14 Financial: Conservatism (including cost stickiness)
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ItemBank accounting conservatism and bank loan quality( 2018-08-30)This study examines the effect of conservatism on bank’s own monitoring effort reflected in its loan portfolio quality. While prior research shows that timely recognition of expected loan losses reduces managerial risk taking through enhanced market discipline, few are the studies that investigate the implication of asymmetric timeliness of losses, otherwise known as conservatism, on bank risk taking or a bank’s own monitoring effort. Building on the premise that the monitoring benefit of conservatism in reducing bank’s risk-taking translates into better loan portfolio quality, this study documents that in a sample of publicly traded bank holding companies in the United States over the period 1994–2014, bank's conservatism is positively associated with loan quality. I also find that the effect of conservatism on loan quality is more pronounced for banks with high ex-ante information asymmetry or distress risk and during the low and high lending growth cycles when loan quality is likely to deteriorate. These findings should be of interest to regulators and policymakers who debate ways to incentivize banks to use their discretion inherent in loan loss provisioning in ways that is more informative and less opportunistic.
ItemDirector-Liability-Reduction Laws and Conditional Conservatism( 2018-08-27)We study non-officer directors’ causal influence on the conditional conservatism of firms’ financial statements. We treat director-liability-reduction laws enacted by the 50 U.S. states in different years since 1986 as exogenous shocks to non-officer directors’ litigation risk. We find decreases in conditional conservatism after the law enactments, which vary predictably with cross-sectional variation in the demand for conditional conservatism from shareholders and lenders. We show that these effects flow through current asset decreases and switches away from Big N auditors. The results are robust to controlling for state antitakeover laws, tests for endogenous law enactment and parallel trends, and other sensitivity checks. Our results are consistent with non-officer directors monitoring and influencing the financial reporting process and have implications for corporate governance and corporate law reforms.
ItemAsymmetrically Timely Response of Earnings to Industry Volume Shocks( 2018-08-23)We provide evidence that researchers examining the timelier response of earnings to bad news than to good news can generate more interpretable results by using industry volume shocks rather than or in addition to returns as the proxy for news. This use provides two main benefits. First, it substantially eliminates known biases in estimates of asymmetric timeliness resulting from the use of returns as the news proxy. Industry return shocks: are removed from firm characteristics (return volatility and loss frequency) known to be associated with these biases; are largely exogenous to individual firms; and drive earnings over the relatively short term, mitigating concerns about unrecognized economic assets immune to conditional conservatism. Second, this use helps researchers distinguish three sources of asymmetric timeliness documented in prior research: conditional conservatism, cost stickiness, and curtailment put options. It is more feasible to identify which costs that are sticky and which investments can be curtailed for individual industries than for the universe of firms. Industry volume shocks interact closely with proxies for resource adjustment costs that determine whether costs are sticky or firms instead curtail the deployment of resources when demand turns down.