Earnings Volatility Research Articles

Practical assessments on the use of financial derivatives as risk management tools

This study examines the risk management strategies of non-financial corporations in less efficient financial markets, such as Portugal and Spain. These markets have liquidity constraints and limited availability of derivatives to hedge corporate risk exposures. The study analyzes how these companies dealt with these challenges and how their hedging strategies affected their performance. The results show a complex relationship between the use of derivatives, earnings volatility, and the market value of companies. The study contributes to business practice by helping companies assess the effectiveness of their hedging strategies and may also influence regulators to adapt rules for less liquid markets.

Dynamics of capital structure determinants: empirical evidence from GCC countries

AbstractThe study empirically examines the factors affecting the financing decisions of non-financial listed companies in Gulf Cooperation Council (GCC) countries. Using static and dynamic two-step generalized method of moments techniques, it analyzes unbalanced panel data from 364 non-financial companies across six GCC countries from 2011 to 2021. The findings partially support optimal capital structure theories, highlighting significant internal factors such as profitability, market-to-book ratio, firm size, earnings volatility, and growth opportunities that influence financing decisions. While no single theory fully explains the financing choices, the association of internal factors with book and market leverage is consistent. The study provides robust and generalizable results, aiding financial institutions and policymakers in formulating pro-development policies and regulations. This research facilitates better coordination between corporate managers and financial institutions, supporting the region’s economic transition. It is the first study to use extensive data from GCC non-financial firms to investigate financing decisions, offering valuable insights for investors and a basis for further analysis of capital structure choices in the region and beyond.

Capital structure: Its effects on earnings volatility, cash flows, and financial performance in commercial banks

This study aimed to clarify the effect of capital structure on earnings volatility and cash flows in the commercial banking sector. The research focused on all 15 banks listed on the Amman Stock Exchange, and data were gathered from their financial statements between 2018 and 2022. The study employed multiple regression analysis to assess the data and test hypotheses. Previous studies have shown mixed results, with some finding a positive relationship between capital structure and financial performance, while others presented opposing views. The findings of this study provide statistical evidence that the debt-to-asset ratio (DTA) positively influenced operating cash flows and their volatility, while negatively affecting profits and their volatility. Additionally, the debt-to-equity ratio (DETE) positively impacted operating cash flows, their volatility, and profit volatility. These results suggest that banks should aim for a balanced capital structure to maintain stable profits and cash flows over time. This requires careful consideration of risks, regulatory requirements, market conditions, and the cost of capital. A balanced approach, involving both debt and equity financing, helps banks manage the risks of fluctuating cash flows and profits.

Pengaruh Volume Penjualan Saham, Profitabilitas, Solvabilitas, Earning Volatility dan Tranding Volume terhadap Volatilitas Harga Saham dengan Kebijakan Deviden sebagai Variabel Mediasi

This research aims to determine the effect of share sales volume, profitability, solvency, earnings volatility and trading volume on share price volatility with dividend policy as a mediating variable in food and beverage companies listed on the Indonesia Stock Exchange for the 2017-2021 period. The sample for this research consisted of 55 companies, using a purposive sampling method with the criteria stating dividend payments for 5 consecutive years. The research results show that debt ratio, return on assets, trading volume have an influence on stock price volatility. However, earnings volatility and share sales volume have no effect on share price volatility. Dividend policy is able to mediate share sales volume on stock price volatility, dividend policy is able to mediate profitability on stock price volatility, dividend policy is able to mediate solvency on stock price volatility, dividend policy is able to mediate earnings volatility on stock price volatility and dividend policy is able to mediate volume trending on stock price volatility in food and beverage companies listed on the Indonesia Stock Exchange for the 2017-2021 period.

