Based on a linear provision/charge-off association and V-shaped scatterplots of these variables a... more Based on a linear provision/charge-off association and V-shaped scatterplots of these variables against nonperforming loan changes, Basu et al. (2020) argue that nonperforming loan changes mis-measure credit quality and linear provision models are mis-specified. They conclude that residual asymmetry controlling for charge-offs results from loan heterogeneity and the real estate crisis. Using additions to nonaccruals to measure credit quality, we find a linear association with provisions, that controlling for charge-offs induces misspecification, and no evidence of provision asymmetry. These results highlight the importance of basing hypotheses and causal models on theoretical underpinnings rather than on plots subject to known fallacies.
We examine the incremental predictive ability and information content of analysts’ provision fore... more We examine the incremental predictive ability and information content of analysts’ provision forecasts to explore the potential effects of the FASB’s new current expected credit loss (CECL) accounting method. Controlling for the recognized loan loss provision, consensus analyst provision forecasts are incrementally associated with future non-performing loans (NPLs) and equity markets returns. This incremental association is increasing in banks’ unconstrained ability to estimate future losses as evidenced by their loan fair value disclosures and the extent of the constraints imposed by the incurred loss model measured by the fraction of heterogeneous loans individually reviewed for impairment. For a sample of analysts that also forecast NPLs, the association between the individual analyst’s provision forecast and future NPLs is increasing in the analyst’s comparative NPL forecasting accuracy. Finally, we find that the association between the analyst’s provision forecast and future NPLs is increasing in EPS forecast errors but decreasing in target price forecast errors. Together these results suggest that the reported provisions under the current incurred loss model do not fully incorporate banks’ information about future losses and that the extent to which this occurs depends both on banks’ ability to forecast expected losses and the constraints imposed by the incurred loss model. These results suggest that analysts forecast future losses beyond those reflected in the recognized provision and that the incremental information in these forecasts and potential CECL provision timeliness effect is greater when the constraints imposed by the incurred loss model are greater.
We ask whether credit rating agencies receive higher fees and gain greater market share when they... more We ask whether credit rating agencies receive higher fees and gain greater market share when they provide more favorable ratings. To investigate this question we use the 2010 rating scale recalibration by Moody's and Fitch, which increased ratings absent any underlying change in issuer credit quality. Consistent with prior research, we find that the recalibration allowed the clients of Moody's and Fitch to receive better ratings and lower yields. We add to this evidence by showing that the recalibration also led to larger fees and to increases in the market shares of Moody's and Fitch. These results are consistent with critics' concerns about the effects of the issuer-pay model on the credit ratings market. (JEL G24, G28, H74, M40, M41)
and workshop participants at the Securities and Exchange Commission and Carnegie Mellon Universit... more and workshop participants at the Securities and Exchange Commission and Carnegie Mellon University for their helpful comments and suggestions.
This paper reports on an examination of the effects of dfferential state taxation of U.S. Governm... more This paper reports on an examination of the effects of dfferential state taxation of U.S. Government obligations (hereinafter, USOs) on how banks structure their investment and financing portfolios. Twenty-seven states tax banks on their USOs holdings or the income from them and twenty-three states and the District of Columbia do not. We find that banks in states which do not tax these investments hold significantly greater amounts of these assets and, as these assets are the least risky assets banks hold, we also find that banks in non-taxed states hold a less risky mix of assets than banks in taxed states. Consistent with compensating for their riskier asset mix, we also find that banks in states that tax USOs hold a higher ratio of capital to assets. This result is consistent with effective bank regulation in that banks in all states are found to evidence similar overall risk, as measured by the ratio of their capital to risk-weighted assets. Finally, the effects shown in this paper are economically significant. We find that banks operating in untaxed states hold, on average, 125% of the amount of USOs held by banks in taxed states and pay state income taxes, on average, at only 16% of the rate of banks in taxed states.
... the contracts as well as their price (eg, Beatty and Weber 2003). Therefore, it is possible t... more ... the contracts as well as their price (eg, Beatty and Weber 2003). Therefore, it is possible that some terms of the contract will be substituted by higher or lower interest rates on the loan. To address this issue, and evaluate whether ...
