Advertisement

Did the banking sector foresee the financial crisis? Evidence from risk factor disclosures

  • Mehrzad Azmi ShabestariEmail author
  • Kevin Moffitt
  • Bharat Sarath
Original Research
  • 14 Downloads

Abstract

Beginning in December 2005, the SEC required registrants to discuss “the most significant factors that make the company risky” under the Risk Factors item (Item 1A) in annual reports. The objective of this research is to evaluate the informativeness and timeliness of Item 1A in the setting of the banking industry during the financial crisis of 2008, and to investigate the characteristics of banks that moved fastest in communicating information through Item 1A as the crisis developed. We first document that the average number of risks disclosed by the national banks increased significantly from 2008 to 2009 and the tone of Item 1A, based on a standard dictionary (Loughran and McDonald in J Finance 66(1):35–65, 2011), also became more negative over this period. By creating a dictionary of financial crisis related words in press articles using an application of Latent Dirichlet Allocation, we show that the appearance of those words also increased from 2008 to 2009. Overall, the results support a finding that the banking industry failed to disclose business risk on a timely basis in their item 1A disclosures even though the purpose of this item is to allow firms to communicate information about all eventualities including those that may not be realized. The results also provide some information about the characteristics of the banks that had better disclosures in anticipation of crisis. Our finding suggests that the firms that disclosed earlier did a better job in pro-actively managing their operations over the financial crisis period.