Earnings Volatility and Research and Development Investment Plan on Firm Valuation in the Philippine E=Commerce Sector

Earnings Volatility and Research and Development Investment Plan on Firm Valuation in the Philippine E=Commerce Sector

Bank wholesale funding in an era of rising geopolitical risk

AbstractThis paper examines the impact of geopolitical risk on bank wholesale funding using a sample of 2333 commercial banks in 41 countries over the period 2002–2021. Evidence suggests that increased geopolitical risk reduces the share of bank wholesale funding. Interestingly, our finding is driven by small and medium‐sized banks, as large banks do not lose funding from wholesale financiers when geopolitical risk is higher. Delving into the mechanisms that drive our findings, we find that wholesale financiers rely on noisy public signals on bank asset quality such as insolvency risk, earnings volatility and bad debts to determine whether to refinance or withdraw their financing. Small banks lose funding from both informed and uninformed wholesale financiers as their asset quality is adversely affected when geopolitical risk is elevated. Large banks with better asset quality are not significantly affected by geopolitical risk and benefit from the flight‐to‐safety motive.

Hedge funds and the positive idiosyncratic volatility effect

Abstract While it is established that idiosyncratic volatility is negatively priced in the cross-section of stock returns, the relation between idiosyncratic volatility and hedge fund returns is largely unexplored. We document that hedge funds with high idiosyncratic volatility earn higher future risk-adjusted returns of 6 percent p.a. than hedge funds with low idiosyncratic volatility. The outperformance arises because hedge funds trade high idiosyncratic volatility stocks wisely. They pick high volatility stocks when they are underpriced and short-sell high volatility stocks when they are overpriced. Our results support the notion that hedge funds’ idiosyncratic volatility is a measure of managerial skill.

How does corporate diversification affect earnings management? A path analysis approach

We examine whether and how corporate diversification affects earnings management. We find that diversified firms exhibit lower earnings management than comparable portfolios of single-segment firms and that the magnitude of reduction in earnings management increases with greater diversification. Using path analysis, we find that diversification decreases earnings management by reducing both earnings volatility and the need for external financing and by increasing the propensity to pay dividends. Our results are robust to using different measures of diversification and earnings management and continue to hold when we account for endogeneity using both the Heckman two-stage model and propensity score matching.

Taming the dragon: stock exchange comment letters and earnings volatility

This study explores the impact of comment letters on earnings volatility motivated by the broad scope of stock exchange comment letters in China and regulators’ concerns regarding earnings-related issues. Using a manually collected sample of Chinese comment letters, we find that receiving a comment letter is associated with increased earnings volatility. Our baseline results survive a host of exercises to mitigate endogeneity, including difference-in-differences, propensity score matching, entropy balancing, and instrumental variables. Channel analysis reveals that comment letters are associated with increased earnings volatility through dampened supply chain stability (economic channel) and reduced use of earnings management to smooth earnings (accounting channel). Our findings contribute to the literature on comment letters in non-US economies and provide important and timely implications for regulators.

Corporate social responsibility and bank liquidity creation during financial crises

AbstractUsing a sample of US banks, this paper investigates how corporate social responsibility (CSR) performance affects bank liquidity creation in financial crises. It shows that banks with better CSR performance reduce more liquidity creation in crises. This effect is stronger for banks with lower Z‐scores or higher earnings volatility. In addition, the results are driven by bank CSR performance related to community, employee relations and diversity. These results are consistent with the notion that banks with good CSR performance reduce liquidity creation to avoid financial distress, which would hurt their employees and the communities they serve.

Intangible and Tangible Investments and Future Earnings Volatility

This study delves into the impact of intangible and tangible investments on future earnings volatility within the European financial market context. Drawing from International Accounting Standards (IAS) 16 and 38, we examine the intricate relationship between fixed assets, expenses, and the uncertainty surrounding forthcoming earnings. Our analysis reveals that intangible assets, often associated with heightened uncertainty and risk, contribute to increased earnings volatility compared to capital expenditures. Furthermore, we find that capitalizing intangible assets serves to alleviate uncertainty, resulting in lower earnings volatility compared to expensing them. Our exploration of industries’ effects further reinforce these findings, with the effect of intangible and tangible investments on earnings volatility being more pronounced in high-tech industries than in low-tech industries. Additionally, our robustness test, utilizing goodwill as a proxy for intangible assets and property, plant, and equipment as a proxy for tangible assets, yields consistent results, further bolstering our findings.

