Beating market expectations and the pricing of firms’ probability of default

This study explores the impact of beating analysts' forecasts on investors' perceptions about firms' default probability. The information contained in analysts’ forecasts, both earnings and revenues, provides additional information to investors in pricing CDSs. While previous research has focused on the impact of beating analysts’ earnings forecasts, this study shows that firms that beat analysts' revenue forecasts also experience, on average, a decrease in the CDS premium around the earnings announcement date. This study also documents that the effect is stronger when firms beat/miss both earnings and revenue forecasts. When firms beat (miss) earnings and miss (beat) revenues, the effect of earnings is the dominant signal. These effects are stronger for firms with high levels of default risk.     

Managing specific accruals vs. structuring transactions: Evidence from banking industry

This study investigates earnings management through managing specific accruals vs. structuring transactions in the banking industry. This paper explores the circumstances under which banks manipulate loan loss provisions vs. circumstances that lead banks to structure loan sales and securitizations for the purpose of achieving earnings benchmarks. Empirical results show that banks manage earnings through loan loss provisions, before resorting to structuring transactions, to avoid small earnings decreases and or just meet or beat analysts' forecasts. The findings imply that structuring loan sales and securitizations is more likely to be used as a secondary instrument. In addition, I find that the earnings of banks with lower discretionary loan loss provisions and higher discretionary gains from loan sales and securitizations are priced more negatively, suggesting that investors impose incremental penalties on the joint use of loan loss provisions and gains from loan sales and securitization to meet or beat earnings benchmarks.     

Earnings performance of major customers and bank loan contracting with suppliers

Using a sample of 3725 loan facility–years for supplier firms that have financial data on their major customers during the period 1995–2011, this study investigates whether the earnings performance of major customers has effect on the price and nonprice terms of loans to the supplier firms. We find that various contracting terms are more favorable for loans to supplier firms whose major customers have higher return on assets (ROA). More importantly, we find that the effect of major customers’ earning performance on loan contracting terms is weaker for the borrowers with prior loan relationships with banks, while it is stronger for the borrowers that are highly dependent on their major customers. Our results suggest that banks take into account major customers’ earnings performance when contracting with their supplier firms, and the informativeness of customer earnings varies with the nature and strength of the customer–supplier relationships.     

Institutional investor type,earnings management and benchmark beaters

This paper classifies institutional investors into transient or long-term by their investment horizons to examine the association between institutional investor type and firms’ discretionary earnings management strategies in two mutually exclusive settings – firms that (do not) use accruals to meet/beat earnings targets. The results support the view that long-term institutional investors constrain accruals management among firms that manage earnings to meet/beat earnings benchmarks. This suggests long-term institutional investors can mitigate aggressive earnings management among these firms. Transient institutional ownership is not systematically associated with aggressive earnings management and is evident only among firms that manage earnings to meet/beat their earnings benchmarks. This indicates transient institution-associated managerial myopia may not be as prevalent as posited by critics. This study highlights the importance of explicitly considering the type of institutional investor and the specific setting when investigating the association between institutional ownership and corporate earnings management.     

The market’s use of supplier earnings information to value customers

In this paper we examine whether the quarterly earnings announcements of supplier firms contain information about their customer’s earnings. Our evidence suggests that they do. Specifically, we find evidence consistent with the market impounding supplier firm earnings information into the stock prices of the firm’s customers. This is consistent with the market using the supplier’s earnings to help assess the customer firm’s future cash flows and/or uncertainty of those cash flows. We also find that the quality of the earnings influences the magnitude of the customer firm’s stock price reaction. The customer’s stock price reaction is increasing in the revenue growth reported by the supplier and the past persistence of the supplier’s earnings. Additional tests reveal that the market reaction is amplified when the customer firm is more dependent on the supplier. Finally, we find that the relative bargaining power of the customer influences the market reaction to supplier earnings. While prior research has documented that the market uses industry peer earnings and customer earnings in pricing a firm’s stock, this is the first study to provide evidence on the market’s use of supplier earnings information.     

Do interbank customer relationships exist? And how did they function in the crisis? Learning from Italy

Using 11 years of monthly Italian bank-by-bank data, this paper correlates the bilateral amounts and the identity of each interbank borrower and lender with a long list of explanatory variables. The results show that interbank customer relationships, i.e. stable and strong relationships between pairs of borrowing and lending banks, do exist in Italy, that they persist over time, and that they functioned well during the crisis, enabling the healthier banks to provide and the troubled ones to receive funds.     

