Intuition suggests that firms with higher cash holdings should be "safer" and have lower credit spreads. Yet empirically, the correlation between cash and spreads is robustly positive. This puzzling finding can be explained by the precautionary motive for saving cash, which in our model causes riskier firms to accumulate higher cash reserves. In contrast, spreads are negatively related to the part of cash holdings that is not determined by credit risk factors. Similarly, although firms with higher cash reserves are less likely to default in the short term, endogenously determined liquidity may be related positively to the longer-term probability of default. Our empirical analysis confirms these predictions, suggesting that precautionary savings are central to understanding the effects of cash on credit risk. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

This article proposes a novel method of extracting the cost of default from the change in the market value of a firm's assets upon default. Using a large sample of firms with observed prices of debt and equity that defaulted over fourteen years, we estimate the cost of default for an average defaulting firm to be 21.7% of the market value of assets. The costs vary from 14.7% for bond renegotiations to 30.5% for bankruptcies, and are substantially higher for investment-grade firms (28.8%) than for highly levered bond issuers (20.2%), which extant estimates are based on exclusively. (JEL G21, G30, G33)

ABSTRACT We estimate linguistic‐based classification models of deceptive discussions during quarterly earnings conference calls. Using data on subsequent financial restatements and a set of criteria to identify severity of accounting problems, we label each call as “truthful” or “deceptive.” Prediction models are then developed with the word categories that have been shown by previous psychological and linguistic research to be related to deception. We find that the out‐of‐sample performance of models based on CEO and/or CFO narratives is significantly better than a random guess by 6–16% and is at least equivalent to models based on financial and accounting variables. The language of deceptive executives exhibits more references to general knowledge, fewer nonextreme positive emotions, and fewer references to shareholder value. In addition, deceptive CEOs use significantly more extreme positive emotion and fewer anxiety words. Finally, a portfolio formed from firms with the highest deception scores from CFO narratives produces an annualized alpha of between −4% and −11%.

We study the mutual relationships between institutional ownership, analyst following and share prices. We show that the pressure on firms to set lower share prices to attract analysts is attenuated by institutional monitoring. Our theory refutes the assumed causal relation between share price and institutional ownership, attributed to the share price–liquidity relation, and we show empirically that share prices and institutional ownership are positively related after controlling for liquidity. Our study provides a rationale for why better firms generally maintain higher share price levels, and offers new insights into the puzzling empirical linkages observed between nominal share price levels and firm fundamentals.

We examine a vertical integration decision within the commercial banking industry. During the last quarter of the 20th century, some community banks reduced their traditional reliance on correspondent banks for upstream products and services by joining bankers' banks, a form of business cooperative. Research on vertical integration focuses primarily on firm-specific investment, market power, and government regulation. However, this case is difficult to explain in terms of these standard vertical integration motives. Our evidence suggests that bankers' banks are a response to technological change and deregulation that results in increased costs faced by community banks in dealing with correspondent banks as both suppliers and potential competitors. For instance, loan participations require sharing proprietary information about major loan customers, something a community bank would not want to provide to a potential competitor.

This article proposes a novel approach to empirically identifying government spending multipliers that relies on two features unique to many low-income countries: (1) borrowing from the World Bank finances a substantial fraction of government spending, and (2) spending on World Bank–financed projects is typically spread out over several years following the original approval of the project. The first fact means that fluctuations in spending on World Bank–financed projects are a significant source of fluctuations in overall government spending in these countries. The second fact means that fluctuations in World Bank–financed spending in a given year are largely determined by fluctuations in project approval decisions made in previous years, and so are unlikely to be correlated with shocks to output in the current year. I use World Bank project-level disbursement data to isolate the component of World Bank–financed government spending in a given year that is associated with past project approval decisions. I use this as an instrument for total government spending to estimate multipliers in a sample of 29 primarily low-income countries where variation in government spending from this source is large relative to the size of the economy. The resulting spending multipliers are small and reasonably precisely estimated to be in the vicinity of 0.5.

We examine how two attributes of preventive and detective controls affect employee performance and employee motivation. Specifically, we examine how the extent to which controls (1) restrict employees’ autonomy, and (2) provide more or less timely feedback impacts employees’ performance and intrinsic motivation. These characteristics are the defining differences between preventive and detective controls in that preventive controls restrict employee autonomy relative to detective controls and preventive controls always provide immediate feedback; whereas, detective controls can provide either immediate feedback or delayed feedback. We conduct an experiment to examine how and why these two types of formal controls impact employees’ performance in an incomplete contract setting in which one dimension of the employees’ task is compensated and one dimension is controlled. The results show that detective controls with more timely feedback improve employees’ performance toward the control objective, without affecting their intrinsic motivation. In contrast, the restriction of autonomy associated with preventive controls, has no additional effect on employees’ performance toward the control objective over detective controls with timely feedback but significantly reduces employees’ motivation. Neither control characteristic has a significant effect on employees’ performance on the compensated dimension of the task, suggesting that monetary incentives continue to provide an effective motivation. Our results reveal the importance of designing and implementing controls that provide timely feedback but do not restrict autonomy.

This paper investigates the association between Malaysian politically connected (PCON) firms and the cost of debt. We extend previous research that finds Malaysian PCON firms are perceived as being of higher risk by the market, and by audit firms, by providing evidence that lenders also perceive these firms as being of higher risk. We also find that PCON firms have a significantly (1) higher extent of leverage, (2) higher likelihood of reporting a loss, (3) higher likelihood of having negative equity, and (4) higher likelihood of being audited by a big audit firm. We suggest that PCON firms are charged higher interest rates by lenders as a result of efficient contracting given their higher inherent risks. Additionally, we find that CEO duality present in PCON firms is perceived by lenders as being more risky, and that a higher proportion of independent directors on the audit committee mitigate this perceived risk.

ABSTRACT This paper investigates the impact of changes in the banking sector on firms’ timely recognition of economic losses. In particular, we focus on the entry of foreign banks into India during the 1990s, which likely causes an exogenous increase in lender demand for timely loss recognition. Analyzing variation in both the timing and the location of the new foreign banks’ entries, we find that foreign bank entry is associated with more timely loss recognition and this increase is positively related to a firm's subsequent debt levels. The change appears driven by a shift in firms’ incentives to supply additional information to lenders and lenders seem to value this information. The increase in timely loss recognition is also concentrated among firms more dependent on external financing: private firms, smaller firms, and nongroup firms. Overall, our evidence suggests that a firm's accounting choices respond to changes in the banking industry.