Market risk reporting by the world's top banks:evidence on the diversity of reporting practice and the implications for international accounting harmonisation

The increasing adoption of international accounting standards and global convergence of accounting regulations is frequently heralded as serving to reduce diversity in financial reporting practice. In a process said to be driven in large part by the interests of international business and global financial markets, one might expect the greatest degree of convergence to be found amongst the world’s largest multinational financial corporations. This paper challenges such claims and presumptions. Its content analysis of longitudinal data for the period 2000-2006 reveals substantial, on going diversity in the market risk disclosure practices, both numerical and narrative, of the world’s top-25 banks. The significance of such findings is reinforced by the sheer scale of the banking sector’s risk exposures that have been subsequently revealed in the current global financial crisis. The variations in disclosure practices documented in the paper apply both across and within national boundaries, leading to a firm conclusion that, at least in terms of market risk reporting, progress towards international harmonisation remains rather more apparent than real.

Capital markets and the market structure of foreign investments

Contrary to the long-received theory of FDI, interest rates or rates of return can motivate foreign direct investment (FDI) in concert with the benefits of direct ownership. Thus, access to investor capital and capital markets is a vital component of the multinational’s competitive market structure. Moreover, multinationals can use their superior financial capacity as a competitive advantage in exploiting FDI opportunities in dynamic markets. They can also mitigate higher levels of foreign business risks under dynamic conditions by shifting more financial risk to creditors in the host economy. Furthermore, the investor’s expectation of foreign business risk necessarily commands a risk premium for exposing their equity to foreign market risk. Multinationals can modify the profit maximization strategy of their foreign subsidiaries to maximize growth or profits to generate this risk premium. In this context, we investigate how foreign subsidiaries manage their capital funding, business risk, and profit strategies with a diverse sample of 8,000 matched parents and foreign subsidiary accounts from multiple industries in 38 countries.We find that interest rates, asset prices, and expectations in capital markets have a significant effect on the capital movements of foreign subsidiaries. We also find that foreign subsidiaries mitigate their exposure to foreign business risk by modifying their capital structure and debt maturity. Further, we show how the operating strategy of foreign subsidiaries affects their preference for growth or profit maximization. We further show that superior shareholder value, which is a vital link for access to capital for funding foreign expansion in open market economies, is achieved through maintaining stability in the rate of growth and good asset utilization.

The value of risk reporting:a critical analysis of value-at-risk disclosures in the banking sector

This paper critically reviews the evolution of financial reporting in the banking sector with specific reference to the reporting of market risk and the growing use of the measure known as Value at Risk (VaR). The paper investigates the process by which VaR became 'institutionalised'. The analysis highlights a number of inherent limitations of VaR as a risk measure and questions the usefulness of published VaR disclosures, concluding that risk 'disclosure' might be more apparent than real. It also looks at some of the implications for risk reporting practice and the accounting profession more generally.

Illiquidity shocks and the comovement between stocks:new evidence using smooth transition

This paper extends the smooth transition conditional correlation model by studying for the first time the impact that illiquidity shocks have on stock market return comovement. We show that firms that experience shocks that increase illiquidity are less liquid than firms that experience shocks that decrease illiquidity. Shocks that increase illiquidity have no statistical impact on comovement. However, shocks that reduce illiquidity lead to a fall in comovement, a pattern that becomes stronger as the illiquidity of the firm increases. This discovery is consistent with increased transparency and an improvement in price efficiency. We find that a small number of firms experience a double illiquidity shock. For these firms, at the first shock, a rise in illiquidity reduces comovement while a fall in illiquidity raises comovement. The second shock partly reverses these changes as a rise in illiquidity is associated with a rise in comovement and a fall in illiquidity is associated with a fall in comovement. These results have important implications for portfolio construction and also for the measurement and evolution of market beta and the cost of capital as it suggests that investors can achieve higher returns for the same amount of market risk because of the greater diversification benefits that exist. We also find that illiquidity, friction, firm size and the pre-shock correlation are all associated with the magnitude of the correlation change. © 2013 Elsevier B.V.

Auditor's engagement risk and audit fees:the role of the audit firm alumni

This study explores the effect of the association of audit firm alumni with their alma mater on audit prices. The tests indicate that there is a moderate reduction of up to 21% in the level of audit fee when alumni (i.e., former employees) of the incumbent audit firm sit on the client board of directors which is consistent with the engagement risk theory. This suggests that there is an 'alumni effect' in the market for audit services. The findings hold only in the large company segment of the market. The results are robust to different model specifications and alternative samples. The sample comprises all executive and non-executive directors who run the UK quoted companies and are simultaneously ICAEW qualified chartered accountants. The study's implications for the accounting profession and the regulators are also discussed. © 2007 The Author Journal compilation © 2007 Blackwell Publishing Ltd.