... Froot, K., D. Scharfstein and J. Stein, 1993, Risk management: Coordinating corporate investm... more ... Froot, K., D. Scharfstein and J. Stein, 1993, Risk management: Coordinating corporate investment and financing policies, Journal of Finance, 1629-1659. ... Page 25. 24 Gorton, G., and R. Rosen, 1995,Banks and derivatives, working paper, University of Pennsylvania. ...
ABSTRACT Multiple SEC 10-K sections require risk disclosures. Disclosures about financial constra... more ABSTRACT Multiple SEC 10-K sections require risk disclosures. Disclosures about financial constraints risk appear in both Item 1A (risk factors) and Item 7 (MD&A), but the disclosure requirements for the two sections differ. We compare and contrast the information content of financial constraints risk disclosures from these two sections to examine how these differences affect the information content of the disclosures. The SEC emphasizes that risks disclosed in Item 7 should result from past known events or uncertainties and be reasonably likely to affect the future, whereas no such probability threshold is imposed on Item 1A disclosures. Firms are also allowed to discuss how to address these risks only in Item 7 and not in Item 1A. Consistent with the disclosure requirements, we find that the difference in the disclosure between Item 1A and Item 7 is positively associated with litigation risk and the likelihood of negative known events. We also find that the disclosure difference is positively associated with ex-ante financial constraints risk measures, especially when firms do not claim to have effectively addressed the risk in Item 7. Our findings suggest that Item 1A contains both ex ante and ex post risk information beyond Item 7 although it is also more likely to be affected by litigation concerns. Our results also suggest that investors can extract more information by recognizing the differences in disclosure requirements and properly combining the Item 7 risk mitigation disclosures with the lower probability risks disclosed in Item 1A. Finally, our results suggest that combining the Item 1A and Item 7 disclosures may lead to more powerful financial constraints measures.
This paper examines three motivations for leveraged ESOP adoption: as a takeover defense, as a me... more This paper examines three motivations for leveraged ESOP adoption: as a takeover defense, as a mechanism for providing incentives to employees and as a vehicle for tax savings. ESOP adoption is more likely for companies with a higher predicted probability of takeover, but ESOP adopters have many characteristics that are different h m takeover targets. Companies that adopt ESOPs can be distinguished from non-adopting companies based on characteristics associated with the tax and incentive effects of these plans. The size of the ESOP is shown to depend primarily on the tax and incentive characteristics.
We study the decision to fund R&D through a separate financing organization (an 'RDFO&#x... more We study the decision to fund R&D through a separate financing organization (an 'RDFO') that takes the form of either a limited partnership or a corporation. The RDFO offers tax and financial reporting benefits. As a form of external funding, it also creates moral hazard and ...
We investigate how private information and monitoring affect the role of accounting quality in re... more We investigate how private information and monitoring affect the role of accounting quality in reducing the investment-cash flow sensitivity. We argue that access to private information and direct restrictions on investments are likely to affect the extent to which accounting quality reduces financing constraints. Our results suggest that for financially constrained firms, banks' access to private information decreases the value of accounting quality. We further find that, for both financially constrained and unconstrained firms, covenants directly restricting capital expenditures also mitigate the importance of accounting quality. Our results suggest that when information asymmetry problems are likely to be the largest, accounting quality is most important. However, the importance of accounting quality is mitigated if outside capital suppliers have access to private information and is eliminated if they impose contractual restrictions on investment. We also provide evidence that banks' access to private information reduces the cash flow sensitivity of cash and mitigates the importance of accounting quality in reducing this sensitivity. This additional evidence suggests that our investment-cash flow sensitivity results are not driven by measurement error of the investment opportunity set.
In this study we examine whether banks owned by interstate multibank holding companies coordinate... more In this study we examine whether banks owned by interstate multibank holding companies coordinate their security gains and losses to manage their tax, earnings, and capital management objectives. Specifically, we examine whether the realization of security gains and losses is related to the objectives of the individual bank, the consolidated group, or both. We find subsidiary banks manage their gain realizations not only to reduce their own state taxes, but also strategically to reduce their consolidated groups' tax expense. Specifically, members of consolidated banking groups shift gain recognition to lower-taxed group members and away from higher-taxed group members. In addition, we find evidence suggesting that banks realize security gains and losses to manage both their own and their groups' financial statement earnings.
