Jeff Jiewei Yu

The Spillover Effect of Fraudulent Financial Reporting on Peer Firms’ Investments

We investigate how high-profile accounting frauds affect peer firms’ investment. We document that peers react to the fraudulent reports by increasing investment during fraud periods. We show that this finding is not driven by frauds that have a higher ex ante likelihood of detection or by an association between fraud and investment booms. In addition, we find that peers’ investments increase in fraudulent earnings overstatements, and in industries with higher investor sentiment, lower cost of capital and higher private benefits of control. We also find evidence consistent with equity analysts potentially facilitating the spillover effect.

Did Information Intermediaries See the Warning Signals of the Banking Crisis from Leading Indicators in Banks’ Financial Statements?

In this paper we address two important questions that emerged in the aftermath of the recent banking crisis. First, did the financial statements of the bank holding companies provide an early warning of their impending distress? Second, whether the actions of four key financial intermediaries (short sellers, equity analysts, Standard Poor’s credit ratings and auditors) were sensitive to the information in the banks’ financial statements about their increasing risk and their approaching distress? We find a significant cross-sectional association between the banks’ 2006 4Q financials and bank failures over 2008-2010 suggesting that the financial statements reflected at least some of the increased risk of bank distress in advance. The mean abnormal short interest in our sample of banks spikes from 0.66% in March 2005 to 2.4% in March 2007. This increase in short interest is also accompanied by a sharp increase over time in the cross-sectional association between short interest and leading financial statement indicators. In contrast, we observe neither a meaningful change in analysts’ recommendations, Standard and Poor’s credit ratings and audit fees nor an increased sensitivity of these actions to financial indicators of bank distress over this time period. Overall, our results suggest that actions of short sellers likely provided an early warning of banks’ upcoming distress prior to 2008 crisis.

Loan Spreads and Unexpected Earnings

This paper provides a more direct test of the superior information hypothesis of banks and informs a long standing policy debate about whether banks serve a special information role in the economy. I circumvent the self-selection bias that contaminated prior studies by obtaining bank loan contracts from mandatory SEC filings. I find that banks set loan spreads at the loan initiation as if they have anticipated (several months in advance) the sign and magnitude of borrowers’ future earnings news unexpected by the stock market. The sensitivity of loan spreads to unexpected earnings is larger where banks have greater incentives to collect private information, for example, for borrowers with negative earnings shocks, fewer analyst following and income-increasing abnormal accruals. Furthermore, a difference-in-differences design confirms that the sensitivity of loan spreads to unexpected earnings increases after Reg FD, when the disclosure regulation limits analysts’ access to private information while banks are exempted from the regulation. Finally, this paper exploits the timing difference in information availability to differentiate whether the documented association of loan spreads and unexpected earnings captures information advantage or correlated omitted risk factors. Consistent with the information argument but not correlated omitted risk factors, the association between loan spreads and unexpected earnings becomes weaker one quarter forward, when uncertainty gradually resolves; and there is no association between loan spreads and unexpected earnings measured two quarters forward, after more private information is revealed during quarterly earnings announcements and bank loan contracts are filed with the SEC for public access.