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The Interaction of Mandatory and Voluntary Disclosures: Evidence from the Dodd-Frank Act Anya Kleymenova and Li Zhang March 31, 2017 PwC Young Scholars Research Symposium III, University of Illinois at Urbana-Champaign Research Setting

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SLIDE 1

The Interaction of Mandatory and Voluntary Disclosures: Evidence from the Dodd-Frank Act

Anya Kleymenova and Li Zhang March 31, 2017 PwC Young Scholars Research Symposium III, University of Illinois at Urbana-Champaign

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SLIDE 2

Research Setting

  • Why is this important?

− Reduction of systemic risk − Increased mandatory disclosure requirements − Directly affect a portion of financial institutions

  • Mixed theoretical predictions on voluntary disclosure for

affected and unaffected banks

− Positive or negative externalities − Pooling vs. separating equilibria − Decreased TBTF guarantees and increased risk of default

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SLIDE 3

Institutional Setting

  • DFA applicability

− Systemically important financial institutions (SIFIs), >$50bln − Large banks, $10-$50bln − Mid-size banks, $1-$10bln and small banks <$1bln

  • Main changes affecting disclosure

− Stress tests − Resolutions of TBTF banks − Swap and derivatives disclosures − Corporate governance and compensation − Credit ratings

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SLIDE 4

Motivation

Positive benefits from disclosure

  • Cost of capital consequences

− Decreased cost of equity capital (e.g., Glosten and Milgrom, 1985; Kim and Verrecchia,

1994; Chae, 2005)

− Improved bond pricing (Morgan and Stiroh, 2001; Easton, Monahan and Vasvari, 2009;

Sengupta, 1998; Balasubramnian and Cyree, 2014)

− Funding providers can distinguish bank types (Balasubramnian and Cyree, 2014;

Ellahie, 2016)

− Increased incentives to monitor (Mehran and Millineaux, 2012)

  • Positive externalities

− Increased voluntary disclosures of affected and non-affected banks (Ball et al.,

2012; Bischof and Daske, 2013)

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SLIDE 5

Motivation (cont.)

Negative costs of disclosure

  • Cost of capital consequences

− Bond prices have high sensitivity to negative news (Easton, et al., 2009)

  • Effects of increased mandatory disclosure for banks

− Cost of inviting further regulatory scrutiny (Armstrong et al., 2016) − Real effects of disclosure (Bond et al. 2012; Gigler et al. 2014; Kanodia and Lee, 1998;

Sapra 2002)

− Endogenous costs of disclosure (Goldstein and Sapra, 2013; Thakor, 2015; Kashyap and

Diamond, 2016)

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SLIDE 6

Research Questions

  • Are there any spillover effects of increased mandatory

disclosure on other banks?

  • What is the impact on voluntary disclosure of banks

subject to increased mandatory disclosure requirements?

  • What are the resulting consequence to the quality of

disclosure?

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SLIDE 7

Sample

  • Bank-specific data

− BHCs FR Y-9C quarterly reports

  • Financial and market data

− Compustat and CRSP

  • Textual analysis-based data

− SEC Edgar 10-Ks and 10-Qs

  • Management forecasts

− IBES

  • Large banks
  • Medium-size banks
  • Small banks
  • Other non-regulated financial institutions and insurance companies
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SLIDE 8

Empirical Research Design (Similarity)

(1) SIMILARITY = β0 + β1POST + β2SIZE + β3BM + β4LOSS + β5RET + β6RET_VOL + β7COVERAGE + β8INS_OWNERSHIP + ε

Where

  • SIMILARITY = cosine similarity of 10Ks (MD&As) following Hanley and Hoberg (2010)
  • Post = 1 for 2011-2014, 0 otherwise
  • Size = natural logarithm of market value of equity
  • BM = ratio of book value of equity to market value of equity
  • Loss = 1 for reported negative income, 0 otherwise
  • RET = cumulative stock returns over prior 12 months
  • RET_VOL = volatility of daily stock returns over prior 12 months
  • COVERAGE = number of analysts covering the firm
  • INS_OWNERSHIP = percentage of shares held by institutional investors
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SLIDE 9

