Did Information Intermediaries See the Warning Signals of the Banking Crisis from Leading Indicators in Banks’ Financial Statements?

64 Pages Posted: 26 Sep 2013 Last revised: 27 Sep 2013

Hemang Desai

Southern Methodist University - Cox School of Business

Shivaram Rajgopal

Columbia Business School

Jeff Jiewei Yu

University of Arizona

Date Written: September 24, 2013

Abstract

In this paper we address two important questions that emerged in the aftermath of the recent banking crisis. First, did the financial statements of the bank holding companies provide an early warning of their impending distress? Second, whether the actions of four key financial intermediaries (short sellers, equity analysts, Standard Poor’s credit ratings and auditors) were sensitive to the information in the banks’ financial statements about their increasing risk and their approaching distress? We find a significant cross-sectional association between the banks’ 2006 4Q financials and bank failures over 2008-2010 suggesting that the financial statements reflected at least some of the increased risk of bank distress in advance. The mean abnormal short interest in our sample of banks spikes from 0.66% in March 2005 to 2.4% in March 2007. This increase in short interest is also accompanied by a sharp increase over time in the cross-sectional association between short interest and leading financial statement indicators. In contrast, we observe neither a meaningful change in analysts’ recommendations, Standard and Poor’s credit ratings and audit fees nor an increased sensitivity of these actions to financial indicators of bank distress over this time period. Overall, our results suggest that actions of short sellers likely provided an early warning of banks’ upcoming distress prior to 2008 crisis.

Suggested Citation

Desai, Hemang and Rajgopal, Shivaram and Yu, Jeff Jiewei, Did Information Intermediaries See the Warning Signals of the Banking Crisis from Leading Indicators in Banks’ Financial Statements? (September 24, 2013). Available at SSRN: https://ssrn.com/abstract=2330404 or http://dx.doi.org/10.2139/ssrn.2330404

Hemang Desai (Contact Author)

Southern Methodist University - Cox School of Business ( email )

Cox School of Business
6212 Bishop Blvd.
Dallas, TX 75275-0333
United States
214-768-3185 (Phone)
214-768-4099 (Fax)

Shivaram Rajgopal

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Jeff Jiewei Yu

University of Arizona ( email )

Tucson, AZ 85721
United States
520-621-1273 (Phone)

HOME PAGE: http://https://accounting.eller.arizona.edu/people/jeff-jiewei-yu

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