on the conservatism in reported earnings.     

The role of the media in corporate governance: Do the media influence managers' capital allocation decisions?

Using 636 large acquisition attempts that are accompanied by a negative stock price reaction at their announcement (“value-reducing acquisition attempts”) from 1990 to 2010, we find that, in deciding whether to abandon a value-reducing acquisition attempt, managers' sensitivity to the firm's stock price reaction at the announcement is influenced by the level and the tone of media attention to the proposed transaction. We interpret the results to imply that managers have reputational capital at risk in making corporate capital allocation decisions and that the level and tone of media attention heighten the impact of a value-reducing acquisition on the managers' reputational capital. To the extent that value-reducing acquisition attempts are more likely to be abandoned, the media can play a role in aligning managers' and shareholders' interests.     

The omnipresent influence of the SEC in the work of the Accounting Principles Board, 1959–1973

During the tenure of the Accounting Principles Board, the Securities and Exchange Commission frequently played an influential role in its deliberations and in its process of establishing accounting principles, as a reminder to the Board of its obligation to serve the investing public. The object of this paper is to document these influences and therefore to explore why the APB seemed to fail in its mission.     

Public Panic and Morale: Second World War Civilian Responses Re‐examined in the Light of the Current Anti‐terrorist Campaign

Following September 11 in the US and July 7 in the UK, the threat to civilians from terrorist attack has become real yet considerable disagreement exists about how people might respond. The effect of aerial bombing on the public's morale during the Second World War and the incidence of psychiatric casualties have been explored to provide reference points for the current terrorist threat. Systematic study of restricted government investigations and intelligence reports into the effect of air‐raids on major British towns and contemporary medical publications have shown that panic was a rare phenomenon and arose in defined circumstances. Morale fluctuated according to the intensity of attacks, preparedness and popular perceptions of how successfully the war was being conducted. Resilience was in part a function of the active involvement of the public in its own defence but also reflected the inability of German bombers to deliver a concentrated attack over a wide area. Most civilians, by their very numbers, were likely to survive. Inappropriate or excessive precautionary measures may serve to weaken society's natural bonds and, in turn, create anxious and avoidant behaviour. Weapons that tap into contemporary health fears have the greatest psychological impact. Efforts by government to engage the public not only build trust but may also make an effective contribution to the campaign against terrorism.     

Bias in the tone of forward‐looking narratives

We extend the prior literature on biased disclosure decisions by examining whether, when and how managers bias the tone of forward‐looking narratives. In order to measure tone we employ techniques of manual content analysis and we aggregate positive, neutral and negative statements into an overall measure of tone.We then analyse the frequency of positive and negative statements for firms with large impending year‐on‐year changes in sales and operating profit margin, and we regress tone cross‐sectionally on four managerial incentive variables that are unrelated to the private signal about future trading, namely loss status, sign of earnings change, business risk, and the existence of an analyst earnings forecast. We find that firms with large impending performance declines bias the tone in the outlook section upwards. Also, we find that loss firms, risky firms and firms with an analyst earnings forecast provide a more positive tone, while firms with an earnings decline provide a more negative tone. Finally, we observe that for a majority of our managerial incentive variables the main vehicle of biasing the tone is to change the number of negative statements, not the number of positive statements. Overall, our findings are difficult to reconcile with predictions from signalling models, but they are consistent with the alternative view of impression management. Our results have policy implications. In particular, they suggest that there is a need to reconsider the current largely unregulated nature of forward‐looking narratives.     

Does debt capacity matter in the choice of debt in reducing the underinvestment problem?

We test the impact of debt capacity on firms’ simultaneous decisions of leverage and debt maturity in reducing underinvestment problems. Examining 24 OECD countries for the period between 1990 and 2011, we find strong evidence, that, unlike previous studies, the role of leverage and debt maturity in reducing underinvestment problems is not homogeneous across firms with varied debt capacity. We find new evidence that, when firms face lower debt capacity constraints, they benefit from their ability to use a greater amount of debt if they shorten their debt maturity, or gain from using longer maturity of debt if they decrease their leverage to reduce underinvestment problems. Our results suggest that they also benefit from the ability of their firms to gain from interest tax shields by financing more with debt or long-term debt, and hence use debt maturity and leverage as strategies substitutes. However, when firms are constrained by concerns over debt capacity, they tend to opt for a lower level of debt that is mainly short-term to reduce the underinvestment problem. Our results suggest that firms with lower debt capacity cannot completely resolve their underinvestment problems by using short-term debt or low leverage, implying that the effects of the liquidity risk outweigh those of underinvestment problems, and hence impose a constraint on firms’ choice of debt.     

Understanding the framing effect: do affective responses to decision options mediate the influence of frame on choice?

Little research has examined how gain- and loss-framed options influence participants’ affective states. In the current paper, we present two studies that measure affective responses to framed options to identify a potential mediator of the relation between frame and choice. We found that participants reported more positive responses after reading gain-framed options that presented a certain outcome compared to loss-framed options that presented a certain outcome, consistent with the choice patterns of the framing effect. We also found that framing effects were mediated by affective evaluation of the options. We suggest future researchers continue to assess the influence of affective response on evaluating options and making decisions.