Thomas G. Ruchti

Bank Regulator Bias and the Efficacy of Stress Test Disclosures

We examine the Federal Reserves (the Fed) propensity to bias reported stress test results in the Comprehensive Capital Analysis and Review (CCAR). Using capital market responses to the CCAR, we develop and estimate a model of biased disclosure that incorporates a regulators trade-off between disciplining banks and promoting short-term stability. We find the Fed biases disclosed capital ratios upwards to prop up large banks, but downwards to discipline poorly capitalized banks. These biases have real effects on bank behavior — propped-up banks are less likely to subsequently improve their capital ratios by raising equity or cutting dividends.

Political Uncertainty and Corporate Transparency

We examine the effect of political uncertainty on corporate transparency and market quality using gubernatorial elections as a source of plausibly exogenous variation in uncertainty. Despite real activity falling in the years leading up to a close election, voluntary disclosure, measured by the frequency and content of voluntary 8-K filings and managerial guidance, increases. These effects are stronger before elections in which the incumbent has termed out or with recent party flipping, and reverse after the election. We find that political uncertainty increases trading costs and reduces analyst information production, which firms mitigate by increasing transparency.

Does Financial Reporting Matter? Evidence from Accounting Standards

By allowing investors to efficiently allocate capital, developed financial markets promote economic growth. We revisit a key component of financial market development, namely financial reporting standards, to identify a channel underpinning this link. We focus on introductions of new financial reporting standards and construct a novel text-based, firm-level measure of sensitivity to these standards. Relative to insensitive firms, sensitive firms reduce securities issuance by 11.4% and, despite compensating with internal sources of funds, cut investment by 10.8% after standards. These findings demonstrate that new standards trigger a substantial reallocation of capital through financial markets.We exploit firms’ voluntary disclosures as a novel firm-specific measure of ex ante sensitivity to individual FASB accounting standards to study the real effects of information regulation. We find that accounting standards impact capital allocation by increasing the cost and reducing the supply of credit and equity financing for sensitive firms. Affected firms respond by drawing down cash reserves and selling more assets compared to insensitive firms. Facing these financial constraints, affected firms cut payout by 2.6% and investment by 3.6%, on average. Our results suggest that accounting standards have economically significant real effects because they reallocate capital in financial markets. JEL Classification: G21, G28, G32, M41

Do Lenders Have Favorite Auditors

Yes. We construct a novel revealed preference measure of financial statement verification based on matching among lenders, borrowers, and auditors. When borrowers use their lenders’ preferred auditors, they borrow larger amounts and at lower rates and contracts depend more on accounting information. Lender preferences are determined by their historical experience with individual auditors; when borrowers in their loan portfolio default or restate their financials, lenders shift their loan portfolio away from the implicated auditor. These preferences impact borrowers’ post-financing auditor choices as well as subsequent matching between borrowers and lenders. Finally, when borrowers follow their lenders’ preferences, loan terms are more sensitive to financials and borrowers are less likely to default in the future. Our findings suggest that, through financial statement verification, auditors play a significant role in contracting efficiency and matching in the private loan market.

The Burden of Being Public: Evidence from Local Labor Markets

We exploit rich, cross-occupation employment data and quasi-experimental variation in IPO completion to quantify the direct labor compliance costs of being a public company. We precisely estimate a small, positive effect of public listings on local employment for compliance occupations that translates to average annual firm-level compliance costs of no higher than

Short-Termism Spillovers from the Financial Industry

1.3M. Using dynamic cross-sectional variation in the regulatory burden for public companies, we find that labor costs are highly sensitive to capital markets regulation. However, our estimates are substantially lower than self-reported compliance costs and suggest that labor costs are likely not an important determinant of listing status.

Market Power and the Profitability of Limit-Order Trading

To meet short-term benchmarks, lenders may alter their monitoring behavior, providing a channel for short-termism incentives to spillover into the corporate sector. We find that lenders with short-termism incentives enforce material covenant violations at abnormally high rates. Further, they are more likely to target high-quality borrowers with which they have a prior relationship and that are less financially constrained. Affected borrowers are more likely to switch lenders, receive worse loan terms on future loans, and reduce investment. Market reactions to technical default announcements when lenders have short-term incentives are 0.63% lower, suggesting that short-termism spillovers are value-decreasing.

Understanding the 'Numbers Game'

I develop a model that quantifies the profitability of trading from limit order data. This method allows for estimation of the effective number of market participants without the need for trader IDs or proprietary datasets. In addition, my framework can evaluate several different questions in modern markets which are difficult to evaluate because of flickering quotes, algorithmic in-and-out strategies and other high frequency changes to the order book. As an illustration of my method, I fit parameters to the model using Google stock surrounding an earnings announcement in the 2nd quarter of 2010.

Taxes and Peer Effects

Two well-known stylized facts on earnings management are that the earnings surprise distribution has a discontinuity at zero, and that positive earnings surprises are associated with positive abnormal returns. We link these two facts in a model of the earnings management decision in which the manager trades off the capital market benefits of meeting earnings benchmarks against the costs of manipulation. We develop a new structural methodology to estimate the model and uncover the unobserved cost function. The estimated model parameters yield the percentage of manipulating firms, magnitude of manipulation, noise in manipulation, and sufficient statistics to evaluate proxies for identifying firms suspected of manipulation. Finally, we use the Sarbanes--Oxley Act as a policy experiment and find that by increasing costs, the Act reduced equilibrium earnings management by 36%. This reduction occurred despite an increase in benefits, consistent with the market rationally becoming less skeptical of firms that just meet benchmarks.