The Volatility of European Banking Systems: A Two-Decade Study

This paper examines the trends and composition of volatility across European banking systems from January 1988 to December 2010. While there is no evidence of a long-term trend in the average level of banking system volatility, there is a change in its composition resulting from the growing importance of International and European nonfinancial components, especially in the largest banking systems. We argue that the changing composition of banking system volatility is the effect of a long-term integration process (with a growing importance of cross-border activities) that has not been influenced by the introduction of the Euro. Our results highlight the increasing vulnerability of the European banking systems to International and European shocks and an increasing likelihood of cross-border banking crises, and the need for regulatory reforms that focus on effective cross-border crisis management and resolution so as to safeguard the systemic stability of European banking in the near future.     

The Unintended Consequences of High Expectations and Pressure on New CEOs

We provide empirical tests of a general version of targeting theory that greater scrutiny could lead to executive abuses. Our results show that new CEOs under higher expectations or pressure are more likely to report meeting analyst forecasts; however, this apparent superior performance dissipates after excluding firms having characteristics synonymous with earnings manipulation. We find evidence that new CEOs under greater pressure are considerably more likely to engage in manipulation while the link between expectations and manipulation is much weaker. The results are strongest for new CEOs whose firms report meeting forecasts and do not “walk down” earnings estimates.     

How prior realized outcomes affect portfolio decisions

Investors have been shown to have particular preferences when it comes to the characteristics of stock they hold in their portfolios, while prior gains and losses have been shown to impact on individuals’ economic decisions, both in an investment context and more widely. This paper is the first to investigate how prior gains and losses affect investors’ preferences for particular stock characteristics and so shape their portfolio compositions. Using a rich dataset combination from China, we conclude that prior realized outcomes play an important role in shaping portfolio composition through their impact on the characteristics of stocks that investors choose to hold. We find that positive prior realized outcomes encourage investors to select stocks with a variety of characteristics broadly consistent with higher risk taking (for example, higher betas and higher levels of idiosyncratic risk), though there are some differences across investor classes. While our empirical results are in line with what one would expect from the existing literature on the disposition and house money effects, we also consider other possible interpretations of the results.     

Qualitative audit materiality and earnings management

This study investigates auditors’ propensity to rely on quantitative materiality thresholds to the exclusion of qualitative materiality thresholds. Specifically, we examine whether auditors are more likely to allow earnings management that is less than typical quantitative materiality thresholds but that nonetheless is qualitatively material. We use changes in tax expense as a proxy for earnings management. Our results indicate that companies with pre-managed earnings that would have missed the consensus analyst forecast are more likely to decrease their tax expense when the magnitude of the decrease is less than quantitative audit materiality thresholds. The results also indicate that firms are more likely to meet or beat the forecast when the amount of earnings management necessary to meet the analyst forecast is less than quantitative materiality. These results are consistent with auditors relying on quantitative materiality thresholds to the exclusion of qualitative materiality thresholds, i.e., the importance of meeting or beating the analyst forecast. Finally, we find that the ability to use tax expense reduction within quantitative materiality to meet or beat analysts’ consensus forecasts was significantly reduced by the SEC’s guidance on materiality in SAB-99 and by the passage of the Sarbanes–Oxley Act.     

Dividend valuation,trading and transactions costs: the 1997 partial abolition of dividend tax credit repayments

Although UK resident tax-exempt shareholders lost the right to repayment of tax credits on dividends paid by UK resident companies in July 1997, they could continue to receive tax credit repayments in respect of dividends received from Irish resident companies until December 1998. In July 1997 the rate of tax credit on Irish companies' dividends was 21%, and this was reduced to 11% in December 1997. We obtain insights into the incentives and behaviour of UK tax-exempt investors in response to these changes in the relative ‘tax attractiveness’ of investments in Irish resident companies. We find that only at its highest rate, 21%, was the level of dividend tax credit on Irish companies' dividends sufficient to induce changes in UK tax-exempt shareholders' investment strategies; and that the propensity for dividend capture by tax-exempt investors is heightened when the dividend tax credit yield is of the order of 0.8 or more and dividend yield is of the order of 2.6% or more.     

The consequences to analyst involvement in the IPO process: Evidence surrounding the JOBS Act

The JOBS Act allows certain analysts to be more involved in the IPO process, but does not relax restrictions on analyst compensation structure. We find that these analysts initiate coverage that is more optimistically biased, less accurate, and generates smaller stock market reactions. Investors purchasing shares following these initiations lose over 3% of their investment by the firm's subsequent earnings release. By contrast, issuers, analysts, and investment banks appear to benefit from this increased bias, as optimism is more positively associated with proxies for firm visibility and investment banking revenues when analysts are involved in the IPO process.     

CORPORATE HEDGING AND SHAREHOLDER VALUE

Although theory suggests that corporate hedging can increase shareholder value in the presence of capital market imperfections, empirical studies show overall mixed support for rationales of hedging with derivatives. Although various empirical challenges and limitations advise some caution with regard to the interpretation of the existing evidence, the results are consistent with derivatives use being just one part of a broader financial strategy that considers the type and level of financial risks, the availability of risk management tools, and the operating environment of the firm. Moreover, corporations rely heavily on pass‐through, operational hedging, and foreign currency debt to manage financial risk.     

Educational Insights: A Hybrid Course in Risk Management and Insurance

Universities and colleges continue to face constraints related to classroom space and faculty time, thus increasing the need to consider options such as hybrid courses that can leverage available resources. This article discusses the benefits of a hybrid course, as well as its design and implementation at a large, public university. In addition, for universities that use the introduction to risk and insurance course as a significant course for attracting majors, we identify the benefits for students from the use of hybrid courses, such as the variety of materials and activities utilized, as well as the flexibility in scheduling. This information may be useful in marketing the course so that it will be immediately attractive to students.     

How well do investors understand loss persistence?

This paper examines investors’ expectations of loss persistence. I develop a model to forecast loss firms’ future earnings based on Joos and Plesko, The Accounting Review 80: 847–870, (2005). This model produces smaller forecast errors than two random walk models and a model that assumes losses are transitory. The results suggest that investors do not fully distinguish the differences in loss persistence captured by the model and instead appear to assume that all losses are transitory. Consequently, investors are surprised by future announcements of negative earnings for firms with predicted persistent losses, and these firms experience significantly negative abnormal returns over the following four quarters. Additional results indicate that the future negative returns of firms with predicted persistent losses are smaller in magnitude when these firms are followed by analysts. The results are robust to controls for various price anomalies and are not driven by short sale constraints.     

A theory of risk disclosure

In this paper, we consider the price effects of risk disclosure. We develop a model in which investors are uncertain about the variance of a firm’s cash flows and the firm releases an imperfect signal regarding this variance. In our model, uncertainty over the riskiness of a firm’s cash flows leads to a variance uncertainty premium in its price. We demonstrate that risk disclosure decreases the firm’s cost of capital by reducing this premium and that the market response to risk disclosure is small when the expected level of risk is high. Moreover, we find that firms acquire and disclose more risk information when their cash flow risk is greater than expected. Finally, we demonstrate that in a multi-asset setting, only risk disclosure concerning systematic risks will impact the cost of capital.