Loan, security, and dividend choices by individual (unconsolidated) public and private commercial banks

Journal of Accounting and Public Policy 19 (2000) 201±235

Loan, security, and dividend choices by individual (unconsolidated) public and private commercial banks Frederick Niswander a,*, Edward P. Swanson b a b

Department of Accounting, School of Business, East Carolina University, GCB 3204 Greenville, NC 27858, USA Lowry Mays College and Graduate School of Business, Texas A&M University, College Station, TX 77843-4353, USA

Abstract Using call report data, we consider whether the discretionary portion of loan loss provisions, loan charge-o€s, securities gains and losses, and dividends are in¯uenced by the bank's level of capital, earnings, and taxes. We studied more than 11,000 banks. We ®nd that banks below a capital adequacy threshold often make discretionary choices that reduce earnings and capital. Banks above the threshold exhibit di€erent discretionary outcomes, with evidence of income smoothing and tax-advantaged actions. Ó 2000 Elsevier Science Ltd. All rights reserved.

1. Introduction The United States (US) savings and loan crisis and questions about the viability of banks in some Asian countries serve as reminders of the importance of realistic reporting of the economic condition of ®nancial institutions (White, 1991, pp. 82±87). Several studies have investigated whether bank managers use their discretion in making accounting and ®nancing choices to manage reported accounting information (Moyer, 1990; Scholes et al., 1990; Collins et al., 1995; Wahlen, 1994; Beatty et al., 1995; Beatty and Harris, 1999). These

*

Corresponding author. Tel.: +1-252-328-6970; fax: +1-252-328-4091. E-mail address: [email protected] (F. Niswander).

0278-4254/00/$ - see front matter Ó 2000 Elsevier Science Ltd. All rights reserved. PII: S 0 2 7 8 - 4 2 5 4 ( 0 0 ) 0 0 0 1 3 - 2

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studies suggest that bank managers often make accounting and ®nancing choices to manage capital levels, earnings, and taxes. These choices can in turn have a substantial e€ect on the evaluation of economic condition. Our study uses data from Consolidated Reports of Condition and Income (call reports) provided by the Federal Deposit Insurance Corporation (FDIC) for each bank insured by the FDIC. For more than 11,000 banks, we examined four accounting and ®nancing choices that allow bank managers substantial discretion over the amount recorded. The four choices are the amount of the loan loss provision, loan charge-o€s, securities gains and losses, and dividends. For each choice, we ®t an ordinary least squares (OLS) regression model with variables to control for non-discretionary behavior and examine whether the remaining (discretionary) variation is associated with capital level, earnings, and marginal tax rate. The OLS regression equations were estimated as a system of simultaneous equations using seemingly unrelated regression (SUR) for each sample year 1987, 1988, and on a pooled basis. During this period, capital adequacy regulations did not vary (Koch, 1995, p. 389; Collins et al., 1995, p. 266). Our study contributes to understanding bank accounting and auditing in four ways. First, we explicitly consider the roles of bank auditors and regulators as well as bank managers in our hypothesis development. 1; 2 As more fully explained in Section 2.2, we suggest that, for low capital banks, auditors and regulators prefer conservative accounting estimates which are usually at variance with the preferences of managers. We predict that, for banks below a capital adequacy threshold used by regulators, the conservative preferences of auditors and regulators will prevail for accounting choices subject to year-end adjustment. In particular, auditors and regulators close scrutiny of a low capital bank's loan portfolio lead managers to exercise discretion conservatively. Second, previous studies (e.g., Moyer, 1990; Beatty et al., 1995; Collins et al., 1995) have investigated one or more of these four choices using data for approximately 150 consolidated public banks. Our research examines public banks at the unconsolidated level, thereby including over 1,500 individual, unconsolidated, public banks. 3 These individual banks are important because

1 Throughout our paper, auditor refers to independent auditors while regulator or examiner refers to the governmental agency or agencies responsible for regulation of the bank. 2 It should be noted that, by design, bank examiners do not perform ®nancial statement audits. Examiners spend considerable time appraising asset quality (particularly the loan portfolio) and management (Koch, 1995, pp. 40±42). For an overview of the examination process, see Cocheo (1986). 3 Consistent with prior research (Moyer, 1990, p. 132; Wahlen, 1994, p. 460; Beatty et al., 1995, p. 246; Collins et al., 1995, p. 270), a bank is classi®ed as a public bank if it is listed on COMPUSTAT (mainframe or PC version) or on CRSP. The remaining banks are classi®ed as private banks.

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regulatory capital constraints apply to subsidiary banks, as well as to the consolidated bank holding company. The use of call report data also allows us to include private banks, which have been omitted from other studies despite their economic importance. 4 Our sample includes over 9,800 private banks. The ability to examine choices of private ®rms on a large scale is probably unique to the banking industry. Third, literature (e.g., Moyer, 1990; Beatty et al., 1995; Collins et al., 1995) suggests that the extent of audit and regulatory scrutiny is in¯uenced by a capital adequacy threshold that distinguishes between potentially troubled banks and those with a safe margin of capital. Managers may be less able to use discretion to manage the capital level, earnings, and taxes for banks below this threshold. Consistent with prior research (e.g., Moyer, 1990), we use a research design that allows a separate analysis of choices by banks below and above a capital threshold (proforma capital of 7.5%). 5 Four subgroups of banks are considered: below-capital-threshold public, below-capital-threshold private, above-capital-threshold public, and above-capital-threshold private. Below-capital-threshold banks have greatest implications for public policy due to the high cost of audit failure to taxpayers, stockholders, and others. Some of our most important results are for these banks. Fourth, we investigate whether discretionary choices di€er depending upon whether a bank is publicly or privately held. We examine whether di€erences occur in the magnitude and direction of their response to incentives provided by capital levels, earnings, and taxes. To our knowledge, our study is the ®rst to combine an extensive set of jointly determined accounting and ®nancing choices, a research design that permits detection of di€erential discretionary choices across capital adequacy thresholds, and a large sample of public and private unconsolidated banks. Our expectations and primary ®ndings are summarized below. We organize the discussion by below-capital-threshold banks, above-capital-threshold banks, and the di€erences between public and private banks. The loan loss provision and loan charge-o€ decisions are the most material discretionary choices and literature indicates that auditors and regulators monitor these choices closely. For below-capital-threshold banks, we expect auditors and regulators want conservative choices that reduce earnings or capital and we expect their preferences will prevail. We found that banks with proforma capital less than 7.5% use accounting discretion in a manner that

4 To the best of our knowledge, the only other studies to use call report data to investigate any of these choices are Carey (1994) and Beatty and Harris (1999). Both examine only the securities gain and loss choice. 5 By capital threshold, we mean a range, rather than a point estimate. As discussed later in the paper, our results are not materially changed by moving the range up or down by 1%.

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further reduces capital (earnings) by recognizing a larger discretionary loan charge-o€ (loan loss provision). These ®ndings are consistent with auditors mandating the use of estimates of earnings and capital for below-capitalthreshold banks that are conservative. (For the loan loss provision, in which earnings and capital level provide con¯icting incentives, earnings dominates capital.) The results are robust and apply to both public and private banks. The results for discretionary securities gains and losses are less robust. 6 Consistent with auditor and regulator conservatism, we found that belowcapital-threshold public and private banks with the lowest capital realize smaller net security gains, thereby further reducing capital. Marginal tax rates are not related to discretionary securities gains and losses. For discretionary dividends, there is no systematic relationship between capital level and dividends for below-threshold banks, possibly because most of these banks pay little or no dividends. For high-capital-threshold banks, we found that accounting and ®nancing choices are often di€erent than for below-capital-threshold banks. Of particular importance, there is little evidence of the auditor conservatism we found for below-capital-threshold banks. Instead, we found evidence that public and private banks with low (high) earnings tend to realize more (fewer) net securities gains, thereby smoothing income. Public banks also use the discretionary portion of the loan provision choice in a manner consistent with smoothing income. In addition, tax minimization has an in¯uence: contrary to our ®ndings for below-capital-threshold banks, we found evidence that higher marginal tax rates result in more loan charge-o€s and fewer net securities gains by both public and private banks above the capital threshold. And ®nally, we provide evidence about the di€erences in discretionary accounting and ®nancing choices between public and private banks. For belowcapital-threshold banks, we found that the magnitude of the conservative use of accounting discretion for the loan loss provision (to reduce earnings) and for the loan charge-o€s (to reduce capital) are larger for public than private banks. These two di€erences may be due to the greater potential legal liability to external auditors from failure of a public bank. In contrast, for above-capital-threshold banks, we found several di€erences. The magnitudes of the tax savings from realizing fewer net securities gains and from greater loan loss charge-o€s are larger for public than private banks. This di€erence likely re¯ects more sophisticated tax-savvy managers at public banks. The magnitude of income smoothing using the loan loss provision is also greater for public than private banks above the capital threshold, probably

6 This observation is generally true of prior research as well. For example, Collins et al. (1995, pp. 265, 266), comment ``. . . the relation between capital and securities gains and losses is less robust than the others . . . :''

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due to greater pressure for public banks to meet expected earnings levels. And ®nally, as capital levels increase, public banks increase dividend payouts more than private banks. Private banks may be retaining funds to minimize the personal tax payments of the owners and to increase bank capital. Results indicate audits and regulatory oversight counter the incentives that managers at banks below a regulatory capital threshold have to use their discretion to increase capital or earnings. The strong contrast between banks above and below the capital threshold in their use of discretion emphasizes the importance of auditor and regulator scrutiny. These conservative results exist for both public and private banks. The issue of whether this conservative bias is desirable is left to policy makers. 7 The remainder of the paper is organized as follows. Section 2 develops our expectations about the in¯uence of auditor monitoring. Section 3 describes the sample, and Section 4 reviews the research design. The empirical results are presented in Section 5. Section 6 summarizes our results.

