14 June 2016
Lingxiang Li (State University of New York): Risk and earnings quality: Evidence from bank enforcement actions
We examine the causal effect of firm risk on earnings quality using a quasi-natural experiment from the banking industry. Specifically, we consider the effect on earnings quality of bank enforcement actions enacted for risk-related (but exogenous to accounting quality) issues versus enforcement actions enacted for risk-unrelated (also exogenous to accounting quality) issues. We find that only the risk-related enforcement actions lead to significant improvement in earnings quality. This improvement is consistently found using a broad range of earnings quality measures and robust to a number of respecifications. In support of the conjecture that earnings quality improves because of the risk-control effect, we find that the observed improvement comes almost exclusively from the punished banks whose risk has been successfully lowered by the risk-related enforcement actions.
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