Bjorn N. Jorgensen

Incentives for effective risk management

Under the new Capital Accord, banks choose between two different types of risk management systems, the standard or the internal rating based approach. The paper considers how a banks preference for a risk management system is affected by the presence of supervision by bank regulators. The model uses a principal–agent setting between a banks owner and its risk management. The main conclusion is that previously unregulated institutions can be expected to switch to the lower quality standard approach subsequent to becoming regulated, i.e., the presence of regulation may induce a bank to decrease the quality of its risk management system.

Public Equity and Audit Pricing in the United States

To what degree are audit fees for U.S. firms with publicly traded equity higher than fees for otherwise similar firms with private equity? The answer is potentially important for evaluating regulatory regime design efficiency and for understanding audit demand and production economics. For U.S. firms with publicly traded debt, we hold constant the regulatory regime, including mandated issuer reporting and auditor responsibilities. We vary equity ownership and thus public securities market contextual factors, including any related public firm audit fees from increased audit effort to reduce audit litigation risk and/or pure litigation risk premium (litigation channel effects). In cross‐section, we find that audit fees for public equity firms are 20–22% higher than fees for otherwise similar private equity firms. Time‐series comparisons for firms that change ownership status yield larger percentage fee increases (decreases) for those going public (private). Results are consistent with litigation channel effects giving rise to substantial incremental audit fees for U.S. firms with public equity ownership.

On the Formation and Structure of International Exchanges

We investigate the formation and structure of 248 financial exchanges throughout the world. First, we empirically analyze the determinants of exchange formation as well as the impact of exchange formation on the domestic countrys economy. Second, conditional on formation, we use a probit model to relate the choice of trading mechanism to the characteristics of the economic environment in which the exchange exists. We find that the main determinants of exchange formation in a country are the degree of economic freedom, the growth of the economy, the availability of technology, and the legal system. In addition, we find that the impact of exchange formation on the macro economy is limited to a reduction in the growth of the monetary aggregates with no significant impact on productivity. Lastly, our results show that the choice of trading mechanism depends on the countrys economic development, the degree of competition, and the extent of economic freedom.

The Valuation Accuracy of Equity Value Estimates Inferred from Conventional Empirical Implementations of the Abnormal Earnings Growth Model: US Evidence

We compare the valuation accuracy of the equity value estimates inferred from empirical implementations of the abnormal earnings growth model (Ohlson and Juettner-Nauroth 2005; the OJ estimates) with the residual income model (Ohlson 1995; the RIV estimates). We find that the OJ estimates generally underperform the RIV estimates. Increasing the forecast horizon for the OJ estimates from two to five years significantly improves their valuation accuracy. However, relative to the RIV estimates, the valuation accuracy of the OJ estimates remains lower even using a five-year forecast horizon. Finally, we compare predicted accounting profitability with actual accounting profitability and find that the lower valuation accuracy of the OJ estimates is attributable to the empirical assumptions regarding future earnings growth beyond the forecast horizon.

An arbitrage free trilateral target zone model

Abstract This paper proposes an arbitrage free trilateral model of a credible target zone regime with bands on each bilateral exchange rate. The no arbitrage condition reduces the system to only two dimensions. Any two rates must obey their own boundaries but, in addition, the free rein for movements is restricted by the band of the redundant rate. Therefore, target zone models defined in bilateral settings do not apply to general systems with a cobweb of bilateral bands, such as the European Monetary System. Since the model has no known analytical solution it is estimated by the method of simulated moments.

On the (Ir)Relevancy of Value-at-Risk Regulation

The measurement and practical implementation of the Value-at-Risk (VaR) criterion is an active and exciting area of research, with numerous recent contributions. This research has almost exclusively been concerned with the accuracy of various estimation techniques and risk measures. Compared to the statistical approach, the financial economic analysis of VaR has been relatively neglected. Guthoff, Pfingsten and Wolf (1996) consider the ranking of projects and traditional performance criteria, while Kupiec and O’Brien (1997) and Steinherr (1998) discuss incentive compatible regulation schemes. The wider issue of the benefits for society of VaR based risk management and supervision has hardly been addressed, see however Danielsson, Jorgensen and de Vries (1999b) and Danielsson, Jorgensen and de Vries (1999a). They consider the implications of externally imposed VaR constraints, the public relevance of the VaR based management and regulation schemes, and incentives for quality improvement. This paper summarizes the public policy aspects of this broader line of reasoning.

Implications of the Integral Approach and Earnings Management for Alternate Annual Reporting Periods

We compare the last 12 months’ earnings ending in quarter four (i.e., fiscal year earnings), three, two and one. Lipe and Bernard (2000) offer two competing explanations for higher volatility in fourth quarter earnings relative to other quarters. First, under the integral approach, any estimation errors in the earlier quarters are corrected through fourth quarter earnings, which could make them more volatile. Second, earnings management concentrated in the fourth quarter renders fourth quarter earnings more volatile. While both explanations have similar implications for the properties of quarterly earnings, their implications differ for the properties of annual earnings ending in each quarter. Our result comparing earnings variability is more consistent with earnings management than the integral approach. We examine the relative earnings attributes and find that fiscal year earnings attributes rank lower. Finally, we re-investigate the accrual anomaly and find that the accrual anomaly is more pronounced for fiscal year earnings.

Numbers Games? A Natural Experiment Investigating Three (Ir)Regularities in Reported Earnings Per Share

We confirm the existence of three irregularities noted in prior research related to reported earnings per share (EPS). First, the unusual pattern in the second digit of reported EPS noted by Thomas (1989) that the second digit of EPS is more likely to be zero and five and less likely to be nine for profit firms while the pattern does not appear for loss firms. Second, the rounding pattern in (unreported) third decimals of EPS noted by Das and Zhang (2003) that the one tenth of a cent is more likely between five and nine for profit firms. Third, the threshold irregularity in EPS changes attributed to Degeorge et al. (1999) and related to Burgstahler and Dichev (1997), that zero changes and one-cent increases are over-represented and one-cent decreases are underrepresented, relative to expectations. Our study confirms that these patterns exist and enhances confidence in each reported irregularity’s validity by identifying matched pairs of firm-years immediately prior to the adoption of SFAS 128. We further extend prior research on EPS irregularities by conducting analysis to discern whether the second digit pattern appears to dominate the threshold irregularity or vice-versa.

Optimal Minimum Wage in the Classic Labor Supply-and-Demand Paradigm

ABSTRACT This article demonstrates that minimum wage laws need not induce unemployment even under the classic labor supply-and-demand paradigm. As a result, minimum wage laws can be welfare-enhancing under the basic labor supply and demand model, suggesting the presence of an optimal minimum wage. We discuss conditions under which the optimal minimum wage level is the subsistence wage level. As a consequence, minimum wages should vary across states or countries with the local subsistence levels.

Overproduction, Aggregate Earnings, and GDP Growth

This paper explores possible links between overproduction and future gross domestic product (GDP) growth. Specifically, we examine the direct effect of overproduction on future GDP growth as well as the moderating effect of overproduction on the relation between aggregate earnings growth and future GDP growth as documented in the literature. We find that overproduction mitigates the positive association between aggregate earnings growth and one-quarter-ahead nominal GDP growth while showing no significant direct effect on future GDP growth. Interestingly, this negative moderating effect is strong enough to reverse the positive association between aggregate earnings growth and one-quarter-ahead GDP growth into a negative association in overproduction periods. We also find that macro forecasters do not fully incorporate the negative moderating effect of overproduction with respect to future GDP growth. Overall, this paper contributes primarily to the literature that links accounting information to GDP growth by identifying overproduction as a moderating factor.