2. E€ect of auditor and regulator monitoring on manager's use of accounting discretion 2.1. Introduction In this section, we examine whether the discretionary portion of accounting numbers is likely to re¯ect the preferences of auditors, regulators, or managers in speci®c settings. We ®rst consider banks with capital below a threshold that increases regulatory scrutiny. Next, we discuss how accounting discretion may be used di€erently in banks above this capital threshold. Finally, we consider whether accounting discretion is likely to be used di€erently in public and private banks. 2.2. Low capital banks 2.2.1. Preferences of managers, auditors, and regulators The costs of regulation can be substantial (Darnell, 1982, pp. 9±10; Chang, 1982, pp. 19±20). Costs are clearly higher for banks with substandard or marginal capital ratios: regulators can impose costly restrictions on managerial ¯exibility by refusing to permit establishment of a branch; refusing to approve a merger; disapproving a change in ownership or control; requiring higher 7 Recently, the SEC cautioned banks to not use loan provisions to manage net income (Securities and Exchange Commission, 1998). Relevant to the SEC position, we found that above-capitalthreshold public banks use the loan loss provision in a manner consistent with income smoothing.

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minimum capital requirements than required of other banks; and requiring changes to ®nancial statement data (Code of Federal Regulations, 1990, paras. 3.10, 325.3, and 325.4). Ultimately, regulators have the authority to close a bank (Code of Federal Regulations, 1990, paragraph 3.14). Because these steps reduce or eliminate managerial control and managers' wealth is reduced by many of these costs, managers of banks at or near regulatory capital constraints are expected to prefer accounting and ®nancing choices that increase reported capital and/or earnings. This expectation is consistent with the views of Moyer (1990, p. 153), Beatty et al. (1995, p. 232), and Collins et al. (1995, p. 267). Although managers of a bank with low capital may wish to reduce regulatory costs, banks that are close to their capital constraints come under increased supervision by regulatory authorities (Thomson, 1991, pp. 9±10; Carroll, 1989, p. 16; Whalen and Thomson, 1988, pp. 17±19), including an increased likelihood of a regulatory examination (Federal Deposit Insurance Corporation, 1988, p. 4). Managers of a bank that is under increased regulatory scrutiny have less ¯exibility in using accounting or ®nancing discretion, since available options would then be in¯uenced by the preferences of auditors and regulators. As further explained below, we suggest that auditors and regulators are likely to favor conservative estimates that fall within the range of probable outcomes. Extant banking literature (e.g., Koch, 1995) and regulatory guidance (e.g., Federal Deposit Insurance Corporation, 1990), speci®cally as pertains to loan-related items, clearly indicates that regulators prefer conservative outcomes. Many bank management texts express the view of Koch (1995) who states: Regulators prefer that the banks err by overestimating potential losses. In contrast, banks often prefer to report the lowest possible reserve that still protects against losses because this provides the highest possible reported net income (Koch, 1995, p. 742). Koch's (1995) views are reenforced by Federal regulations. The FDIC Manual of Bank Examination Policies requires banks to maintain a level of loan loss allowance which is not only adequate, but is also conservative, re¯ecting the diculty inherent in estimating future credit losses (Federal Deposit Insurance Corporation, 1990, Section 3.1, Loans). Further, bankers believe that examiners are conservative. In 1986, the American Banking Association interviewed a cross-section of bankers. Paraphrasing the bankers' comments, the association's journal said that when a bank gets into ®nancial trouble ``examiners don't want their present actions second guessed'' and as a consequence they are conservative (Examiners grow tougher..., 1986, p. 19).

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In accounting and auditing, there exists a long tradition of conservatism as a response to uncertainty. Independent auditors are concerned with the risk and consequences of audit failure, including its e€ect on their professional reputation and legal liability (Davis and Simon, 1992, pp. 66±67; Stice, 1991, p. 516; Palmrose, 1988, p. 57). Accounting researchers have found that auditor conservatism plays a role in many empirical and experimental settings, including: auditor switching (DeFond and Subramanyam, 1998, p. 37; Krishnan and Stephens, 1995, pp. 195±196; Krishnan, 1994, p. 214); audit reporting (Francis and Krishnan, 1999, p. 157); audit evidence search (McMillan and White, 1993, p. 444; Trotman and Sng, 1989, pp. 566±568; Kida, 1984); analytical review (Kinney and Uecker, 1982, pp. 66±68); and auditor accountability (Ho€man and Patton, 1997, p. 228; Peecher, 1996, pp. 133±139). In particular, Hackenbrack and Nelson (1996, p. 45) found that ``. . . auditors tend to require highengagement risk clients to adopt conservative reporting methods.'' Thus, for low capital banks, we expect auditors and bank examiners prefer conservative measures of capital and earnings. An alternative argument can be made that audits and examinations result in unbiased, rather than conservative, accounting estimates. By demanding conservative estimates, independent auditors may be criticized by bank managers and could lose future audit engagements. Regulatory examiners could be forced to justify conservative actions to supervisors. 8 The argument for unbiased estimates has some merit, but since the accurate (unbiased) amounts are unknown and the risk that auditors will be criticized for a bank failure is higher if capital or earnings have been overstated, we believe a risk adverse auditor would prefer conservative estimates for low capital banks. 2.2.2. Manager and auditor power Limits on managers' use of their accounting discretion are in¯uenced by the extent to which managers and auditors have con¯icting preferences and whether one of the parties is in a position of power to strongly in¯uence or dictate the outcome. Con¯icts occur between an auditor and their client during the course of an audit. Resolution of auditor/client con¯icts is often e€ected through a bargaining process (Lev, 1979, p. 166), wherein each of the participants can be viewed as possessing a certain amount of power to enforce their respective positions (Goldman and Barlev, 1974, pp. 707±711; Nichols and Price, 1976, pp. 335±336). Given that disagreements occur and that management and auditors may have con¯icting incentives, especially when the client is facing 8 Extant regulations, however, encourage conservative estimates and research ®nds that accountability increases auditor conservatism (Ho€man and Patton, 1997, p. 228; Lord, 1992, p. 103).

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®nancial distress, the issue becomes: which party would be expected to prevail in a given situation? To answer that question, extant literature suggests two factors that must be evaluated. The ®rst one concerns the audit service contract. Early theoretical work in generalized audit settings suggests that managers are in a powerful position relative to auditors, primarily because managers can in¯uence audit fees and hire or ®re the auditor (Emerson, 1962; Goldman and Barlev, 1974, p. 710; Nichols and Price, 1976, pp. 338±340). However, in bank audits, management's position is much weaker. Unlike most businesses, banks are faced with two sets of outside evaluators ± the external auditor hired by the bank and the bank examiner. Although bank managers have a measure of economic power over their external auditor, they cannot ®re the bank examiner. Further, although non-bank management generally has wide latitude in negotiating the fees of external auditors, bank examiners do not charge a separate fee that can be threatened. 9 As a consequence, the power of bank management in an accounting con¯ict is likely much more limited than the power of non-bank management. The second factor a€ecting power is the ®nancial health of the client. Survey and empirical research suggest that client ®nancial distress results in a shift of power to the auditor. Knapp (1985, p. 202) found that clients in good ®nancial condition are perceived as having the upper hand, while those in poor shape are unlikely to prevail in a con¯ict with auditors. Using audit quality review ®ndings for government entities, Deis and Giroux (1992, pp. 467±469) developed an audit quality score. Deis and Giroux (1992, p. 476) found that audit quality increased as ®nancial health of the client declined. Petroni and Beasley (1996, p. 156) o€er a maintained hypothesis that auditing e€ort is greater for clients in poor ®nancial health. Hackenbrack and Nelson (1996, p. 45) also support the notion that auditors prevail when clients are in poor ®nancial health. For these reasons, we believe that auditors' preferences are more likely to dominate managers' preferences for banks below a capital threshold that results in increased regulatory scrutiny. In the next section, we relax this conclusion when the accounting or ®nancing choice is not subject to audit adjustment. 2.2.3. Whether the accounting choice is subject to audit adjustment The resolution (or even the very existence) of a con¯ict is in¯uenced by the nature of the item being examined. Absent errors or irregularities, the accounting treatment of most transactions which occur during the year is not 9

Even if a portion of deposit insurance premiums is viewed as an indirect audit fee, the power of bank managers is not increased since they are unable to modify the audit fee component.