Managing risk in software development projects:a case study

Purpose - The main objective of the paper is to develop a risk management framework for software development projects from developers' perspective. Design/methodology/approach - This study uses a combined qualitative and quantitative technique with the active involvement of stakeholders in order to identify, analyze and respond to risks. The entire methodology has been explained using a case study on software development project in a public sector organization in Barbados. Findings - Analytical approach to managing risk in software development ensures effective delivery of projects to clients. Research limitations/implications - The proposed risk management framework has been applied to a single case. Practical implications - Software development projects are characterized by technical complexity, market and financial uncertainties and competent manpower availability. Therefore, successful project accomplishment depends on addressing those issues throughout the project phases. Effective risk management ensures the success of projects. Originality/value - There are several studies on managing risks in software development and information technology (IT) projects. Most of the studies identify and prioritize risks through empirical research in order to suggest mitigating measures. Although they are important to clients for future projects, these studies fail to provide any framework for risk management from software developers' perspective. Although a few studies introduced framework of risk management in software development, most of them are presented from clients' perspectives and very little effort has been made to integrate this with the software development cycle. As software developers absorb considerable amount of risks, an integrated framework for managing risks in software development from developers' perspective is needed. © Emerald Group Publishing Limited.

The relationship between market share and information in a high-tech industry

The role of information in high-technology markets is critical (Dutta, Narasimhan and Rajiv 1999; Farrell and Saloner 1986; Weiss and Heide 1993). In these markets, the volatility and volume of information present managers and researchers with the considerable challenge of monitoring such information and examining how potential customers may respond to it. This article examines the effects of the type and volume of information on the market share of different technological standards in the Local Area Networks (LAN) industry. We identify three different types of information: technological, availability and adoption. Our empirical application suggests that all three types of information have significant effects on the market share of a technological standard, but their direction and magnitude differ. More specifically, technology-related information is negatively related to market share as it demonstrates that the underlying technology is immature and still evolving. Both availability and adoption-related information have a positive effect on market share, but the former is larger than the latter. We conclude that high-tech firms should emphasize the dissemination of information, especially availability-related, as part of their promotional strategy for a new technology. Otherwise, they may risk missing an opportunity to achieve a higher share and establish their market presence.

Risk assessment applied to comsumer products with reference to CE marking machines for use at work

New Approach’ Directives now govern the health and safety of most products whether destined for workplace or domestic use. These Directives have been enacted into UK law by various specific legislation principally relating to work equipment, machinery and consumer products. This research investigates whether the risk assessment approach used to ensure the safety of machinery may be applied to consumer products. Crucially, consumer products are subject to the Consumer Protection Act (CPA) 1987, where there is no direct reference to “assessing risk”. This contrasts with the law governing the safety of products used in the workplace, where risk assessment underpins the approach. New Approach Directives are supported by European harmonised standards, and in the case of machinery, further supported by the risk assessment standard, EN 1050. The system regulating consumer product safety is discussed, its key elements identified and a graphical model produced. This model incorporates such matters as conformity assessment, the system of regulation, near miss and accident reporting. A key finding of the research is that New Approach Directives have a common feature of specifying essential performance requirements that provide a hazard prompt-list that can form the basis for a risk assessment (the hazard identification stage). Drawing upon 272 prosecution cases, and with thirty examples examined in detail, this research provides evidence that despite the high degree of regulation, unsafe consumer products still find their way onto the market. The research presents a number of risk assessment tools to help Trading Standards Officers (TSOs) prioritise their work at the initial inspection stage when dealing with subsequent enforcement action.

A flexible cost function model with risk

In examining bank cost efficiency in banking inclusion of risk-taking of banks is very important. In this paper we depart from the standard modeling approach and view risk intimately related to the technology. Thus, instead of controlling for risk by viewing them as covariates in the standard cost function we argue that the technology differs with risk, thereby meaning that the parameters of the parametric cost function changes with risk in a fully flexible manner. This is accomplished by viewing the parameters of the cost function as nonparametric functions of risk. We also control for country-specific effects in a fully flexible manner by using them as arguments of the nonparametric functions along with the risk variable. The resulting cost function then becomes semiparametric. The standard parametric model becomes a special case of our semiparametric model. We use the above modeling approach for banks in the EU countries. Actually, European financial integration is seen as a stepping stone for the development of a competitive single EU market that promotes efficiency and increases consumer welfare, changing the risk profile of the European banks. Particularly, financial integration allows more risk diversification and permits banks to use more advanced risk management instruments and systems, however it has at the same time increased the probability of systematic risks. Financial integration has increased the risk of contagion and changed its nature and scope. Consequently the bank’s risk seems to be an important issue to be investigated.