Dependent Variable: SIMILARITY_10K (1) Dependent Variable: SIMILARITY_MDA (2) Intercept 0.851*** (43.62) 0.449*** (11.78) POST 0.018*** (2.91) 0.056*** (3.14) SIZE

  • 0.007**

(-2.03)

  • 0.009

(-1.23) BM

  • 0.008

(-1.54)

  • 0.014

(-1.32) LOSS

  • 0.002

(-0.34)

  • 0.003

(-0.18) RET

  • 0.009

(-1.31)

  • 0.001

(-0.06) RET_VOL

  • 0.056

(0.27) 0.512 (1.05) COVERAGE 0.002** (2.20) 0.003 (1.05) INS_OWNERSHIP 0.002 (0.11)

  • 0.011

(-0.35) Year FE Yes Yes No of OBS 1,816 1,816 R-Squared 0.93% 1.09%

Similarity Test: Large vs. Other Banks (Table 3)

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SLIDE 10

Empirical Research Design (Voluntary Disclosure)

(2) ISSUE = β0 + β1TR + β2POST + β3 TR×POST + β4SIZE + β5BM + β6LOSS + β7RET + β8RET_VOL + β9COVERAGE + β10INS_OWNERSHIP + ε

Where

  • Issue = 1 if issues management forecast, 0 otherwise
  • Post = 1 for 2011-2014, 0 otherwise
  • TR

= 1 for large banks, 0 otherwise

  • TR x Post = 1 for large banks in the post period, 0 otherwise
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SLIDE 11

Dependent Variable: ISSUE (1) Dependent Variable: ISSUE_GOODNEWS (2) Dependent Variable: ISSUE_BADNEWS (3) Intercept

  • 3.350***

(-8.20)

  • 4.387***

(-10.25)

  • 4.130***

(-8.82) TR

  • 0.452

(-1.10)

  • 0.295

(-0.65)

  • 0.578

(-1.46) POST

  • 1.019***

(-5.50)

  • 1.043***

(-3.65)

  • 0.592**

(-2.50) TR × POST

  • 1.369**

(-2.40)

  • 0.952*

(-1.72)

  • 1.234*

(-1.87) SIZE

  • 0.038

(-0.71)

  • 0.0001

(-0.01)

  • 0.053

(-0.91) BM

  • 0.758***

(-3.29)

  • 0.841***

(-3.86)

  • 0.655***

(-2.65) LOSS

  • 0.586***

(-3.97)

  • 0.790***

(-3.99)

  • 0.348**

(-2.03) RET

  • 0.159

(-1.03)

  • 0.025

(-0.15)

  • 0.297

(-1.56) RET_VOL 6.506 (1.23) 7.061 (1.30) 2.527 (0.45) COVERAGE 0.109*** (7.57) 0.076*** (5.76) 0.111*** (7.99) INS_OWNERSHIP 2.755*** (6.79) 2.754*** (6.87) 2.604*** (6.14) Industry/Quarter FE Yes Yes Yes No of OBS 30,552 30,552 30,552 Pseudo R-Squared 21.86% 20.09% 19.53%

Voluntary Disclosure: Large Banks vs. Others (Table 4)

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SLIDE 12

Dependent Variable: ISSUE (1) Dependent Variable: ISSUE_GOODNEWS (2) Dependent Variable: ISSUE_BADNEWS (3) Intercept

  • 3.537***

(-8.37)

  • 4.541***

(-10.21)

  • 4.288***

(-9.00) MID

  • 0.231

(-0.64)

  • 0.344

(-0.87) 0.070 (0.19) POST

  • 1.184***

(-6.07)

  • 1.284***

(-4.15)

  • 0.690***

(-2.81) MID × POST

  • 0.899

(-1.15)

  • 0.686

(-0.86)

  • 1.261

(-1.55) SIZE

  • 0.014

(-0.26) 0.025 (0.49)

