On the Market Discipline of Informationally-Opaque Firms: Evidence from Bank Borrowers in the Federal Funds Market

FRB of New York Staff Report No. 257

FDIC Center for Financial Research Working Paper No. 2006-09

62 Pages Posted: 20 Sep 2006

See all articles by Adam B. Ashcraft

Adam B. Ashcraft

Federal Reserve Bank of New York

C. Hoyt Bleakley

University of Chicago - Booth School of Business; University of Chicago

Date Written: August 2006

Abstract

Using plausibly exogenous variation in demand for federal funds created by daily shocks to reserve balances, we identify the supply curve facing a bank borrower in the inter-bank market, and study how access to overnight credit is affected by changes in public and private measures of borrower creditworthiness. While there is evidence that lenders respond to adverse changes in public information about credit quality by restricting access to the market in a fashion consistent with market discipline, there is also evidence that borrowers are able to respond to adverse changes in private information about credit quality by increasing leverage as if to offset the future impact on earnings. While the responsiveness of investors to public information is comforting, we document evidence which suggests that banks are able to manage the real information content of these disclosures. In particular, public measures of loan portfolio performance have information about future loan chargeoffs, but only in quarters when the bank is examined by supervisors. However, the loan supply curve is not any more sensitive to public disclosures about nonperforming loans in an exam quarter, suggesting that investors are unaware of this information management.

Keywords: Earnings management, market discipline, opaqueness

JEL Classification: G14, G18, G21

Suggested Citation

Ashcraft, Adam B. and Bleakley, C. Hoyt, On the Market Discipline of Informationally-Opaque Firms: Evidence from Bank Borrowers in the Federal Funds Market (August 2006). FRB of New York Staff Report No. 257, FDIC Center for Financial Research Working Paper No. 2006-09, Available at SSRN: https://ssrn.com/abstract=931164 or http://dx.doi.org/10.2139/ssrn.931164

Adam B. Ashcraft (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045-0001
United States
212-720-1617 (Phone)
212-720-8363 (Fax)

C. Hoyt Bleakley

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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