Keywords

Banking industry Financial crisis Item 1A Risk disclosures Timely 

JEL Classification

M41 

Notes

References

  1. Aebi V, Sabato G, Schmid M (2012) Risk management, corporate governance, and bank performance in the financial crisis. J Bank Finance 36(12):3213–3226CrossRefGoogle Scholar
  2. Arslan-Ayaydin Ö, Florackis C, Ozkan A (2014) Financial flexibility, corporate investment and performance: evidence from financial crises. Rev Quant Finance Acc 42(2):211–250.  https://doi.org/10.1007/s11156-012-0340-x CrossRefGoogle Scholar
  3. Bao Y, Datta A (2014) Simultaneously discovering and quantifying risk types from textual risk disclosures. Manag Sci 60(6):1371–1391CrossRefGoogle Scholar
  4. Barth ME, Landsman WR (2010) How did financial reporting contribute to the financial crisis? Eur Account Rev 19(3):399–423CrossRefGoogle Scholar
  5. Barth JR, Trimbath S, Yago G (2003) Before the Enron collapse: what corporate CFOs around the world said about the status of accounting and disclosure practices. Rev Pac Basin Financ Mark Polic 6(4):433–440CrossRefGoogle Scholar
  6. Blei DM (2012) Probabilistic topic models. Commun ACM 55(4):77–84CrossRefGoogle Scholar
  7. Blei DM, Ng A, Jordan M (2003) Latent Dirichlet allocation. J Mach Learn Res 3:993–1022Google Scholar
  8. Bochkay K, Levine CB (2017) Using MD&A to improve earnings forecasts. J Acc Audit Finance 34(3):458–482.  https://doi.org/10.1177/0148558X17722919 CrossRefGoogle Scholar
  9. Buckley C (1993) The importance of proper weighting methods. In: Proceedings of the workshop on human language technology. Association for computational linguistics, pp 349–352Google Scholar
  10. Campbell JL, Chen H, Dhaliwal DS, Lu H, Steele LB (2014) The information content of mandatory risk factor disclosures in corporate filings. Rev Acc Stud 19:396–455CrossRefGoogle Scholar
  11. Dias JG, Ramos SB (2014) The aftermath of the subprime crisis: a clustering analysis of world banking sector. Rev Quant Finance Acc 42(2):293–308.  https://doi.org/10.1007/s11156-013-0342-3 CrossRefGoogle Scholar
  12. Fahlenbarch R, Stulz RM (2011) Bank CEO incentives and credit crisis. J Financ Econ 99(1):11–26CrossRefGoogle Scholar
  13. Fields TD, Lys TZ, Vincent L (2001) Empirical research on accounting choice. J Acc Econ 31:255–307CrossRefGoogle Scholar
  14. Gordon EA, Henry E, Peytcheva M, Sun L (2013) Discretionary disclosure and the market reaction to restatements. Rev Quant Finance Acc 41(1):75–110.  https://doi.org/10.1007/s11156-012-0301-4 CrossRefGoogle Scholar
  15. Henry E, Leone A (2010) Measuring qualitative information in capital markets research. Working paper, University of MiamiGoogle Scholar
  16. Hope O, Hu D, Lu H (2016) The benefits of specific risk-factor disclosures. Rev Acc Stud 21:1005–1045CrossRefGoogle Scholar
  17. Huang KW, Li ZL (2011) A multilabel text classification algorithm for labeling risk factors in SEC form 10-K. ACM Trans Manag Inf Syst 2(3):1–19CrossRefGoogle Scholar
  18. Jin JY, Kanagaretnam K, Lobo GJ (2011) Ability of accounting and audit quality variables to predict bank failure during the financial crisis. J Bank Finance 35(11):2811–2819CrossRefGoogle Scholar
  19. Johnson S (2010) SEC pushes companies for more risk information. CFO Magazine, August 2Google Scholar
  20. Jones KS (1972) A statistical interpretation of term specificity and its applications in retrieval. J Doc 28:11–21CrossRefGoogle Scholar
  21. Jorion P (2002) How informative are value-at-risk disclosures? Acc Rev 77:911–931CrossRefGoogle Scholar
  22. Kothari SP, Shu S, Wysocki P (2009) Do managers withhold bad news? J Acc Res 47:241–276CrossRefGoogle Scholar
  23. Kravet T, Muslu V (2013) Textual risk disclosures and investors’ risk perceptions. Rev Acc Stud 18:1088–1122CrossRefGoogle Scholar
  24. Li J, Wei L, Lee CF, Zhu X, Wu D (2018) Financial statements based bank risk aggregation. Rev Quant Finance Acc 50(3):673–694.  https://doi.org/10.1007/s11156-017-0642-0 CrossRefGoogle Scholar
  25. Linsmeier TJ, Thornton DB, Venkatachalam M, Welker M (2002) The effect of mandated market risk disclosures on trading volume sensitivity to interest rate, exchange rate, and commodity price movements. Acc Rev 77:343–377CrossRefGoogle Scholar
  26. Loughran T, McDonald B (2011) When is a liability not a liability? Textual analysis, dictionaries, and 10-Ks. J Finance 66(1):35–65CrossRefGoogle Scholar
  27. Malloy MP (2010) Anatomy of a meltdown: a dual financial biography of the subprime mortgage crisis. Aspen Publishers, New YorkGoogle Scholar
  28. Nelson KK, Pritchard AC (2014) Carrot or stick? The Shift from voluntary to mandatory disclosure of risk factors. J Empir Legal Stud 13:266–297CrossRefGoogle Scholar
  29. O’Connor B, Bamman D, Smith NA (2011) Computational text analysis for social science: model assumptions and complexity. In: Proceedings of the NIPS workshop on computational social science and the wisdom of crowdsGoogle Scholar
  30. Rajgopal S (1999) Early evidence on the informativeness of the SEC’s market risk disclosures: the case of commodity price risk exposure of oil and gas producers. Acc Rev 74:251–280CrossRefGoogle Scholar
  31. Ross A (2008) JP Morgan Pays $2 a Share for Bear Stearns. The New York Times. https://www.nytimes.com/2008/03/17/business/17bear.html. Accessed 9 June 2017
  32. Roulstone DT (1999) Effect of SEC financial reporting release No. 48 on derivative and market risk disclosures. Acc Horiz 13:343–363CrossRefGoogle Scholar
  33. Salton G (1972) A new comparison between conventional indexing (Medlars) and automatic text processing (Smart). J Am Soc Inf Sci 23(2):75–84CrossRefGoogle Scholar
  34. Salton G, Buckley C (1988) Term-weighting approaches in automatic text retrieval. Inf Process Manag 24(5):513–523CrossRefGoogle Scholar
  35. Schrand CM (1997) The association between stock-price interest rate sensitivity and disclosures about derivative instruments. Acc Rev 72:87–109Google Scholar
  36. Securities and Exchange Commission (SEC) (2004) Securities offering reform. Release Nos. 33-8501, 34-50624. https://www.sec.gov/rules/proposed/33-8501.htm. Accessed 17 July 2014
  37. Securities and Exchange Commission (SEC) (2005) Securities offering reform. Release Nos. 33-8591, 34-52056. https://www.sec.gov/rules/final/33-8591.pdf. Accessed 17 July 2014
  38. Securities and Exchange Commission (SEC) (2007) Smaller reporting company regulatory relief and simplification. Release Nos. 33-8876, 34-56994:39-2451. https://www.sec.gov/rules/final/2007/33-8876.pdf. Accessed 17 July 2014
  39. Stulz RM, Beltratti A (2012) The credit crisis around the globe: why did some banks perform better? J Financ Econ 105(1):1–17CrossRefGoogle Scholar
  40. Watson RD (2008) Subprime mortgages, market impact, and safety nets. Rev Pac Basin Financ Mark Polic 11(3):465–492CrossRefGoogle Scholar
  41. Watts RL, Zimmerman JL (1986) Positive accounting theory. Englewood Cliffs, NJ Prentice HallGoogle Scholar
  42. Wong MHF (2000) The association between SFAS No. 119 derivatives disclosures and the foreign exchange risk exposure of manufacturing firms. J Acc Res 38:387–417CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Towson UniversityTowsonUSA
  2. 2.Rutgers UniversityPiscatawayUSA

Personalised recommendations