Bank Earnings Management and Tail Risk during the Financial Crisis

44 Pages Posted: 22 May 2012 Last revised: 14 Feb 2014

Lee J. Cohen

University of Georgia - Department of Finance

Marcia Millon Cornett

Bentley University - Department of Finance

Alan J. Marcus

Boston College - Department of Finance

Hassan Tehranian

Boston College - Department of Finance

Date Written: October 5, 2012

Abstract

We show that a pattern of earnings management in bank financial statements has little bearing on downside risk during quiet periods, but seems to have a big impact during a financial crisis. More aggressive earnings managers prior to 2007 exhibit substantially higher risk once the financial crisis begins. This risk is evident in both the incidence of large weekly stock price “crashes” as well as in the pattern of full-year returns. Consistent with the literature on earnings management and crash risk in industrial firms, these results support the hypothesis that banks can use accounting discretion to hide relevant information for some time, but in a period of severe distress in which accounting choices can no longer obscure performance, information comes out in larger amounts, resulting in substantially worse stock market returns. We also show that these stock price crashes predict future deterioration in operating performance, which is of greater direct relevance to regulators, and thus may serve as an early warning signal of impending problems.

Keywords: financial institutions, opacity, crashes, transparency

JEL Classification: G01, G11, G21, G28, M40

Suggested Citation

Cohen, Lee J. and Cornett, Marcia Millon and Marcus, Alan J. and Tehranian, Hassan, Bank Earnings Management and Tail Risk during the Financial Crisis (October 5, 2012). Journal of Money, Credit, and Banking, Vol. 46, No. 1, 2014. Available at SSRN: https://ssrn.com/abstract=2064928 or http://dx.doi.org/10.2139/ssrn.2064928

Lee J. Cohen

University of Georgia - Department of Finance ( email )

Terry College of Business
Athens, GA 30602-6253
United States

Marcia Millon Cornett

Bentley University - Department of Finance ( email )

175 Forest Street
Waltham, MA 02154
United States

Alan J. Marcus (Contact Author)

Boston College - Department of Finance ( email )

Fulton Hall
Chestnut Hill, MA 02467
United States
617-552-2767 (Phone)
617-552-0431 (Fax)

Hassan Tehranian

Boston College - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States
617-552-3944 (Phone)
617-552-0431 (Fax)

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