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subject to change. An example is the gain or loss recorded on the sale of marketable securities. The securities portfolio of a bank serves a number of purposes: it is a storehouse of liquidity; it is an integral part of asset±liability management; and the interest generated is an important contributor to bank earnings (Sinkey, 1989, chapters 13, 15, and 16; Hempel and Simonson, 1991, chapter 11). One or more of these purposes often dictates the purchase and sale of securities throughout the year. If prudent bank management requires the sale of securities, managers have considerable choice as to which securities to sell; thus managers can in¯uence the magnitude of any gain or loss realized. Since securities gains and losses are not subject to ex post audit adjustment, regulators have little control over the level of securities gain or loss (Beatty and Harris, 1999, p. 304, also make this argument). Accounting for dividend payments is similar, since once the transaction has occurred, the ®nancial e€ect is recorded and not subject to adjustment. Further, some evidence indicates that bank regulators do not systematically intervene during the year to force reduced dividend payments (French, 1991, p. 7; Horne, 1991, p. 15). Unlike completed transactions, many accruals and estimates are not ®nalized until year-end and are subject to auditor adjustment. Important accruals and estimates for banks include loan loss provisions and loan charge-o€s. Signi®cant judgement is involved in estimating these loan-related items (Sinkey, 1989, pp. 543±546; Wahlen, 1994, pp. 457±458; Beaver et al., 1989, p. 162). The vast majority of regulatory oversight time is spent on the loan portfolio, including loan classi®cation (as performing vs. non-performing), loan loss provision, and loan charge-o€s (Mitchell, 1984, p. 19; May, 1991, p. 61; Koch, 1995, pp. 40±43). In the 1980s, regulatory pressure was increased in the areas of loan portfolios and the allowance process (Walter, 1991, pp. 24±25; Spinard, 1992, p. 59). This regulatory pressure leads to potential disagreements with bank managers whose judgement may be questioned (Fleischer, 1991, pp. 33± 35; Nadler, 1991, p. 19). The extent of con¯ict can be substantial over loan charge-o€s, since an increased amount reduces capital dollar-for-dollar. A change in the loan loss provision also directly a€ects earnings, but it has a smaller, and opposite, e€ect on capital. 10 To summarize, for banks below a capital threshold that results in increased regulatory scrutiny, we expect auditor conservatism to prevail in con¯icts with

10

During the period of study, the primary capital adequacy ratio was de®ned as the book value of stockholders' equity plus the loan loss allowance divided by total assets plus the loan loss allowance (Scholes et al., 1990, p. 642; Beatty et al., 1995, p. 233). Capital is therefore increased by increasing the loan loss allowance, which can be accomplished by increasing the provision or decreasing charge-o€s. Increasing the provision by $1 increases the allowance by $1 and reduces book net income by $1 …1 ÿ t†, where t equals the marginal tax rate for book purposes. The net e€ect is to increase capital by $1 …t†. Decreasing charge-o€s by $1 increases the loan loss allowance by $1 and, consequently, increases regulatory capital by $1.

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managers that involve accounting discretion over items subject to year-end adjustment (e.g., loan loss provisions and loan charge-o€s). For completed transactions (e.g., securities gains and losses, and dividends), we expect auditors are not able to restrict managers' use of discretion. 2.3. High capital banks The shift of power to auditors that occurs when a bank is in poor ®nancial health should shift back towards managers when a bank is in good ®nancial condition. Further, since federal bank examiners operate in a resource-constrained environment, they concentrate their scarce audit resources on low capital banks, not those with high capital (e.g., Federal Deposit Insurance Corporation, 1988, p. 4). For example, during the period of this study (1987 and 1988), a goal of the FDIC was to audit troubled banks on a yearly basis, but only to perform ®eld audits on non-troubled banks every two years (Federal Deposit Insurance Corporation, 1988, p. 4). These two factors suggest that managers' incentives should become dominant for all discretionary accounting and ®nancing choices when capital is relatively high. Yet, we expect managers of ®nancially healthy banks to no longer focus on increasing capital and/or earnings. Managers may make positive or negative discretionary accruals to maximize payments under a bonus plan (Healy, 1985, pp. 86±87), to comply with accounting provisions in contracts (Watts and Zimmerman, 1986, pp. 179±199), or to smooth income (Beatty and Harris, 1999, p. 30; Ronen and Sadan, 1981). Depending upon a bank's incentives, managers may want to increase or decrease income. As explained in Section 2.4, we expect above-threshold public banks to manage earnings to a greater extent than above-threshold private banks. We also expect mangers of above-capital-threshold banks to incorporate the e€ect of taxes in their discretionary choices. The marginal corporate tax rate should a€ect the level of loan charge-o€s and realized securities gains and losses but not loan loss provisions and dividends since these items do not a€ect corporate taxable income (Collins et al., 1995, pp. 268±270). Following Scholes et al. (1990, p. 633), we estimated relative marginal tax rates using the proportion of assets represented by municipal bond holdings. Higher levels of municipal bonds are a surrogate for a higher marginal tax rate. As the marginal tax rate increases, each dollar of loan charge-o€ provides a greater tax shield and each dollar of realized securities gain costs more in taxes. As a result, we expect a positive (negative) relationship between the marginal rate and loan charge-o€s (net security gains). 11 These relationships are consistent with extant

11

We expect this relationship to be evident for banks above and below the capital threshold.

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literature (Scholes et al., 1990, p. 645; Collins et al., 1995, p. 270; Beatty et al., 1995, p. 242; Beatty and Harris, 1999, p. 309). 2.4. Public and private bank comparisons Empirical accounting research that explores di€erences between public and private ®rms is limited ± primarily because data are extremely dicult to obtain. 12 Further, the banking literature contains relatively little theoretical work to guide our tests. Our analysis is therefore somewhat exploratory. Unlike our tests for below- and above-capital-threshold banks, for public and private banks we are not interested in whether the discretionary actions are di€erent from zero, but whether the actions of public and private banks are di€erent from one another. Our expectations are stated accordingly. For banks with capital below the threshold, we do not expect any substantial di€erences between the discretionary actions of public and private banks. Auditors would continue to seek conservative numbers, and managers would prefer to report higher capital and/or earnings. However, for abovecapital-threshold banks, we expect the discretionary actions of public and private banks will diverge. The manager and/or owner of a private bank typically has a greater proportion of his or her personal wealth concentrated in bank ownership (Sullivan and Spong, 1998, p. 22). Hughes and Mester (1998, pp. 314±317) show managers use capital to signal risk and that there is a negative relationship between capital and risk. Thus, compared to public banks, we expect private banks to have higher capital (signaling lower risk) and to take discretionary actions to maintain or improve capital. This can be accomplished by above-threshold private banks recording a larger loan loss provision, more net securities gains, fewer loan charge-o€s, and lower dividend payouts when compared to abovethreshold public banks. In the case of the earnings incentive for banks above the capital threshold, consistent with Beatty and Harris (1999, p. 302), we argue that information asymmetry between managers and stockholders and/or agency cost issues will result in greater earnings management by public banks when compared to private banks. This could result in public banks making greater use than private banks of the loan loss provision and net securities gains to smooth income. In Section 2.3 we argued that, ceteris paribus, banks seek to maximize the tax shield provided by deductions and minimize the tax cost imposed on 12

For some available research, see Beatty and Harris (1999), Cloyd et al. (1996), and Penno and Simon (1986).

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income. Cloyd et al. (1996, pp. 25±26) present evidence consistent with the notion that private ®rms are more inclined to make decisions that increase taxrelated cash ¯ows when compared to public ®rms. Thus, we expect abovethreshold private banks will record greater loan charge-o€s and fewer net securities gains than will above-threshold public banks, for a given a marginal tax rate. Our expectations for public and private banks are summarized at the bottom of Table 9.

3. Sample The sample data were obtained from annual FDIC tapes. These tapes report ®nancial and other data for each bank covered by FDIC deposit insurance (substantially all banks in the US). Data are provided at the individual bank level, rather than as a consolidated group. The data are from 1987 and 1988. These years were chosen because they are in the middle of a time period in which capital ratio rules were stable (e.g., Koch, 1995, p. 389). Capital adequacy rules changed in 1985 and risk-adjusted capital standards were adopted in late 1989 (to become fully e€ective in 1992) (e.g., Koch, 1995, p. 389). Thus, 1987 and 1988 are years in which bank data should be relatively free from nonrecurring adjustments for changes in capital adequacy regulations. 13 Table 1, panel A reports the number of banks used in the analysis, the number removed, and the reasons for their removal. We ®rst deleted mutual savings banks, foreign banks, banks in US possessions, and non-banks (banks with Bank Charter Codes of 30 and above). 14 Next, new banks, those not in existence for at least four years as of the end of the year, were removed because evidence suggests that they are structured and operated in a di€erent manner than established banks (e.g., Avery and Belton, 1987, p. 252). 15 Small banks, 13

As suggested by a reviewer, the in¯uence of proposed changes in capital adequacy requirements on bank accounting and ®nancing choices is also a subject worthy of study. Knowledge of behavior under capital requirements that do not vary provides a benchmark for studying the e€ect of changes. 14 These banks are included on the tapes because they must report to the FDIC, similar to domestic banks. However, their regulatory structure di€ers substantially from other banks. Mutual savings banks are similar to savings and loan institutions and are subject to regulations which di€er, in many material respects, from those for commercial banks. For the other types of banks listed, their operations and, in many cases, primary regulators di€er from those of US banks. 15 New banks require a number of years of operation before ®nancial statement balances re¯ect normal operating relationships. For example, loans to total assets are low until the loan portfolio becomes mature; loans are not seasoned so loan losses are more dicult to estimate; and new banks have lower interest expense as a percentage of assets since liabilities are a smaller proportion of the balance sheet (Avery and Belton, 1987, p. 252).