Banking R. A lton G ilb e rt D a vid C. W h e elo ck International C h risto p her J. N e e ly M ... more Banking R. A lton G ilb e rt D a vid C. W h e elo ck International C h risto p her J. N e e ly M ich a el R. P a k k o P a tric ia S. P o lla rd M acroeconomics D o n ald S. A lle n R ich ard G. A n d erso n Ja m e s B. B u llard M ich a el J. D u e k e r Jo sep h A. R itter John A. Tatom D a n ie l L.
Page 1. Why Do Banks Contractually Obligate Borrowers to Engage in Interest Rate Protection? Anne... more Page 1. Why Do Banks Contractually Obligate Borrowers to Engage in Interest Rate Protection? Anne Beatty beatty.86@osu.edu, 614-292-5418 Fisher College of Business The Ohio State University 442 Fisher Hall 2100 Neil Avenue Columbus, OH 43210 ...
We explore how an accounting measure of information asymmetry between lead and participating lend... more We explore how an accounting measure of information asymmetry between lead and participating lenders influences syndication structures by examining whether lead lenders’ commercial and industrial (C&I) loan loss provision validity affects the fraction of loans they retain. Consistent with C&I provision validity reflecting banks’ underlying screening and monitoring effectiveness, we find that this measure reflects lead lender’s past relationship with borrowers and is associated positively with equity market reactions to loan announcements and future loan loss recovery rate and negatively with future large borrower bankruptcies. We then find lead lender’s loan share decreases specifically with C&I provision validity, but not with non-C&I provision validity. Consistent with an information effect, we further find that this association is attenuated by i) alternative information sources, including borrowers’ credit ratings and industry-level accounting debt contracting value and ii) by previous lead/participant relationships and participant/borrower relationships.
This paper examines the extent to which bank holding companies trade-off the use of investment se... more This paper examines the extent to which bank holding companies trade-off the use of investment securities and interest rate swaps when managing interest rate risk inherent in their core business. We find that both securities and swaps are used to hedge interest rate risk and that these two types of financial instruments are used as substitute hedging mechanisms. Our evidence suggests that the FASB's current proposal limiting hedge accounting treatment to derivative financial instruments may not reflect how banks manage interest rate risk. In addition, the discrepancy in accounting treatment may lead banks to prefer one of these two types of financial instruments.
This paper documents evidence on the efficacy of maturity-gap disclosures of commercial banks in ... more This paper documents evidence on the efficacy of maturity-gap disclosures of commercial banks in indicating their net interest income that is exposed to interest-rate risk. For the large sample of banks that filed call reports from 1990 to 1997, a period that includes a wide range of interest rate movements, we find that (i) one-year maturity gap measures are significantly related to the one-yearand three-years-ahead change in net interest income, (ii) fixed-rate and variable-rate instruments differ in explanatory ability, and (iii) the one-to-five-year aggregate gap measures also have some power in explaining three-year-ahead changes in net interest income. These findings hold after controlling for the ex post growth in assets as well as the amount of rate-sensitive assets and liabilities (a competing set of explanatory variables). Because the Securities and Exchange Commission (SEC)'s [Securities and Exchange Commission (SEC), (1997). Disclosure of accounting policies for derivative financial instruments and derivative commodity instruments and disclosure of qualitative and quantitative information about market risk inherent in derivative financial instruments, other financial instruments, and derivative commodity instruments.
The Journal of the American Taxation Association, 2001
In this paper we examine the effects of differential state taxation of U.S. Government obligation... more In this paper we examine the effects of differential state taxation of U.S. Government obligations (USOs) on how banks structure their investment and financing portfolios, the riskiness of banks' assets, and how implicit tax effects are impounded in investments' returns. Twenty-seven states tax USOs (taxing states) and 23 states and the District of Columbia do not (nontaxing states). We find that banks in taxing states hold significantly greater amounts of USOs, which are among the least risky assets banks can hold, and we find that these banks hold a less risky mix of assets. Consistent with compensating for the lower risk of their asset mix, we also find that these banks hold less capital. Taken together, these results are consistent with effective bank regulation enforcement, since banks have similar capital to risk-weighted asset ratios in spite of differing tax-based incentives to hold riskless assets. We also examine the impact of implicit taxes on banks' USO holdi...
