Bad Financial Condition Research Articles

Predicting volatility and correlations with Financial Conditions Indexes

We model the impact of financial conditions on asset market volatilities and correlations. We extend the Spline-GARCH model for volatility and DCC model for correlation to allow for inclusion of indexes that measure financial conditions. In our empirical application we consider daily stock returns of US deposit banks during the period 1994–2011, and proxy financial conditions by the Bloomberg Financial Conditions Index (FCI) which comprises the money, bond, and equity markets. We find that worse financial conditions are associated with both higher volatility and higher correlations between stock returns, especially during crises. Moreover, inclusion of the FCI in volatility and correlation modeling improves Value-at-Risk estimates, particularly at short horizons.

Market discipline during crisis: Evidence from bank depositors in transition countries

The Central European banking industry is dominated by foreign-owned banks. During the recent crisis, for the first time since the transition, foreign parent companies were frequently in a worse financial condition than their subsidiaries. This situation created a unique opportunity to study new aspects of market discipline exercised by non-financial depositors. Using a comprehensive data set, we find that the recent crisis did not change the sensitivity of deposit growth rates to accounting risk measures. We establish that depositors’ actions were more strongly influenced by negative press rumors concerning parent companies than by fundamentals. The impact of rumors was especially perceptible when rumors turned out ex post to be founded. Additionally, we document that public aid announcements were primarily interpreted by depositors as confirmation of a parent company’s financial distress. Our results indicate that depositors react rationally to sources of information other than financial statements; this discovery has policy implications, as depositor discipline is usually the only viable and universal source of market discipline for banks in emerging economies.

Going-concern modified audit opinions for non-profit organizations

Non-profit organizations constitute an important share of the U.S. economy, and recent audit failures and GAO findings highlight the importance of auditor reporting decisions in this sector. In this study, we examine going-concern modified audit opinions for non-profit organizations. Using audit opinion data for 3,567 non-profits exhibiting some signs of financial stress, we find that non-profits are more likely to receive a goingconcern modified opinion if they are smaller, are in worse financial condition, expend less on program-related activities, and have more internal control related audit findings. Our analysis of the subsequent resolution of the going-concern uncertainties suggest that only 27 percent of the non-profits receiving an initial going-concern modified audit opinion filed for dissolution in the subsequent four fiscal years. Our findings fill a gap in an important area that has received little research attention, and provide a useful benchmark for non-profits and their auditors.

Market Discipline During Crisis: Evidence from Bank Depositors in Transition Countries

The Central European banking industry is dominated by foreign-owned banks. During the recent crisis, for the first time since the transition, foreign parent companies were frequently in worse financial conditions than their subsidiaries. This situation created a unique opportunity to study new aspects of depositor discipline. In this article, we investigate whether depositors flexibly accommodated to the changing sources of risk. We also analyse the informational foundations of depositors' decisions. Using a comprehensive data set, we find that the recent crisis did not change the sensitivity of deposit growth rates to accounting risk measures. We establish that depositors' actions were much more strongly influenced by press rumours concerning parent companies than by fundamentals, and that the impact of rumours on deposit growth rates was highly economically significant. Additionally, we document that public aid announcements were interpreted by depositors primarily as a confirmation of a parent company's financial distress. Our results have important policy implications, as depositor discipline is usually the only viable and universal source of market discipline for banks in emerging economies.

Predicting Covariance Matrices with Financial Conditions Indexes

We model the impact of financial conditions on asset market volatilities and correlations. We extend the Spline-GARCH model for volatility and DCC model for correlation to allow for inclusion of indexes that measure financial conditions. In our empirical application we consider daily stock returns of US deposit banks during the period 1994-2011, and proxy financial conditions by the Bloomberg Financial Conditions Index (FCI) which comprises the money, bond, and equity markets. We find that worse financial conditions are associated with both higher volatility and higher correlations between stock returns, especially during crises. Moreover, including the FCI in volatility and correlation modeling improves Value-at-Risk estimates, particularly at short horizons.

How Did Depositors React to the Recent Crisis? Evidence from the Central European Banking Industry

The Central European banking industry is dominated by foreign-owned banks. During the recent crisis, for the first time since the transition, foreign parent companies were frequently in worse financial conditions than their subsidiaries. This situation created a unique opportunity to study new aspects of depositor discipline. In this article, we investigate whether depositors flexibly accommodated to the changing sources of risk. We also analyse the informational foundations of depositors’ decisions. Using a comprehensive data set, we find that in Central European countries, the recent crisis did not change the sensitivity of deposit growth rates to accounting risk measures. Additionally, we establish that depositors’ actions are much more strongly influenced by press rumours concerning parent companies than by fundamentals and that public aid announcements are interpreted primarily as confirmation of a parent company’s financial distress. Our results have policy implications and illustrate the importance of reputational capital during periods of crisis.