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Table 1 Sample informationa Panel A: Number of observations Banks on the FDIC tapes each year Less reductions for: Savings banks, foreign banks, banks in possessions, and non-banks (charter codes 30 or higher) Banks not in existence for 4 years as of 12/31/87 or 12/31/88, as appropriate Assets less than $10 million Zero assets, zero operations, zero loans, in liquidation, or missing data required to construct regressions Total useable observations

1987

1988

14,799

14,246

1,183

1,202

853

684

785

726

358

302

11,620

11,332

Panel B: Observations classi®ed as public/private and high/low capital PFCAP PFCAP 1987 Data <7.5% P 7.5%

Total

Public banks Private banks

444 1,085

1,210 8,881

1,654 9,966

Total

1,529

10,091

1,620

PFCAP <7.5%

PFCAP P 7.5%

Public banks Private banks

356 1,089

1,202 8,685

1,558 9,774

Total

1,445

9,887

11,332

1988 Data

Total

a

All observations are from Consolidated Reports of Condition and Income, for the calendar years indicated, as provided by the Federal Deposit Insurance Corporation.

those with less than $10 million in assets, were then removed because they are likely to have a di€erent cost curve than other banks (Kolari and Zardkoohi, 1987, pp. 64±72). Finally, we removed banks with zero assets, zero operations, zero loans, or missing data for required variables. The ®nal sample of 11,620 banks from 1987 and 11,332 banks from 1988 was used to ®t regressions that isolate the discretionary portion of the accounting and ®nancing choices. Table 1, panel B summarizes the number of public and private banks in our sample.

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4. Research design 4.1. Model development We use OLS regression to ®t separate models to investigate how managers use their discretion in recording the loan loss provision (LLP), loan charge-o€s (LCO), security gains and losses (SGL), and dividends (DIV). Because discretionary choice decisions may be determined jointly (Moyer, 1990, p. 142; Beatty et al., 1995, p. 232) the OLS regression models are estimated as a system of simultaneous equations using SUR. To increase the relation to prior research, regression variables are similar to Collins et al. (1995, pp. 289±290) as noted in Table 2. Each of the four regression models includes one or more control variables designed to measure the non-discretionary portion of the choice. The control variables for both the loan provision and loan charge-o€ choices are beginning loan loss allowance (BLLA), beginning non-performing loans (BNPL), and the change in non-performing loans during the year (CHNPL). The beginning loan allowance is included in the LCO model because a higher allowance would indicate greater charge-o€s are expected. It is included in the LLP model because accounting practice indicates that provisions over time are auto-correlated. Non-performing loans are included in both models as an indicator of loan portfolio default risk. This balance is a relatively non-discretionary risk indicator because interest and principal payments more than 90 days overdue must be classi®ed as non-performing. For the SGL model, the control variable is the amount of unrealized appreciation at the beginning of the period (APPREC). This represents the net pre-tax gain or loss a bank would realize if the entire securities portfolio was sold at that time. 16 The larger (smaller) the amount of unrealized appreciation, the larger (smaller) the net gain likely to be realized in the absence of manager bias. The prior year's dividends (PYDIV) serve as a control variable for the DIV model. Bank dividends have been shown to be relatively stable over time (French, 1991, pp. 6±7) and dividend payments have been shown to be sticky even when capital is low (French, 1991, p. 7; Horne, 1991, p. 15). This suggests that the level of dividends paid in the prior year is a reasonable estimate of an unbiased dividend payment. The models also contain incentive variables to investigate whether managers' choice decisions are biased in the sense that the managers have used their

16 Unlike SFAS 115, Accounting for Certain Investments in Debt and Equity Securities (FASB, 1993, paragraph 19), which requires disclosure of gross unrealized holding gains and gross unrealized holding losses, the call reports provide only the net unrealized gain or loss.

F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

215

Table 2 Variables used in this studya Dependent variables LLP LCO SGL DIV

ˆ ˆ ˆ ˆ

Loan loss provision Loan charge-o€s Securities gains or losses Common stock dividends

Independent variables of interest and dummy variables PFCAP

ˆ Proforma capital (following Collins et al., 1995, pp. 289±290) calculated as: primary capital at the beginning of the year, plus operating income before securities gains or losses, loan loss provision, and taxes.

EARN

ˆ Non-discretionary earnings (following Collins et al., 1995, p. 290) calculated as operating income before securities gains or losses, loan loss provision, and taxes.

MUNI

ˆ Municipal securities held calculated as percentage of banks' assets held in tax-advantaged municipal bonds as of the beginning of the year.

D1, D2, D3, D4

ˆ Dummy variables denoting four categories of banks as follows: Category D1 D2 D3 D4 Public banks, PFCAP 1 0 0 0 <7.5% Private banks, PFCAP 0 1 0 0 <7.5% Public banks, PFCAP 0 0 1 0 P 7:5% Private banks, PFCAP 0 0 0 1 P 7:5%

Control variables BLLA BNPL CHNPL APPREC PYDIV

ˆ Beginning balance of loan loss allowance ˆ Beginning balance of non-performing loans ˆ Change in balance of non-performing loans during the year. ˆ Di€erence between the cost and fair market value of the securities portfolio as of the beginning of the year. A negative number indicates that cost exceeds FMV. ˆ Common stock dividends paid in the prior year.

a

Note: In OLS regression equations, all non-dummy variables are scaled by total assets. Our variable names are the same as those used by Collins et al. (1995, pp. 289±290) except for APPREC and PYDIV.

discretion to manage the level of proforma capital (PFCAP), earnings (EARN), or corporate taxes (MUNI). Each of the four accounting and ®nancing choices a€ect the level of capital; the loan loss provision and securities gains and losses also change earnings; and loan charge-o€s and securities gains and losses modify taxes. If the capital, earnings, or tax variables are signi®cant

216

F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

in explaining a choice, this suggests that managers have made a biased accounting or ®nancing choice. The regression models have been designed to be consistent with prior research, as mentioned previously (e.g., Collins et al., 1995, pp. 289±290). The incentive variables are always the same as those used by Collins et al. (1995, pp. 289±290). 17 The control variables for the LLP and LCO models are also identical to Collins et al. (1995, pp. 289±290). 18 In order to increase explanatory power and use the types of data provided in call reports, the control variables for the SGL model and the DIV model di€er from Collins et al. (1995). 19 The incentive and control variables used in each regression model are summarized below. Accounting or ®nancing choice

Incentive variables (discretionary portion)

Control variables (non-discretionary portion)

LLP LCO SGL DIV

PFCAP EARN PFCAP MUNI PFCAP EARN MUNI PFCAP

BLLA BNPL CHNPL BLLA BNPL CHNPL APPREC PYDIV

We have hypothesized that accounting discretion is used di€erently by public and private banks and by banks above and below a capital adequacy threshold used by regulators. Thus, we have four categories of banks that may use discretion di€erently: below-capital-threshold public, below-capitalthreshold private, above-capital-threshold public, and above-capital-threshold private. To allow for di€erences, we use dummy variables to permit regression coecients for the intercept and for the non-control continuous variables to vary between the four categories. 20

17

For LCO, both the Collins et al. (1995, p. 290) model and our model use a MUNI variable to capture the e€ect of taxes on the non-discretionary component of accounting choice. The Collins et al. (1995, p. 290) variable is based on tax-advantaged municipal bonds as a percentage of the banks' investment portfolio. Because we scale all other continuous variables by total assets, we measure MUNI as municipal bonds divided by total assets. 18 However, Collins et al. (1995, p. 264) used these variables in bank-speci®c regressions ®t over a twenty-year period, while we used the variables in cross-sectional models pooled across years. 19 Information on unrealized appreciation in the securities portfolio spread was unavailable in the data used by Collins et al. (1995). 20 Note that we do not apply the dummy variables to the control variables. To the extent that the control variables accurately capture the Generally-Accepted-Accounting-Principles-derived portion of the dependent variable, no adjustment to the control variables is necessary. As a sensitivity test, we ran our models allowing interactions with all continuous variables and obtained results that are statistically the same as the results reported.

F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

217

The threshold between low and high capital banks is based upon guidelines established by the FDIC and the Oce of the Comptroller of the Currency (OCC). In 1985, regulators adopted uniform capital adequacy rules that established certain tiers, or zones, for capital adequacy evaluations (Mitchell, 1984, p. 21). Although regulators established a ¯oor (5.5% of primary capital), in practice, they used a higher threshold: Banks with primary capital over 7% were deemed by regulators to be adequately capitalized and were not examined as closely as those with less capital (Mitchell, 1984, pp. 20±21; Sinkey, 1989, pp. 606±608; Golembe and Holland, 1986, pp. 731±733). Since primary capital includes any discretionary behavior, we need to convert the regulator-derived 7% primary capital standard into our proforma capital metric, PFCAP. PFCAP is de®ned, consistent with Collins et al. (1995, pp. 289±290), as primary capital from the prior year plus current operating income before discretionary items. To reconcile between regulatory primary capital and an approximation of PFCAP, we must add the loan loss provision, add an estimate of income taxes, and subtract securities gains (add losses). Using 1988 medians, regulatory primary capital of 7% of assets equals a PFCAP of 7.52% of assets. For simplicity, we use PFCAP of 7.5% or more to denote an abovecapital-threshold bank and less than 7.5% for a below-capital-threshold bank. 21

5. Empirical results 5.1. Descriptive analysis Table 2 provides a description of the variables used in the tables. The directional expectations for model variables are set forth in Table 3. Table 4 presents the number of observations and the mean and median values of all variables used in the regression equations. Amounts are presented for the entire sample, for public and private banks, and for banks above and below the capital adequacy threshold. All amounts, except total assets and the number of observations, are de¯ated by total assets. Medians present a more informative picture than means since the values are not normally distributed.

