No abstract

Operational risk announcements are unexpected adverse media news that potentially harm the reputation of financial institutions. This paper examines the equity-based and debt-based reputational effects of financial sentiment tones in operational risk announcements and shows how such reputational effects are moderated by alternative sources of public information. Our analysis reveals that the net negative tone and litigious tone have adverse reputational effects, and the uncertainty tone mitigates the adverse reputational impact. Additionally, alternative, simultaneous sources of information neutralize the reputational effects of textual tones. First, third-party information about the event (i.e. regulatory announcements and final settlements) dissolves the favorable (adverse) reputational impact of the uncertainty tone (litigious tone). Second, loss amount disclosure and firm recognition substitute the reputational effects of the net negative tone and uncertainty tone only in Anglo-Saxon countries and market-based economies. Overall, our findings indicate that the reputational effects of the media materialize most when there is lack of certain, quantifiable and regulated public information about the operational risk event.

Operational risk incidences are likely to increase the degree of information asymmetry between firms and investors. We analyze operational risk disclosures by U.S. financial firms during 1995-2009 and their impact on different measures of information asymmetry in the firms' equity markets. Effective spreads and the price impact of trades are shown to increase around the first announcements of such events and to revert after the announcement of their settlement. This is especially pronounced for internal fraud and business practices related events. Market makers respond to higher information risk around the first press cutting date by increasing the quoted depth to accommodate an increase in trading volumes.The degree of information asymmetry around operational risk events may be influenced by the bank's risk management function and the bank's governance structure. We indeed find that information asymmetry increases more strongly after events' first announcements when firms have weaker governance structures-lower board independence ratios, lower equity incentives of executive directors, and lower levels of institutional ownership. In contrast, the firms' risk management function has little to no impact on information asymmetry. We interpret this as evidence that the risk management function is primarily driven by regulatory compliance needs. The results of this study contribute to our understanding of information asymmetry around operational risk announcements. They help to shed light on the role that regulation and corporate governance can play in order to establish effective disclosure practices and to promote a liquid and transparent securities market.

This paper investigates whether more favorable stock recommendations and higher credit ratings serve as a reputational asset or reputational liability around reputation-damaging events.Analyzing the reputational effects of operational risk announcements incurred by financial institutions, we find that firms with a "Buy" stock recommendation or "Speculative Grade" credit rating are more likely to incur an equity-based reputational damage. In addition, firms with lower credit ratings incur a much more severe debt-based reputational damage. Moreover, credit ratings are more instrumental in mitigating the debt-based reputational damage caused by fraud incidents or incurred in non-banking activities. Furthermore, the misconduct of senior management could demolish the reputation of firms with less heterogeneous stock recommendations. Finally, credit ratings serve as an equity-based reputational asset in the short term but turn into an equity-based reputational liability in the long term. Overall, our analysis reveals that stock recommendations represent a reputational burden and credit ratings act as a reputational shield; however, the persistence and magnitude of such reputational effects are moderated by time and event characteristics.