Market Discipline During Crisis: Evidence from Bank Depositors in Transition Countries

The Central European banking industry is dominated by foreign-owned banks. During the recent crisis, for the first time since the transition, foreign parent companies were frequently in worse financial conditions than their subsidiaries. This situation created a unique opportunity to study new aspects of depositor discipline. In this article, we investigate whether depositors flexibly accommodated to the changing sources of risk. We also analyse the informational foundations of depositors’ decisions. Using a comprehensive data set, we find that the recent crisis did not change the sensitivity of deposit growth rates to accounting risk measures. We establish that depositors’ actions were much more strongly influenced by press rumours concerning parent companies than by fundamentals, and that the impact of rumours on deposit growth rates was highly economically significant. Additionally, we document that public aid announcements were interpreted by depositors primarily as a confirmation of a parent company’s financial distress. Our results have important policy implications, as depositor discipline is usually the only viable and universal source of market discipline for banks in emerging economies.

Off-balance-sheet credit risk of the top 20 Japanese banks

The study of off-balance-sheet (OBS) credit risk across the top 20 Japanese banks indicated that financial derivatives were heavily used by the top four banks and that loan commitments are the largest source of credit risk among traditional OBS instruments. The notional amounts of derivative contracts make up 92 per cent of total OBS activities. There is a wide difference across the banks in the use of derivative leverage. As compared to the US and European banks, Japanese banks use fewer OBS instruments as a percentage of their assets. This implies that Japanese banks are more conservative and risk averse in general than their US or European counterparts, especially given the bad financial condition of the banks and Japan.

Firm Financial Condition and Airline Price Wars

A firm that knows that cutting price may trigger a price war must weigh present versus future gains and losses when considering such a move. The firm's financial situation can affect how it values such tradeoffs. Using data on 14 major airlines between 1985 and 1992, I test the hypothesis that firms in worse financial condition are more likely to start price wars. Empirical results suggest that this is true, particularly for highly leveraged firms. The article also explores which firms join existing price wars and finds that a firm is more likely to enter a price war the greater the share of its traffic on routes served by the price-war leader.

Firm Financial Condition and Airline Price Wars

If cutting price can trigger a price war, then a firm must weigh present versus future gains and losses when considering such a move. How a firm values such tradeoffs can be affected by its financial situation. Using data on 14 major airlines between 1985 and 1992, this paper tests the hypothesis that firms in worse financial condition are more likely to start price wars. Empirical results suggest that this is true, particularly for highly leveraged firms. The paper also explores which firms join existing price wars, and finds that a firm is more likely to enter a price war when the share of its traffic on routes that are also served by the price war leader is greater.

ERRATA: "FOKKER, A CLASH OF CULTURE?"

What role do cultural play in the survival of companies that face existential problems? We try to provide some answers by looking at the decline of the Dutch aircraft manufacturer Fokker. In 1996 this company went bankrupt and among the causes of this event cultural factors rank high, at least at first sight. We show that differences in national culture could have played a role in one of the defining moments in Fokker's existence: the failed take-over by the German aerospace giant Deutsche Aerospace (DASA). But we also show that an over-ambitious management was responsible for the situation in which there were no other options to survive besides a take-over by DASA. An increasing gap between the ambitions of the management to be one of the worlds prime aerospace companies and the limited resources of what was essentially a second-league player put Fokker in such a bad financial condition that it surely had to become an unbearable burden for DASA. So culture played a role in Fokker's decline, but its influence was at its peak long before the problems that brought the company down were recognised.

Analysis of Financial Performance of U.S. Electric Utilities

U.S. electric utilities have experienced a tough time since the early 1970s. Utilities that had construction programs of large base-load plants, especially nuclear plants, fell into bad financial condition for many reasons, including construction delays and cancellations. An improvement of financial performance is observed for the electric utility industry as a whole after mid-1980s, as construction programs came to an end. However, utilities that completed nuclear power plants in recent years as well as utilities that cancelled plants at the final stage of the construction were not saved from bad financial times. Utilities that are continuing construction also have potential risk of not being able to recover plant cost through early 1990s. As a result, U.S. electric utility industry will be divided distinctly into two groups: utilities with strong cash position and utilities with extremely serious financial problems.