21 To test the sensitivity of our capital threshold, we also set the PFCAP cuto€ to 8% and again to 7%. Our results are substantially the same as those reported in the paper. This sensitivity check illustrates that our capital threshold does not represent a bright line, but a range within which manager and regulator choices may vary among individual banks. Choices may vary on a crosssectional basis because banks are not identical, and di€erences caused by loan concentration, growth rates, quality of management, regional location, and other factors, cause regulators to take action in the case of one bank, but not another, even when capital levels are identical.

218

F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

Table 3 Summary of hypothesized e€ects for all modelsa Variable of interest

Outcome preferred by Managers

LLP model PFCAP Below-threshold banks Above-threshold banks EARN Below-threshold banks Above-threshold banks LCO model PFCAP Below-threshold banks Above-threshold banks MUNI All banks SGL model PFCAP Below-threshold banks Above-threshold banks EARN Below-threshold banks Above-threshold banks MUNI all banks DIV model PFCAP Below-threshold banks Above-threshold banks

Hypothesized observed e€ect

Auditors

ÿ ‡=ÿ

‡ ‡=ÿ

‡ ‡=ÿ

‡ ‡=ÿ

ÿ ‡=ÿ

ÿ ‡=ÿ

‡ ‡=ÿ

ÿ ‡=ÿ

ÿ ‡=ÿ

‡

‡=ÿ

‡

ÿ ‡=ÿ

‡ ‡=ÿ

ÿ ‡=ÿ

ÿ ‡=ÿ

‡ ‡=ÿ

ÿ ‡=ÿ

ÿ

‡=ÿ

ÿ

‡ ‡=ÿ

‡ ‡=ÿ

‡ ‡=ÿ

a Below-threshold banks are those with proforma capital (PFCAP) <7.5% while above-threshold banks have proforma capital P 7:5%. As more fully explained in the text, the above e€ects are consistent with: Below-threshold banks ± managers have a preference for exercising capital- and earnings-increasing discretion. ± auditors have a preference for capital- and earnings-decreasing discretion (conservatism). ± auditors are successful in constraining manager actions for those variables which are determined at year end (LLP and LCO models), but not for those which are made throughout the year (SGL and DIV models). Above-threshold banks ± no systematic direction. All banks ± regardless of bank capital level, managers seek to maximize the after-tax e€ect of discretionary income or deduction (MUNI).

Mean Median

Mean Median

Mean Median

Mean Median

Mean Median

Mean Median

Mean Median

Mean Median

PFCAP

EARN

BLLA

BNPL

CHNPL

LCO

MUNI

Mean Median

LLP

Number of observations Total assets (in millions)

5.80% 4.66%

0.58% 0.27%

)0.13% )0.05%

1.54% 0.93%

0.79% 0.62%

1.39% 1.46%

10.11% 9.74%

0.68% 0.34%

244.0 45.5

11,620

1987

4.96% 3.83%

0.46% 0.19%

)0.06% )0.02%

1.30% 0.76%

0.84% 0.66%

1.42% 1.49%

10.16% 9.76%

0.53% 0.25%

263.1 46.7

11,332

1988

All observations

1987

4.45% 3.74%

0.59% 0.26%

)0.11% )0.04%

1.42% 0.87%

0.91% 0.73%

1.33% 1.44%

8.68% 8.57%

0.74% 0.35%

1,220.2 125.6

1,654

1988

4.19% 3.55%

0.51% 0.21%

0.01% )0.00%

1.19% 0.68%

0.98% 0.76%

1.44% 1.57%

8.90% 8.75%

0.60% 0.28%

1,423.0 162.2

1,558

1987

6.02% 4.88%

0.58% 0.27%

)0.13% )0.05%

1.55% 0.94%

0.77% 0.59%

1.40% 1.47%

10.34% 9.96%

0.67% 0.34%

82.0 40.2

9,966

1988

5.09% 3.91%

0.45% 0.19%

)0.07% )0.02%

1.32% 0.78%

0.82% 0.64%

1.41% 1.47%

10.36% 9.95%

0.51% 0.24%

78.3 40.8

9,774

1987

2.85% 1.70%

0.81% 0.33%

)0.12% )0.02%

2.11% 1.00%

0.95% 0.65%

0.48% 0.79%

6.21% 6.71%

0.90% 0.40%

538.6 65.7

1,529

1988

2.23% 1.22%

0.84% 0.29%

0.07% 0.03%

2.09% 0.97%

1.07% 0.69%

0.43% 0.83%

5.98% 6.56%

0.93% 0.35%

411.7 60.5

1,445

6.25% 5.23%

0.55% 0.26%

)0.13% )0.06%

1.45% 0.93%

0.77% 0.62%

1.53% 1.54%

10.70% 10.10%

0.64% 0.33%

199.4 43.2

10,091

1987

5.36% 4.36%

0.41% 0.18%

)0.08% )0.03%

1.19% 0.74%

0.81% 0.66%

1.56% 1.55%

10.77% 10.14%

0.47% 0.24%

241.4 45.4

9,887

1988

Proforma capital P 7.5%

Proforma capital <7.5%

Public banks

Private banks

All observations split into

All observations split into

Table 4 Mean and median values of variables (all values, except observations and total assets, are shown as a percentage of total assetsa

F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235 219

a

Mean Median

Mean Median

APPREC

DIV

0.37% 0.25%

0.82% 0.60%

0.03% 0.00%

1987

0.42% 0.28%

)0.13% )0.07%

0.00% 0.00%

1988

All observations

Variables are as described in Table 2.

Mean Median

SGL

Table 4 (continued)

1987

0.46% 0.36%

0.45% 0.32%

0.03% 0.00%

1988

0.56% 0.42%

)0.09% )0.06%

0.00% 0.00%

1987

0.36% 0.24%

0.88% 0.68%

0.03% 0.00%

1988

0.39% 0.26%

)0.13% )0.07%

0.00% 0.00%

1987

0.13% 0.00%

0.31% 0.18%

0.04% 0.00%

1988

0.14% 0.00%

)0.33% )0.13%

)0.01% 0.00%

0.41% 0.29%

0.89% 0.69%

0.03% 0.00%

1987

0.46% 0.32%

)0.10% )0.05%

0.00% 0.00%

1988

Proforma capital P 7.5%

Proforma capital <7.5%

Public banks

Private banks

All observations split into

All observations split into

220 F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

221

In 1987, the median unconsolidated bank had total assets of just over $45.5 million, proforma capital of 9.7% of assets ($4.4 million), and proforma earnings of 1.46% of assets ($664,000). 22 With regard to the accounting choices investigated in our study, the median bank had a beginning loan loss allowance of $282,000, took $123,000 of loan charge-o€s, recorded a current loan loss provision of $153,000, net securities gains of $1,000, and paid dividends of $114,000. Public and private banks exhibit similar median levels of loan loss provisions, loan charge-o€s, proforma earnings, change in non-performing loans, and realized securities gains. In contrast, private banks have fewer assets, more proforma capital, lower beginning loan loss allowance, higher beginning nonperforming loans, greater municipal bond holdings, greater unrealized appreciation in the securities account (in 1987, but not in 1988), and lower dividend payments. When the observations are dichotomized into banks with proforma capital above and below 7.5%, the two groups have similar levels of loan loss provision, beginning loan loss allowance, beginning non-performing loans (in 1987 but not in 1988), and realized securities gains/losses. Below-capital-threshold banks have more assets, lower earnings, less improvement in non-performing loans, slightly more loan charge-o€s, a much lower marginal tax rate, less unrealized securities appreciation, and lower dividend payments. 5.2. Results by choice model 5.2.1. Overview The results for each choice model are set forth in Tables 5±8. For each detailed model, the control variables (BLLA, BNPL, CHNPL, APPREC, and PYDIV, as appropriate) explain the non-discretionary component of variation in the choice decision. Each model incorporates dummy variables to classify banks into one of four categories based on whether PFCAP (a measure of prediscretionary bank capital) is over or under the 7.5% threshold and whether the bank is public or private. The discretionary variables of interest re¯ect the variation associated with the capital, earnings, or tax incentives for each category of bank. The dummy variables are constructed to discern whether the variable of interest is di€erent from zero rather than di€erent from the actions of a base group. In the tables, data on the incentive variables are presented ®rst because they are the variables of interest, followed by the control variables, and then the intercepts.

22

We cite several dollar amounts to provide readers with information about the magnitude of the accounting and ®nancing choices. Most of the dollar amounts are not reported on Table 4.

0.00433 0.00110 0.00013 ÿ0.00120

0.04467 0.36954 0.32581 3.396 1.382 0.205 ÿ 4.105

3.930 79.701 67.340

ÿ0.31937 ÿ21.849 ÿ0.02615 ÿ 3.087 0.04235 4.147 0.00282 0.586

ÿ ÿ ‡=ÿ ‡=ÿ

0.384 ÿ0.842 0.503 6.176

t-value

0.00797 ÿ0.01052 0.00337 0.01618

Par. Est.

