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Our analytical description of how banks’ responses to asset price changes can result in procyclical leverage reveals that for banks with a binding regulatory leverage constraint, absent differences in regulatory risk weights across assets, leverage is not procyclical. For banks without a binding constraint, fair value and bank regulation both can contribute to procyclical leverage. Empirical findings based on a large sample of US commercial banks reveal that bank regulation explains procyclical leverage for banks relatively close to the regulatory leverage constraint and contributes to procyclical leverage for those that are not. Fair value accounting does not contribute to procyclical leverage.
This paper attempts to tease out some of the reasons why the history of M&A accounting has been so fraught. It compares the different M&A accounting regimes which have been tried over time in UK, US and international standards. It illustrates the quantitative impact of alternative accounting regimes on financial statements. It asks whether the resulting numbers make any difference to decisions and behaviour. It charts the rising scale of M&A expenditures which have accompanied the different accounting regimes. And it suggests that a number of historical developments have intensified the challenges posed by accounting for M&A – developments in firms’ investment choice between M&A or new tangibles, in the role of intangibles, in means of payment for M&A, in stock market price movements, in the synergies created by M&A, and in “creative accounting.”
We develop and empirically test a trade-off model for the analysis of leverage changes in mergers and acquisitions. This study extends prior findings of a post-merger increase in leverage for the acquiring firm by linking this leverage increase to merging firms that are less correlated, create significantly larger growth options, have lower bankruptcy costs and lower volatility. Specifically, we show that acquiring firms are more likely to finance diversifying acquisitions with debt as equity holders exploit the increased debt capacity with higher leverage resulting in total merger gains that are positively associated with financial synergies. This study further corroborates recent theoretical evidence of a U-shaped relationship between growth options and leverage theoretically and empirically in the context of mergers.
This paper investigates whether and how financial restatements affect the market for corporate control. We show that firms that recently filed financial restatements are significantly less likely to become takeover targets than a propensity score-matched sample of non-restating firms. For those restating firms that do receive takeover bids, the bids are more likely to be withdrawn or take longer to complete than those made to non-restating firms. Finally, there is some evidence that deal value multiples are significantly lower for restating targets than for non-restating targets. Our analyses suggest that the information risk associated with restating firms is the main driver of these results. Overall, this study finds that financial restatements have profound consequences for the allocation of economic resources in the market for corporate control.
This paper is concerned with the allegation that fair value accounting rules have contributed significantly to the recent financial crisis. It focuses on one particular channel for that contribution: the impact of fair value on actual or potential failure of banks. The paper compares four criteria for failure: one economic, two legal and one regulatory. It is clear from this comparison that balance sheet valuations of assets are in two cases crucial in these definitions, and so the choice between “fair value” or other valuations can be decisive in whether a bank fails; but in two cases fair value is irrelevant. Bank failures might arise despite capital adequacy and balance sheet solvency due to sudden shocks to liquidity positions. Two of the most prominent bank failures cannot, at first sight, be attributed to fair value accounting: we show that Northern Rock was balance sheet solvent, even on a fair value basis, as was Lehman Brothers. The anecdotal evidence is augmented by empirical tests that suggest that mark-to-market accounting does not increase the perceived bankruptcy risk of banks.
This paper examines the size-effect in the German stock market and intends to address several unanswered issues on this widely known anomaly. Unlike recent evidence of a reversal of the size anomaly we document a conditional relation between size and returns. We also detect strong momentum across size portfolios. Our results indicate that the marginal effect of firm size on stock returns is conditional on the firm’s past performance. We use an instrumental variable estimation to address Berk’s critique of a simultaneity bias in prior studies on the small firm effect and to investigate the economic rationale behind firm size as an explanatory variable for the variation in stock returns. The analysis in this paper indicates that firm size captures firm characteristic components in stock returns and that this regularity cannot be explained by differences in systematic risk.
We investigate stock return and trading volume reactions to analyst recommendation changes issued by local and foreign analysts for international stocks from 40 countries cross-listed in the U.S. We find that recommendation changes by analysts based in the U.S. lead to significantly higher abnormal returns and lower abnormal volumes in the home market of the cross-listed firm, compared to changes made by local analysts. Our results are strengthened by an identification strategy that relies on analysts who move locations. We do not find evidence that the U.S.-location premium to analyst recommendations can be explained by a bonding or certification role of U.S. analysts or differences in broker or analyst characteristics. Our findings suggest that U.S. analysts facilitate U.S. investors’ access to investments in the foreign firm’s home market. U.S. analysts seem to improve the information environment and stock return responsiveness of cross-listed firms, in particular for firms from developed countries where the local analyst advantage is smaller.
