Inferring Accounting Information from Corporate Financing Choices: An Examination of Security Issuances in the Banking Industry

Abstract

This study examines the impact of regulatory capital and its components (i.e., earnings, loan loss provisions, charge-offs and growth) on bank managers' financing decisions and investors' interpretations of those decisions. This paper is related to two streams of research. We add to the corporate finance literature that seeks to explain the market's reaction to security issuances by improving specification through use of a set of homogenous firms. We extend the accounting literature that links regulatory capital increasing options with bank performance by examining whether investors infer that performance. We find that managers' financing choices reflect their private information regarding the levels of regulatory capital and earnings in the issuance year and possibly their private information regarding regulatory capital and loan loss provisions in subsequent years. We document a negative market reaction to capital-increasing issuances and a positive reaction to capital-decreasing issuances. A cross-sectional analysis of that market reaction indicates that investors infer managers' expectations of earnings in the issuance year and regulatory capital in subsequent years.