‡ ‡ ‡=ÿ ‡=ÿ

Ho

p-value

0.0007 0.1671 0.8376 0.0001

0.0001 0.0001 0.0001

0.0001 0.0010 0.0001 0.5577

0.3506 0.2000 0.6152 0.0001

0.276 ÿ1.024 ÿ0.428 5.471

t-value

0.00513 0.00145 ÿ0.00081 ÿ0.00175

0.05019 0.36740 0.33813 3.076 1.422 ÿ1.105 ÿ4.451

3.312 54.869 49.397

ÿ0.43884 ÿ23.428 ÿ0.09165 ÿ8.491 0.09277 6.948 ÿ0.01508 ÿ2.270

0.00770 ÿ0.01646 ÿ0.00314 0.01932

Par. Est.

N ˆ 11; 332 1988

N ˆ 22; 952 Pooled Par. Est.

0.07143 0.36699 0.31715 0.0021 0.00382 0.1550 ÿ0.00074 0.2690 0.00057 0.0001 ÿ0.00077

0.0009 0.0001 0.0001

0.0001 ÿ0.12685 0.0001 0.06418 0.0001 ÿ0.01583 0.0232 0.02168

0.3914 ÿ0.00775 0.1528 0.01559 0.6683 0.01413 0.0001 0.01306

p-value

t-value

1.950 ÿ0.588 0.400 ÿ1.797

4.137 56.319 46.815

ÿ5.470 4.761 ÿ1.011 3.128

ÿ0.248 0.795 0.939 3.386

N ˆ 11; 620 1987

0.0512 0.5566 0.6894 0.0723

0.0001 0.0001 0.0001

0.0001 0.0001 0.3123 0.0018

0.4020 0.2134 0.3480 0.0007

p-value

b

‡ b10 …EARNi  D2i † ‡ b11 …EARNi  D3i † ‡ b12 …EARNi  D4i † ‡ b13 BLLAi ‡ b14 BNPLi ‡ b15 CHNPLi ‡ ei :

Variables are described in Table 2. All variables, except dummy variables, are divided by total assets. p-values are one-tailed for Ho with a directional expectation; two-tailed otherwise. c Models in Tables 5±8 are solved as a system of regression equations using SUR. The system-weighted R2 for the SUR system of equations is 0.4114 for 1987, 0.4235 for 1988, and 0.4115 for the pooled model. d LLPi ˆ b1 D1i ‡ b2 D2i ‡ b3 D3i ‡ b4 D4i ‡ b5 …PFCAPi  D1i † ‡ b6 …PFCAPi  D2i † ‡ b7 …PFCAPi  D3i † ‡ b8 …PFCAPi  D4i † ‡ b9 …EARNi  D1i †

a

Intercept variables: b1 : Public, PFCAP <7.5% b2 : Private, PFCAP <7.5% b3 : Public, PFCAP P 7.5% b4 : Private, PFCAP P 7.5%

Control variables: b13 : BLLA b14 : BNPL b15 : CHNPL

Discretionary variables: PFCAP b5 : Public, PFCAP <7.5% b6 : Private, PFCAP <7.5% b7 : Public, PFCAP P 7.5% b8 : Private, PFCAP P 7.5% EARN b9 : Public, PFCAP <7.5% b10 : Private, PFCAP <7.5% b11 : Public, PFCAP P 7.5% b12 : Private, PFCAP P 7.5%

Variable

Table 5 LLP model and OLS regression results solved using SURa ;b; c; d 222 F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

0.00647 6.404 0.00045 0.692 ÿ0.00391 ÿ7.034 ÿ0.00327 ÿ13.292

0.43015 0.26277 0.16427

44.860 67.842 40.434

ÿ2.004 ÿ0.885 3.719 3.481

ÿ0.01040 ÿ0.00239 0.00760 0.00210

‡ ‡ ‡ ‡

t-value

ÿ7.626 ÿ3.413 2.616 5.394

Par. Est.

ÿ ÿ0.12031 ÿ ÿ0.03377 ‡=ÿ 0.01419 ‡=ÿ 0.01179

Ho

p-value

0.0001 0.4890 0.0001 0.0001

0.0001 0.0001 0.0001

0.0226 0.1880 0.0001 0.0003

0.0001 0.0003 0.0089 0.0001

t-value

34.539 44.955 27.031

0.00660 4.932 0.00306 3.694 ÿ0.00436 ÿ6.790 ÿ0.00384 ÿ11.394

0.44968 0.25597 0.15811

0.00024 0.028 ÿ0.00066 ÿ0.163 0.00380 1.229 0.00294 3.324

ÿ0.13736 ÿ6.426 ÿ0.08312 ÿ6.545 0.01562 2.614 0.01119 3.726

Par. Est.

N ˆ 11; 332 1988

N ˆ 22; 952 Pooled

0.0001 0.0002 0.0001 0.0001

0.0001 0.0001 0.0001

0.4888 0.4353 0.0969 0.0005

0.0001 0.0001 0.0090 0.0002

p-value

0.00621 ÿ0.00328 ÿ0.00312 ÿ0.00269

0.42137 0.26153 0.16784

ÿ0.00537 ÿ0.00367 0.01053 0.00059

ÿ0.11115 0.03341 0.00929 0.01288

Par. Est.

t-value

4.048 ÿ3.239 ÿ2.648 ÿ7.552

29.491 48.736 29.761

ÿ0.811 ÿ1.013 3.685 0.710

ÿ4.721 2.140 0.767 4.067

N ˆ 11; 620 1987

0.0001 0.0012 0.0081 0.0001

0.0001 0.0001 0.0001

0.2086 0.1556 0.0001 0.2388

0.0001 0.0162 0.4429 0.0001

p-value

b

‡ b10 …MUNIi  D2i † ‡ b11 …MUNIi  D3i † ‡ b12 …MUNIi  D4i † ‡ b13 BLLAi ‡ b14 BNPLi ‡ b15 CHNPLi ‡ ei :

Variables are described in Table 2. All variables, except dummy variables, are divided by total assets. p-values are one-tailed for Ho with a directional expectation; two-tailed otherwise. c Models in Tables 5±8 are solved as a system of regression equations using SUR. The system-weighted R2 for the SUR system of equations is 0.4114 for 1987, 0.4235 for 1988, and 0.4115 for the pooled model. d LCOi ˆ b1 D1i ‡ b2 D2i ‡ b3 D3i ‡ b4 D4i ‡ b5 …PFCAPi  D1i † ‡ b6 …PFCAPi  D2i † ‡ b7 …PFCAPi  D3i † ‡ b8 …PFCAPi  D4i † ‡ b9 …MUNIi  D1i †

a

Intercept variables: b1 : Public, PFCAP <7.5% b2 : Private, PFCAP <7.5% b3 : Public, PFCAP P 7.5% b4 : Private, PFCAP P 7.5%

Control variables: b13 : BLLA b14 : BNPL b15 : CHNPL

Discretionary variables: PFCAP b5 : Public, PFCAP <7.5% b6 : Private, PFCAP <7.5% b7 : Public, PFCAP P 7.5% b8 : Private, PFCAP P 7.5% MUNI b9 : Public, PFCAP <7.5% b10 : Private, PFCAP <7.5% b11 : Public, PFCAP P 7.5% b12 : Private, PFCAP P 7.5%

Variable

Table 6 LCO model and OLS regression results solved using SURa; b;c; d F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235 223

Control variables: b17 : Public, APPREC

Discretionary variables: PFCAP b5 : Public, PFCAP <7.5% b6 : Private, PFCAP <7.5% b7 : Public, PFCAP P 7.5% b8 : Private, PFCAP P 7.5% EARN b9 : Public, PFCAP <7.5% b10 : Private, PFCAP <7.5% b11 : Public, PFCAP P 7.5% b12 : Private, PFCAP P 7.5% MUNI b13 : Public, PFCAP <7.5% b14 : Private, PFCAP <7.5% b15 : Public, PFCAP P 7.5% b16 : Private, PFCAP P 7.5%

Variable

0.03565

ÿ0.00315 ÿ1.143 ÿ0.00151 ÿ 1.058 ÿ0.00299 ÿ 2.764 ÿ0.00056 ÿ 1.709

ÿ ÿ ÿ ÿ 24.928

ÿ1.550 ÿ1.063 ÿ3.144 ÿ6.690

ÿ0.01003 ÿ0.00393 ÿ0.01422 ÿ0.01403

ÿ ÿ ‡=ÿ ‡=ÿ

2.020 1.613 0.284 ÿ0.261

t-value

0.01187 0.00538 0.00048 ÿ0.00018

Par. Est.

) ) ‡=ÿ ‡=ÿ

Ho

p-value

0.0001

0.1266 0.1452 0.0029 0.0437

0.0606 0.1440 0.0017 0.0001

0.0217 0.0533 0.7765 0.7941

0.05354

ÿ0.00572 0.00030 ÿ0.00065 0.00062

ÿ0.01057 ÿ0.00906 ÿ0.00282 ÿ0.00517

0.00567 0.00716 ÿ0.00040 ÿ0.00020

Par. Est.

t-value

19.590

ÿ1.189 0.133 ÿ0.398 1.254

ÿ1.195 ÿ1.781 ÿ0.446 ÿ1.646

0.660 1.512 ÿ0.197 ÿ0.204

N ˆ 11; 332 1988

N ˆ 22; 952 Pooled

Table 7 SGL model and OLS regression results solved using SURa; b;c; d

0.0001

0.1172 0.4472 0.3453 0.1049

0.1162 0.0375 0.6555 0.0997

0.2548 0.0653 0.8441 0.8382

p-value

N ˆ 11; 620 t-value

0.03209

ÿ0.00286 ÿ0.00306 ÿ0.00467 ÿ0.00126

15.786

ÿ0.850 ÿ1.672 ÿ3.233 ÿ2.860

ÿ0.00477 ÿ0.494 0.00114 0.209 ÿ0.02487 ÿ3.828 ÿ0.02178 ÿ7.802

0.01541 1.891 0.00394 0.837 0.00008 0.023 ÿ0.00121 ÿ1.285

Par. Est.

