Three essays in financial intermediation: a regulatory perspective

Harithsa, Jyothsna, Giridhar
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Francis, Bill, B.
Clark, Brian
Fan, Rui
Garc ́ıa, Raffi, E
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This dissertation consists of three essays on the role of added regulation on financial advisory firms and bank holding companies. Compliance with stringent added regulations can create ethical dilemmas in financial institutions, causing them to employ unsavory activities such as financial misconduct or corporate tax planning to increase their corporate bottom line. In the first essay, I study how a change in regulatory oversight of mid-size advisory firms from the SEC to the local state regulator can result in increased fraud, emboldened by stronger social connections with local regulators. In the second essay, I study how added transparency requirements create an environment of regulatory uncertainty, which can further lead to increased tax planning in banks. The added cash from tax planning can help banks comply with the minimum capital requirements of bank stress tests. While tax planning itself is not an illegal activity, investors and regulators alike do not always approve of it. While the first two chapters of this dissertation focus on the unintended consequences of regulation, the third chapter highlights an improvement in bank reporting quality following the global financial crisis. The first essay of my dissertation investigates how strong social ties affect agent-regulator relationships and financial misconduct in U.S. registered investment advisories. Using difference-in-differences to exploit the quasi-experimental properties of the Dodd-Frank Act, I find that the change in regulatory purview increases the fraudulent malpractice in mid-sized advisory firms compared to large advisories. Financial misconduct increases at advisories more socially connected to regulators, even after controlling for geographical distance. The results show a disrupting agent-regulator relationship effect when the officer belongs to the largest homogeneous group, white males, and insignificance among female and under-represented minority groups. Consequently, the change in regulators and misconduct affect advisory firm performance and services. In the second essay, using U.S. bank stress tests and regression discontinuity, I find that stress tests have unintended consequences of intensifying tax planning and increasing tax avoidance. Stress-test banks increase tax avoidance by accelerating charge-offs, net interest, and non-interest expenses. However, this increase in tax planning is not optimally maximized, leading to lower effective tax planning compared to non-stress-test banks. Banks with a substantial increase in tax avoidance under the Dodd-Frank Act tend to increase their risk, investing in high-risk-weight assets and lending in riskier loan categories. These findings are consistent with tax minimization conditions under added regulatory attention and policy uncertainty. In the third essay, I study the effects of transparency disclosures on the reporting quality, i.e., restatements and accounting and advisory-related expenses of U.S. banks. I exploit the quasi-experimental set-up provided by the Dodd-Frank stress tests, which mandate policy thresholds according to bank asset size. Using a difference-in-difference design, I find that stress-test banks encounter substantially increased quality in reporting oversight in the form of decreased restatements issued, and face increased advisory and consulting fees to comply with improved reporting standards. The findings, consistent with the literature on increased transparency, indicate improved reporting standards and show a decrease in restatements issued, increased consulting and advisory expenses, while overall legal expenses decline in the immediate years following the regulation.
School of Management
Lally School of Management
Rensselaer Polytechnic Institute, Troy, NY
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