Comment on “Error and Regulatory Risk in Financial Institution Regulation”

Comment on 'Error and Regulatory Risk in Financial Institution Regulation'

The Financial Crisis and the Response of the United States: Will Dodd Frank Protect Us from the Next Crisis?

Since June 2007, the creditworthiness of structured finance products has deteriorated rapidly. The number of downgrades in November 2007 alone exceeded 2,000 and many downgrades were severe, with 500 tranches downgraded more than 10 notches. Massive downgrades continued in 2008. More than 11,000 of the downgrades affected securities that were rated AAA. This paper studies the credit rating crisis of 2007-2008 and in particular describes the collapse of the credit ratings of ABS CDOs. Using data on ABS CDOs we provide suggestive evidence that ratings shopping may have played a role in the current crisis. We find that tranches rated solely by one agency, and by S&P in particular, were more likely to be downgraded by January 2008. Further, tranches rated solely by one agency are more likely to suffer more severe downgrades.(This abstract was borrowed from another version of this item.)

Redesigning the SEC: Does the Treasury Have a Better Idea?

George Stigler's work on the theory of regulation is one of those rare contributions--rare for the rest of us, though not for him--which force a fundamental change in the way important problems are analyzed.

Are Junk Bonds Junk?

In this paper, we examine the relationship between credit ratings, credit ratings changes and earnings management. Since the 1997 Asian Financial Crisis, many listed firms collapsed, leading investors to suffer losses. As a result, credit ratings have become a very important indicators of firms’ financial stability for investors, government agencies and debt issuers and other stakeholders. Firms with a similar credit rating are grouped together as firms of similar credit quality (Kisgen 2006) because credit ratings provide an ‘economically meaningful role’ (Boot et al. 2006). Numerous studies find that managers care deeply about their credit ratings (Graham and Harvey 2001; Kisgen 2009; Hovakimian at al. 2009). Firms that borrow equity in the form of bonds may have incentives to increase credit ratings with opportunistic earnings management. A change in a firm’s credit ratings has a direct impact on a firm’s profitability. Firm’s benefit from better terms from suppliers, enjoy better investment opportunities and have lower cost of capital when their credit risk is lower. Firms incur a higher cost of debt and experience additional costs when their credit risk is higher. American studies find that firms use earnings management to influence credit ratings (Ali and Zhang 2008; Jung et al. 2013; Alissa et al 2013). Credit rating agencies have stated they assume financial statements to be reasonable and accurate (Securities and Exchange Commission, 2003; Standard and Poor’s, 2006) and they do not consider themselves to be auditors. They take the information in the financial statements as accurate. Therefore, there is a potential for managers to engage in earnings management to influence credit ratings. In South Korea, there have been numerous experiments with auditor legislation because of financial collapses due to earnings management in the 2000s. Therefore, a decomposition of the relation between opportunistic earnings management and credit ratings is an important consideration for Korean accounting academia. Previous Korean studies have examined whether credit ratings in period t are significantly related to level of earnings management in the same period; however, those studies fail to find the consistent results. It is widely known that credit rating agencies allow one year credit watch period to assess default risk before credit rating decision. Firms with an incentive to increase their credit ratings through earnings management will only realize if earnings management positively influences credit ratings in the following year. Therefore, we focus on establishing a relationship between the levels of earnings management at time t and credit ratings / changes at time t+1. Our study provides a more robust analysis by establishing if both accrual based and real earnings management in period t influences credit ratings and credit rating changes in period t+1. Using a sample of 1,717 Korean KRX firm-years from 2002 to 2013, we find a negative relation between earnings management in period t and credit ratings in period t+1, suggesting that firms with higher credit ratings have lower levels of earnings management. Moreover, we find that firms that experience a credit ratings change in period t+1 are less likely to engage in opportunistic earnings management in period t, suggesting that firms do not have the potential to increase credit ratings. We also find that firms that experience a credit rating increase in period t+1 have a negative association with opportunistic earnings management for accruals measures. Moreover, when we split our sample into firms that experience 1) a credit rating increase, 2) decrease and 3) remaining the same, we find that firms that engage in earnings management are more likely to remain unchanged or experience a credit rating decrease. Thus, taken together, we find no evidence of relationship between opportunistic earnings management and an increase in credit ratings in the South Korean public debt market. Our results may be of interest to regulators, credit rating agencies, market participants and firms that question whether level of earnings management in current year influences credit ratings in the subsequent period.

