This study examines the impact of regulatory capital and several of its determinants (i.e., earnings, loan loss provisions, charge‐offs and growth) on bank managers' financing decisions and investors' interpretations of those decisions. The analysis is related to two streams of research. We add to the corporate finance literature that seeks to explain the market's reaction to security issuances by developing and testing a refined set of predictions of the demand for debt and equity capital using a sample of capital‐regulated firms (banks). We extend the accounting literature that links regulatory capital‐management decisions with bank performance by examining whether investors infer that performance. We find that bank managers' financing choices reflect their private information regarding the levels of regulatory capital, earnings, and charge‐offs in the issuance year. We document a negative market reaction to capital‐increasing issuances and a positive reaction to capital‐decreasing issuances. A cross‐sectional analysis of that market reaction indicates that investors infer managers' expectations of earnings in the issuance year.

We review research from the 1990s that examines the determinants and consequences of accounting choice, structuring our analysis around the three types of market imperfections that influence managers’ choices: agency costs, information asymmetries, and externalities affecting non-contracting parties. We conclude that research in the 1990s made limited progress in expanding our understanding of accounting choice because of limitations in research design and a focus on replication rather than extension of current knowledge. We discuss opportunities for future research, recommending the exploration of the economic implications of accounting choice by addressing the three different reasons why accounting matters.

In this study of sell-side analysts’ forecasts, we explore the effects of analyst aptitude, learning-by-doing, and the internal environment of the brokerage house on forecast accuracy. Our results indicate that analysts’ aptitude and brokerage house characteristics are associated with forecast accuracy, while learning-by-doing is only associated with forecast accuracy when we do not control for analysts’ company-specific aptitude in forecasting. It is unlikely that this result is caused by measurement errors because it is robust when we use a sub-sample where we can accurately measure experience.

Equity-for-debt swaps, Earnings expectations, Information effect

Gu and Xue [2008. The superiority and disciplining role of independent analysts. Journal of Accounting and Economics, this issue, doi:10.1016/j.jacceco.2008.02.002] study the disciplining effect of independent analysts on the accuracy and forecast relevance of the forecasts of non-independent analysts. One of the intriguing results is that while independent analysts issue inferior forecasts, their presence appears to reduce the forecast bias, improve the forecast accuracy and increase the forecast relevance of forecasts issued by non-independent analysts. We explore alternative explanations for the Gu–Xue results. Our evidence of endogenous entry and exit of independent analysts provides a more compelling explanation for the reported results.

During Spring 2000, the Internet Stock Index declined 45%. Using a sample of internet firms, this paper investigates whether this decline was associated with new disclosures, such as earnings, analyst forecast revisions, and web-traffic measures, or to a “reassessment” by investors of pre-existing information. We find only modest evidence that the decline was associated with new disclosures. However, returns and post-decline stock prices are significantly explained by 1999 annual report data. When earnings are decomposed into gross profit and various expenses, traditional financial information contributes significantly more in explaining the cross-sectional returns and price levels than non-financial information.

Bradshaw, Richardson, and Sloan (BRS) find a negative relation between their comprehensive measure of corporate financing activities and future stock returns and future profitability. Noticing that accounting accruals are increases in net operating assets on a company's balance sheet, we question whether it is possible to distinguish between the ‘external financing anomaly’ documented by BRS and the ‘accrual anomaly’ first documented by Sloan [1996. Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review 71, 289–315]. We show that once controlling for total accruals, the relation between external financing activities and future stock returns is attenuated and not statistically significant. These findings are consistent with Richardson and Sloan [2003. External financing, capital investment and future stock returns. Working Paper, University of Pennsylvania and University of Michigan].

Abarbanell and Lehavy provide evidence that analysts’ forecast errors are not normally distributed exhibiting a high occurrence of extreme negative forecast errors (left-tail asymmetry) and a high occurrence of small positive forecast errors (middle asymmetry). This is important for researchers who rely on techniques that are sensitive to the distributional assumptions of analysts’ forecast errors. Many of the conclusions drawn by Abarbanell and Lehavy, however, are based on visual impressions (as opposed to formal empirical tests) or based on methods that are very sensitive to the empirical methods used (e.g., whether the serial correlation of forecast errors is caused by the left-tail asymmetry).

Accounting research frequently uses R2, for example, to measure value relevance. We show analytically that scale effects present in levels regressions increase R2, and this effect increases in the scale factor's coefficient of variation. Thus, between-sample comparisons of R2 are invalid, unless one controls for differences in the scale factor's coefficient of variation. Applying our analysis to prior research, we show that the documented increase in value relevance of accounting is attributable to increases in the coefficient of variation of the scale factor. Controlling for this effect, there has been a decline in value relevance, as measured by R2.

In order for security prices to be informationally efficient, incentives must exist for traders to engage in costly information acquisition. This paper provides empirical evidence on this proposition. We observe that risk arbitrageurs (i.e., market participants who trade in securities of firms that are involved in mergers, tender offers, and voluntary liquidations) are able to generate private information regarding the success or failure of corporate reorganizations. Moreover, risk arbitrageurs earn substantial returns on their trading activities. These results suggest that security prices are sufficiently noisy to create incentives for costly information acquisition.