Economic policy uncertainty and credit risk in microfinance: A cross‐country analysis

AbstractUsing a cross‐country data set of 670 microfinance institutions (MFIs) in nine countries from 1999 to 2018, this study examines the impact of economic policy uncertainty (EPU) on the credit risk of MFIs. The empirical results show that EPU significantly increases the credit risk of MFIs. Our findings are valid in a series of robustness checks. The moderating effects reveal that group lending can mitigate the impact of EPU on the credit risk of MFIs and that EPU has a weaker impact on nongovernmental organizations (NGOs) and cooperatives and credit unions (Coop/CUs). We explore potential channels through which credit risk is influenced by EPU from the perspectives of earnings volatility and cost. We find that EPU increases the credit risk of MFIs not only by reducing profitability and leverage levels and increasing earnings volatility but also by raising financing costs.

Does derivative usage boost firm value in an economy with controls? Evidence from India

AbstractThe role of derivatives on firm valuation has recently become a subject of intense debate for emerging markets where there is greater asset price volatility, illiquidity, and the absence of common regulations and accounting standards. Given the lack of data availability, disclosure inconsistency and distinctive regulatory requirements for Indian firms, we assess the impact of corporate hedging via derivative use on the performance of BSE-100 non-financial firms over the period 2010–2017. Our results from keywords-based hand-collected derivative usage data show that all types of derivatives, except rate derivatives, have a significant and positive impact on firm value through channels of reduced earnings volatility and increased leverage with tax benefits. Firms with greater leverage tend to benefit from the use of rate derivatives. Still, among those highly leveraged firms, the ones who experience high earnings volatility are unable to benefit from rate derivatives. Besides, hedge accounting benefits firms in dealing with earnings volatility when they have higher derivatives exposure. As capital controls on international flows can limit the use of derivatives, we show that firms with currency risk exposure in terms of long-term foreign currency debt do benefit from rate derivatives. Our results are also robust with a matched sample for derivative users and non-users. Overall, we conclude that easing regulatory controls on derivatives dealings can be beneficial for firms in growing emerging economies.

Cost Structure and the Usefulness of Earnings

We investigate the relation between the usefulness of earnings and firm cost structure. We document that the usefulness of earnings to external users decreases in the degree of operating leverage, which measures the proportion of fixed to variable costs, and that this decline extends at least partially from the relation between the degree of operating leverage and two earnings properties: aggressive revenue recognition to meet an earnings target and earnings volatility. Our results illustrate how firm fundamentals influence a firm’s information environment and thereby the usefulness of earnings to external users. This paper was accepted by Ranjani Krishnan, accounting. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2021.03023 .

Hedge accounting, IFRS 9, and audit fees: Evidence from China

AbstractUsing data for 2016–2021 on a sample of Chinese non‐financial firms, this study documents a positive association between the use of hedge accounting and audit fees and finds that the new requirements under International Financial Reporting Standards 9 (IFRS 9) help mitigate this positive relationship. Channel analyses show that the new hedge accounting requirements mitigate earnings volatility and accruals management, which results in audit fee reductions. Further, the post‐IFRS 9 audit fee decrease is greater among large audit firms, firms in regions with higher marketisation levels and firms with better corporate governance.