The global financial crisis that started in 2007 sparked several academic debates about the role that financial sector regulators played in the crisis and prompted policy reforms in the financial supervision architectures of several countries. This book focuses on the question of what accountability, independence, transparency and, more generally, governance mechanisms applicable to financial regulators can better contribute to building responsive, responsible and effective regulatory and supervisory frameworks that tackle the weaknesses of the pre-crisis regimes. It re-visits the concepts of accountability and independence of financial regulators as well as the main economic theories underlying financial services policy-making, in light of the crisis experience. In addition, it critically examines the post-crisis institutional frameworks of financial regulation and supervision in the EU, the US and Canada with a view to assessing whether the financial regulators of the post-global financial crisis era are well suited to effectively address the challenges and threats that global financial markets pose to the stability, integrity and good functioning of financial systems as well as to the protection of consumers, investors and society at large.Topics addressed in this volume include:- The theoretical foundations of accountability and independence in financial regulation after the crisis; - The influence of economic theory on the quality of financial regulation and supervision;- Accountability in the European Banking Union and the European System of Financial Supervision;- Post-crisis structures of financial regulation in the US and their impact on consumer/investor protection and financial stability;- The role of financial supervision architecture in the stability of the Canadian financial system. The contributors to this volume are economists, lawyers, political scientists and sociologists from both academia and practice. Therefore, this book will be highly relevant to scholars and practitioners in these areas.

신용등급평가기관들이 제시하는 기업의 신용등급은 채무불이행 위험(defaiult risk)에 관한 유용한 정보를 제공하기 때문에 자본시장 참여자나 채권시장 참여자에게 매우 중요하다 할 수 있다. 선행연구에 따르면 신용등급은 기업의 규모, 부채비율, 성장률 등과 같이 신용평가기관이 신용감시기간(credit watch period) 동안 평가하는 다양한 채무불이행 위험에 의해 결정된다. 한편 기업의 재무성과는 시장참여자들의 투자 의사결정에 매우 중요한 지표이다. 재무성과가 우수한 기업들은 안전한 투자처로 인식될 가능성이 높고 따라서 채무불이행 위험이 낮은 기업으로 인지될 수 있다. 기업의 재무성과가 기업의 채무불이행 위험을 탐지할 수 있는 지표로 사용될 수 있는지 관한 의문은 매우 중요함에도 불구하고 이와 관련된 연구는 실로 매우 부족한 실정이다. 본 연구는 다양한 재무성과 지표들이 기업의 차기 신용등급과 가지는 관련성을 고찰함으로써 이들이 차기신용등급과 신용등급 변화에 관하여 제공하는 추가적인 정보에 초점을 맞춘다.BR 본 연구는 2002에서 2013년까지 최근 12개년도의 유가증권상장사 기업표본을 사용하여 기업의 재무성과와 신용등급 및 신용등급 변화의 관련성을 조사함으로써 이들이 채무불이행을 유의적으로 낮추는 지표로 활용될 수 있는지를 고찰하였다. 구체적으로 EPS, CPS, ROA, ROE, ROS를 기업 재무성과의 대용치로 사용하여 각각의 변수가 기업의 차기 신용등급 및 신용등급 변화에 영향을 미치는지를 살펴보았다. 연구결과, 선행연구에서 기업의 재무성과 대용치로 주로 사용된 바 있는 ROA, ROE, ROS는 신용등급 및 신용등급의 변화와 일관적으로 유의적인 관련성을 갖지 않는 것으로 나타났다. 한편 EPS와 CPS는 모든 분석에서 일관적인 결과가 관찰되었다. 우리나라 상장기업의 경우 신용등급이 급격하게 변하지 않고 유지되는 경우가 빈번한데 이는 기업들이 신용등급 관리에 만전을 기하기 때문이라는 해석이 가능하다. 따라서 신용등급이 당기에서 차기로 변화하지 않은 기업들과 변화한 기업들을 비교하는 분석을 수행한 결과 재무성과가 좋은 기업들은 차기 신용등급이 유지되는 경향이 강한 것으로 나타났다. 나아가 추가분석에서는 본 연구 표본을 신용등급이 상향조정된 기업, 하향조정된 기업, 변화하지 않은 기업으로 분류하고 차기 신용등급을 종속변수로 사용한 동일한 분석을 반복해보았다. 연구결과 재무성과가 좋은 기업들은 신용등급이 상향조정되거나 그대로 유지되는 경향이 강한 것으로 나타났다. 한편 신용등급이 하향조정된 기업만을 대상으로 수행된 분석에서는 차기 신용등급과 당기 재무성과의 유의한 관련성을 발견할 수 없었다. 본 연구의 실증분석 결과를 종합적으로 요약하면 EPS와 CPS가 채무불이행 위험에 대해 추가적인 정보를 제공할 수 있는 재무성과 지표로서 활용될 수 있음을 보여주는 결과라 할 수 있다. 본 연구는 자본시장 및 채권시장참여자, 규제기관, 신용평가기관이 기업의 채무불이행 위험을 평가할 때 활용할 수 있는 유용한 지표를 제시했다는 점에서 의미를 찾을 수 있다.