  • 0.033

(-0.55) BM

  • 0.720***

(-3.12)

  • 0.847***

(-3.79)

  • 0.588**

(-2.45) LOSS

  • 0.582***

(-3.88)

  • 0.806***

(-3.95)

  • 0.336*

(-1.95) RET

  • 0.145

(-0.94) 0.020 (0.13)

  • 0.315*

(-1.66) RET_VOL 7.671 (1.43) 7.684 (1.38) 3.425 (0.61) COVERAGE 0.118*** (7.94) 0.084*** (6.18) 0.118*** (8.34) INS_OWNERSHIP 2.660*** (6.61) 2.653*** (6.68) 2.517*** (6.00) Quarter FE Yes Yes Yes No of OBS 33,082 33,082 33,082 Pseudo R-Squared 25.69% 21.73% 20.75%

Voluntary Disclosure: Medium Banks vs. Others (Table 5)

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SLIDE 13

Dependent Variable: FLS_10Q Intercept 0.038*** (2.98) TR

  • 0.021

(-1.61) POST 0.204*** (29.20) TR × POST

  • 0.031***

(-3.52) SIZE

  • 0.016***

(-7.57) BM

  • 0.001

(-0.20) LOSS

  • 0.005

(-1.02) RET 0.002 (0.31) RET_VOL 0.364** (2.03) COVERAGE 0.003*** (3.61) INS_OWNERSHIP 0.103*** (8.12) Industry/Quarter FE Yes No of OBS 30,552 R-Squared 26.23%

Voluntary Disclosure: Forward-looking Forecast (Table 6)

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SLIDE 14

Empirical Research Design (Forecast Characteristics)

(3) MF_WIDTH = β0 + β1TR + β2POST + β3 TR×POST + β4SIZE + β5BM + β6LOSS + β7RET + β8RET_VOL + β9COVERAGE + β10INS_OWNERSHIP + ε

Where

  • MF_WIDTH = width of the annual management forecast divided by the stock price
  • Post = 1 for 2011-2014, 0 otherwise
  • TR

= 1 for large banks, 0 otherwise

  • TR x Post = 1 for large banks in the post period, 0 otherwise
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SLIDE 15

Dependent Variable: MF_WIDTH All annual management forecasts (1) Good news annual management forecasts (2) Bad news annual management forecasts (3) Intercept

  • 0.005

(-1.19)

  • 0.002

(-0.47)

  • 0.007

(-1.48) TR 0.0004 (0.12)

  • 0.001

(-0.27) 0.003 (0.72) POST 0.001 (0.64) 0.001 (0.50) 0.001 (1.14) TR × POST

  • 0.007*

(-1.89)

  • 0.007*

(-1.95)

  • 0.008*

(-1.80) SIZE 0.001 (1.17) 0.001 (0.94) 0.001 (1.19) BM 0.005*** (3.33) 0.003** (2.45) 0.005*** (3.30) LOSS 0.003*** (2.78) 0.002** (2.18) 0.003** (2.46) RET

  • 0.001

(-0.36) 0.001 (0.57)

  • 0.003

(-1.49) RET_VOL 0.334*** (3.93) 0.279** (2.47) 0.360*** (4.76) COVERAGE

  • 0.0002

(-1.50)

  • 0.0002

(-1.61)

  • 0.0001

(-1.42) INS_OWNERSHIP 0.0004 (0.18) 0.001 (0.19) 0.0003 (0.13) Industry/Quarter FE Yes Yes Yes No of OBS 2,304 1,126 1,178 R-Squared 24.42% 21.45% 31.61%

Forecast Characteristics Test: Large Banks vs. Others (Table 7)

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SLIDE 16

Additional Analyses

  • Regression Discontinuity research design

− Explore banks’ disclosure behavior around size thresholds

  • Bank-specific tests

− Specific textual disclosures (categories, phrases and words) − Specific characteristics of disclosures (Zur, 2015) − Forward-looking − Other regulatory changes