Based on a linear provision/charge-off association and V-shaped scatterplots of these variables a... more Based on a linear provision/charge-off association and V-shaped scatterplots of these variables against nonperforming loan changes, Basu et al. (2020) argue that nonperforming loan changes mis-measure credit quality and linear provision models are mis-specified. They conclude that residual asymmetry controlling for charge-offs results from loan heterogeneity and the real estate crisis. Using additions to nonaccruals to measure credit quality, we find a linear association with provisions, that controlling for charge-offs induces misspecification, and no evidence of provision asymmetry. These results highlight the importance of basing hypotheses and causal models on theoretical underpinnings rather than on plots subject to known fallacies.
We examine the incremental predictive ability and information content of analysts’ provision fore... more We examine the incremental predictive ability and information content of analysts’ provision forecasts to explore the potential effects of the FASB’s new current expected credit loss (CECL) accounting method. Controlling for the recognized loan loss provision, consensus analyst provision forecasts are incrementally associated with future non-performing loans (NPLs) and equity markets returns. This incremental association is increasing in banks’ unconstrained ability to estimate future losses as evidenced by their loan fair value disclosures and the extent of the constraints imposed by the incurred loss model measured by the fraction of heterogeneous loans individually reviewed for impairment. For a sample of analysts that also forecast NPLs, the association between the individual analyst’s provision forecast and future NPLs is increasing in the analyst’s comparative NPL forecasting accuracy. Finally, we find that the association between the analyst’s provision forecast and future NPLs is increasing in EPS forecast errors but decreasing in target price forecast errors. Together these results suggest that the reported provisions under the current incurred loss model do not fully incorporate banks’ information about future losses and that the extent to which this occurs depends both on banks’ ability to forecast expected losses and the constraints imposed by the incurred loss model. These results suggest that analysts forecast future losses beyond those reflected in the recognized provision and that the incremental information in these forecasts and potential CECL provision timeliness effect is greater when the constraints imposed by the incurred loss model are greater.
We ask whether credit rating agencies receive higher fees and gain greater market share when they... more We ask whether credit rating agencies receive higher fees and gain greater market share when they provide more favorable ratings. To investigate this question we use the 2010 rating scale recalibration by Moody's and Fitch, which increased ratings absent any underlying change in issuer credit quality. Consistent with prior research, we find that the recalibration allowed the clients of Moody's and Fitch to receive better ratings and lower yields. We add to this evidence by showing that the recalibration also led to larger fees and to increases in the market shares of Moody's and Fitch. These results are consistent with critics' concerns about the effects of the issuer-pay model on the credit ratings market. (JEL G24, G28, H74, M40, M41)
and workshop participants at the Securities and Exchange Commission and Carnegie Mellon Universit... more and workshop participants at the Securities and Exchange Commission and Carnegie Mellon University for their helpful comments and suggestions.
This paper reports on an examination of the effects of dfferential state taxation of U.S. Governm... more This paper reports on an examination of the effects of dfferential state taxation of U.S. Government obligations (hereinafter, USOs) on how banks structure their investment and financing portfolios. Twenty-seven states tax banks on their USOs holdings or the income from them and twenty-three states and the District of Columbia do not. We find that banks in states which do not tax these investments hold significantly greater amounts of these assets and, as these assets are the least risky assets banks hold, we also find that banks in non-taxed states hold a less risky mix of assets than banks in taxed states. Consistent with compensating for their riskier asset mix, we also find that banks in states that tax USOs hold a higher ratio of capital to assets. This result is consistent with effective bank regulation in that banks in all states are found to evidence similar overall risk, as measured by the ratio of their capital to risk-weighted assets. Finally, the effects shown in this paper are economically significant. We find that banks operating in untaxed states hold, on average, 125% of the amount of USOs held by banks in taxed states and pay state income taxes, on average, at only 16% of the rate of banks in taxed states.
... the contracts as well as their price (eg, Beatty and Weber 2003). Therefore, it is possible t... more ... the contracts as well as their price (eg, Beatty and Weber 2003). Therefore, it is possible that some terms of the contract will be substituted by higher or lower interest rates on the loan. To address this issue, and evaluate whether ...
