# Presentation: 604640

## Session on Information and Transparency

- Discussion
- by
- Edward J. Kane
- _Boston College_

- September 15, 2006

- 6th Annual FDIC-JFSR Research Conference

## Central Issue: How Do Changes in Accounting Rules Affect Financial Institutions? 

- Does Enhanced “Accounting Disclosure” Increase **Transparency** and **Stability**?
- Because the Degree of Information Asymmetry is a Managerial Decision Variable, Does Expanding Disclosure Requirements Merely Force Malevolent Insiders (Where They Exist) to **Hide Threaded Needles of Information** Inside an Even **Larger** Haystack of Disinformation?

## I. Paper by Rocco Huang

- Huang focuses **primarily** on: the **correlation** between two proxy indices:
- 			1. Nier’s 17-variable index of a firm’s 	  	    	   **accounting informativeness (AI)**.
-     2. LLorente, Michaely, Saar, and Wang’s index of 	   **private information trading (PIT)**.
- And on how these variables correlate with **bank-specific** **variables **and country-level indices of **supervisory power** **(SP)**.
- _Omitted Variables_: No consideration of country-level measures of supervisor’s **enforcement** **technology **or imposed **legal penalties** for violating focal laws and regulations. [Example of token $1 fines for exceeding 55 mph in Montana in 1970s and early 1980s.]

## MODELLING ISSUES

- 1. Only PIT is modelled as an **endogenous variable**; AI and SP are not.
- 2. PIT is the **output of a prior regression** , so it has its **own error term**. (PIT is the “slope shifter” in a regression of the form:
- 			y = a + (b + cV)x + u.
- 	Because coefficient standard errors are understated, **conventional t-values greatly overstate the true significance of such variables. **
- 3. PIT is aggressively interpreted. **More simply**, it is a measure of market **liquidity** _per se_.
- 4. Especially where insider trading is illegal, insiders would be smarter to do their trading in **credit default swaps** and other derivatives markets.

## Sampling and Interpretation Issues

- 1. _Representativeness_: What is the statistical population? Inclusion in Datastream and the benign macroeconomic era of 2003-2005 limits reach of findings.
- 2. _Potential Heckman Bias_: Most country-level variables may be conceived  as resulting endogenously from sectoral bargaining in the political economy.
- 		Given his marginal t-values, the author should test 	for this directly. For example, for reverse causation 	from AI to SP.
- The deeper policy question is not only “Why does society regulate banks?”, but also “Why do banks in a given country permit themselves to be regulated and in particular ways?”

## NIER Paper

- Uses a **partly larger** and **partly smaller** dataset than Huang.
- More banks (550)
- More years (1994-2000), but no overlapping.
- Fewer countries (32). **Huge sample sizes (N = upwards of 2500) raise issue of Lindley Paradox. **
- Same 17-Variable Disclosure Index (AI) as Huang.
- Endogenous variable is a zero-one **“individual-bank crisis indicator”** c(i, t).
- 	   Crisis is defined as a stock return in the 5% lower trail of the distribution of annual equity returns across all banks and years in the sample.

## Probit Model*of c(i, t)

- Pr[c(i, t) = 1] is made a function of selected:
- 		1. Macroeconomic Variables
- 		2. Bank-Level Variable
- 		3. Structural Variables
- 		   a. Transparency (lagged AI)
- 		   b. Deposit-Insurance Characteristics
- 		4. Time Trend
- 		* Hazard models could handle trends better.
- 		[5. Endogeneity of AI is Investigated in a Two-	     Stage Framework. Evidence of Simultaneous-	     Equation Bias Emerges: **Negative Coefficient ****	****     Assigned to AI Becomes Almost Twice as ****	****     Large!!]**

## AI Has Negative Sign
Unlimited Deposit Insurance Coverage Has a Positive Sign

Main Criticism: 
Need to remove simultaneous-equation bias. 

Not only has AI and DI coverage been shown to be endogenous, but Hovakimian, Laeven, and a third author (JFSR, 2003; 390 banks, 56 countries, 1991-1999) show via a Heckman model that it is important to allow for the endogeneity of DI design features and link them to country characteristics before concluding anything about their effects on bank-level variables.   

- Unlimited Deposit Insurance Coverage Has a Positive Sign
- _Main Criticism_:
- Need to remove simultaneous-equation bias.
- Not only has AI and DI coverage been shown to be endogenous, but Hovakimian, Laeven, and a third author (JFSR, 2003; 390 banks, 56 countries, 1991-1999) show via a Heckman model that it is important to allow for the endogeneity of DI design features and link them to country characteristics before concluding anything about their effects on bank-level variables.

- _Main Findings:_

## Additional Criticisms

- 1. Need to set tougher significance levels for samples of this size.
- 2. Need to investigate the **waste of stock-price information** built into the indicator definition. Could try to explain GARCH-type models of return volatility instead.
- 3. Need to do more with simultaneity.

## Beatty Paper

- Focuses on two 2003 changes in the Accounting Treatment of **one** Instrument: **Trust Preferred Securities (TPS)**.
- This instrument was invented specifically for banks as a device to lighten tax and regulatory burdens from capital requirement.
- By itself, the first accounting change firmed up the **legality of the tax benefit**.
**Neither** change altered the **regulatory benefit**.
- Issue: Did Accounting Change in How TPS Were Reported Affect Future TPS Issuance?

## Two Kinds of Statistical Tests

**Differences in Means** of Two-Year “Issuance Indicator” Before and After the Accounting Change For Subsamples of BHC That Fall on One Side or Another of Selected Conditioning Variables
-     a. _Sample Composition_:   Pre-Change N  	Post-Change N
-  b. _Results_: Many differences are significant _only_ in the pre-period.
- 2.  **Aggregate Probit Regression **of indicator on Predetermined Conditioning Variables, With Slope-Shifts For Post-Period.
-     a. Sample included 905 issuances and 10,449 non-issuances.
-     b. _Results_: Three-slope dummies are significant: Public debt and negative-tax positive. Four others are not significant.

-            Issuances:   806	107
- Non-Issuances:  1,314    1,475

## Criticism: Post Hoc Ergo Proper Hoc

- The paper produces evidence of *a regime change in issuance*. However, it does _not_ show:
- 1. That there is *exactly *_*one*_ regime change and that 2003 is the _*best place to locate*_ the switching point.
- 2. Whether _*other changes*_ in bank or investor environments (e.g., the effects of other tax and regulatory events) might help to explain the shift.