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SLIDE 17

Conclusions

  • DFA impact on mandatory disclosure

− Evidence of spillover effects on other banks

  • Changes in voluntary disclosures

− Decrease in voluntary disclosures for large banks − No change in voluntary disclosures of mid-size banks − Decrease in frequency of forward-looking disclosures

  • Changes in precision of voluntary disclosure

− Decrease in the width of the range forecast

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SLIDE 18

Contribution

  • Spillover effects to other banks from mandatory disclosure

− Preliminary evidence of positive effects of mandatory disclosure regulations on other banks

  • Informs the debate on the consequences of increased

mandatory disclosure requirements for financial institutions

  • First study to investigate the effect of the DFA disclosure

requirements on banks voluntary disclosures

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SLIDE 19

Appendix

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SLIDE 20

Variables N Mean Std Dev 25% Median 75% SIMILARITY_10K 1,816 0.819 0.073 0.811 0.843 0.859 SIMILARITY_MDA 1,816 0.446 0.179 0.289 0.541 0.580 ISSUE 34,786 0.065 0.246 0.000 0.000 0.000 ISSUE_GOODNEWS 34,786 0.031 0.173 0.000 0.000 0.000 ISSUE_BADNEWS 34,786 0.031 0.172 0.000 0.000 0.000 FLS_10Q 34,786 0.173 0.188 0.000 0.160 0.300 MF_WIDTH 2,304 0.007 0.009 0.002 0.004 0.008 TR 34,786 0.049 0.216 0.000 0.000 0.000 POST 34,786 0.455 0.498 0.000 0.000 1.000 MID 34,786 0.122 0.327 0.000 0.000 0.000 SIZE 34,786 6.109 2.040 4.549 5.957 7.491 BM 34,786 0.952 0.743 0.528 0.792 1.132 LOSS 34,786 0.183 0.386 0.000 0.000 0.000 RET 34,786 0.090 0.351

  • 0.058

0.106 0.272 RET_VOL 34,786 0.027 0.019 0.015 0.020 0.032 COVERAGE 34,786 4.004 5.299 0.000 2.000 6.000 INS_OWNERSHIP 34,786 0.448 0.304 0.168 0.427 0.707

Descriptive Statistics: (Table 1)

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SLIDE 21

Correlation Matrix of Main Variables: (Table 2)

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (1) ISSUE

1.000

(2) ISSUE_GOODNEWS

0.678 1.000

(3) ISSUE_BADNEWS

0.677

  • 0.032

1.000

(4) FLS_10Q

  • 0.008

0.007

  • 0.017

1.000

(5) TR

0.011 0.008 0.002

  • 0.056

1.000

(6) POST

  • 0.058
  • 0.054
  • 0.022

0.066 0.024 1.000

(7) MID

  • 0.069
  • 0.048
  • 0.044
  • 0.008
  • 0.084

0.039 1.000

(8) SIZE

0.208 0.143 0.144

  • 0.006

0.280 0.090

  • 0.106

1.000

(9) BM

  • 0.098
  • 0.074
  • 0.062

0.018

  • 0.016

0.045

  • 0.016
  • 0.368

1.000

(10) LOSS

  • 0.071
  • 0.057
  • 0.040

0.014

  • 0.060
  • 0.048
  • 0.097
  • 0.205

0.270 1.000

(11) RET

0.026 0.026 0.009 0.016

  • 0.003

0.259 0.016 0.124

  • 0.300
  • 0.212

1.000

(12) RET_VOL

  • 0.075
  • 0.051
  • 0.051

0.051

  • 0.045
  • 0.165
  • 0.019
  • 0.348

0.497 0.377

  • 0.085

1.000

(13) COVERAGE

0.245 0.154 0.183 0.040 0.460 0.102

  • 0.049

0.599

  • 0.110
  • 0.098

0.016

  • 0.123

1.000

(14) INS_OWNERSHIP

0.236 0.165 0.163 0.110 0.129 0.077

  • 0.109

0.640

  • 0.181
  • 0.061

0.034

  • 0.172

0.449 1.000