The theoretical underpinnings of financial regulation have led to an obsessive quest for transparency. This has not only led to a gradual increase in disclosure requirements, but has also generated some other unintended consequences, such as structural conflicts of interests, which affect the modes of information (and opinion) production of influential actors. Credit rating agencies, for example, have also in their own right raised new regulatory concerns. Within this wider context, this article explores whether regulatory initiatives to stringently discipline credit rating agencies’ activities (particularly with a view to issuing sovereign ratings), or other initiatives which reflect an increasing willingness to control speech in financial markets (for instance those targeting activist shareholder strategies), are in line with relevant principles guaranteeing the freedom of expression which have seemingly remained a blind spot of financial regulators. Financial regulation, transparency, disclosure, information, opinion, freedom of expression, financial disintermediation, credit rating agencies, shareholder activism, financial evaluation

Recent amendments to the UK Financial Services and Markets Act 2000 (FSMA) by the Financial Services Act 2012 reflect the growing orthodoxy of duality of financial (prudential) regulation and consumer protection, a path also followed in sections 129 to 131 of Australia’s National Consumer Credit Protection Act 2009 and in the establishment of the US Consumer Financial Protection Bureau. The duality of regulation model has led to the creation of two separate bodies for regulating the activities of banks and financial institutions. One regulator is typically responsible for prudential regulation while consumer protection broadly defined is the second regulator’s responsibility. Although the assumption is that prudential regulation and consumer protection operate in different coherent spheres, their dividing line is often nebulous in practice. One area where both financial regulation and consumer protection concerns overlap is consumer indebtedness. In August 2014, the aggregate personal debt in the UK was £1.455 trillion; the average household debt was £55,088; the average individual adult debt was £28,813, which was about 116 per cent of earnings; estimated interest repayments were £162 million per day and £59.2 billion over a 12-month period; average household annual interest repayments were £2,242, while individuals paid £1,173 constituting about 4.7 per cent of earnings in annual interest repayments. The total outstanding mortgage debt relating to about 11.1 million households was £1.29 trillion. Households owed on average £115,940 in mortgage debt and paid average annual interest of £3,733. In relation to consumer credit, the outstanding lending was £162.2 billion, while the average individual adult and household consumer credit debts were £3,220 and £6,155, respectively. In relation to credit cards, the average household debt was £2,180. Interest payments for the total debt of £57.6 billion would cost the average credit card holder £54 per month to clear the debt in five years or £38 per month to clear in ten years. The size of consumer debt in the UK renders it a significant phenomenon. Size alone does not turn a phenomenon into a problem, but there is also evidence of market failure. For example, recent consumer indebtedness statistics in the UK suggest a huge and growing problem despite widespread public concern and varying degrees of regulatory intervention.1 The Citizens Advice Bureaux in England andaverage, in the UK, one person every five minutes and 297 every day are declared bankrupt. There are 118 mortgage possession claims, 87 mortgage possession orders and 71 repossessions of mortgaged properties every day in the UK. It is largely because of the consequences of consumer indebtedness that responsible lending is attracting increased attention. Responsible lending involves evaluating contextual factors that impact on a borrower’s ability to repay loans. The factors include existing indebtedness, employment situation, caring responsibilities, psychological, physical and emotional health situations, personal habits and consumption. As a result, Charlie McCreevy, the European Union Internal Market Commissioner, described responsible lending and responsible borrowing respectively as ‘[w]here the credit products sold are appropriate for consumers’ needs and are tailored to their ability to repay’ and ‘where consumers provide relevant, complete and accurate information on their financial conditions’.2 The Internal Market Commissioner, therefore, regarded both responsible lending and responsible borrowing as ‘vital components in ensuring a stable and effective market’.3