1987

0.0001

0.1976 0.0473 0.0006 0.0022

0.3106 0.4173 0.0001 0.0001

0.0293 0.2015 0.9813 0.1990

p-value

224 F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

ÿ0.00044 ÿ0.00008 0.00042 0.00028

ÿ1.244 ÿ0.420 2.679 4.180

0.2136 0.6744 0.0074 0.0001

ÿ0.00005 ÿ0.00025 0.00015 0.00017

ÿ0.096 ÿ0.904 0.793 1.745

0.9237 0.3659 0.4278 0.0810

ÿ0.00064 ÿ1.268 0.00015 0.528 0.00079 2.518 0.00052 5.637

0.2049 0.5974 0.0118 0.0001

b

‡ b16 …MUNIi  D4i † ‡ b17 APPRECi ‡ ei :

‡ b10 …EARNi  D2i † ‡ b11 …EARNi  D3i † ‡ b12 …EARNi  D4i † ‡ b13 …MUNIi  D1i † ‡ b14 …MUNIi  D2i † ‡ b15 …MUNIi  D3i †

Variables are described in Table 2. All variables, except dummy variables, are divided by total assets. p-values are one-tailed for Ho with a directional expectation; two-tailed otherwise. c Models in Tables 5±8 are solved as a system of regression equations using SUR. The system-weighted R2 for the SUR system of equations is 0.4114 for 1987, 0.4235 for 1988, and 0.4115 for the pooled model. d SGLi ˆ b1 D1i ‡ b2 D2i ‡ b3 D3i ‡ b4 D4i ‡ b5 …PFCAPi  D1i † ‡ b6 …PFCAPi  D2i † ‡ b7 …PFCAPi  D3i † ‡ b8 …PFCAPi  D4i † ‡ b9 …EARNi  D1i †

a

Intercept variables: b1 : Public, PFCAP <7.5% b2 : Private, PFCAP <7.5% b3 : Public, PFCAP P 7.5% b4 : Private, PFCAP P 7.5% F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235 225

‡ ‡ ‡=ÿ ‡=ÿ

Ho

0.00129 0.00047 ÿ0.00146 ÿ0.00092

0.32918

0.00312 0.00219 0.05956 0.03485

Par. Est.

2.090 1.214 ÿ4.272 ÿ6.124

58.743

0.318 0.359 17.480 25.933

t-value

p-value

0.0366 0.2246 0.0001 0.0001

0.0001

0.3753 0.3598 0.0001 0.0001

0.00205 0.00049 0.00014 ÿ0.00137

0.33413

ÿ0.00282 0.00197 0.04579 0.04092

Par. Est.

t-value

2.322 0.923 0.323 ÿ6.116

40.564

ÿ0.196 0.233 11.241 20.501

N ˆ 11; 332 1988

N ˆ 22; 952 Pooled

0.0202 0.3562 0.7466 0.0001

0.0001

0.4224 0.4078 0.0001 0.0001

p-value

t-value

42.817 0.00017 0.194 0.00044 0.776 ÿ0.00651 ÿ9.649 ÿ0.00042 ÿ2.108

0.32266

0.01598 0.00262 0.10975 0.02839

Par. Est.

1.191 0.295 15.793 15.888

N ˆ 11; 620 1987

0.8462 0.4379 0.0001 0.0351

0.0001

0.1169 0.3839 0.0001 0.0001

p-value

b

Variables are described in Table 2. All variables, except dummy variables, are divided by total assets. p-values are one-tailed for Ho with a directional expectation; two-tailed otherwise. c Models in Tables 5±8 are solved as a system of regression equations using SUR. The system-weighted R2 for the SUR system of equations is 0.4114 for 1987, 0.4235 for 1988, and 0.4115 for the pooled model. d DIV ˆ b D1 ‡ b D2 ‡ b D3 ‡ b D4 ‡ b …PFCAP  D1 † ‡ b …PFCAP  D2 † ‡ b …PFCAP  D3 † ‡ b …PFCAP  D4 † ‡ b PYDIV ‡ e : i i i i i i i i i i i i i i i 1 2 3 4 5 6 7 8 9

a

Intercept variables: b1 : Public, PFCAP <7.5% b2 : Private, PFCAP <7.5% b3 : Public, PFCAP P 7.5% b4 : Private, PFCAP P 7.5%

Control variable: b9 : PYDIV

Discretionary variables: PFCAP b5 : Public, PFCAP <7.5% b6 : Private, PFCAP <7.5% b7 : Public, PFCAP P 7.5% b8 : Private, PFCAP P 7.5%

Variable

Table 8 DIV model and OLS regression results solved using SURa; b;c;d

226 F. Niswander, E.P. Swanson / J. Accounting and Public Policy 19 (2000) 201±235

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The system-weighted R2 for the SUR system of equations is 0.4114 for 1987, 0.4235 for 1988, and 0.4115 for the pooled model. P -values presented are one-tailed for variables with a directional expectation and two-tailed for all others. In the interest of concise exposition, the following commentary will discuss the pooled model unless one of the individual year model is substantively di€erent. It should be noted that, in all models, the statistical signi®cance and magnitude of the parameter estimates of the control variables, when compared to the discretionary variables, suggest that a signi®cant proportion of the examined accounting and ®nancing choices are non-discretionary. This factor, along with the high system-weighted R2 suggest that the non-discretionary components of the models are reasonably well-speci®ed. 5.2.2. The loan loss provision (LLP) Model The LLP models are reported in Table 5. The control variables, BLLA, BNPL, and CHNPL, are positive and signi®cant at 0.0009 or better in all models. Proforma capital is not related to the discretionary loan loss provision for below-capital-threshold public and private banks (p ˆ 0:3506 and 0.20, respectively). As hypothesized, earnings is negatively related to the loan loss provision for below-capital-threshold public and private banks (p ˆ 0:001 or better), although the annual regressions are inconsistent for private banks. The e€ect of earnings is the dominant discretionary e€ect in the model ± a $1 decrease in proforma earnings results in a 32! public bank (3! private bank) increase in discretionary loss provision, whereas the capital e€ect on discretionary provision is not signi®cantly di€erent from zero. Overall, these results support the income-decreasing e€ect of close auditor scrutiny for below-capital-threshold banks. The use of discretion by above-capital-threshold public and private banks is mixed. Private banks demonstrate a positive relationship between the loan loss provision and proforma capital …p ˆ 0:0001†, while the relationship for public banks is also positive but not signi®cant …p ˆ 0:6152†. For the earnings incentive, annual regressions are inconsistent which clouds inferences which could be drawn from the pooled regression. Estimates for 1987 and 1988 for private banks are signi®cant, but are of opposite sign, resulting in no overall systematic relationship in the pooled model …p ˆ 0:5577†. The pooled model for public banks shows a signi®cant positive relationship …p ˆ 0:0001† which is a function of strong 1988 results. The latter ®nding suggests public banks use the loan loss provision to smooth earnings, at least in some years. Finally, above-capital-threshold banks use accounting discretion di€erently than below-capital-threshold banks as concerns earnings …F -value ˆ

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379:2; p-value ˆ 0:0001† but not for capital …F -value ˆ 0:764; p-value ˆ 0:382†. 23 Overall, the results for earnings suggest auditor conservatism is in¯uential for below-capital-threshold banks, but such conservatism is not evident at high capital levels. 5.2.3. The loan charge-o€ (LCO) model The LCO models are presented in Table 6. Again, the control variables, BLLA, BNPL, and CHNPL, are consistently positive and signi®cant at p ˆ 0:0001 in all models. These results are as expected and consistent with prior research (e.g., Moyer, 1990; Collins et al., 1995). As hypothesized, there is a negative relationship (p ˆ 0:0003) between proforma capital level and loan charge-o€s for banks with capital below the 7.5% threshold (except for private banks in 1987 where the relationship is positive). A negative relationship indicates that discretion is reducing capital for below-capital-threshold banks, consistent with auditors' preference for conservative estimates. Using the pooled model coecients, a $1 drop in proforma capital results in a 12! and 3! increase in discretionary loan chargeo€s for public and private banks, respectively. For above-capital-threshold banks, the relationship between proforma capital and loan charge-o€s is positive and the pooled model is signi®cant (p ˆ 0:0089 or better) for both public and private banks (public banks in 1987 are not signi®cant). For PFCAP, the di€erence in discretion between banks above and below the capital threshold is striking …F -value ˆ 84:470; p-value ˆ 0:0001†. Above-capital-threshold banks show a positive relationship for MUNI (p ˆ 0:0003 or better), as hypothesized, suggesting banks seek to eciently utilize tax writeo€s by taking more discretionary charge-o€s as the tax rate increases. As was evident in the case of PFCAP, the actions of banks above and below the capital threshold are very di€erent with regard to the tax rate surrogate, MUNI …F -value ˆ 13:178; p-value ˆ 0:0003†. Table 6 also shows that the relationship between MUNI and discretionary loan charge-o€s is negative for below-threshold banks (p ˆ 0:0226 for public banks and a non-signi®cant p ˆ 0:1880 for private banks in the pooled model, although annual regressions are weaker). The result for below-capital-threshold banks is contrary to our expectations. Both our hypothesis and our result for these banks are consistent with Collins et al. (1995, p. 281) who also expected a positive relationship and found the opposite.