Empirical Analysis of Factors Affecting Stock Liquidity --Taking Ping An Bank as an Example

With the continuous development of the Chinese economy, the stock market has become one of the important choices for investors, and the liquidity of the stock market has always been the focus of investors. Ping An Bank is one of China's well-known commercial banks and occupies an important position in the A-share market. The goal of this paper is to study the relationship between stock liquidity and return volatility, risk factors, circulation market value and cross-period of risk factors. Through ordinary least squares (OLS) regression analysis, it can be found that earnings volatility and circulating market value have an impact on stock liquidity significantly, that is, the higher the earnings volatility and circulating market value, the higher the stock liquidity. Risk factors and cross-terms of risk factors have no significant influence on stock liquidity. These findings have important implications for investors and market regulators to help them more fully assess stock value and risk and make more informed investment decisions.

Crime and covenants

Crime is a major concern in the U.S., with implications for the allocation of resources due to the uncertainty associated with it. This paper examines whether the U.S. state property crime rate is a source of uncertainty that induces lenders to increase and tighten covenants as a result of increased risk. I found that greater crime exposure by borrowers leads lenders to impose higher and tighter covenants. The results remain robust to various covenant intensity measures and are not driven by endogeneity. A difference-in-difference test shows that a firm's relocation to a higher-crime-prone state significantly increases covenant intensity. I explore two potential channels that drive the effect of property crime: earnings volatility and reduced collateral value of firms operating in crime-ridden states. I find that covenants and spreads are complementary factors in the presence of higher property crimes.

Financialization, earnings volatility, and firm turbulence in the risk society

ABSTRACT This paper explores financialization through the lens of with profits accruing primarily through financial channels through risk commodification. While financialization ostensibly increases corporate profits, individual firms have been experiencing escalating volatility driven by heightened competition and technological disruptions. To the extent that firm instability is driven by something fundamental that cannot be reduced for shareholders through portfolio diversification, financialization simultaneously disperses risks to workers, fostering economic instability and exacerbating income inequality. The paper delineates a rise in earnings volatility among workers, attributing it to structural changes in labour markets marked by contingent work arrangements and diminished job security. This volatility reflects broader societal shifts towards a more precarious workforce, necessitating a re-evaluation of traditional measures of economic security. The confluence of these trends manifests in the intertwining of firm turbulence and wage volatility, particularly pronounced in the non-manufacturing sector. In parallel, financialization has also led to rising industrial concentration and market power in the U.S. economy that centralises profit. Superstar firms emerge as key actors, uniquely positioned to maximise their risk/return profile. By restricting profits to a small core of well-compensated workers, these firms are simultaneously offering higher wages while driving down the labour share, thus exacerbating income inequality.

Financing Payouts

Abstract We find that 43% of firms that make payouts also raise capital during the same year, resulting in 31% of aggregate payouts being externally financed, primarily with debt. Most financed payouts cannot be explained by payout smoothing in response to volatile earnings or investment (rather, they are the result of firms persistently setting payouts above free cash flow). In fact, 25% of aggregate payouts could not have been paid without the firms simultaneously raising capital. Profitable firms with moderate growth use debt-financed payouts to jointly manage their leverage and cash, thus highlighting the close relationship between payout and capital structure decisions.

Expected idiosyncratic entropy

PurposeWe propose a risk factor for idiosyncratic entropy and explore the relationship between this factor and expected stock returns.Design/methodology/approachWe estimate a cross-sectional model of expected entropy that uses several common risk factors to predict idiosyncratic entropy.FindingsWe find a negative relationship between expected idiosyncratic entropy and returns. Specifically, the Carhart alpha of a low expected entropy portfolio exceeds the alpha of a high expected entropy portfolio by −2.37% per month. We also find a negative and significant price of expected idiosyncratic entropy risk using the Fama-MacBeth cross-sectional regressions. Interestingly, expected entropy helps us explain the idiosyncratic volatility puzzle that stocks with high idiosyncratic volatility earn low expected returns.Originality/valueWe propose a risk factor of idiosyncratic entropy and explore the relationship between this factor and expected stock returns. Interestingly, expected entropy helps us explain the idiosyncratic volatility puzzle that stocks with high idiosyncratic volatility earn low expected returns.