The nature of information in commercial bank loan loss disclosures.

Bank financial statements provide three separate disclosures of changing loan portfolio default risks: changes in non-performing loans, loan loss provisions and loan chargeoffs. The objectives of this study are to analyze the information in each of these loan loss disclosures about future cash flows and to examine how investors impound this information in bank stock prices. Accounting for loan loss provisions involves management discretion. Changes in non-performing loans and loan chargeoffs, as less discretionary measures of loan default risks, may enable investors to estimate management's use of discretion over reported loan loss provisions. If so, then an interesting question arises: what do discretionary provisions reveal? The results suggest that bank managers increase discretionary components of loan loss provisions when future cash flow prospects improve. Unexpected provisions are positively related to changes in cash flows through three years into the future. Also, bank stock returns indicate that investors interpret unexpected provisions as "good news" about future cash flows. Unexpected changes in non-performing loans and unexpected chargeoffs are important pieces of "bad news" about loan losses. These two disclosures are negatively related to future changes in cash flows and current period stock returns. Stock prices react positively to the release of unexpected provisions and negatively to the release of unexpected changes in non-performing loans and unexpected chargeoffs around earnings announcement dates and financial statement release dates. The observed reactions are not very robust, however. They are most pronounced when at least one of the unexpected loan loss disclosures is unusual. Changes in non-performing loans and chargeoffs are important pieces of information to use in interpreting the discretionary components of provisions. The relations between provisions and both returns and future cash flows are positive only when changes in non-performing loans and chargeoffs are included in the analysis. This study provides evidence on managers' use of discretion over financial reporting choices, and demonstrates a context in which the market infers valuation implications from discretionary reporting choices of managers. The results also provide a context in which the market's interpretation of a disclosure on the income statement is conditioned on related balance sheet and footnote disclosures.Ph.D.Business AdministrationUniversity of Michigan, Horace H. Rackham School of Graduate Studieshttp://deepblue.lib.umich.edu/bitstream/2027.42/105807/1/9208681.pdfDescription of 9208681.pdf : Restricted to UM users only

Managers' investment decisions: Incentives and economic consequences arising from leases

What incentives do managers face that might give rise to inefficient investments in leases? If managers make inefficient investments in leases, what economic consequences arise for those managers and their firms? We develop a model of expected investments in leased assets and use the residuals from the model as proxies for inefficient investments. We find that, in contrast to investments in capital expenditures, leasing appears to be a mechanism through which managers can seemingly over-invest, even among firms with high quality financial reporting and negative free cash flows. Examining economic consequences, we predict and find that unexpected investments in leased assets trigger increasing future sales growth but declining future earnings growth for as long as three years ahead. We also find a negative relation with contemporaneous stock returns, suggesting investors view unexpected investments in leases as value destructive. Finally, despite negative returns consequences, we find that unexpected investments in leases are associated with higher CEO compensation driven primarily by future sales growth. Our study suggests that compensation contracts that reward growth may give managers' incentives to drive sales growth with larger-than-expected investments in leased assets, which lead to slower future earnings growth and negative share price consequences for investors. Our results should inform managers and board members, investors, and researchers interested in investment efficiency, corporate governance, and leases