23

In the interests of conciseness, comparisons between banks above and below the capital threshold are given for the pooled model and are presented in the text rather than a table.

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229

5.2.4. The securities gain and loss (SGL) model The model for SGL is given in Table 7. As expected, the control variable APPREC is positive and signi®cant at p ˆ 0:0001. Proforma capital for below-capital-threshold banks is positive and signi®cant in the pooled model (p ˆ 0:0533 or better). Individual year results are also positive, but weaker. A positive sign indicates fewer (more) gains are recorded as the level of capital declines (increases). This result is consistent with the conservative preferences of auditors, but not with the preferences of managers, which were expected to prevail. It is possible that auditors and examiners have a greater in¯uence on the realization of securities gains and losses than we expected. Earnings is negatively related to securities gains for below-capitalthreshold banks, as hypothesized, but the signi®cance level is p ˆ 0:06 for public banks, not signi®cant for private banks at p ˆ 0:144, and annual regressions are generally weak. Among above-capital-threshold banks, changes in the level of capital are not associated with securities gains and losses. For changes in earnings, a strong response in 1987 is combined with a weaker relationship in 1988 to provide pooled results which are signi®cantly negative for both public and private banks (p ˆ 0:0017 or better). A negative sign suggests that more (fewer) gains are realized when earnings decline (increase), consistent with income smoothing. The marginal tax rate is negative but not signi®cant for below-capitalthreshold banks. Above-capital-threshold banks demonstrate a signi®cant negative relationship (although 1988 has a p-value of 0.1049), as hypothesized, which is consistent with managing the after-tax bene®ts of securities sales. Finally, banks above and below the capital threshold use their discretion di€erently in the case of capital …F -value ˆ 5:902; p ˆ 0:0151† and earnings …F -value ˆ 4:422; p ˆ 0:038†, but not for taxes …F -value ˆ 0:114; p-value ˆ 0:7355†. 5.2.5. The dividends (DIV) model The DIV models are presented in Table 8. Prior year dividends are positively related to current dividend levels (p ˆ 0:0001), consistent with prior research and the notion that dividend payments are sticky from year-to-year. For below-capital-threshold banks, capital is not signi®cantly related to dividend payments. As would be expected, these banks pay low dividends. Above-capital-threshold banks exhibit a strong positive relationship between capital and dividend payments (p ˆ 0:0001). As constructed, PFCAP is essentially the prior year's capital plus the current year's pre-discretionary income. Thus, current year income and PFCAP will move in similar directions with similar magnitudes. Banks increase (decrease) their dividend payouts as income rises (falls), thus creating a positive relationship between PFCAP and

230

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dividends for banks above the capital threshold with public banks demonstrating a stronger e€ect than private banks (6! for each additional dollar of capital versus 3:5!). Banks below and above the capital threshold use their discretion very differently …F -value ˆ 54:499; p-value ˆ 0:0001†. The coecient estimates for private banks are less than 10 percent of the level indicated for their abovethreshold counterparts: 0:2! per $1 of additional proforma capital for low capital private banks versus 3:5! for high capital banks, with public banks showing an even greater disparity. 5.2.6. Public/private bank comparisons Table 9 compares the choices of public and private banks, using parameter estimates previously reported on Tables 5±8. An F -test is used to discern whether the coecients are signi®cantly di€erent. In the interest of concise exposition, results are presented only for the pooled model. For below-capital-threshold banks, we hypothesized there would be no di€erence between the choice of public and private banks. In six of the eight comparisons, we cannot reject a null hypothesis of no di€erence in the discretionary actions of public and private banks. Our large sample size ensures we have sucient statistical power to have con®dence in this ®nding. In the two cases where the use of discretion di€ers between public and private banks, below-capital-threshold public banks take larger loan loss provisions and larger loan charge-o€s. In each case, the sign of the coecient indicates a greater level of conservatism for choices by public banks. The greater conservatism may result because public banks have more depositors and more external stakeholders than private banks, which would increase the potential legal liability of auditors. In addition, engagement risk (Hackenbrack and Nelson, 1996, p. 44) may be greater for public banks. For above-capital-threshold banks, the size of the discretionary actions of public and private banks di€ers in ®ve of eight instances at the 0.075 signi®cance level. In the LLP model, private banks use their discretion over the loan loss provision to increase capital by a larger amount than public banks. In contrast, the earnings incentive plays a larger role for public banks than private banks. Since a positive sign suggests income smoothing, public banks likely use the provision to smooth to a greater extent than private banks. These expected ®ndings provide some support for the notion that earnings are more important to public banks (consistent with Beatty and Harris, 1999, p. 301, and others), while capital is of more concern to private banks (as suggested by Sullivan and Spong, 1998, pp. 17±23). Two other di€erences result from the tax savings incentive. Results for our tax variable, MUNI, show that above-threshold public and private banks use their discretion over loan charge-o€s and securities gains to minimize taxes, but, contrary to our expectations, public banks are more aggressive than pri-

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Table 9 Public versus private bank comparisons (pooled model)a Below-capital-threshold Banks

Above-capital-threshold Banks

Public vs Private Par. Est. LLP model: PFCAP, public PFCAP, private EARN, public EARN, private

0.00797 ÿ0.01052 ÿ0.31937 ÿ0.02615

LCO model: PFCAP, public PFCAP, private MUNI, public MUNI, private

ÿ0.12031 ÿ0.03377 ÿ0.01040 ÿ0.00239

SGL model: PFCAP, public PFCAP, private EARN, public EARN, private MUNI, public MUNI, private

0.01187 0.00538 ÿ0.01003 ÿ0.00393 ÿ0.00315 ÿ0.00151

DIV model: PFCAP, public PFCAP, private

0.00312 0.00219

Public vs Private

F-value

p-value

Par. Est.

0.591

0.4420

311.890

0.0001

22.060

0.0001

1.895

0.1687

0.929

0.3351

0.674

0.4118

0.283

0.5950

0.00048 ÿ0.00018 ÿ0.01422 ÿ0.01403 ÿ0.00299 ÿ0.00056

0.006

0.9356

0.05956 0.03485

0.00337 0.01618 0.04235 0.00282 0.01419 0.01179 0.00760 0.00210

F-value

p-value

3.195

0.0739

12.605

0.0004

0.170

0.6803

6.768

0.0093

0.131

0.7176

0.001

0.9700

4.710

0.0300

46.024

0.0001

a

As more fully explained in the text, the expectations for coecients are as follows: Below-capital-threshold banks: No Di€erences Above-capital-threshold banks: LLP Model: PFCAP: Coecient for private banks larger than public banks EARN: Coecient for private banks smaller than public banks LCO Model: PFCAP: Coecient for private banks smaller than public banks MUNI: Coecient for private banks larger than public banks SGL Model: PFCAP: Coecient for private banks larger than public banks EARN: Coecient for private banks larger than public banks MUNI: Coecient for private banks smaller than public banks DIV Model: PFCAP: Coecient for private banks smaller than public banks Accordingly, p-values for below-capital-threshold banks are reported as two-tailed, while p-values for above-capital-threshold banks are one-tailed.

vate banks. Large, usually public, banks have been shown to have greater operational sophistication than smaller, generally private, banks in the areas of credit risk analysis (English and Nelson, 1998, pp. 2±6) and derivatives

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(Heinecke and Shen, 1995, pp. 1±2). If this sophistication carries over to taxrelated decisions, then public banks are likely to implement more e€ective strategies to minimize taxes. The ®nal di€erence among above-capital-threshold banks arises from the e€ect of capital level on the amount of dividends paid out. Private banks pay out less in dividends as the level of capital increases than do public banks. This result was anticipated and likely re¯ects an attempt to reduce the taxes paid by the owners of private banks. Lower dividends also increase capital, which is a greater concern for private than public banks (as discussed previously). 6. Concluding remarks Our study contributes to recent literature which examines accounting and ®nancing choices by banks. The literature to-date (e.g., Moyer, 1990; Collins et al., 1995; Beatty et al., 1995) has focused on the choices of public banks at the consolidated (holding company) level. We use call report data to examine public banks at the individual (subsidiary) level and to include a large sample of privately held banks ± the latter have not been included in prior studies. In addition, we speci®cally examine the interplay of auditor and manager preferences among banks below a capital adequacy threshold. Our ®ndings are summarized in Section 1. With regard to future research, we chose, as noted earlier, to study a time period in which capital requirements did not vary. Future research could examine the e€ects of changes in capital requirements on accounting and ®nancing choices. The current movement toward bank consolidation could also in¯uence accounting and ®nancing choices. For example, an acquired bank may be under considerable pressure to report higher earnings to show the managers made a wise purchase. In general, the use of call report data has great potential for future research. Acknowledgements The authors would like to thank participants at the Annual Meeting of the American Accounting Association (Niswander and Swanson, 1998), the University of Wisconsin Accounting Doctoral Alumni Conference, Bruce Behn, Don Fraser, Terry War®eld, and especially the insightful comments of the two anonymous reviewers References Avery, R., Belton, T., 1987. A comparison of risk-based capital and risk-based deposit insurance. Federal Reserve Bank of Cleveland Economic Review 23 (4), 20±30.

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