Analyst reputation and management earnings forecasts

Prior studies show that analysts with high reputation are influential in the market. This paper examines whether managers consider analyst reputation in shaping their voluntary disclosure strategy. Using Institutional Investor magazine’s All-American (AA) rankings as a proxy for analyst reputation, we find that the coverage of AA analysts is positively associated with the likelihood of quarterly management earnings forecasts (MEFs). We also find that AA analysts’ forecast optimism is more positively associated with the likelihood of MEFs than non-AA analysts’ forecast optimism when the firm is covered by AA analysts. Analyses based on AA analyst coverage changes and AA status changes confirm the relation between analyst reputation and MEFs. We further find that analyst reputation influences other MEF properties, such as forecast news, bias, and revisions, and that our results are robust to alternative measures of analyst reputation. Further analyses show that market reactions at quarterly earnings announcements are more positive (negative) when firms meet/beat (miss) AA analysts’ forecasts than when firms meet/beat (miss) non-AA analysts’ forecasts. Collectively, our findings suggest that managers strategically provide voluntary forecasts by taking into account the reputation of individual analysts following their firms.     

Discretion in bank loan loss allowance,risk taking and earnings management

We study whether banks use the allowance for loan losses (ALL) for efficiency or for opportunistic reasons. We find that banks that had higher abnormal ALL during the period prior to the 2007–2009 crisis engaged in less risk taking during the pre‐crisis period and had a lower probability of failure during the crisis period. In testing earnings management to meet or beat earnings benchmarks, we find that abnormal ALL is unrelated to next period's loss avoidance and just meeting or beating the prior year's earnings. Our results suggest that banks use ALL for efficiency and not for opportunistic purposes.     

Auditor reputation and earnings management: International evidence from the banking industry

We examine the relation between auditor reputation and earnings management in banks using a sample of banks from 29 countries. In particular, we examine the implications of two aspects of auditor reputation, auditor type and auditor industry specialization, for earnings management in banks. We find that both auditor type and auditor industry specialization moderate benchmark-beating (loss-avoidance and just-meeting-or-beating prior year’s earnings) behavior in banks. In addition, we find that once auditor type and auditor industry specialization are included in the same tests, only auditor industry specialization has a significant impact on constraining benchmark-beating behavior. In separate tests related to income-increasing abnormal loan loss provisions, we find that both auditor type and auditor expertise constrain income-increasing earnings management. Again, in joint tests, only auditor industry expertise has a significant impact on constraining income-increasing earnings management.     

Anticipated Earnings Announcements and the Customer–Supplier Anomaly

I test whether the anticipation of earnings news stimulates acquisition of customer information and mitigates returns to the customer–supplier anomaly documented by Cohen and Frazzini (“Economic Links and Predictable Returns.” The Journal of Finance 63 (2008): 1977–2011). I find that attention to a firm's publicly disclosed customers increases shortly before the firm announces earnings, and that customer stock returns predict supplier stock returns shortly before, but not after, the supplier's earnings announcement. I further find some evidence that these predictable returns are increasing in the level of customer information acquisition. These results are unique to anticipated disclosure events and suggest that anticipation of supplier earnings announcements resolves investor limited attention to customer information and accelerates price discovery of customer news.     

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.     

To beat or not to beat? The importance of analysts’ cash flow forecasts

We investigate the implications of firms’ benchmark-beating patterns with respect to analysts’ quarterly cash flow forecasts for firms’ current capital market valuation and their future performance. We hypothesize that nonnegative earnings surprises are more likely to be supported by real operating performance and signal higher earnings quality if they are achieved via higher than expected cash flows or lower than expected accruals. We show that firms beating analyst earnings forecasts have larger positive capital market reactions and larger earnings response coefficients if they beat analyst cash flow forecasts or report lower than expected accruals. We also demonstrate that these firms’ superior future performance may provide an economic justification for their more favorable market response. Our findings suggest that firms’ ability to beat analyst cash flow forecasts is informative regarding the quality of their earnings surprises.     

Customer concentration and loan contract terms

We study pricing and non-pricing features of loan contracts to gauge how the credit market evaluates a firm’s customer-base profile and supply-chain relations. Higher customer concentration increases interest rate spreads and the number of restrictive covenants featured in newly initiated as well as renegotiated bank loans. Customer concentration also abbreviates the maturity of those loans as well as the relationship between firms and their banks. These effects are intensified by customers’ financial distress, the level of relationship-specific investments, and the use of trade credit in customer–supplier relations. Our evidence shows that a deeper exposure to a small set of large customers bears negative consequences for a firm’s relations with its creditors, revealing limits to integration along the supply chain.     