... Froot, K., D. Scharfstein and J. Stein, 1993, Risk management: Coordinating corporate investm... more ... Froot, K., D. Scharfstein and J. Stein, 1993, Risk management: Coordinating corporate investment and financing policies, Journal of Finance, 1629-1659. ... Page 25. 24 Gorton, G., and R. Rosen, 1995,Banks and derivatives, working paper, University of Pennsylvania. ...
ABSTRACT Multiple SEC 10-K sections require risk disclosures. Disclosures about financial constra... more ABSTRACT Multiple SEC 10-K sections require risk disclosures. Disclosures about financial constraints risk appear in both Item 1A (risk factors) and Item 7 (MD&A), but the disclosure requirements for the two sections differ. We compare and contrast the information content of financial constraints risk disclosures from these two sections to examine how these differences affect the information content of the disclosures. The SEC emphasizes that risks disclosed in Item 7 should result from past known events or uncertainties and be reasonably likely to affect the future, whereas no such probability threshold is imposed on Item 1A disclosures. Firms are also allowed to discuss how to address these risks only in Item 7 and not in Item 1A. Consistent with the disclosure requirements, we find that the difference in the disclosure between Item 1A and Item 7 is positively associated with litigation risk and the likelihood of negative known events. We also find that the disclosure difference is positively associated with ex-ante financial constraints risk measures, especially when firms do not claim to have effectively addressed the risk in Item 7. Our findings suggest that Item 1A contains both ex ante and ex post risk information beyond Item 7 although it is also more likely to be affected by litigation concerns. Our results also suggest that investors can extract more information by recognizing the differences in disclosure requirements and properly combining the Item 7 risk mitigation disclosures with the lower probability risks disclosed in Item 1A. Finally, our results suggest that combining the Item 1A and Item 7 disclosures may lead to more powerful financial constraints measures.
This paper examines three motivations for leveraged ESOP adoption: as a takeover defense, as a me... more This paper examines three motivations for leveraged ESOP adoption: as a takeover defense, as a mechanism for providing incentives to employees and as a vehicle for tax savings. ESOP adoption is more likely for companies with a higher predicted probability of takeover, but ESOP adopters have many characteristics that are different h m takeover targets. Companies that adopt ESOPs can be distinguished from non-adopting companies based on characteristics associated with the tax and incentive effects of these plans. The size of the ESOP is shown to depend primarily on the tax and incentive characteristics.
We study the decision to fund R&D through a separate financing organization (an 'RDFO&#x... more We study the decision to fund R&D through a separate financing organization (an 'RDFO') that takes the form of either a limited partnership or a corporation. The RDFO offers tax and financial reporting benefits. As a form of external funding, it also creates moral hazard and ...
We investigate how private information and monitoring affect the role of accounting quality in re... more We investigate how private information and monitoring affect the role of accounting quality in reducing the investment-cash flow sensitivity. We argue that access to private information and direct restrictions on investments are likely to affect the extent to which accounting quality reduces financing constraints. Our results suggest that for financially constrained firms, banks' access to private information decreases the value of accounting quality. We further find that, for both financially constrained and unconstrained firms, covenants directly restricting capital expenditures also mitigate the importance of accounting quality. Our results suggest that when information asymmetry problems are likely to be the largest, accounting quality is most important. However, the importance of accounting quality is mitigated if outside capital suppliers have access to private information and is eliminated if they impose contractual restrictions on investment. We also provide evidence that banks' access to private information reduces the cash flow sensitivity of cash and mitigates the importance of accounting quality in reducing this sensitivity. This additional evidence suggests that our investment-cash flow sensitivity results are not driven by measurement error of the investment opportunity set.
In this study we examine whether banks owned by interstate multibank holding companies coordinate... more In this study we examine whether banks owned by interstate multibank holding companies coordinate their security gains and losses to manage their tax, earnings, and capital management objectives. Specifically, we examine whether the realization of security gains and losses is related to the objectives of the individual bank, the consolidated group, or both. We find subsidiary banks manage their gain realizations not only to reduce their own state taxes, but also strategically to reduce their consolidated groups' tax expense. Specifically, members of consolidated banking groups shift gain recognition to lower-taxed group members and away from higher-taxed group members. In addition, we find evidence suggesting that banks realize security gains and losses to manage both their own and their groups' financial statement earnings.