We provide new evidence on the information content of insider sales using SEC Form 4 footnote disclosures. Extracting and analysing the descriptions about the nature of the insider sale contained in Form 4 footnotes, we are able to distinguish discretionary from nondiscretionary insider sales. We find that discretionary insider sales are informative to investors and produce significantly lower abnormal returns to the trade filing than nondiscretionary sales. Consistent with investors not fully reacting to the information in these footnotes we find that discretionary insider sales are highly predictive of future negative stock returns and are associated with a higher propensity of analyst downgrades, larger negative earnings surprises and a higher likelihood of future litigation. Our findings suggest that insiders strategically use footnote disclosures describing liquidity-motivated sales to disguise information-based sales.
Using survey data from a sample of senior investment professionals from mainstream (i.e. not SRI funds) investment organizations we provide insights into why and how investors use reported environmental, social and governance (ESG) information. The primary reason survey respondents consider ESG information in investment decisions is because they consider it financially material to investment performance. ESG information is perceived to provide information primarily about risk rather than a company’s competitive positioning. There is no one size fits all, with the financial materiality of different ESG issues varying across sectors. Lack of comparability due to the lack of reporting standards is the primary impediment to the use of ESG information. Most frequently, the information is used to screen companies with the most often used method being negative screening. However, negative screening is perceived as the least investment beneficial while full integration into stock valuation and positive screening considered more beneficial. Respondents expect negative screening to be used less in the future, while positive screening and active ownership to be used more.
We develop a general equilibrium model to investigate the adverse effects of liquidity risk on price discovery and to examine the interaction of (externally or internally imposed) solvency requirements for financial institutions with the accounting measurement for financial assets in markets under stress. The model develops liquidity demand and supply curves generating two types of general equilibria: liquid and illiquid. We then investigate the adverse feedback effects in the illiquid equilibrium in response to banks selling risky assets to satisfy solvency requirements. Our model captures negative externalities of other banks responding to a liquidity shock with precautionary hoarding and predicts that the potential of bank runs reduces the motivation to hoard. Model results further suggest that applying mark-to-market accounting in the illiquid equilibrium can lead to loss spirals transforming a bank’s illiquidity problem to one of insolvency. We discuss several policy implications for the role of fair value accounting in linking liquidity and solvency problems of banks during times of market stress.
The purpose of this study is to consolidate the existing body of knowledge on the materiality of nonfinancial information, particularly environmental, social and governance (ESG or sustainability) disclosures, by reviewing the theoretical and empirical evidence on this topic drawing from the academic literature in accounting, economics, finance, law, and management. The paper discusses the theoretical foundations of the concept of materiality and presents evidence on the changing views on the materiality of nonfinancial disclosures from the perspective of the securities and disclosure regulation in the U.S. It relates the arguments for the materiality of nonfinancial information to the stakeholder theory of the corporation. Building on the conceptual foundations the study then reviews the theoretical and empirical evidence in the management literature on corporate social responsibility, the accounting literature on sustainability disclosures and the economics and finance literature on responsible investing. This study reconciles and extracts new insights from the existing evidence in these various fields in order to inform the academic debate on the materiality of nonfinancial disclosures and to open new avenues for research.
We provide evidence on the benefits and costs of voluntary earnings forecasts by bidding firms during acquisitions, shedding light on the motives and capital market consequences of voluntary disclosures. Specifically, we find a higher propensity of forecast disclosure when the acquisition is made with stock and during periods of high bidder valuations, when target shareholders are concerned about receiving overvalued shares. These forecasts are associated with a higher likelihood of deal completion, expedited deal closing, and with a lower acquisition premium. Our results are most consistent with forecast disclosure positively affecting the value perceptions of target shareholders. The evidence, however, also suggests that the benefits of forecast disclosure only accrue to bidders that have built a credible forecasting reputation prior to the acquisition. Furthermore, we document that merger forecasts attenuate the generally negative investor reaction to acquisition announcements. Explaining why not all bidders forecast, we provide evidence on high forecasting costs, particularly higher likelihood of post-merger litigation.