Ronald E. Shrieves

Discretionary accounting and the behavior of Japanese banks under financial duress

This paper investigates utilization of discretionary accounting practices in the context of international bank regulation under the Basle Accord. Specifically, we explore implications of earnings management as a means of regulatory-capital arbitrage by Japanese banks during a period of financial duress, 1989-1996. Using a sample of 607 pooled time series and cross-sectional observations, we find evidence that Japanese banks’ lending was capital constrained, and that banks set gains on securities sales and loan-loss provisions in such a way as to smooth reported income and replenish regulatory capital. Our results support the hypothesis that the form of earnings management examined may have been instrumental in enabling some Japanese banks to comply with international capital regulation. We contend that this behavior is otherwise inexplicable on the basis of significant informational, tax or economic motivations.

Earnings Management and Executive Compensation: A Case of Overdose of Option and Underdose of Salary?

We present and test hypotheses about how the components of compensation influence earnings management behavior. Hypotheses are based, in part, on the observation that discretion over accounting accruals gives managers a potentially valuable timing option that will lead to strategies for maximizing their compensation. Our empirical analysis shows that earnings management intensity, as measured by the absolute value of discretionary current accruals scaled by asset size, is related to managerial compensation contract design. We find the amounts of stock options and bonuses, and the incentive intensity of stock options, are positively related to earnings management intensity, whereas salaries are negatively related. Results do not reliably support either positive or negative effects of long-term incentive plans or restricted stock compensation on earnings management intensity, aside from the incentive intensity effect of restricted stock. We show that magnitudes of the effects of some compensation variables on earnings management intensity are conditional on proximity of premanaged earnings to specified targets. The importance of our findings is the strong evidence they provide that compensation contract design does influence earnings management, and that the influences of the various compensation components appear to be largely predictable on a presumption that (at least some) managers behave opportunistically.

Bankruptcy Avoidance as a Motive For Merger

The phenomenal growth in corporate merger activity of the 1960s revived interest in the motives and effects relating to corporate mergers. In recent years, many theories for explaining mergers have been discussed and tested in the literature of finance, law, and economics. Various authors have argued that motives for merger include increased market power [15, 21, 23], achievement of operating or managerial scale economies [2, 8], diversification [6], tax reduction [19], growth maximization [14, 16], and bankruptcy avoidance [7, 10, 12, 13]. The bankruptcy avoidance motive is perhaps the most recently articulated of all merger motives, and perhaps the only one for which no systematic attempts at empirical validation have been forthcoming.

FREE CASH FLOW (FCF), ECONOMIC VALUE ADDED (EVA™), AND NET PRESENT VALUE (NPV):. A RECONCILIATION OF VARIATIONS OF DISCOUNTED-CASH-FLOW (DCF) VALUATION

ABSTRACT The paper assists the user of DCF methods by clearly setting forth the relationship of free-cash-flow (FCF) and economic value added (EVA™) concepts to each other and to the more traditional applications of DCF thinking. We follow others in demonstrating the equivalence between EVA and NPV, but our approach is more general in that it links the problems of security valuation, enterprise valuation, and investment project selection. Additionally, our approach relates more directly to use of standard financial accounting information. Beginning with cash budget identity, we show that the discounting of appropriately defined cash flows under the free-cash-flow valuation approach (FCF) is mathematically equivalent to the discounting of appropriately defined economic profits under the EVA™ approach. The concept of net operating profit after-tax (NOPAT), found by adding after-tax interest payments to net profit after taxes, is central to both approaches, but there the computational similarities end. The FCF approach focuses on the periodic total cash flows obtained by deducting total net investment and adding net debt issuance to net operating cash flow, whereas the EVA™ approach requires defining the periodic total investment in the firm. In a project valuation context, both FCF and EVA™ are conceptually equivalent to NPV. Each approach necessitates a myriad of adjustments to the accounting information available for most corporations.

The extension of international credit by US banks: a disaggregated analysis, 1988-1994

We use simultaneous equation estimation techniques to analyze decisions made by 35 US banks with respect to credit extended domestically and to credit extended within 16 foreign countries, 1988-1994. Our results indicate that foreign credit extension by US banks follows the commercial expansion of US businesses abroad and is greater in countries with expanding economies. They are inconsistent with the notion that banks trade off credit activities undertaken domestically and abroad.