Banking R. A lton G ilb e rt D a vid C. W h e elo ck International C h risto p her J. N e e ly M ... more Banking R. A lton G ilb e rt D a vid C. W h e elo ck International C h risto p her J. N e e ly M ich a el R. P a k k o P a tric ia S. P o lla rd M acroeconomics D o n ald S. A lle n R ich ard G. A n d erso n Ja m e s B. B u llard M ich a el J. D u e k e r Jo sep h A. R itter John A. Tatom D a n ie l L.
Page 1. Why Do Banks Contractually Obligate Borrowers to Engage in Interest Rate Protection? Anne... more Page 1. Why Do Banks Contractually Obligate Borrowers to Engage in Interest Rate Protection? Anne Beatty beatty.86@osu.edu, 614-292-5418 Fisher College of Business The Ohio State University 442 Fisher Hall 2100 Neil Avenue Columbus, OH 43210 ...
We explore how an accounting measure of information asymmetry between lead and participating lend... more We explore how an accounting measure of information asymmetry between lead and participating lenders influences syndication structures by examining whether lead lenders’ commercial and industrial (C&I) loan loss provision validity affects the fraction of loans they retain. Consistent with C&I provision validity reflecting banks’ underlying screening and monitoring effectiveness, we find that this measure reflects lead lender’s past relationship with borrowers and is associated positively with equity market reactions to loan announcements and future loan loss recovery rate and negatively with future large borrower bankruptcies. We then find lead lender’s loan share decreases specifically with C&I provision validity, but not with non-C&I provision validity. Consistent with an information effect, we further find that this association is attenuated by i) alternative information sources, including borrowers’ credit ratings and industry-level accounting debt contracting value and ii) by previous lead/participant relationships and participant/borrower relationships.
This paper examines the extent to which bank holding companies trade-off the use of investment se... more This paper examines the extent to which bank holding companies trade-off the use of investment securities and interest rate swaps when managing interest rate risk inherent in their core business. We find that both securities and swaps are used to hedge interest rate risk and that these two types of financial instruments are used as substitute hedging mechanisms. Our evidence suggests that the FASB's current proposal limiting hedge accounting treatment to derivative financial instruments may not reflect how banks manage interest rate risk. In addition, the discrepancy in accounting treatment may lead banks to prefer one of these two types of financial instruments.
This paper documents evidence on the efficacy of maturity-gap disclosures of commercial banks in ... more This paper documents evidence on the efficacy of maturity-gap disclosures of commercial banks in indicating their net interest income that is exposed to interest-rate risk. For the large sample of banks that filed call reports from 1990 to 1997, a period that includes a wide range of interest rate movements, we find that (i) one-year maturity gap measures are significantly related to the one-yearand three-years-ahead change in net interest income, (ii) fixed-rate and variable-rate instruments differ in explanatory ability, and (iii) the one-to-five-year aggregate gap measures also have some power in explaining three-year-ahead changes in net interest income. These findings hold after controlling for the ex post growth in assets as well as the amount of rate-sensitive assets and liabilities (a competing set of explanatory variables). Because the Securities and Exchange Commission (SEC)'s [Securities and Exchange Commission (SEC), (1997). Disclosure of accounting policies for derivative financial instruments and derivative commodity instruments and disclosure of qualitative and quantitative information about market risk inherent in derivative financial instruments, other financial instruments, and derivative commodity instruments.
The Journal of the American Taxation Association, 2001
In this paper we examine the effects of differential state taxation of U.S. Government obligation... more In this paper we examine the effects of differential state taxation of U.S. Government obligations (USOs) on how banks structure their investment and financing portfolios, the riskiness of banks' assets, and how implicit tax effects are impounded in investments' returns. Twenty-seven states tax USOs (taxing states) and 23 states and the District of Columbia do not (nontaxing states). We find that banks in taxing states hold significantly greater amounts of USOs, which are among the least risky assets banks can hold, and we find that these banks hold a less risky mix of assets. Consistent with compensating for the lower risk of their asset mix, we also find that these banks hold less capital. Taken together, these results are consistent with effective bank regulation enforcement, since banks have similar capital to risk-weighted asset ratios in spite of differing tax-based incentives to hold riskless assets. We also examine the impact of implicit taxes on banks' USO holdi...
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