Knowledge that Transforms

The widespread Italian practice of multiple borrowing has been studied with respect to the continuity of bank lending and to the interest rates charged to individual borrowers. However, there is a lack of empirical evidence on the effects of multiple credit relationships over the fragility of the corporate borrowers. Two theses are competing: one asserts that multiple borrowing results in a desirable sharing of risks; the other, that the parcellization of loans substantially weakens the discipline exercised by the banks and makes corporate borrowers more fragile. Through multivariate techniques, we check whether the indicators describing the structure of lending relationships can help, along with balance-sheet variables, to separate healthy from failed firms. This exercise shows that multiple banking relationships are associated with a higher riskiness of the borrowers, even though the impact is moderate in comparison with the importance of real and financial variables derived from balance sheets.

This study tests predictions that pricing multiples on and incremental explanatory power of equity book value (net income) increase (decrease) as financial health decreases. Tests using a sample of 396 bankrupt firms and tests using a larger, pooled sample both yield inferences consistent with predictions. Findings are robust to inclusion of controls for industry, size, return-on-equity, and volatility of equity returns. Equity book value and net income multiples and incremental explanatory power vary predictably across three illustrative industries, selected based on the likely extent of unrecognized intangible assets.

We examine the effect of underwriting relationships on analysts' earnings forecasts and recommendations. Lead and co-underwriter analysts' growth forecasts and recommendations are significantly more favorable than those made by unaffiliated analysts, although their earnings forecasts are not generally greater. Investors respond similarly to lead underwriter and unaffiliated `Strong buy' and `Buy' recommendations, but three-day returns to lead underwriter `Hold' recommendations are significantly more negative than those to unaffiliated `Hold' recommendations. The findings suggest investors expect lead analysts are more likely to recommend `Hold' when `Sell' is warranted. The post-announcement returns following affiliated and unaffiliated analysts' recommendations are not significantly different.

A cross-sectional analysis of cash compensation paid to CEOs of 713 US firms reveals that the sensitivity of compensation to earnings varies directly with earnings persistence. Additional analysis indicates that this sensitivity is greater for cases where executives are approaching retirement. Such evidence suggests the use of earnings persistence to counterbalance adverse consequences of earnings-based contracting with managers who face finite decision horizons.

A model of earnings, cash flows and accruals is developed assuming a random walk sales process, variable and fixed costs, and that the only accruals are accounts receivable and payable, and inventory. The model implies earnings better predict future operating cash flows than current operating cash flows and the difference varies with the operating cash cycle. Also, the model is used to predict serial and cross-correlations of each firm's series. The implications and predictions are tested on a 1337 firm sample over 1963–1992. Both earnings and cash flow forecast implications and correlation predictions are generally consistent with the data.

We empirically document a strategy through which corporations avoid state income taxes. Examining aggregated American state and Canadian provincial data from 1983–1991, we find corporate income tax revenues are concave in corporate tax rates, consistent with firms shifting their tax bases to more favourably taxed jurisdictions. Additional tests exploit unique features of state formula apportionment systems and find manufacturing shipments from states that tax outside their borders (throwback states) are decreasing in corporate income tax rates on sales.

We investigate whether banks with low capital ratios use accounting accruals for capital ratio management. We focus on a time where we expect a change in bank managers behavior regarding certain accruals. In 1989 regulatory changes created (removed) incentives to depress loan loss provisions (write-offs) after (before) 1989. Our results show that banks with low capital ratios reduced their loan loss provisions and increased write-offs during the 1990–1992 period compared to the 1985–1988 period. Banks with high capital ratios exhibited no difference in loss provisions, but did significantly increase loan write-offs during 1990–92.

We show that a model of undifferentiated price competition closely predicts US audit market concentration. Contracting practices, client size distributions and differences in auditor productivity jointly determine audit firms' market shares. In contrast to prior literature, neither quality differences nor economies of scale for larger firms are necessary in our model to explain audit market concentration.

Two trade-offs arise in an agency relationship when the same accounting signal is used for both performance evaluation and investment evaluation. Using the signal for performance evaluation, (1) directly influences the informativeness of the signal for investment evaluation, (2) induces manipulation, which, in turn, lowers the informativeness of the signal for investment evaluation. The principal can increase her welfare by delegating the investment decision to the agent, setting up multiple control systems, or using the outcome of the investment for performance evaluation. We show the implications of using each alternative on incentive contracts, equilibrium effort, and manipulation levels.