The impact of religiosity on earnings quality: International evidence from the banking sector

We examine the impact of religiosity on earnings quality, utilising a global sample of 1283 listed banks headquartered in 39 countries and covering the period 2002–2018. Using instrumental variables two-stage least squares regressions, we demonstrate that religiosity has a significant positive impact on banks’ earnings quality. We further show that the impact of religiosity becomes more pronounced among banks headquartered in countries where religion is an important element of national identity and in countries with weak legal protection. We show that the effects of religiosity are more intense during the global financial crisis period. Overall, these findings support the notion that high religiosity tends to reduce unethical activities by managers and can function as an alternative control mechanism for minimising agency costs. Our empirical investigation is robust to alternative model and sample specifications.     

Evidence of differing market responses to beating analysts’ targets through tax expense decreases

Returns are positive when firms meet or beat analysts’ consensus forecasts, but negative when firms miss. Prior research finds little substantial discount for managing earnings to beat the forecasts via accruals generally. We consider whether the market reward for beating the forecast is smaller when firms use tax expense decreases, which are visible and transparent at the earnings announcement date, unlike accruals. When firms beat analysts’ forecasts by decreasing their tax expense relative to the third-quarter rate, the market discounts the reward by an economically significant amount: approximately 86%. We document lower persistence of current-year tax changes for those firms that decrease tax expense to beat the target. The observed discount for beating the forecast only because of a third to fourth quarter tax decrease may reflect market perceptions of the lack of persistence of the decrease.     

Capital and Earnings Management: Evidence from Alternative Banking Business Models

This paper examines whether institutional characteristics distinguishing Islamic from conventional banks lead to distinctive capital and earnings management behavior through the use of loan loss provisions. In our sample countries, the two banking sectors operate under different regulatory frameworks: conventional banks currently apply the “incurred” loan loss model until 2018 whereas Islamic banks mandatorily adopt an “expected” loan loss model. Our results provide significant evidence of capital and earnings management practices via loan loss provisions in conventional banks. This finding is more prominent for large and loss-generating banks. By contrast, Islamic banks tend not to use loan loss provisions in either capital or earnings management, irrespective of the bank's size, earnings profile, or the structure of their loan loss model. This difference may be attributed to the constrained business model of Islamic banking, strict governance, and ethical orientation.     

Investment bank monitoring and bonding of security analysts’ research

We assess investment banks’ influence over the agreement between their analysts’ research behavior and their clients’ interests, in the post-reform era. Competing banks discipline their analysts with worse career outcomes for producing biased reports, issuing shirking reports, and for involvement in the earnings guidance game, showing meaningful monitoring of their analysts. Highly reputable banks provide more monitoring discipline of their analysts and bonding of their moral hazard than other banks. The findings agree with the banks taking responsibility for aligning analysts’ behavior with clients’ interests.     

Economic policy uncertainty and bank earnings opacity

Using a sample of U.S. banks and an index for economic policy uncertainty developed by Baker et al. (2016), we investigate whether economic policy uncertainty is systematically related to bank earnings opacity. When economic policy is relatively uncertain, it is easier for bank managers to distort financial information, as unpredictable economic policy changes make assessing the existence and impact of hidden “adverse news” more difficult for investors and creditors. Economic policy uncertainty also increases the fluctuation in banks’ earnings and cash flows, thus providing additional incentives and opportunities for bank managers to engage in earnings management. Our results show that uncertainty in economic policy is positively related to earnings opacity, proxied by the magnitude of discretionary loan loss provisions and the likelihood of just meeting or beating the prior year’s earnings, and negatively related to the level of accounting conservatism (i.e., the timeliness of recognition of bad news relative to good news). Collectively, our results suggest that economic policy uncertainty leads to greater earnings opacity. We also find that the impact of economic policy uncertainty on financial reporting distortion is less pronounced for stronger banks (i.e., banks with high capital ratios).     

Can pure play internet banking survive the credit crisis?

This paper positions the pure-play internet banking model (PPI) as a hybrid business model that combines features of both relationship and transaction banking. Although in terms of customer orientation PPI banks may partly resemble relationship banks, they lack their comparative advantage in generating borrower-specific information. Instead, the characteristic features of PPI banks are low costs and easy scalability. While the latter may enable PPI banks to quickly capture market share, it may also generate overexposure in risky markets. We present a case study on ING Direct, one of the leading global PPI banks and address the sustainability of the PPI business model by comparing the ING Direct foreign operations. The findings for ING Direct are validated using data for E-Trade Bank. We conclude that managing growth appears to be the prime challenge to PPI banks.