Knowledge that Transforms

We investigate how external credit market development affects corporate earnings management, by studying the impact of the U.S. interstate banking and branching deregulations on the intensity of accruals-based and real earnings management. We find that the banking and branching deregulations significantly decrease both accruals-based and real earnings-management intensity among firms in deregulated states. The effect is stronger for those deregulated states that have lower bank branch density before deregulation and states that have greater out-of-state bank entry after deregulation. The impact on corporate earnings management is channelled through increased banking competition and credit supply providing firms with easier access to external financing. The findings are robust to various endogeneity concerns. We further document that interstate banking and branching deregulations reduce the instances of financial results being subsequently affected by accounting restatements and improve firms’ information environment.

We explore the impact of low and negative monetary policy rates in core world economies on bank lending in four small open economies – Canada, Chile, the Czech Republic and Norway – using confidential bank-level data. We show that the impact on lending in these small open economies depends on the interest rate level in the core. During normal times, monetary policy cuts in the core can reduce credit supply in small open economies. In contrast, when interest rates in the core are low, further expansionary monetary policy increases lending in small open economies, consistent with an international bank lending channel. These results have important policy implications, suggesting that central banks in small open economies should watch for the impact of potential regime switches in core economies’ monetary policy when rates shift to and from the very low end of the distribution.

Can leaders’ names have an impact on their compensation and firm performance? We reason about how and why certain leaders’ names are related to higher financial compensation, yet unrelated to their ability to lead a company and thus firm performance. Based on a sample of 6132 CEOs working at large, publicly traded (S&P 1500) firms, we find that CEOs who have more “fluent” names—or names associated with feelings of cognitive ease (e.g., shorter length, more common)—obtain greater financial as well as non-financial perks, even though they are no more competent. Therefore, the study looks beyond the influence of sex- and race-typed names to help explain the observed mismatch between top management compensation and firm performance. We discuss the theoretical implication of this study for the cognitive bias and discrimination literature, and managerial implications for strategic human resource management.

We develop an empirical network model to characterize the density of bilateral sovereign credit risk spillovers during the European debt crisis. We show that the spillover density is often asymmetric with heavy tails and that its location and shape vary strongly and systematically in relation to published indicators of systemic stress. Using auxiliary panel data models, we show that the intensity of bilateral spillovers is related to the portfolio investment exposures among country pairs. Because our spillover statistics can be updated daily, they represent a valuable supplement to existing weekly and monthly measures of systemic stress.

In this paper, we analyze the effect of a policy recommendation on the performance of an artificial interbank market. Financial institutions stipulate lending agreements following a public recommendation and their individual information. The former is modeled by a reinforcement learning optimal policy that maximizes the system’s fitness and gathers information on the economic environment. The policy recommendation directs economic actors to create credit relationships through the optimal choice between a low interest rate or a high liquidity supply. The latter, based on the agents’ balance sheet, allows determining the liquidity supply and interest rate that the banks optimally offer their clients within the market. Thanks to the combination between the public and the private signal, financial institutions create or cut their credit connections over time via a preferential attachment evolving procedure able to generate a dynamic network. Our results show that the emergence of a core–periphery interbank network, combined with a certain level of homogeneity in the size of lenders and borrowers, is essential to ensure the system’s resilience. Moreover, the optimal policy recommendation obtained through reinforcement learning is crucial in mitigating systemic risk.

We find that social capital, as captured by associational networks and social norms in US counties where corporate headquarters are located, is positively associated with cash dividend payouts in local firms. The positive effect is incremental to other known local factors affecting dividends, is robust to a range of sensitivity analyses, and extends to corporate decisions about whether to pay dividends or not. Social capital mitigates managerial private financial incentives to limit dividends and encourages higher dividends among firms facing greater free cash flow problems. Social capital also attenuates over-investment of free cash flow.

Limited coverage is a standard feature in deposit insurance schemes. It is used to limit moral hazard, and achieves this objective by reinforcing market discipline: depositors have more incentives to monitor banks’ risk-taking if they have skin in the game. In this paper, I study market discipline and coverage levels by analyzing the relationship of funding costs and deposit growth with banks’ risk. I use a database of Colombian banks’ balance sheets and take advantage of a sudden, significant, and exogenous increase in the coverage level that occurred in April 2017. I find evidence of market discipline throughout the period of analysis and most results are consistent with it not being reduced by the change in the coverage level. The results are nuanced, however. Two variables are impacted: one in the quantity and the other in the price dimension. Furthermore, results also vary when I look at specific groups of banks separately. Market discipline is not present in big banks. Too big-to-fail perceptions seem to limit it. This is also the case for banks concentrated in fully insured deposits, where limited coverage has a less prevalent role.

The paper studies the effectiveness of bank resolutions using a comprehensive database on banks headquartered in 18 European countries over the period 2000–19. By means of difference-in-differences methodology, we find that impaired asset segregations – otherwise known as bad banks – have been more effective than state-funded recapitalisations of distressed banks. While recapitalised banks seem to have used the injected funds mainly to clean up their balance sheets by reducing problem loans and cutting down on lending, banks that segregated assets increased progressively their lending after the creation of the bad bank. For both types of banking crisis interventions, we find a significant ex-post reduction in the cost of bank funding and shift towards deposit funding.

This paper investigates the effects of national culture on bank liquidity creation. Using a sample that covers 66 countries over the 2001–2014 period, we find that individualism is associated with greater bank liquidity creation. This evidence lends more weight to the risk-taking and overconfidence bias explanations. We also find that the effect is stronger for larger banks. Moreover, individualism is associated with more (less) liquidity creation in developed (developing) countries, suggesting that social connections and better access to soft information are relevant explanations in developing countries. Additional analysis suggests that the other cultural dimensions of uncertainty avoidance and power distance are related to lower bank liquidity creation. The results remain robust for a battery of sensitivity checks, and for confronting endogeneity and omitted variables concerns.

This paper describes the balance sheet adjustments of debt and equity financed firms over time in an economy subject to taste shocks. A model is developed that describes a representative firm with a stochastic diminishing returns technology and a set of financial contracts that resolve a conflict-of-interest problem between differentially risk-averse bondholders and stockholders. The contractual resolution of this conflict-of-interest problem between the two agents is shown to shape certain stylized facts of business cycles ignored in Keynesian and Classical models. Changes in investor risk aversion and equity valuations trigger real investment decisions that can cause business cycles. Bond covenants then have the firm adjusting its financing decisions so as to offset any risk-shifting associated with the investment decisions. Stockholders manage the asset side of the firm’s balance sheet while bondholders (regulators in the case of banks) manage the financing side. In this way the welfare of both investors is coalesced over the business cycle. A similar type of analysis accounts for the age distribution of workers, and the size distribution of firms over the business cycle. Evidence presented here and elsewhere fails to reject these predictions for the U.S. non-financial and financial corporate sectors.