Evidence on the Association between Mergers and Capital Structure

This article examines whether merger per se may be related to changes in the capital structure of the participating firms. The findings are consistent with the existence of merger-related incentives to increase financial leverage for a significant subset of merging firms. No evidence has been found that supports the latent debt capacity hypothesis. There is a strong relationship between merger accounting procedures (purchase vs. pooling) and relative increases in leverage accompanying mergers. This relationship reflects the potential for increased debt capacity and/or wealth shifting by the managements of acquiring firms. The terms of purchase of the acquired company were consistent with an immediate increase in leverage in the merging entities. Analysis of the year-by-year relative leverage positions of purchase merger firms indicates an immediate and persistent relative increase in financial leverage. Similar investigation of pooling accounting mergers detects no such systematic changes in leverage. Finally, analysis of the relationship between pre-merger cash flow correlation for merging firms and relative changes in leverage tend to support both the increased debt capacity theory and the coinsurance wealth transfer theory.

The multibank holding company effect on cost efficiency in banking

This paper tests the hypothesis that differences in the organizational form embodied in independent banks, one-bank holding companies, and multibank holding companies result in differences in operating cost efficiency. The transaction and agency cost paradigms for analysis of organizational efficiency provide theoretical motivation for the hypothesis. The effects of organizational form on bank operating expenses for individual banks are evaluated on subsamples divided into quartiles based on total revenue. Results indicate that for banks having revenues in the lowest quartile, both one-bank and multibank holding company affiliates are cost efficient relative to independent banks. Multibank holding company affiliates are cost efficient relative to both one-bank affiliates and independent banks for banks in the interquartile range. No significant differences in cost efficiency are noted banks in the highest revenue quartile. Relative efficiency at the organizational level is also evaluated. Results provide evidence of lower operating costs for banking operations of both multibank and one-bank holding company organizations relative to independent banks. Taken as a whole, the results imply that holding company affiliation conveys cost advantages to banking units below the 75th revenue percentile.

Financing Loan Growth at Banks

We analyze investment and financing decisions for a broad sample of affiliated and independent banks during the 1994–1998 period. Our results indicate that growth in lending at affiliated banks is supported by net equity financing flows from parent holding companies. We also provide evidence that loan growth at affiliated banks, relative to independent banks, is less constrained by capital availability. Both findings appear relevant to understanding the diminishing role of independent banks in aggregate lending.

Do Shareholders Benefit from Corporate Misconduct? A Long‐Run Analysis

To test if shareholders benefit from corporate misconduct, we analyze long‐run operating and stock performance before and after allegations are publicly disclosed. We provide the first empirical evidence that shareholders benefit from corporate misconduct. We find positive abnormal stock returns during the prediscovery period, which are only partially reversed during the postdiscovery period. Partitioning the results based on the relation between the alleged offending firm and damaged party, we find prediscovery outperformance is driven by third‐party misconduct, and postdiscovery underperformance is driven by related‐party misconduct. Although operating performance results are somewhat sensitive to the metric analyzed, overall they are consistent with the stock performance results. Taken as a whole, our findings provide evidence of a net benefit to shareholders from corporate misconduct when the damaged party is unrelated to the offending firm. Additionally, the disparity between postdiscovery operating performance based on the offending firms relation with the offended party highlights the importance of reputational penalties.

Evidence on the Role of Holding Company Acquisitions in the Management of Bank Capital

This article addresses the issue of the impact of bank acquisitions on the capital positions of acquired banks. The hypothesis tested is that acquisition-related capital changes reflect divergent capital-related acquisition motives which induce significant infusion of capital into some acquired banks and significant withdrawals from others.This study confirms that,on average, bank holding company acquisitions reduce the relative capital position of acquired banks, but it also indicates that this average effect masks evidence that acquisitions contribute to relative increases in capital in a significant subset of acquired banks. The results herein demonstrate that results of prior studies regarding the impact of acquisition and/or holding company affiliation on bank capital positions suffer from misspecification.The finding that there are divergent implications of acquisition for capital growth is consistent with the notion that acquisitions by bank holding companies may be providing important financial synergies to the banking industry by serving as a mechanism for relatively efficient reallocation of equity capital among affiliated banks.