Risk and structural instability in US house prices

This paper employs a Component GARCH in Mean model to show that house prices across a number of major US cities between 1987 and 2009 have displayed asset market properties in terms of both risk-return relationships and asymmetric adjustment to shocks. In addition, tests for structural breaks in the mean and variance indicate structural instability across the data range. Multiple breaks are identified across all cities, particularly for the early 1990s and during the post-2007 financial crisis as housing has become an increasingly risky asset. Estimating the models over the individual sub-samples suggests that over the last 20 years the financial sector has increasingly failed to account for the levels of risk associated with real estate markets. This result has possible implications for the way in which financial institutions should be regulated in the future.

Decision support for lifecycle planning and risk management of small-scale biomass combined heat and power (bCHP) projects in the UK

Biomass is projected to account for approximately half of the new energy production required to achieve the 2020 primary energy target in the UK. Combined heat and power (CHP) bioenergy systems are not only a highly efficient method of energy conversion, at smaller-scales a significant proportion of the heat produced can be effectively utilised for hot water, space heating or industrial heating purposes. However, there are many barriers to project development and this has greatly inhibited deployment in the UK. Project viability is highly subjective to changes in policy, regulation, the finance market and the low cost incumbent; a high carbon centralised energy system. Unidentified or unmitigated barriers occurring during the project lifecycle may not only negatively impact on the project but could ultimately lead to project failure. The research develops a decision support system (DSS) for small-scale (500 kWe to 10 MWe) biomass combustion CHP project development and risk management in the early stages of a potential project’s lifecycle. By supporting developers in the early stages of project development with financial, scheduling and risk management analysis, the research aims to reduce the barriers identified and streamline decision-making. A fuzzy methodology is also applied throughout the developed DSS to support developers in handling the uncertain or approximate information often held at the early stages of the project lifecycle. The DSS is applied to a case study of a recently failed (2011) small-scale biomass CHP project to demonstrate its applicability and benefits. The application highlights that the proposed development within the case study was not viable. Moreover, further analysis of the possible barriers with the DSS confirmed that some possible modifications to be project could have improved this, such as a possible change of feedstock to a waste or residue, addressing the unnecessary land lease cost or by increasing heat utilisation onsite. This analysis is further supported by a practitioner evaluation survey that confirms the research contribution and objectives are achieved.

Sticky credit spreads, macroeconomic activity and equity market volatility

We uncover high persistence in credit spread series that can obscure the relationship between the theoretical determinants of credit risk and observed credit spreads. We use a Markovswitching model, which also captures the stability (low frequency changes) of credit ratings, to show why credit spreads may continue to respond to past levels of credit risk, even though the state of the economy has changed. A bivariate model of credit spreads and either macroeconomic activity or equity market volatility detects large and significant correlations that are consistent with theory but have not been observed in previous studies. © 2010 Nova Science Publishers, Inc. All rights reserved.

Dividend increases and initiations and default risk in equity returns

This study extends the Grullon, Michaely, and Swaminathan (2002) analysis by incorporating default risk. Using data for firms that either increased or initiated cash dividend payments during the 23-year period 1986-2008, we find reduction in default risk. This reduction is shown to be a priced risk factor beyond the Fama and French (1993) risk measures, and it explains the dividend payment decision and the positive market reaction around dividend increases and initiations. Further analysis reveals that the reduction in default risk is a significant factor in explaining the 3-year excess returns following dividend increases and initiations. © Copyright Michael G. Foster School of Business, University of Washington 2011.

The paradoxes of risk management in the banking sector

This paper uses empirical evidence to examine the operational dynamics and paradoxical nature of risk management systems in the banking sector. It demonstrates how a core paradox of market versus regulatory demands and an accompanying variety of performance, learning and belonging paradoxes underlie evident tensions in the interaction between front and back office staff in banks. Organisational responses to such paradoxes are found to range from passive to proactive, reflecting differing organisational, departmental and individual risk culture(s), and performance management systems. Nonetheless, a common feature of regulatory initiatives designed to secure a more structurally independent risk management function is that they have failed to rectify a critical imbalance of power - with the back office control functions continuing to be dominated by front office trading and investment functions. Ultimately, viewing the 'core' of risk management systems as a series of connected paradoxes rather than a set of assured, robust practices, requires a fundamental switch in emphasis away from a normative, standards-based approach to risk management to one which gives greater recognition to its behavioural dimensions.