Part 1 General overview: regulating financial services and markets in the 21st century - an overview, Eilis Ferran and Charles A.E. Goodhart reforming financial regulation - progress and priorities, Howard Davies. Part 2 Objectives and principles: regulatory principles and the financial services and markets act 2000, Colin Mayer examining the objectives of financial regulation - will the new regime succeed? a practitioner's view, Amelia C. Fawcett incentive v. rule-based financial regulations - a role for market discipline, Rahul Dhumale. Part 3 Regulation of senior management: directors' fiduciary duties and the approved persons regime, Colin Bamford fiduciary duties, regulation of companies and regulation of individuals, Adam Ridley. Part 4 Discipline, enforcement and human rights: regulatory discipline and the European contention on human rights - a reality check, Daniel F. Waters and Martyn Hopper holding the balance - effective enforcement, procedural fairness and human rights, Thomas A.G. Beazley. Part 5 Accountability: regulating the regulator -a lawyer's perspective on accountability and control, Alan Page regulating the regulator - an economist's perspective on accountability and control, Charles A.E. Goodhart public accountability in the financial sector, Rosa M. Lastra and Heba Shams. Part 6 European regulation: regulating European markets - the harmonization of securities regulation in Europe in the new trading environment, Eddy Wymeersch the case for a European securities commission, Gilles Thieffry. Part 7 International regulation: new issues in international financial regulation, John Eatwell the financial stability forum (FSF) - just another acronym?, Andrew G. Haldane the need for efficient international financial regulation and the role of a global supervisor, Kern Alexander. Part 8 Role of rating agencies: the role of rating agencies in global market regulation, Steven L. Schwarcz the role of credit rating agencies in the establishment of capital standards for financial institutions in a global economy, Howell E. Jackson. Part 9 Technological change and regulation: the challenge of technology - regulation of electronic financial markets.

Politicians, Interest Groups, and Regulators: A Multiple-Principals Agency Theory of Regulation, or "Let Them Be Bribed"

The Direct Regulation of Potential Systemic Risk of Hedge Funds in the U.S. before and after the Dodd-Frank Act

PurposeFirm management has an incentive to improve credit ratings to enjoy the reputational and financial benefits associated with higher credit ratings. In this study, the authors question whether audit effort in hours can be considered incrementally increasing with credit ratings. Based on legitimacy theory, the authors conjecture that firms with higher credit ratings will demand higher levels of audit effort to signal audit and financial quality compared to firms with higher levels of credit risk.Design/methodology/approachThe authors conduct empirical tests using a sample of Korean-listed firms using a sample period covering 2001–2015.FindingsThe results show that firms with higher credit ratings demand higher audit effort in hours compared to client firms with lower credit ratings. The authors interpret that firms with higher ratings (lower risk) demand higher levels of audit effort in hours to reduce information asymmetry and to demonstrate that financial reporting systems are robust based on audit effort signaling audit quality. The authors also interpret that firms with lower credit ratings do not have incentives to signal similar audit quality. The authors also capture the “Big4 auditor expertise” effect by demonstrating that client firms audited by nonBig4 auditors demand additional audit effort with increasing credit rating compared to Big4 clients.Research limitations/implicationsAudit effort is considered a signal of firm risk in the literature. This study’s results show evidence that audit effort is inversely related to firm risk.Practical implicationsThe results show that audit hour information is informative and likely managed by firm stakeholders. Internationally, it is not possible to capture the audit demand of clients because listing audit hours on financial statements is not a rule. Given that audit hours can be considered informative, the authors believe that legislators could consider implementing a policy to mandate that audit hours be recorded on international annual reports to enhance transparency.Originality/valueSouth Korea is one of few countries to list audit effort on annual reports. Therefore, the link between audit effort and credit ratings is unique in South Korea because it is one of few countries in which market participants likely monitor audit effort.